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Jim Simons, a hedge fund manager, to the US Congress: “Most culpable [for the crisis of 2008], in my opinion, were the ratings agencies.”

  • "Our strategies are usually contrarian."
  • "Medallion Fund is almost entirely employee-owned."
  • "We charge ourselves fees."
  • 'In my view hedge funds were not a major contributor to the [crisis of 2008]. Generally [they] have increased liquidity and reduced volatility in the markets.”
  • "Each hedge fund’s leverage is controlled by its lenders."
  • He’s in favour of more financial regulation.

CSPAN via NYT




Say you find a sucker and you make a bet with him. A bet that is so good for you and so bad for him that you can barely believe he signed on to it. You are smirking inside and when you’re not facing him anymore you break into gleeful, villainous laughter.

A couple months later the contract comes due. You find the sucker and he has made dumb bets all over town. He’s cleaned out and you can’t draw blood from a stone.

That’s counterparty risk.




"Pricing" risk means, in part, assessing the probability of some sh*tty outcome.

Like, “Well, Baggins, what are the chances that…

  • interest rates move against us?”
  • the company defaults on its debts?”
  • a chain reaction based in the short-debts of South Asian markets triggers a worldwide fear of Russian default, thus causing a prolonged period of high volatility that nearly wipes out the American financial sector because of a single highly-leveraged hedge fund run by Nobel laureates?”
  • you make me a mustard sandwich?”

It means more, though, because of risk aversion, loss aversion, and the interaction of one investment with others in one’s portfolio.




The point of statistical arbitrage is to make markets consistent. For example, if

  • GBP trades against USD at 2:1, and
  • USD trades against JPY at 10 000:1, then
  • GBP had better be trading against JPY at 20 000:1 !!

! Anything else wouldn’t make sense. Wouldn’t be fair either. The Japanese shouldn’t get a better or worse deal vis-à-vis the British than anybody else.

So stat arbs look for inconsistencies across markets — across currencies, products, different issues of the same stock — and trade against them.

(Source: matlab.com)




CAPM assumes a positive correlation between risk and reward. The exact opposite is true with value investing. If you buy a dollar bill for 60 cents, it’s riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case.

One quick example: The Washington Post Company in 1973 was selling for $80 million in the market. At the time, that day, you could have sold the assets to any one of ten buyers for not less than $400 million, probably appreciably more. The company owned the Post, Newsweek, plus several television stations in major markets. Those same properties [were] worth $2 billion [in 1984], so the person who would have paid $400 million would not have been crazy.

What’s the social function of Warren Buffett's style of value investing? It saves worthy, established companies from being unfairly shorted below a base sanity valuation.

Consider that large companies have more employees, more customers, and more suppliers. Saving them is like stopping a large swath of forest from burning.

But for my personality type, I’m not as interested in big, publicly held companies. Maybe it’s unreasonable of me. But I am more for shorting the big dogs (the over-valued ones) and for longing the small guys (the ones that just need to be given a chance).

I think that’s more exciting and more interesting. Maybe it’s also more speculative; maybe you have less control over the risk.

(Source: amazon.com)




In 1949, the total value of listings on the New York Stock Exchange was $150 billion. In 1984, the total value of all US public equities was $2 trillion. In 2005, the total value of Big Board listings was $20 trillion, plus $3 trillion listed on NASDAQ.

Then, from Oct 2007 - Oct 2008, US stock market capitalization lost $7 trillion.

various sources including several versions of The Intelligent Investor

(Source: seekingalpha.com)




Antifragility

Nassim Taleb wants us all to go long vol — not just be able to withstand volatility, but to actively seek it out.

He can certainly bet that way (and does — though it’s not paying off), but it’s a bad idea to make society anti-fragile.

