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!
Sunday, June 29, 2008
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!
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