Posts tagged with finance

In smile modelling or pictures of the term structure of options or bonds, one speaks of a “volatility landscape” or “risk landscape”.



That is assigning numbers to price-points and time-points; contingencies form a “surface”.


I tend to forget that for farmers, the actual landscape—the actual (sur)face of the Earth is itself the risk landscape.


  • Hillocks get more sun (could be good or bad depending on the cooling-degree days
    New Hampshirel CDD 1895-2009
    , the chance of frost, and the abundance of rain)
  • Dells and ravines get more water—which could be good if it’s dry,
    or catastrophic in case of flood.
  • Of course that depends on the crop type. Rice wants to be flooded. Even I know that.

  • And just like derivatives, agriculture has its term contingencies. Water in autumn is too late to grow the baby saplings but, too, a flood might not be as bad for the granary as it was for spring's seedlings.
  • Symbiosis between “funded” (planted) neighbours could result in a “value-added merger” if, for example, the bugs which are attracted to one plant fend off another plant’s predators.
  • A monogenetic crop could all be wiped out by the same disease.
  • Diversification, then, would seem to mirror finance as one wants to invest fully in the “cash crop” (let’s say a junk bond), but risks increase as eggs are concentrated in one basket.
  • If a farmer could get “negative correlated assets” (half the plants do better in dry; half do better in wet), that would reduce the “portfolio variation”.
  • Is there anything in finance that, like alfalfa, regenerates the “soil” for the next year’s crop?
  • We speak of “exposure” in finance—well, furrows in la terre literally change the exposure to the sun over the course of its chariot ride across the sky!

So you convolve the crop type with the weather it receives localised to its exact spot in the ground. (its place in the "field" — oh! I mean its place in the field!)

Is it possible, then, to apply the lessons of modern portfolio theory to crop selection?

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Flash Boys is deliberately set up to suggest a “perfect world gone bad” scenario: As if, prior to the advent of HFT, … nobody ever got bad fills and liquidity was provided by a fairy godmother who never skimmed. It is … irresponsible, … dumb and deceptive, … to … talk about HFT without talking about what HFT replaced.

… Why … did floor traders and market makers play a key role in the function of markets for multiple centuries? Because floor traders provide liquidity. Liquidity provision is a service, and it has a cost. A discussion of what HFT replaced—with examination of new systems, old systems, and continuity between the two, with attendant pluses and minuses [would have been better]. Yet for Lewis it barely [merits] a paragraph.

Liquidity has always been an issue. The more size you want to move, the more of an issue it becomes. There has always been a need for middlemen to provide it, and friction / incentive issues in doing so, ever since the fabled meeting under the Buttonwood tree.

In the late 1980s, the Justice department busted 46 traders and brokers in the Chicago trading pits. The stealing had gotten so bad, the FBI came onto the trading floor.

Flash Boys reveals itself as a tempest in a teapot on pages 52 and 64. (I speak here of the hardcover edition from Amazon.) When Lewis … uses real numbers, the frivolity of his case is revealed.

On page 52 … an HFT “tax” that amounts to $160 million per day on $225 billion worth of volume. That is significantly less than one-tenth of one percent.

's review of { Flash Boys by Michael Lewis }

The auction for capital has happened in such diverse places as under banyan trees, in coffee shops, in whore houses, near the sandal market (Egypt, Jerusalem), in a cave, at farm crossroads, near lake edges and river deltas, at magic springs, over a levee, in private country club gardens, etc.

The folks who made it more comfortable thrived (Mr. Lloyd, for example). The folks who made this process more uncomfortable eventually killed the golden goose (not many trades in Florence anymore, and it is all Savanarola and the Bishop’s fault. Bonfire of Vanities indeed).

user “Bachelier”

(Source: mail.nuclearphynance.com)

risk, however measured, is not positively related to (rational) expected returns. It goes up a bit as you go from Treasuries, or overnight loans, to the slightly less safe BBB bonds, or 3 year maturities. But that’s it, that’s all you get for merely taking the psychic pain of risk.

Just as septic tank cleaners do not make more than average, or teachers of unruly students do not make more than average, merely investing in something highly volatile does not generate automatic compensation. Getting rich has never been merely an ability to withstand some obvious discomfort.

@condoroptions Interviews Tadas Viskanta of Abnormal Returns - Part 1

  • brokerage model is broken. mutual fund model is broken. ETF’s are the wave of the future.
  • Minute 10. Did the U.S. equity premium dissolve during the lost decade of the aughties?
  • falkenblog
  • Minute 13. Do proper accounting. Many investors do not receive the headline equity premium due to tax, cost of intermediary services, etc.
  • Minute 15. We have to make decisions at some point. Let’s not count angels on pinheads.
  • Minute 17. First, second, third waves of ETF’s. (the most opinionated segment)
  • Minute 19. “It’s an ETF; how bad can it be?” You’re not getting spot natgas or spot oil. Watch out for the fund’s inefficient rolling of futures contracts.
  • "slow burn" approach to currency investing
  • Minute 22. The time cost of becoming an informed investor (currencies, options, futures, ETF’s, ….) 
  • "It’s really easy to blow up an account trading spot forex"
  • using options to sculpt your portfolio—trading what you understand to limit risk—rather than using leverage to take strong positions
  • liquidity an issue for less famous options
  • "Somebody who’s just trading $AAPL long and short is likely to get shook out of a trade"
  • "There are no good books"
  • PART 2
  • complexity — leverage — liquidity issues
  • cognitive biases & financial advisors
  • financial advisors as a buffer between your decisions and the market
  • advisors who mirror what their clients say
  • Minute 3. Higher turnover by those who hold higher-volatility asset classes.
  • Minute 7. There are a lot of things [non-UHNW] people can do with their lives that generate a lot better financial return than fighting for an extra 100 basis points per year. (e.g., saving). We have infinitely more control over our personal choices than over the markets or whatever products we invest in.
  • Minute 8. People chasing higher yield without understanding what they’re doing.
  • Minute 9. Josh Brown does a post every year reviewing what was the “hot thing” that year. You don’t have to be in it.
  • You’re your own portfolio manager. You get to define success for yourself. That does not mean you need to match the S&P.
  • media consumption — a “liberal arts” or “consilience” or “cross-disciplinary” approach to financial news
  • Minute 12. Individual investors are actually more free than institutional investors, in that their time horizons are quarterly, daily, and annual.
  • Minute 16. Viskanta: In 20 years, brokerages will have automated tools for individual investors. (algorithmic)
  • "the long march of indexing" — Viskanta: people either are or will over-index
  • fracking totally broke the long-run correlation between oil and natgas — an unforeseeable technology

