What it is:
A price ratchet is a trigger that changes the price of a security.
How it works (Example):
For example, let's assume that the United States government defaults on interest payments on its Treasury securities. Because the event raises the risk-free rate, the event acts as a price ratchet and triggers a decrease in stock prices. Wars, natural disasters, and other significant events can be price ratchets.
Why it Matters:
Knowing what triggers change in the market is one of the most fundamental goals of analysts and investors. Accordingly, events like natural disasters, wars, and government defaults are of tremendous global interest, and calculating the degree to which these price ratchets change securities prices is extremely important either directly or indirectly to most investors.