Comment:
Such a waste!
This is a very costly way of dragging down long term rates. As I have noted on many earlier posts, it once more makes me thing how much most cost-efficiently the fed could control long term rates with interest rate BICs that replicate the whole interest rate curve
See earlier posts on the topic:
http://kongtcheu.blogspot.com/2009/03/fed-will-inject-1-trillion-more-into.html
http://kongtcheu.blogspot.com/2009/04/ftcom-comment-opinion-let-central-banks.html
http://kongtcheu.blogspot.com/2009/07/op-ed-contributor-great-preventer.html
News References:
http://online.wsj.com/article/SB10001424052748703506904575592471354774194.html?mod=WSJ_hp_LEFTWhatsNewsCollection
http://www.nytimes.com/2010/11/04/business/economy/04fed.html?_r=1&ref=business
http://www.washingtonpost.com/wp-dyn/content/article/2010/11/03/AR2010110305412.html
Thursday, November 4, 2010
Wednesday, August 25, 2010
The Deficit Debate - BICs
This post is meant to refer to a knol Ihave written in response to a recent question posed on the Institute for New Economic Thinking (INET) community website : “Will public deficit reduction encourage private sector growth, or undermine a needed stimulus to recovery & lead to Japan-style stagnation?” This lead me, in view of my work on BICs, to wonder whether the deficit is really the right metric to focus on and analyze the extent to which it could be misleading.
I argue that the government balance sheet, rather than its cash flow position -from which the deficit is computed - should really be what eyes are focused on. The focus on balance would have and should better focus minds on stimulating high returns investments for sustainable recovery and expansion, some of which I discuss.
BICs enter in the picture because using their methodological prescription would make reliable and practical the complex and almost canutian task of computing the values of the different items on the government balance sheet.
I am gratified that the debate INET moderating team has picked on some of my suggestions and highlighted them in the debate summary(http://ineteconomics.org/blog/inet-community-responds-deficit-debate) as: "As far as new, creative solutions to the debate, a few users, such as kongtcheu, have urged governments to invest in entrepreneurship and clean energy projects, suggesting that these investments will create jobs and growth in the future."" I meant to say more than that.
References
Kongtcheu, Phil. The Deficit Debate - BICs:Is the deficit the right metric to focus on ? And what prescriptions does this leads to? [Internet]. Version 45. Basis Instruments Contracts (BICs). 2010 Aug 25. Available from: http://knol.google.com/k/phil-kongtcheu/the-deficit-debate-bics/24v2kgtuvzk2v/30.
http://ineteconomics.org/blog/inet-community-responds-deficit-debate
I argue that the government balance sheet, rather than its cash flow position -from which the deficit is computed - should really be what eyes are focused on. The focus on balance would have and should better focus minds on stimulating high returns investments for sustainable recovery and expansion, some of which I discuss.
BICs enter in the picture because using their methodological prescription would make reliable and practical the complex and almost canutian task of computing the values of the different items on the government balance sheet.
I am gratified that the debate INET moderating team has picked on some of my suggestions and highlighted them in the debate summary(http://ineteconomics.org/blog/inet-community-responds-deficit-debate) as: "As far as new, creative solutions to the debate, a few users, such as kongtcheu, have urged governments to invest in entrepreneurship and clean energy projects, suggesting that these investments will create jobs and growth in the future."" I meant to say more than that.
References
Kongtcheu, Phil. The Deficit Debate - BICs:Is the deficit the right metric to focus on ? And what prescriptions does this leads to? [Internet]. Version 45. Basis Instruments Contracts (BICs). 2010 Aug 25. Available from: http://knol.google.com/k/phil-kongtcheu/the-deficit-debate-bics/24v2kgtuvzk2v/30.
http://ineteconomics.org/blog/inet-community-responds-deficit-debate
Saturday, June 26, 2010
IAFE 2010 Annual Conference - Talk: Physics envy may be hazardous to your wealth
Physics envy may be hazardous to your wealth...YES, but how?
http://web.mit.edu/alo/www/Papers/physics8.pdf
This talk was quite interesting, delivered with quiet passion and confidence that was not obnoxious, or as one would say in Chinese 自信但不骄傲.
