Free markets, random walk -- are key principles in capital markets.
In free markets -- free is definitely missing. Our markets are not free. The bankers are free to take home the profits. The people are left holding the losses. Quite an equitable distribution of winners and losers.
The random walk -- that is at any given instant the price of a security can move in either direction -- randomly --. Do you know you can have the view that a stock price will appreciate -- and therefore go long? But starting today you can have the view that stock will depreciate -- and however you cannot sell? The randomness manifests only because of such diametrically opposite viewpoints are equally likely. Since only positive outlooks are actionable, the markets can only go up. Therefore, the market is no longer random. There is a bias.
Free markets are not free any more if you are an ordinary share holder. And there is no randomness to the security price movements. Keywords are mis-leading.
Wednesday, September 17, 2008
Is it or Is it Not -- Moral Hazard?
In all the public bail out designed and archestrated by elected officials and executive branch -- it has often been argued that common share holders will not be
protected because it is a moral hazard.
So what is the purpose of the bail out ? Who are we bailing out?
So let us review Bear Stearns. Bear Stearns had a lot of complex derivative positions on its books, including CDO, IRS and CDS. Scores of individuals rushed to their desk
early each weekday to make sure these instruments were properly maintained on the books. BS traded these instruments with counterparties including other broker dealers, hedge funds and investment managers. If Bear made money these counterparties lost money and vice versa. If Bear went bankrupt these counterparties cannot claim their bounties or their windfall winnings.
Let us review what the government did -- allowed Bear to fail by extending the loan after they failed to JP Morgan to buy out Bear on fire sale. Why did they extend this loan to JP Morgan...We were told without the bail out the entire system will collapse. What system? The employees lost their life savings! No that would be a moral hazard -- in other words more people would take more reckless risk without concern for the risk thinking that the government (the public and the people's printing press) would bail them out. So what is the system they protected?
Let us skin the cat another way. If Bear vanished who stands to loose. The counterparties. The people who worked lost their life savings along with their livelihood. So the government bailed out the counterparties without any consideration for moral hazard however justified bankrupting the employees with
exactly that -- you guessed it moral hazard.
So please help me is it or is it not moral hazard?
protected because it is a moral hazard.
So what is the purpose of the bail out ? Who are we bailing out?
So let us review Bear Stearns. Bear Stearns had a lot of complex derivative positions on its books, including CDO, IRS and CDS. Scores of individuals rushed to their desk
early each weekday to make sure these instruments were properly maintained on the books. BS traded these instruments with counterparties including other broker dealers, hedge funds and investment managers. If Bear made money these counterparties lost money and vice versa. If Bear went bankrupt these counterparties cannot claim their bounties or their windfall winnings.
Let us review what the government did -- allowed Bear to fail by extending the loan after they failed to JP Morgan to buy out Bear on fire sale. Why did they extend this loan to JP Morgan...We were told without the bail out the entire system will collapse. What system? The employees lost their life savings! No that would be a moral hazard -- in other words more people would take more reckless risk without concern for the risk thinking that the government (the public and the people's printing press) would bail them out. So what is the system they protected?
Let us skin the cat another way. If Bear vanished who stands to loose. The counterparties. The people who worked lost their life savings along with their livelihood. So the government bailed out the counterparties without any consideration for moral hazard however justified bankrupting the employees with
exactly that -- you guessed it moral hazard.
So please help me is it or is it not moral hazard?
Thursday, July 17, 2008
Markets are entropic!
Recall our endorsement of Mr. George Soros in http://holmdelinvestmentclub.blogspot.com/2008/06/equal-access.html
regarding the fact that US Capital Markets are really not free markets.
Mr. Soros observes the US Capital Markets continue to function because the government agencies often intervene and stabilize.
What more proof would you like? SEC decrees some stocks may not go bankrupt and disallow shorting in those stocks. What about Wellman which is near bankrupt? What about ATHM that went bankrupt? Enron, Win Dixie, Calpine. How does the SEC choose whose greenback to protect whose not to protect. What is random about the market?
Financials -- it can only go one way -- UP -- until this short rules are lifted.
The markets are asymmetric. It can only go up. There is no downtick rule to buy long.
Try shorting the stock because your analysis recommends a negative outlook. But you cannot.
You need to wait for uptick rule. All of these makes going long easy and shorting harder.
Like entropy markets can only go up. Why is the SEC in on this? Does it help the listed companies! Of course not! The listed companies take investors money during the initial public offering -- IPO --. Post IPO when I sell IBM and say you buy IBM money changes hand but not a penny finds its way to the company. All the post market action fetches nada -- zippo -- to the company investors think they are funding. Stock price helps executives pocket more money at the expense of unsuspecting workers and investing public. Welcome to the asymmetric entropic markets! The capital markets -- free style --.