It’s true that the financial sector enjoyed disproportionate rents but it’s not true that the smartest and brightest work there. …[T]he place is littered with failed scientists. Worse, it’s littered with idiot savants. There are once in a while people working there who have trained for the job — Very good PhDs in finance and economics, for example, or good M&A lawyers, and they usually strike me as the ones who offer the best contributions to their organizations.


cf, Eric Falkenstein

(Source: condoroptions.com)

Two interesting ideas here:

  • "trading time"
  • price impact of a trade proportional to exp( √size )

Code follows:

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(Source: finmath.stanford.edu)

I’m trying to do retrospectives on financial predictions as I stumble across them on the Web. Here’s one that turned out correct: @EpicureanDeal said not to buy Blackstone Group when it went public.

"A little knowledge is a dangerous thing." Like, say, a little knowledge of cool and funky rich people or private equity deals from the paper. I’d rather be financially illiterate than taken hold of this bag.

From 35, to 25, to 15, to 5. Since the market bottom $BX has quintupled which is basically in line with the S&P.

Correlation since 2008 of the S&P to $BX has been 95%, so you can rule out a “complementary growth” argument for the buy.

Reproducible analysis:

reChart(up.col='yellow', dn.col='light blue', color.vol=FALSE)
chartSeries(BX/SPY)         #quantmod automatically matches subsets for you!
reChart(up.col='yellow', dn.col='light blue', color.vol=FALSE)
bx <- BX['2008:']
sp <- SPY['2008:']

An Insider’s Perspective on the Basel Reforms (por stanfordbusiness)

  • regulatory framework contributed to market uncertainty over distresed banks
  • worried about transmitting financial distress to real economy
  • reduce procyclicality
  • focus on interconnectedness
  • trying really hard not to screw things up worse
  • trying to avoid unintended conequences … although some consequences were intended
  • common equity may be the only thing that really matters
  • didn’t intend Basel II to incent hybrid capital
  • even though Basel III didn’t increase capital requirement ratios much, it did increase the required capital simply by redefining risk
  • distressed banks, in order to save face, were paying dividends and buying back shares—blowing out their capital base—because if they conserved like they needed to, the market would smell blood and eat them
  • prior to the crisis of 2008, even regulators weren’t clear on why capital requirements were necessary or what capital actually meant
  • "tie our own hands"
  • countercyclical buffer
  • capital conservation is no longer about solvency or market perceptions: it’s about having enough capital to withstand a period of market stress and still being solvent even during the duress
  • "to state the obvious, we can’t know what «the capital level at which the firm would be viewed as viable by the market»"
  • trying to find a real-world 99% confidence interval for firm failure
  • (not easy, since probability doesn’t exist)
  • empirical 99% risk-weighted loss
  • "eye of the beholder"
  • "leap of faith" (#econometrics)
  • "translating fun things like economics into real things like accounting is challenging"
  • only have Basel I and Basel II risk classifications, can’t find out what Basel III risk-weighting will be
  • requires a lot of “judgement” (I could think of a less nice word for that)
  • We have never seen the market’s worst because the Federal Reserve stepped in in 2008—so we really don’t know the most catastrophic case that banks might self-insure at.
  • Basel III requires 4.5% minimum capital ratio (Basel I was 4%-6%). “How did we get the half percent? Having sat in the room the whole time I’m still not sure how we got a half percent.”)
  • …plus Capital Buffer 2.5%
  • …plus Counteryclical Buffer up to 2.5%

Audience questions

  • Evan Pico, $C: Why assume wholesale credit can go all the way to zero?
  • "We’re trying to assume something worse than history could happen.”
  • The Basel Committee bases its rules not on the firms that did OK in the crisis but on failed banks—which if they weren’t acquired would have failed even harder—and on what might have happened if X,Y,Z hadn’t saved our arses as much as they did. Worst case scenario.
  • observation period
  • Mimi Mangus, Union Bank: QIS template. We don’t have the data to calculate LCR or NSFR. So it seems like you’re analysing B.S. Are we supposed to pay money to answer your questions?
  • MM: “Regional banks don’t have 100% Liquidity Coverage Ratio like Goldman. We hold a lot of GSE’s, MBS, and traditional loans. Maybe we need to replace Fannie and Freddie with a member-bank mutual.” Comparison of US to Australia.
  • "We want collateral to be liquid both in private markets and through the central bank."
  • "I have new sympathy for people who try to predict climate change—predicting something uncertain in the future with very certain costs in the now."

Buffett&#8217;s call

Buffett’s call