He proposed a thought provoking taxonomy for classifying various levels of risk and uncertainty
Taxonomy of Risk & Uncertainty:
Level 1: Complete Certainty i.e no randomness, as in physics, all parameters are deterministic;
Level 2: Risk without Uncertainty, i.e randomness but coming fully random variables whose law and parameters are completely identified;
Level 3: Fully Reducible Uncertainty;
With sufficient data, using existing statistical estimation methods, we can get to level 2.
Level 4: Partially Reducible Uncertainty
Parameters of random variables estimated as in Level 3may vary unpredictably
Level 5: Irreducible Uncertainty: Total uncertainty as to the nature and random variables driving observed data that can be improved with even more data.
Technical criticism:
At the very least,Level 2 & 3 should be merged. There is really no real life situation, except in controlled experiments, where the law of the random variable is written on the wall. You always have to estimate it. 4& 5 could be more tightly put together, so that really there are only 3 levels: No randomness, randomness with a precisely defined law and and randomness with a law that is not fully known.
Each of the last two levels creates the need for potentially redundant hedges.
(From memory 8 days later) One example he uses in the talk but that is not in the paper online and that caught my attention is the example of the Drawing of an urn containing let's say 100 balls colored black or white.
In the first example we know there are 50 white balls and 50 black balls.The question much one would pay to take part in a game where if one guesses correctly the color of the ball taken out of the urn, one receives let's say $100.
The conclusion here appears to be that one should pay $50.
In the second case we do not know how many black or red balls there are in the urn. Using iterative reasoning that boils down to what is known in information theory as a maximum entropy inference, it also appears one should pay $50.
He notes there is a psychological bias for red.
This leads me to my practical criticism of the paper
Practical Criticism:
This was an analysis of uncertainty from the viewpoint of a statistician/econometrician rather than from the viewpoint of a Risk Manager that is still prey to the mindset of a physicist in its analysis.
As I explained in my article in the Investment Professional last summer "BICs, the PPIP and the fallacies of expectations based risk management", the correct answer of what one should be willing to pay in the example he gives really is: "it all depends..."
Curiously, he refers admiringly in his online paper to Taleb's Black Swans without really addressing issues of hedging robustness that are the risk management dual correspondent of uncertainty issues.
References:
Smoke and Mirrors - BICS, the PPIP, and the Fallacies of Expectations-Based Risk Management
http://www.iafe.org/html/06182010.php
http://web.mit.edu/alo/www/Papers/physics8.pdf
http://www.newyorker.com/online/blogs/currents/2010/06/new-yorker-currents-nassim-taleb-on-risk-and-robustness.html
http://web.mit.edu/alo/www/Papers/physics8.pdf
This talk was quite interesting, delivered with quiet passion and confidence that was not obnoxious, or as one would say in Chinese 自信但不骄傲.
He proposed a thought provoking taxonomy for classifying various levels of risk and uncertainty
Taxonomy of Risk & Uncertainty:
Level 1: Complete Certainty i.e no randomness, as in physics, all parameters are deterministic;
Level 2: Risk without Uncertainty, i.e randomness but coming fully random variables whose law and parameters are completely identified;
Level 3: Fully Reducible Uncertainty;
With sufficient data, using existing statistical estimation methods, we can get to level 2.
Level 4: Partially Reducible Uncertainty
Parameters of random variables estimated as in Level 3may vary unpredictably
Level 5: Irreducible Uncertainty: Total uncertainty as to the nature and random variables driving observed data that can be improved with even more data.
Technical criticism:
At the very least,Level 2 & 3 should be merged. There is really no real life situation, except in controlled experiments, where the law of the random variable is written on the wall. You always have to estimate it. 4& 5 could be more tightly put together, so that really there are only 3 levels: No randomness, randomness with a precisely defined law and and randomness with a law that is not fully known.
Each of the last two levels creates the need for potentially redundant hedges.
(From memory 8 days later) One example he uses in the talk but that is not in the paper online and that caught my attention is the example of the Drawing of an urn containing let's say 100 balls colored black or white.
In the first example we know there are 50 white balls and 50 black balls.The question much one would pay to take part in a game where if one guesses correctly the color of the ball taken out of the urn, one receives let's say $100.
The conclusion here appears to be that one should pay $50.
In the second case we do not know how many black or red balls there are in the urn. Using iterative reasoning that boils down to what is known in information theory as a maximum entropy inference, it also appears one should pay $50.
He notes there is a psychological bias for red.