My confidence! It is rock bottom and sinking further deep. But it is not my confidence that SEC is trying to shore up. It is the super mega rich that are protected. I will not see 10 cents to the dollar on the amount I lost on Calpine, Enron, ATHM, Winn Dixie, Lucent and so on. I just recovered from 2001 redistribution event the internet bubble. I am wiped clean now once again.
The capital markets are the best and biggest wealth re-distribution system!
Better days are ahead! 9 months from now. May be 18 months. Sometime in the future better days are ahead. Just kidding, let us not time the market. Until then...
regarding the fact that US Capital Markets are really not free markets.
Mr. Soros observes the US Capital Markets continue to function because the government agencies often intervene and stabilize.
What more proof would you like? SEC decrees some stocks may not go bankrupt and disallow shorting in those stocks. What about Wellman which is near bankrupt? What about ATHM that went bankrupt? Enron, Win Dixie, Calpine. How does the SEC choose whose greenback to protect whose not to protect. What is random about the market?
Financials -- it can only go one way -- UP -- until this short rules are lifted.
The markets are asymmetric. It can only go up. There is no downtick rule to buy long.
Try shorting the stock because your analysis recommends a negative outlook. But you cannot.
You need to wait for uptick rule. All of these makes going long easy and shorting harder.
Like entropy markets can only go up. Why is the SEC in on this? Does it help the listed companies! Of course not! The listed companies take investors money during the initial public offering -- IPO --. Post IPO when I sell IBM and say you buy IBM money changes hand but not a penny finds its way to the company. All the post market action fetches nada -- zippo -- to the company investors think they are funding. Stock price helps executives pocket more money at the expense of unsuspecting workers and investing public. Welcome to the asymmetric entropic markets! The capital markets -- free style --.
My confidence! It is rock bottom and sinking further deep. But it is not my confidence that SEC is trying to shore up. It is the super mega rich that are protected. I will not see 10 cents to the dollar on the amount I lost on Calpine, Enron, ATHM, Winn Dixie, Lucent and so on. I just recovered from 2001 redistribution event the internet bubble. I am wiped clean now once again.
The capital markets are the best and biggest wealth re-distribution system!
Better days are ahead! 9 months from now. May be 18 months. Sometime in the future better days are ahead. Just kidding, let us not time the market. Until then...
Sunday, June 29, 2008
At the margin -- Change is in order
It definitely is not the idea but the implementation -- poor implementation.
We already discussed Hedge Fund and the qualified investor whose money can grow at Hedge Fund rates but not the common man's $. The underlying principal is not a bad idea. It is meant to mitigate greed so someone does not loose their shirt betting everything they own on highly risky
investment vehicles such as Hedge Fund.
Let us look at futures today. An agreement to buy a harvest or product of mining etc at a future date for a fixed price is an excellent risk transfer mechanism. The forward contract as they are called is beneficial to the producer eliminating the uncertainty. The standardized version of the forward traded by exchanges also known as futures is a notable innovation and makes the asset
class fungible. Increases commerce.
All of them rely on the notion of margin. Regulation T as it is known. This regulation allows people to borrow money and buy assets or borrow assets and sell (shorting), reducing the capital burden. Also allows ordinary people to leverage their finances and prosper faster.
The case against the margin is that it is susceptible for abuse and facilitates speculation.
This can however be overcome by a slight modification of the Regulation T. Current regulation works by fixed percentage without regard to the volume. 50% initial margin for equities. What if Regulation T is modified such that increasing amounts of capital is required to sell short larger volume. This can be stipulated by % ADV (percentage average daily volume). Less than 1% ADV current Regulation T holds.
And stipulate a ladder where at some %ADV say 5% one would have to maintain 100% margin.
This can be parameterized in three different ways -- security level, account level and market level --. %ADV is parameterization at the security level as ADV varies by security.
In addition, margin transaction above 25% ADV in aggregate for a given security.
Account level restriction may be that no single account may transact on a margin basis beyond a certain % ADV. That limit may be 0.5%. The limit must allow everyone to engage in short selling but no single individual or entity to abuse the system.
Aggregate Limit (or a variation of the same) cited above will serve to regulate market wide in the aggregate.
This will reduce pump and dump behavior and unchecked speculation. I certainly do not fully subscribe to the view that current oil prices are the result of speculators in the futures market.
Until next time! Bye!