Let me define a few words describing potential responses to volatility:

  • fragile — Taleb means systems that break when catastrophic volatility is applied; he’s thinking of people who deep short volatility or at least indirectly bet on stability
  • robust — like a bridge, or an earthquake-resistant building: built to withstand shocks
  • agile — able to adapt to shocks
  • anti-fragile — shock-loving; shock-seeking; volatility-loving; risk-avid

Taleb points out that there is no word for "the opposite of fragile”; only for “not fragile”. True.

But we really shouldn’t try to make the system break in the case of no catastrophes. Imagine a bridge that shattered only-and-always, when no cars drove on it. Or a building that toppled only-and-always, when no earthquakes were shaking it. (Those would be anti-fragile things.)

It would be stupid to build things that way. Same with the financial system — we want to be prepared for bad times but also, ready to capitalise on good times. A mouse who’s so afraid of cats that it never goes to look for food, will die.

What makes anti-fragility an especially bad idea in finance, is that people might try to sabotage, tweak, or influence the system to make their bet pay off. Let’s say some powerful crook is long volatility — that is, s/he will only get paid if some huge catastrophe happens within the next year. Maybe s/he will engineer a catastrophe. That could be truly terrible.

UPDATE: @nntaleb has clarified on twitter that he does intend “antifragility” to mean “long gamma”.

UPDATE 2: Jared (@condoroptions) suggests at minute 30 of this Volatility View podcast that @nntaleb must mean long convexity, not long gamma. I interpret that to mean buying stability, selling normal levels of volatility, and buying extreme levels of volatility. In other words things will usually stay the same, but when they change they’ll change more than people expect.
That answers the finance part. I still don’t see how to practically design real things to be antifragile without giving up normal functionality under typical circumstances.




Derivatives contracts allow you to make bets on an asset without owning it. Like a side bet. I don’t have to own, watch, or like the Dallas Cowboys to bet on their success / failure.

You can bet on a company by buying its stock, or you can bet someone that it will go up. The latter is a derivative contract. Today the $$$ value of side bets exceeds the trading in original securities by a factor of 40.

For example there is $800 million worth of wheat (3 million metric tonnes) in the world — or at least that’s this year’s production of hard red winter wheat #1, ordinary protein.

But on the Chicago Board of Trade alone there were 22 million bets this year, betting about those 3 million MT.

Supposedly there are $1 quadrillion worth of derivatives contracts being traded today.

People talk about it like it’s a bad thing — but it’s neither good nor bad, by itself. It’s scary for regulators because they can barely measure, much less control, what people are doing with their money. They worry about systemic collapse on the one hand, if people make correlated mistakes — but on the other hand, if they over-regulate then they will choke off freedom of property.





Volatility

Volatility, in finance, refers to the wiggliness of the time series. You observe the price of a security go up and down over time. If it changes a lot, that’s high vol: unstable, unpredictable. If it changes only a little, that’s low vol: stable, consistent.
There are many ways to define volatility, just as there are different ways to measure distance. Portfolio variation should be measured with a quasimetric (unidirectional metric).
But for all those definitions, it should mean roughly: the magnitude of change in the price, during some time interval.

Volatility

Volatility, in finance, refers to the wiggliness of the time series. You observe the price of a security go up and down over time. If it changes a lot, that’s high vol: unstable, unpredictable. If it changes only a little, that’s low vol: stable, consistent.

There are many ways to define volatility, just as there are different ways to measure distance. Portfolio variation should be measured with a quasimetric (unidirectional metric).

But for all those definitions, it should mean roughly: the magnitude of change in the price, during some time interval.


hi-res




The point of high-frequency trading is to smooth markets over time.

Imagine that you know a big block order is coming in. Some huge pension fund needs to send 70,000 checks out next week so they’re selling some asset.

The asset’s price doesn’t really deserve to go down. The fund just wants to cash out. So you buy the huge block order and dole it out in smaller pieces as regular buy orders ebb in over the next few weeks. Or, you know, minutes.

You just smoothed the asset’s price, as well you should.

That’s not ultra-high-frequency trading — which is more about having the fastest technology — making it possible to liquidate a position RIGHT, RIGHT, RIGHT now.