This leads me to my practical criticism of the paper
Practical Criticism:
This was an analysis of uncertainty from the viewpoint of a statistician/econometrician rather than from the viewpoint of a Risk Manager that is still prey to the mindset of a physicist in its analysis.
As I explained in my article in the Investment Professional last summer "BICs, the PPIP and the fallacies of expectations based risk management", the correct answer of what one should be willing to pay in the example he gives really is: "it all depends..."
Curiously, he refers admiringly in his online paper to Taleb's Black Swans without really addressing issues of hedging robustness that are the risk management dual correspondent of uncertainty issues.
References:
Smoke and Mirrors - BICS, the PPIP, and the Fallacies of Expectations-Based Risk Management
http://www.iafe.org/html/06182010.php
http://web.mit.edu/alo/www/Papers/physics8.pdf
http://www.newyorker.com/online/blogs/currents/2010/06/new-yorker-currents-nassim-taleb-on-risk-and-robustness.html
Saturday, June 19, 2010
IAFE 2010 Annual Conference - Keynote Speech: The Possible Misdiagnosis of a Crisis
A few words on some of the talks at the 2010 International Association of Financial Engineers meeting.
Let's start with the Keynote Speech: "The Possible Misdiagnosis of a Crisis" by Richard Roll,Japan Chair of Finance, UCLA & 2009 IAFE/SunGard Financial Engineer of the Year Winner
* The recent global financial crisis has been blamed on several factors
* Elementary principles of finance suggest that none of these explanations are likely
* There is an alternative diagnosis consistent with financial principles
* The current treatment may be exacerbating the symptoms
In his talk he used 3 hypotheses to conclude that the current crisis is due to the government's increased share of national wealth in the US economy at the expense of the private sector:
H1. The some of all assets equals the sum of liabilities on a balance sheet.
H2. Merkets are forward looking
H3. Total wealth in an economy decreases as the share of government ownership increases. As a way of benchmark he put forward the statistic that a 20% increase in total wealth by the government results in a 50% decrease in aggregate wealth.
H1 is axiomatic; H2 is reasonable. H3??? Well...
From these hypotheses he reasoned that the total loss of wealth in the US Economy caused by the real estate bust was due to an increase ownership of the government in the US economy.He stated that this was a fact that had been observed in many other countries including China India, Brazil. The more government retreated from the economy the more aggregate wealth increased.
First of all I have to tip my hat to him for sticking his neck out there and saying something that stirred strong emotions.
However, I was really surprised that such an eminent and seasoned scholar would make such an extraordinary dubious claim as in H3 and back it with such little evidence in a keynote speech.
The most compelling evidence to disprove this argument is a comparison of loss of wealth in the US during the dot com bust and the real estate bust. The dot com bust occurred in an environment where more laiseez faire, welfare reform arguments were the dominant philosophy with the repeal of the Glass–Steagall Act, the incoming republican administration and all that.The real estate bust in 2007 triggered a more aggressive government interventionist posture in the real economy. For a comparison, I turn to Jeffrey D. Benson of the blog American MacroEconomic Dynamism:
"How much wealth has actually been destroyed in the current housing decline versus the 2001 tech burst? According to the Case Shiller Indices (the most accurate housing guage available) In 2006, the value of U.S. residential real estate totaled US$ 22.4 trillion. Since this recording the national pricing indices (based on 20 metropolitan areas) has decline 19.87%. This is a loss of asset valuation equal to $4.5 Trillion. To put this loss into perspective, according to the International Monetary Fund the U.S. Gross Domestic Product in 2007 was 13.8 Trillion. So is this decline in value a direct hit to the Net Worth of the United States. Absolutely. If the value of liabilities declined proportionally to asset price then the answer would be no, but they clearly do not. The United States has significantly overstated it's wealth. Sound familiar?
In 2001 the Dot.com bubble was another significant overstatement of wealth. The Nasdaq Composite Index is a market capitalization weighted index of more than 5000 stocks. Comprising all Nasdaq-listed common stocks, it is the most commonly used index for tracking the Nasdaq. The Dow Jones Wilshire 5000 Total Market Index represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. No other index comes close to offering its comprehensiveness. For comparison, the NASDAQ listed securities compose 19% of the 5000 Total Market Index. The Market Capitalization of the Dow Jones Wilshire 5000 Full Cap was $16.7 Trillion as of April 30, 2008. Comparatively, the market cap at the end of Q1 in 2000 was approximately $16 trillion (only slightly smaller). However, between 2000 Q1 and Q1 2003 the index lost a stunning 43% of its valuation. In other words, $7.1 Trillion of wealth was lost."
