Re: Credit Default Swap (CDS) - Lehman Final Results In

[David Farber <dave () farber net>]

Begin forwarded message:

From: "Marc Aniballi | Personal" <marcaniballi () gmail com>
Date: October 23, 2008 11:05:57 PM EDT
To: <dave () farber net>, "'ip'" <ip () v2 listbox com>
Subject: RE: [IP] Re:    Credit Default Swap (CDS) - Lehman Final  
Results In

Hi Dave;

Bruce's statement really strikes me oddly. Is this sarcasm? Disgust?  
Or his view of reality, rhetorically stated.

Any analytical model for a market that becomes generally accepted will  
cease to be relevant, because its application to the market causes the  
market to change.

I've always found "leverage" to be the most interesting thing. It is  
based on the idea the markets are generally predictable (who ever came  
up with that idea?!). "Margin," the amount of money you must "put up"  
in order to "control" a certain asset is based on the expected  
fluctuation of that asset over a specific timeframe. (B&S model is one  
way to calculate this, albeit no longer very reliable). So in stock  
markets, there is a 2:1 leverage, generally (for individual investors)  
and sometimes a 4 or more:1 for day traders. This is because the  
expectation is that the stock won't likely lose 50% of its value very  
quickly (allowing the broker time to call the loan before you go into  
negative territory) - Day traders get higher leverage because they  
must close positions before EOD and intraday losses are rarely 25% of  
a stock's price. This works in general, but as we saw in 2000-2001, a  
lot of individual investors (and institutional ones too) got caught  
when many stocks did just that.

In derivatives, the leverage can be much larger. A currency trade can  
easily support 100:1 leverage ($1000 controls $100,000) because (using  
USD as an example) currencies rarely move an entire penny in a day  
(also, since this is a cash trade, the broker can automatically close  
out high risk positions with little loss). And a move of 1 penny on a  
$100,000 position equals $1000. However (again) recent markets show  
how this is not always the case.

Now these derivatives are very close to their underlying assets  
(stocks, currency, etc.) - CDSs are (as has been beautifully  
illustrated on your list (too bad mainstream media isn't picking it  
up!) much more obscure.

I suppose the best way to look at this is: If you buy and sell actual  
assets (stocks, bonds, commodities, etc.) then you already accept the  
vagaries of supply and demand and at least have some nominal assurance  
that the asset you purchased has some intrinsic value (you can eat  
your corn, if you can't find someone to buy it!).

If you buy or sell derivatives in order to "insure" your existing  
assets (and you trust that the insurer can remain solvent if you ever  
need to collect), then you are also fairly safe, since you still have  
(or have the right to) an asset of some kind. (Now if your assets are  
also questionable, then you really need to re-evaluate your business/ 
investment models!!)

The danger is when you decide to speculate (be the "risk manager") in  
derivatives. The role of speculator is risky, and is no different than  
gambling (not casino gambling, more like basement poker) - However, if  
you go to a casino, gamble, borrow more to gamble, and then lose it  
all, you have no one to blame but yourself, and gentlemen will show up  
on your doorstep with a request for payment, usually backed up by a  
baseball bat.


Marc Aniballi

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-----Original Message-----
From: David Farber [mailto:dave () farber net]
Sent: October-23-08 8:20 PM
To: ip
Subject: [IP] Re: Credit Default Swap (CDS) - Lehman Final Results In



Begin forwarded message:

From: Bruce R Koball <bkoball () well com>
Date: October 23, 2008 2:57:21 PM EDT
To: David Farber <dave () farber net>
Cc: ip <ip () v2 listbox com>
Subject: Re: [IP] Re:    Credit Default Swap (CDS) - Lehman Final
Results In

and the failure of Black-Scholes was at the center of the Long Term
Capital meltdown, yes?

-brk-





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