We already discussed Hedge Fund and the qualified investor whose money can grow at Hedge Fund rates but not the common man's $. The underlying principal is not a bad idea. It is meant to mitigate greed so someone does not loose their shirt betting everything they own on highly risky
investment vehicles such as Hedge Fund.
Let us look at futures today. An agreement to buy a harvest or product of mining etc at a future date for a fixed price is an excellent risk transfer mechanism. The forward contract as they are called is beneficial to the producer eliminating the uncertainty. The standardized version of the forward traded by exchanges also known as futures is a notable innovation and makes the asset
class fungible. Increases commerce.
All of them rely on the notion of margin. Regulation T as it is known. This regulation allows people to borrow money and buy assets or borrow assets and sell (shorting), reducing the capital burden. Also allows ordinary people to leverage their finances and prosper faster.
The case against the margin is that it is susceptible for abuse and facilitates speculation.
This can however be overcome by a slight modification of the Regulation T. Current regulation works by fixed percentage without regard to the volume. 50% initial margin for equities. What if Regulation T is modified such that increasing amounts of capital is required to sell short larger volume. This can be stipulated by % ADV (percentage average daily volume). Less than 1% ADV current Regulation T holds.
And stipulate a ladder where at some %ADV say 5% one would have to maintain 100% margin.
This can be parameterized in three different ways -- security level, account level and market level --. %ADV is parameterization at the security level as ADV varies by security.
In addition, margin transaction above 25% ADV in aggregate for a given security.
Account level restriction may be that no single account may transact on a margin basis beyond a certain % ADV. That limit may be 0.5%. The limit must allow everyone to engage in short selling but no single individual or entity to abuse the system.
Aggregate Limit (or a variation of the same) cited above will serve to regulate market wide in the aggregate.
This will reduce pump and dump behavior and unchecked speculation. I certainly do not fully subscribe to the view that current oil prices are the result of speculators in the futures market.
Until next time! Bye!
Saturday, June 21, 2008
The wonderful world of Capital Markets
Fund after fund claim their performance record with an attendant disclaimer that past results
are not indicators of future results.
And this is also an industry where Risk Management is a first class activity. The sum total of resources allocated to risk management is quite significant. And yet quite regularly major catastrophic events occur rather predictably. If power companies fail comparably we would experience an uproar. If cable television were to blank out on us, even congress might act.
Cannot figure this one. If everyone is practicing state of the art risk management and catastrophic meltdowns occur system wide, we can only question the validity of the basic
practice of risk management.
The industry considers variance (or square root of variance the standard deviation)as a risk measure. The normal state is that asset prices fluctuate randomly without history or memory.
If the markets are expected to fluctuate how can an expected measure be used to predict much less manage unexpected outcomes. Though semi variance, distributions other than Gaussian
are proposed Taleb's extreme black swan events offers most promise.
Considering that most price movements (upward or downward) occur in a concentrated manner in a few sessions. It is a well known fact that a few dozen days of outlier up days can account for most of the appreciation and similarly a few dozen days of down days can account for much of the loss. So I would shock my portfolio to the top 10 downward moves for each asset held and understand the sensitivity to the portfolio. I would not consider 250 day historic volatility or other normally distributed measure.
Second, for risk management purposes, subject the portfolio to extreme correlated movements not the covariance/correlation matrix constructed out of historical data. Shock the assumptions underlying the covariance/correlation construction methods.
Every major market meltdown suggests that risk management is NOT working as practiced today. It is not! Industry is begging for sea change.
are not indicators of future results.
And this is also an industry where Risk Management is a first class activity. The sum total of resources allocated to risk management is quite significant. And yet quite regularly major catastrophic events occur rather predictably. If power companies fail comparably we would experience an uproar. If cable television were to blank out on us, even congress might act.
Cannot figure this one. If everyone is practicing state of the art risk management and catastrophic meltdowns occur system wide, we can only question the validity of the basic
practice of risk management.
The industry considers variance (or square root of variance the standard deviation)as a risk measure. The normal state is that asset prices fluctuate randomly without history or memory.
If the markets are expected to fluctuate how can an expected measure be used to predict much less manage unexpected outcomes. Though semi variance, distributions other than Gaussian
are proposed Taleb's extreme black swan events offers most promise.
Considering that most price movements (upward or downward) occur in a concentrated manner in a few sessions. It is a well known fact that a few dozen days of outlier up days can account for most of the appreciation and similarly a few dozen days of down days can account for much of the loss. So I would shock my portfolio to the top 10 downward moves for each asset held and understand the sensitivity to the portfolio. I would not consider 250 day historic volatility or other normally distributed measure.
Second, for risk management purposes, subject the portfolio to extreme correlated movements not the covariance/correlation matrix constructed out of historical data. Shock the assumptions underlying the covariance/correlation construction methods.