In order to make a statement on China, the proxy by which a comparison would be made is India. Here again In China, we have state capitalism and a government controlled economy. India has a more liberal democratic tradition. So far China has outperformed India year after year for the past 3 decades.
In Russia, the failure of liberalization policies of the early 1990s led to the strong state reassertion and state capitalism under Putin with popular support.
In Africa in the late 80s and 1990s, the IMF liberal orthodoxy led to the crumbling of national welfare in so many economies...
And on and on and on....
How could such a respected scholar and from all appearances a nice and sound minded person make such a claim, I am still scratching my head...
As I have made the case many times before in my BICs book and Knol collection and blogs, the role of government is bound to increase as population density increase, and this is due to what I have called the holistic theorem.
References:
The 2010 IAFE Annual Conference
Housing Bubble vs. Tech Bubble Loss of Wealth in Dollars denominated terms by Jeffrey D. Benson of the blog American MacroEconomic Dynamism
Let's start with the Keynote Speech: "The Possible Misdiagnosis of a Crisis" by Richard Roll,Japan Chair of Finance, UCLA & 2009 IAFE/SunGard Financial Engineer of the Year Winner
* The recent global financial crisis has been blamed on several factors
* Elementary principles of finance suggest that none of these explanations are likely
* There is an alternative diagnosis consistent with financial principles
* The current treatment may be exacerbating the symptoms
In his talk he used 3 hypotheses to conclude that the current crisis is due to the government's increased share of national wealth in the US economy at the expense of the private sector:
H1. The some of all assets equals the sum of liabilities on a balance sheet.
H2. Merkets are forward looking
H3. Total wealth in an economy decreases as the share of government ownership increases. As a way of benchmark he put forward the statistic that a 20% increase in total wealth by the government results in a 50% decrease in aggregate wealth.
H1 is axiomatic; H2 is reasonable. H3??? Well...
From these hypotheses he reasoned that the total loss of wealth in the US Economy caused by the real estate bust was due to an increase ownership of the government in the US economy.He stated that this was a fact that had been observed in many other countries including China India, Brazil. The more government retreated from the economy the more aggregate wealth increased.
First of all I have to tip my hat to him for sticking his neck out there and saying something that stirred strong emotions.
However, I was really surprised that such an eminent and seasoned scholar would make such an extraordinary dubious claim as in H3 and back it with such little evidence in a keynote speech.
The most compelling evidence to disprove this argument is a comparison of loss of wealth in the US during the dot com bust and the real estate bust. The dot com bust occurred in an environment where more laiseez faire, welfare reform arguments were the dominant philosophy with the repeal of the Glass–Steagall Act, the incoming republican administration and all that.The real estate bust in 2007 triggered a more aggressive government interventionist posture in the real economy. For a comparison, I turn to Jeffrey D. Benson of the blog American MacroEconomic Dynamism:
"How much wealth has actually been destroyed in the current housing decline versus the 2001 tech burst? According to the Case Shiller Indices (the most accurate housing guage available) In 2006, the value of U.S. residential real estate totaled US$ 22.4 trillion. Since this recording the national pricing indices (based on 20 metropolitan areas) has decline 19.87%. This is a loss of asset valuation equal to $4.5 Trillion. To put this loss into perspective, according to the International Monetary Fund the U.S. Gross Domestic Product in 2007 was 13.8 Trillion. So is this decline in value a direct hit to the Net Worth of the United States. Absolutely. If the value of liabilities declined proportionally to asset price then the answer would be no, but they clearly do not. The United States has significantly overstated it's wealth. Sound familiar?
In 2001 the Dot.com bubble was another significant overstatement of wealth. The Nasdaq Composite Index is a market capitalization weighted index of more than 5000 stocks. Comprising all Nasdaq-listed common stocks, it is the most commonly used index for tracking the Nasdaq. The Dow Jones Wilshire 5000 Total Market Index represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. No other index comes close to offering its comprehensiveness. For comparison, the NASDAQ listed securities compose 19% of the 5000 Total Market Index. The Market Capitalization of the Dow Jones Wilshire 5000 Full Cap was $16.7 Trillion as of April 30, 2008. Comparatively, the market cap at the end of Q1 in 2000 was approximately $16 trillion (only slightly smaller). However, between 2000 Q1 and Q1 2003 the index lost a stunning 43% of its valuation. In other words, $7.1 Trillion of wealth was lost."
