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

Unity of Purpose

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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

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.

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

Too Big to Fail

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Unity of Purpose

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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#

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

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.

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?

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.

Inroduction to BICs -Top Pick Knol Award ! Cheers!

My article Introduction to Basis Instruments Contracts (BICs) for Mathematics, Finance, and Economics has received a Google Knol "Top Pick Knol Award". Cheers!


Ah! Someone highjacked the review section of the article and messed it up, Ritu..? anyways..