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

[David Farber <dave () farber net>]

Begin forwarded message:

> From: "David P. Reed" <dpreed () reed com>
> Date: October 23, 2008 7:09:31 AM EDT
> To: dave () farber net
> Cc: ip <ip () v2 listbox com>
> Subject: Re: [IP] Re:   Credit Default Swap (CDS) - Lehman Final  
> Results In
>
> I find this "valuation" of CDS's fascinating, because of the  
> following "law":  Black Scholes option valuation says that the value  
> of a security that derives value from an underlying *uncertain*  
> asset is dependent on the product of the underlying asset value and  
> the volatility of that asset.   To be worth zero, under Black- 
> Scholes, one needs both a very low volatility and a very low  
> underlying asset value.
>
> CDS's *should* follow Black Scholes.  It's the "bible" truth.  Yet  
> we have a very *high* volatility (uncertainty) in the underlying  
> assets!  Nearly infinite - because we cannot predict the future.  So  
> the "bible" appears to be wrong.
>
> Now this is where the mathematicians of finance lost it, and the  
> physicists failed to remember their culture.   The "bible" depends  
> on some assumptions.  Those assumptions are no longer written down.   
> It is assumed that the market will never move to a state that  
> violates such assumptions.
>
> I can share the math with you if you want, but it would be simpler  
> if you just go and buy Dixit and Pindyck's "Investment under  
> Uncertainty", which beautifully explains it all so that a  
> mathematician and physicist can understand it.
>
> The paradox is resolvable.   The mathematics are based on core  
> assumptions that fail to scale.  Yet the "market" is at scale, not  
> at the micro level where Black Scholes holds true.  Greed - the  
> attempt to scale to become masters of the universe - falsified the  
> assumptions of the greedy modelers.
>
> David Farber wrote:
> > Begin forwarded message:
> >
> > *From: *"Norman MacLeod" <gaelwolf () waypt com <mailto:gaelwolf () waypt com 
> > >>
> > *Date: *October 22, 2008 9:31:56 PM EDT
> > *To: *<dave () farber net <mailto:dave () farber net>>
> > *Subject: **RE: [IP] Re:    Credit Default Swap (CDS) - Lehman  
> > Final Results In*
> >
> > OK . . . so it’s a good thing that the Depository Trust and  
> > Clearing Corporation has valued CDSs at 1.3 cents on the dollar?
> > . . . and what then is the face value of all those other CDSs out  
> > there in the wild?  If they are redeemable at similar values . . .  
> > what does that do to the global economy?
> >             Norman
> > *From:* David Farber [mailto:dave () farber net] *Sent:* Wednesday,  
> > October 22, 2008 5:18 PM
> > *To:* ip
> > *Subject:* [IP] Re: Credit Default Swap (CDS) - Lehman Final  
> > Results In
> >   Begin forwarded message:
> > *From: *Steve Rayson <steverayson () hotmail com <mailto:steverayson () hotmail com 
> > >>
> > *Date: *October 22, 2008 5:58:32 PM EDT
> > *To: *<dave () farber net <mailto:dave () farber net>>
> > *Subject: **RE: [IP] Credit Default Swap (CDS) - Lehman Final  
> > Results In*
> > http://dealbook.blogs.nytimes.com/2008/10/22/lehman-debt-swaps-settled-for-52-billion/
> > Sellers of insurance on *Lehman Brothers* debt made net payments of  
> > $5.2 billion to settle an estimated $400 billion or more in credit  
> > default swaps, the *Depository Trust and Clearing* Corporation said  
> > Wednesday.
> > As predicted, the net payments were a fraction of the $400  
> > billion.  Its interesting to me that despite the fact that the  
> > Depository Trust and Clearing Corporation said this was going to  
> > happen, there was still lots of fear last week that the number was  
> > going to be in the 100's of billions.
> >
> > -Steve
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