In order to make a statement on China, the proxy by which a comparison would be made is India. Here again In China, we have state capitalism and a government controlled economy. India has a more liberal democratic tradition. So far China has outperformed India year after year for the past 3 decades.
In Russia, the failure of liberalization policies of the early 1990s led to the strong state reassertion and state capitalism under Putin with popular support.
In Africa in the late 80s and 1990s, the IMF liberal orthodoxy led to the crumbling of national welfare in so many economies...
And on and on and on....
How could such a respected scholar and from all appearances a nice and sound minded person make such a claim, I am still scratching my head...
As I have made the case many times before in my BICs book and Knol collection and blogs, the role of government is bound to increase as population density increase, and this is due to what I have called the holistic theorem.
References:
The 2010 IAFE Annual Conference
Housing Bubble vs. Tech Bubble Loss of Wealth in Dollars denominated terms by Jeffrey D. Benson of the blog American MacroEconomic Dynamism
Thursday, May 27, 2010
Easy Money, Hard Truths
I liked this piece in the times quite a lot. It is a useful refresher course on macroeconomics and articulate the deficit hawks thoughtful worries about ballooning deficits and debt. It argues fairly persuasively that the lack of apparent inflation in reported numbers might be a smoking mirror or at any rate unhealthy.
It is a fairly challenging counter argument to the "forget-about-the-deficit,-there-is-no- inflation,-expansionary-government-policies" Krugman regularly pushes in his pieces.
The weakness of this analysis in my view is that it is poorly prescriptive. Mindless belt tightening at all costs as one would would asphyxiate the economy making the current predicament even worse. Krugman pushes for expansion but in traditional sectors of the economy.
What I have failed to see in both analyses is the effort to help flow credit to start ups in the services industry who are likely to open up the new industries which are most likely to help the country grow out of its mounting liabilities. When I read about the paltry efforts to get money through the SBA, it is quite puzzling. Thomas Friedman regularly does a god job at drawing the need to focus efforts on high tech startups of the future, but again his prescription for helping flow money in a timely manner to this sector is neither refined nor well calibrated enough.
And this would get me to... BICs
References:
http://www.nytimes.com/2010/05/27/opinion/27einhorn.html?hp=&pagewanted=all
It is a fairly challenging counter argument to the "forget-about-the-deficit,-there-is-no- inflation,-expansionary-government-policies" Krugman regularly pushes in his pieces.
The weakness of this analysis in my view is that it is poorly prescriptive. Mindless belt tightening at all costs as one would would asphyxiate the economy making the current predicament even worse. Krugman pushes for expansion but in traditional sectors of the economy.
What I have failed to see in both analyses is the effort to help flow credit to start ups in the services industry who are likely to open up the new industries which are most likely to help the country grow out of its mounting liabilities. When I read about the paltry efforts to get money through the SBA, it is quite puzzling. Thomas Friedman regularly does a god job at drawing the need to focus efforts on high tech startups of the future, but again his prescription for helping flow money in a timely manner to this sector is neither refined nor well calibrated enough.
And this would get me to... BICs
References:
http://www.nytimes.com/2010/05/27/opinion/27einhorn.html?hp=&pagewanted=all
Monday, May 17, 2010
High Frequency Traders and Liquidity
See: Speedy New Traders Make Waves Far From Wall St.
I was reading this article in the times and it just illustrated the fallacy of the argument that high frequency traders provide indispensable liquidity in the markets. Like all other normal or continuous trading assumptions about markets we question here this is one more. These assumptions work in normal times, but when they are most needed, they don't. And it makes dynamic or continuous time derivatives hedging potentially disastrous.
And this is where BICs, with there pre-determined contractual agreements provide economically valuable edge.
I was reading this article in the times and it just illustrated the fallacy of the argument that high frequency traders provide indispensable liquidity in the markets. Like all other normal or continuous trading assumptions about markets we question here this is one more. These assumptions work in normal times, but when they are most needed, they don't. And it makes dynamic or continuous time derivatives hedging potentially disastrous.
And this is where BICs, with there pre-determined contractual agreements provide economically valuable edge.
Thursday, May 6, 2010
Derivatives Clearinghouses Are No Magic Bullet. Really ?
