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On Systemic Risk - Black Swans Or Market Innovations?
Institutional Risk Analyst's Chris Whalen together with Dennis Santiago and former NY Fed economist Richard Alford take on the topic of systemic risk, and present it in a unique light. (pdf link)
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Spot on
Just read the post at the IRA. Makes for quality discussion and thought provoking reflection.
The "Black Swan' approach assumes a stable distribution of price changes with fatter than "normal" tails. The alternative posits that the distribution of possible price changes was altered by innovation and the low cost of leverage. It also posits that the new distributions allowed, indeed require, more extreme price movements.
Thanks for posting this one TD.
I am encouraged and dismayed at the same time. What did I learn? That VaR models use normal distributions. What the flying fuck on that one! ANY system that incorporates human emotions and insider information will never have a normal distribution. So that is the dismayed part.
The encouraged part is how easily one can expose this "no one saw this freak occurance coming" argument is exposed as BS.
I very much appreciate that their alternate hypothesis to the black swan framework utilized the imagery of jumping to different quantum levels. It very much squares with Koo's idea of the balance sheet recession where a shift in what is being optomized (reducing debt as opposed to maximizing profit) causes a sudden shift in where the market clears.
Normal distributions are the wrong fit overall but there is no distribution for panic or mania that fits with any model, or at least one you're trying to sell.
i thought 'black swan' was the name of the bizarro-world deus ex machina who messes up our 'win-win' situations. oh cruel demiurge!
LISTEN UP....JUST HEARD THE USD IS GOING TO COLLAPSE....PLEASE CONFIRM THIS....
Heard from whom?
I confirm.
now what?
"However useful or necessary "normal" statistical measures such as VaR might be, it will not be sufficient to insulate institutions or the system from risk arising from rapidly evolving market structures and practices."
If 'practices' is a euphemism for 'fraud', and the leverage yielded from such 'practices', there can be no disagreement on this point. Of course, a most effective manner to insulate the system from such institutional risk is to allow failure or force unwinding of an institution engaging in such 'practices'. Instead, by socializing the risk, we've got a set of measures in place which essentially is as logical as stating 'heroin is not a gateway drug'.
Need a picture of Bernanke and Tim "Eddie Haskell" Geithner under duress. Anyone have one?
Hard to find a photo of that. Had to settle for one sans Little Timmy:
http://punditkitchen.files.wordpress.com/2008/12/political-pictures-paul...
Not under duress.
Merely being questioned by Maxine Waters.
Since Ron Dellums is no longer there..
Just need a pic of Timmy covering his ears, to complete the monkey picture. This begs a skilled Photoshop.
Quantum economics
http://www.youtube.com/watch?v=vQpEI0Rz41M
exactly
Goldman and Bank of Amerika run the markets along with Geithner, and beagle boy Ben. There is no free markets, only welfare capitalism and socialism for capitalism.
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
Duh! Missed something?
After the fact, the event is rationalized by hindsight, as if it had been expected.
A well-summarized reminder that we still stare headlong into illiquidty-insolvency and those who may have (or had) the greatest capacity steer us clear of crashes are incapable of doing so.
Damn good paper. I have to pass this around to my friends.
I looked at few private MBS deals in 05-06. These deals were built on two assumptions. (1) A zero probability of a nation wide RE decline. (2) A zero probability of a decline in any one region greater than 10% in any given year. That was crazy. As discussed in this piece, things happen. But MBS was not a Black Swan. This was not some creature that jumped out and surprised us. It was out in the open, swimming in the same lake as the originators of the swill MBS.
The folks that were doing this knew it would end bad. They were just making too much money to leave the table. The big error was misjudging how fast things could move once they got moving. There was a recognition of the risk. The assumption was that liquidity would be sustained and positions reduced with manageable losses. A month before LEH went under there no liquidity in major asset classes. There was no exit from the ship.
Financial innovation was a euphemism for "more leverage". It led to the jump in Vol and the resulting illiquidity.
Come on, be fair to Taleb. He never said the financial crisis was a black swan. Go read his site.
Black Swans are a good explanation for some phenomena as for example a solar flare event that knocks out the powergrids all over the world.
You know it could - and over a long enough timeline will - happen but you don't know when. It could strike tomorrow or in 100 or in 1000 years. In any case it would be easy, but costly, to prepare for that, simply by hardening the powergrid. This however, would eat into executives pay and investor dividends, so it is not done under the assumption that such an event is 'extremly unlikely'.
Even though the assumption is wrong, it is a convenient one (for executives and investors). The math used to justify the assumption is just the fig leaf used to cover this - in essence reckless and egoist - choice by the executives and investors.
In control fraud, not only accounting becomes a tool for fraud, but also math and science in general.
The financial crisis, on the other hand, is not a black swan event even by Taleb's own definition. The setup of the financial system practically guaranteed the outcome we are now seeing. There is no surprise there.
So Taleb's remarks and concepts are useful in general. They just don't apply in this case of the financial crisis. Black swans are usually well seen in advance as 'possibilities' but not acted on for (mostly) convenience or costs by adjusting one's 'assumptions' about reality.
http://www.examiner.com/x-2383-Honolulu-Exopolitics-Examiner~y2009m3d27-Electrical-power-grid-to-be-blasted-by-2012-solar-storms
http://science.nasa.gov/headlines/y2006/10mar_stormwarning.htm
from NASA: "History shows that big sunspot cycles 'ramp up' faster than small ones," he says. "I expect to see the first sunspots of the next cycle appear in late 2006 or 2007—and Solar Max to be underway by 2010 or 2011."
Who's right? Time will tell. Either way, a storm is coming.
We have had massive solar flares before. The biggest was the carrington event.
In September of 1859, the entire Earth was engulfed in a gigantic cloud of seething gas, and a blood-red aurora erupted across the planet from the poles to the tropics. Around the world, telegraph systems crashed, machines burst into flames, and electric shocks rendered operators unconscious. Compasses and other sensitive instruments reeled as if struck by a massive magnetic fist. For the first time, people began to suspect that the Earth was not isolated from the rest of the universe. However, nobody knew what could have released such strange forces upon the Earth–nobody, that is, except the amateur English astronomer Richard Carrington.
http://www.newscientist.com/article/mg20127001.300-space-storm-alert-90-...
http://www.spaceweather.com/
Still no sun dancers. But when they come they are going to be jumping hard.
http://www.youtube.com/watch?v=fNu9wp3tYdU&feature=related