El-Erian: Worst-case scenario may spark correction

Mohamed El-Erian, chief economic adviser at Germany-based Allianz, told CNBC on Tuesday that his worst-case scenario could spark a correction in the stock market.

In a "Squawk Box" interview, El-Erian stressed he's not predicting a correction—calling it a "risk scenario, not the baseline."

The former Pimco co-CEO warned it all comes down to whether there's a paradigm shift away from investors believing in a low volatility environment, against a backdrop of an improving U.S. economy and manageable European problems. "If all that changes, then you a looking at at least a 10 percent correction," he said.

El-Erian also predicted a Greek exit from the euro would cause "short-term chaos," but it would not bring the global economy to its knees. He expects short-term losses and a lot of volatility. "The reason it would not be a major catastrophe is because Europe has done a lot to navigate a Grexit [Greek exit]."

Debt talks between Greece and its euro zone creditors broke down late Monday, raising concern ahead of the expiration of Greece's current bailout loan later this month.

On one side of the standoff, Greece sees the euro zone as a house of cards, in which a Greek exit would bring down the rest. Germany, on the other, considers the 19 single currency nations as climbers held together by a rope, with Greece as a weak link that may need to be cut loose.

El-Erian said the truth lies somewhere in the middle if not "more to the 'climbers' characterization than the 'house of cards,' ... [but] not decisive enough to make one side feel that strong."

Varchev Finance