See: http://online.wsj.com/article/SB10001424052748703871904575216251915383146.html
Derivatives Clearinghouses Are No Magic Bullet. Really? but not for the reason this guy gives...and he is a professor at some big Ivy league School!
I read this article with a certain sense of bemusement at the level of ignorance the author therein demonstrated. He seems to have no understanding of issues of 2-timing, N-timing in bilateral netting agreements. The issues he worries about would be addresses in centralized or interconnected hierarchical clearing system as explained in my knol and powerpoint/ youtube presentation
References:
The Holistic Theorem
http://online.wsj.com/article/SB10001424052748703871904575216251915383146.html
Derivatives Clearinghouses Are No Magic Bullet. Really? but not for the reason this guy gives...and he is a professor at some big Ivy league School!
I read this article with a certain sense of bemusement at the level of ignorance the author therein demonstrated. He seems to have no understanding of issues of 2-timing, N-timing in bilateral netting agreements. The issues he worries about would be addresses in centralized or interconnected hierarchical clearing system as explained in my knol and powerpoint/ youtube presentation
References:
The Holistic Theorem
http://online.wsj.com/article/SB10001424052748703871904575216251915383146.html
Tuesday, April 27, 2010
Comments On "Chances Are..." By Steven Strogatz & BICs
Reading this piece general public piece on conditional probabilities brought me back more than 17 years ago back when in my senior year in college I was being introduced to conditional probabilities. Indeed in the manner it was taught it was seen as impenetrably daunting and really hard to relate to anything practical. But overtime as I have assimilated the theoretical and practical use of conditional probabilities, I must say the formal approach, once assimilated is very mechanical in helping produce accurate estimations. What is often confounding in making estimates based on conditional probabilities, is that the language used corrupts thoughts. That is why examples such as the Monty Python one and the Mammogram results interpretation are so confounding to educated and otherwise intelligent people.
It seems to me educational curriculums should focus on teaching the intuitive and formal approaches simultaneously and move towards pointing out when the intuitive approach finds its limitations and must be overtaken by the more formal one.
I also realize how BICs as extensions and generalizations of the concept of conditional probabilities must be patiently taught to be better understood over time
References:
Chances Are, By Steven Strogatz. Opiniator piece in the NY Times 04/25/2010
BICs
The Wider Scope of BICs
It seems to me educational curriculums should focus on teaching the intuitive and formal approaches simultaneously and move towards pointing out when the intuitive approach finds its limitations and must be overtaken by the more formal one.
I also realize how BICs as extensions and generalizations of the concept of conditional probabilities must be patiently taught to be better understood over time
References:
Chances Are, By Steven Strogatz. Opiniator piece in the NY Times 04/25/2010
BICs
The Wider Scope of BICs
Sunday, April 18, 2010
BEWARE WHAT YOU WISH FOR: Goldman Sachs, Fabrice Tourre, Derivatives Clearing
As I read the story of the SEC case against Goldman Sachs and one of its employees, I could not help but say to myself, BEWARE WHAT YOU WISH FOR, and this for two reasons:
1)The financial industry has been lobbying very hard against the requirement to settle all derivatives trades through a clearing house, essentially to protect the money making business of structuring customized deals for investors and various hedge funds and other market participants. What Goldman finds itself in the hot seat for is essentially for having brokered synthetic trades, the abacus deals between investors and a hedge fund that allowed the hedge fund to be short the real estate market on a large scale. If all such trades had been cleared through a clearinghouse, such an issue might not have arisen. Goldman seems to have made $15M on the deal and may have done hundred such deals, but now the stock price lost more than 12.5% and more than 12B in market cap on Friday and its reputation is seriously damaged.Is it worth it?
2)The second thought is about the trader Fabrice Tourre a product of the french mathematical education system who just as me straight out of college went to Wall Street. In many respect he is the perfect overachiever who did best on the path he was led onto without questioning too much its foundations. Now he is out there hanging. The guy is about six years younger than me and he helps me feel more secure about my choice in developing BICs of not going with the flow, even if it means in the short term paying a heavy price.
References:
http://www.nytimes.com/2010/04/17/business/17goldman.html?fta=y
WSJ Op-ed:Clearinghouses Are the Answer
Complex derivatives should be regulated like commodity futures.