Every major market meltdown suggests that risk management is NOT working as practiced today. It is not! Industry is begging for sea change.
Sunday, June 1, 2008
Equal Access
I simply do not understand why one has to be accredited to invest in hedge funds.
If someone has the willingness to bear the risk why should they not be allowed to participate in Hedge Funds? Why should anyone care how fast my 100 dollars can grow?
Lottery tickets highest and casino do not have a litmus test as to who can participate. Hedge funds are much better speculative instruments than these two.
We can agree the core intent is not all that evil just a poor implementation. The constraint should be placed in a different dimension. Access to hedge funds must be open to all -- with a single restriction -- one cannot bet more than 10% of networth. May be 5%.
Government can exercise better regulatory powers by insisting that every one follow Credit Suisse model of compensation. Bonus is placed into an account with a vesting scheme at CS. Imagine if Bear employees bonus from the last 3 years had been placed into a vesting scheme, the employess could have bailed out Bear on their own.
All of this stifles the average guy. This is not the only instance. Think of the public company bankruptcies all of us have suffered through. In my own investment history I have made several poor choices including ATHM, Win Dixie, Calpine etc. Not sure what happend to ATHM.
I was told I should bear the risk. Risk vs Reward is the foundation of modern finance and free market system. My shares became worthless. But Win Dixie relisted. Calpine was a little fairer -- in that I was given warrants --.
Not quite. Not if you are Savings and Loan Association of 80s, Long Term Capital of the 90s and
Bear Stearns (really JPM) of recent days. Government steps in and bails the risk takers out.
I am in agreement with George Soros. Once again my respect and adoration for this immigrant and his audacious pursuit in life has grown. More power to George Soros!
If someone has the willingness to bear the risk why should they not be allowed to participate in Hedge Funds? Why should anyone care how fast my 100 dollars can grow?
Lottery tickets highest and casino do not have a litmus test as to who can participate. Hedge funds are much better speculative instruments than these two.
We can agree the core intent is not all that evil just a poor implementation. The constraint should be placed in a different dimension. Access to hedge funds must be open to all -- with a single restriction -- one cannot bet more than 10% of networth. May be 5%.
Government can exercise better regulatory powers by insisting that every one follow Credit Suisse model of compensation. Bonus is placed into an account with a vesting scheme at CS. Imagine if Bear employees bonus from the last 3 years had been placed into a vesting scheme, the employess could have bailed out Bear on their own.
All of this stifles the average guy. This is not the only instance. Think of the public company bankruptcies all of us have suffered through. In my own investment history I have made several poor choices including ATHM, Win Dixie, Calpine etc. Not sure what happend to ATHM.
I was told I should bear the risk. Risk vs Reward is the foundation of modern finance and free market system. My shares became worthless. But Win Dixie relisted. Calpine was a little fairer -- in that I was given warrants --.
Not quite. Not if you are Savings and Loan Association of 80s, Long Term Capital of the 90s and
Bear Stearns (really JPM) of recent days. Government steps in and bails the risk takers out.
I am in agreement with George Soros. Once again my respect and adoration for this immigrant and his audacious pursuit in life has grown. More power to George Soros!
Friday, March 2, 2007
Welcome!
I am Raman Kannan, passionate about self help.
Most of work hard for an entire life and upon retirement realize social security does not meet
even modest expectations.
We have to accept Social Security as it is. It is what it is.
But we can change how we prepare ourselves for retirement. We can help ourselves by developing the discipline to invest and be invested in sound asset classes and retire into
millionaire status.
Myself and a few other friends from Holmdel formed the Holmdel Investment Club. The HIC
is a forum to air our concerns, interests and strategies to build a respectable nest egg.
HIC does not offer a get rich quick trick or an idea. HIC offers ideas to start small, stay the course and end up with a sizeable nest egg. Time, compounding and world wide economic growth will help us achieve our goals.
--
RK
03/02/2007
Most of work hard for an entire life and upon retirement realize social security does not meet
even modest expectations.
We have to accept Social Security as it is. It is what it is.
But we can change how we prepare ourselves for retirement. We can help ourselves by developing the discipline to invest and be invested in sound asset classes and retire into
millionaire status.
Myself and a few other friends from Holmdel formed the Holmdel Investment Club. The HIC
is a forum to air our concerns, interests and strategies to build a respectable nest egg.
HIC does not offer a get rich quick trick or an idea. HIC offers ideas to start small, stay the course and end up with a sizeable nest egg. Time, compounding and world wide economic growth will help us achieve our goals.
--
RK
03/02/2007
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