1)The financial industry has been lobbying very hard against the requirement to settle all derivatives trades through a clearing house, essentially to protect the money making business of structuring customized deals for investors and various hedge funds and other market participants. What Goldman finds itself in the hot seat for is essentially for having brokered synthetic trades, the abacus deals between investors and a hedge fund that allowed the hedge fund to be short the real estate market on a large scale. If all such trades had been cleared through a clearinghouse, such an issue might not have arisen. Goldman seems to have made $15M on the deal and may have done hundred such deals, but now the stock price lost more than 12.5% and more than 12B in market cap on Friday and its reputation is seriously damaged.Is it worth it?
2)The second thought is about the trader Fabrice Tourre a product of the french mathematical education system who just as me straight out of college went to Wall Street. In many respect he is the perfect overachiever who did best on the path he was led onto without questioning too much its foundations. Now he is out there hanging. The guy is about six years younger than me and he helps me feel more secure about my choice in developing BICs of not going with the flow, even if it means in the short term paying a heavy price.
References:
http://www.nytimes.com/2010/04/17/business/17goldman.html?fta=y
WSJ Op-ed:Clearinghouses Are the Answer
Complex derivatives should be regulated like commodity futures.
Saturday, April 3, 2010
On Financial Reform :Regulation Vs. Size of Banks, A false dichotomy?
The debated on financial reform as summarized by Krugman in his latest piece in the NYT seems to have boiled down to the Volker position of limiting the size of financial institutions so that they do not reach a too big to fail size or the position of Krugman of tight and generalized regulation of Banks and shadow banks.
It seems to me that both analysis miss the simple but central ingredient needed to secure the financial system while not impending economic growth and that is a centralized clearing of all trades. Centralized clearing by nature remove a lot of the incentives in the buildup of too big to fail financial entities, it brings a level of transparency that all times gives regulator a clear picture of the dangers in the positions taken by financial/ economic actors.
A simple example to illustrate the power of centralized counterparty on trades. When you go online to buy an item or at the to a store and you use a credit card, that transaction is facilitated and secured by the existence of a centralized counterparty who keeps track of your assets and liabilities and authorize the transaction only when you have enough credit. No party to the transaction takes credit risk on the other and the system is robust. If the same worked among financial trading institutions the same efficiency and security would be gained, eliminating much of the systemic risks that are the source of current concerns.
See:
http://www.nytimes.com/2010/04/02/opinion/02krugman.html?src=me&ref=general
The Holistic Theorem
It seems to me that both analysis miss the simple but central ingredient needed to secure the financial system while not impending economic growth and that is a centralized clearing of all trades. Centralized clearing by nature remove a lot of the incentives in the buildup of too big to fail financial entities, it brings a level of transparency that all times gives regulator a clear picture of the dangers in the positions taken by financial/ economic actors.
A simple example to illustrate the power of centralized counterparty on trades. When you go online to buy an item or at the to a store and you use a credit card, that transaction is facilitated and secured by the existence of a centralized counterparty who keeps track of your assets and liabilities and authorize the transaction only when you have enough credit. No party to the transaction takes credit risk on the other and the system is robust. If the same worked among financial trading institutions the same efficiency and security would be gained, eliminating much of the systemic risks that are the source of current concerns.
See:
http://www.nytimes.com/2010/04/02/opinion/02krugman.html?src=me&ref=general
The Holistic Theorem
Friday, March 19, 2010
Greek Derivatives, Derivatives' Greeks, BICs and the Risk Management Illusions that lead to recent financial disasters
This Knol article points to a strange coincidence of words and circumstances surrounding the Greek debacle and the dangers associated with the use of Greeks in financial derivatives risk management...
Check it out!
http://knol.google.com/k/phil-kongtcheu/greek-derivatives-derivatives-greeks/24v2kgtuvzk2v/23#
Check it out!
http://knol.google.com/k/phil-kongtcheu/greek-derivatives-derivatives-greeks/24v2kgtuvzk2v/23#
Monday, March 8, 2010
Negative Numbers, Rational Numbers, Complex Numbers and BICs
This post is prompted by recent articles by Steven Strogatz in the New York Times where he explains how negative numbers , rational numbers, complex numbers come into the picture in order to better deal with real life problems. Prof. Strogratz is a professor of applied mathematics at Cornell University. His style is very entertaining. The articles are a very interesting and accessible read and some of the comments of readers are sometimes even more interesting.
Likewise, as I make the case in my Introductory article on BICs, the necessity for BICs emerge from the need to tractably manage the risk management problems brought about by the emergence of complex derivative contracts.
To Read:
http://opinionator.blogs.nytimes.com/2010/02/14/the-enemy-of-my-enemy/
http://opinionator.blogs.nytimes.com/2010/02/21/division-and-its-discontents/
http://opinionator.blogs.nytimes.com/2010/03/07/finding-your-roots/?hp
http://knol.google.com/k/introduction-to-basis-instruments-contracts-bics-for-mathematics-finance-and#view
Likewise, as I make the case in my Introductory article on BICs, the necessity for BICs emerge from the need to tractably manage the risk management problems brought about by the emergence of complex derivative contracts.
To Read:
http://opinionator.blogs.nytimes.com/2010/02/14/the-enemy-of-my-enemy/
http://opinionator.blogs.nytimes.com/2010/02/21/division-and-its-discontents/
http://opinionator.blogs.nytimes.com/2010/03/07/finding-your-roots/?hp
http://knol.google.com/k/introduction-to-basis-instruments-contracts-bics-for-mathematics-finance-and#view
Wednesday, February 24, 2010
The Stimulus Evidence One Year On
I read this piece by Robert Barro in the WSJ shrugging my head in distrust over macro-economists and their analysis. To understand what I mean, contrast this piece with this one by Krugman written in January http://www.nytimes.com/2010/01/18/opinion/18krugman.html
The real moral of the story here is that there will always be a very reputable and leading economist to support whatever position one wants to take on a macro economic issue. Why is that? The answer lies in the number of assumptions one needs to make without much hedging backup to come to any prescription.
From the distance of BICs master obsessed with being able to hedge probabilistic assumptions, I was tinged by:
- the widespread assumption that multipliers used are fixed quantities,
- Wildly speculative sentences such as "...second, this multiplier provides a reasonable gauge (and likely an upper bound because of the strong wartime boost to labor supply due to patriotism) for the effects of nondefense government purchases.".
- I did not see any inflationary discount when adding up the numbers.
The real moral of the story here is that there will always be a very reputable and leading economist to support whatever position one wants to take on a macro economic issue. Why is that? The answer lies in the number of assumptions one needs to make without much hedging backup to come to any prescription.
From the distance of BICs master obsessed with being able to hedge probabilistic assumptions, I was tinged by:
- the widespread assumption that multipliers used are fixed quantities,
- Wildly speculative sentences such as "...second, this multiplier provides a reasonable gauge (and likely an upper bound because of the strong wartime boost to labor supply due to patriotism) for the effects of nondefense government purchases.".
- I did not see any inflationary discount when adding up the numbers.
Thursday, February 11, 2010
Citi Plans Crisis Derivatives
This CLX plan appears to be a pickup from my article in the investment professional where I lambasted Krugman's analysis of the Treasury's PPIP and the fallacy of expectations based risk management he perpetuated in his analysis. In particular I pointed out the rise in funding cost at times of crisis not priced into such analysis to show how the computation of the so-called free lunch to PPIP investors was misguided.
The prescription in the article was to find replication contracts such as BICs that replicate the risks taken on as early as possible and keep uncertainty to a minimum.
However this contract, interesting as it may be only marginally addresses the range of risks. Anyway was it not Citi who would have needed such a contract last time? How could it safely be the underwriter?
The prescription in the article was to find replication contracts such as BICs that replicate the risks taken on as early as possible and keep uncertainty to a minimum.
However this contract, interesting as it may be only marginally addresses the range of risks. Anyway was it not Citi who would have needed such a contract last time? How could it safely be the underwriter?
Thursday, February 4, 2010
Power-Reverse Dual Currency (PRDC) business & BICs
On January, 28th, 2010, Risk.net reported that losses and increasing hedging costs have led many smaller firms to leave the Power-Reverse Dual Currency (PRDC) business, leaving a rump of major banks operating in the market. This represents yet another example where had a BICs market on the currencies and interest rates involved existed, there would have been no such issue. Not only hedging activity would have been contracted before hand, in addition the atomic structure of replicating BICs would have made nearly impossible for counterparties to identify what the contract held is in order to attempt a 'squeeze'; furthermore most of the individual BICs would be used for other hedging purposes unrelated to PRDCs, ensuring the liquidity of the market on those contracts.
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