Posts tagged with risk

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.
  • Or say you wish that lucrative bridge loan’s IRR were applied to your entire portfolio—perhaps this is like a plant with rare seeds, or a plant that only takes in exactly perfect parts of your land.
  • 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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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.

The Audacity of Despair

by David Simon (creator of The Wire)

  • arch cynicism about the public purpose of television
  • The Wire is not hyperbolic about our inability to solve our own problems.
  • The news media buries and forgets relevant information.
  • New Orleans was not destroyed by Hurricane Katrina. An untethered barge breached the retaining wall, destroying the Ninth Ward.
  • Three years later during Hurricane Gustav, another barge was unsecured in the same canal.
  • The Wire is not about sinister people doing sinister things. There’s no fun in that. There’s no drag in writing a show about bad guys and good guys. First of all, it’s not credible. And second of all, it’s not where the real evil lurks.
  • As a reporter: “Every time someone dragged out a statistic, I immediately distrusted it as [probably fabricated or] dubious [method]”
  • Management: No sooner does someone invent a useful measure of institutional progress, than someone else begins to game it to the point that the measure becomes useless.
  • "In my city [Baltimore], every single effort to quantify progress was an effort by somebody to advance themselves.”
  • People are promoted or leave to another job before anyone figures out what they got was dross.
  • Cops retire with a pension despite making zero progress in 40 years in the war on drugs.
  • Why? is the only of the 5W’s+1H that matters. That could have made journalism “a game for grown-ups”.
  • Bulls∗∗t US government claims about progress in Vietnam.
  • More profitable for Chicago Tribune Company’s shareholders to stop asking Why?—and lay off reporters.
  • This was due to their monopoly: they didn’t need top-quality journalism to compete. But the drop in quality, if efficient at the time, made the papers soft targets when the Web became big half a decade later.
  • He thinks Internet reporting is less magazine-like and more frothy. I contend ∃ both.
  • Crime wasn’t going down anymore. So robberies became larcenies. Aggravated assaults became common assaults. Felonies were leached down to misdemeanors.” Robberies in southwest Baltimore went down 70%. The commander was promoted to head of CID. Next boss went in, crime went up 70%, he took the flack.
  • "40% decline in crime, but the murder rate stayed constant. [red flag] The only thing that that says rationally is that they’ve opened up a gun range in West Baltimore and they’re better shots.”
  • Any reporter who had any sense of his beat would know this was a huge red flag, would dig deeper into the data and call the complainants.
  • "How is it that we’re able to talk about this in an entertainment medium—television—but not in journalism?”
  • Curfew for Blacks in Baltimore (fallacious arrests). ACLU tries to sue, but by the time it wends its way through the courts the practice has stopped; the Mayor has become Governor.
  • "If you walk into The Other America and ask people how they feel about certain things, you’re likely to hear how they feel.”
  • "We stole facts from real life, but thematically the people we stole the most from were Euripides, Aeschylus, and Sophocles."


Spring 2011 Lapham’s Quarterly, “Lines of Work”
Another interesting space.


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."

It’s much easier to destroy than to build. I can destroy not just one £20,000 car, but all the £20,000 cars in a car park, with a little planning and maybe a few hundred expenditure (accelerants and matches). And I could do a decent job of destroying a car with only £10 (crowbar).

Nothing in his pockets but knives and lint.

Same with houses—fire for example is a very effective tool per-effort for ruining lives. Four skinny pirates with a modicum of guns & ammo can hijack a vessel that cost $10 million or $100 million to build.


File:Somali Pirates.jpg


Despite it being so easy to destroy, where I live things are quite peaceful. Nobody slashes all the tyres in a car park, for example. Why? Economic theory says that when the cost of something goes down we’ll see more of it. Shouldn’t this be true as well for the destruction of other peoples’ lives & property?

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I had a Managing Director tell me years ago … that the best strategy to succeed in investment banking was to keep your seat. Success would come, and success would go, but you could never enjoy the fruits of good luck or a heated market if you weren’t in a position where you could get paid. Young and naïve as I was, I remember finding this advice rather cynical and dispiriting. Surely you kept your seat and made lots of money for your firm because you were really good, because clients respected and trusted you, because you gave them great advice. Because you were better than anybody else. This was stupid on my part. He was right.

Nobody is indispensable in my industry. Nobody. Ever. For every hotshot trader or investment banker glorying in her run of luck and outsized compensation, there are twenty waiting in the wings who could do just as good a job. And a hundred who would be willing to work for half pay to prove they could do so too.

I’ve said it a billion times: in investment banking or sales and trading, you’re only as good as your last deal or your last trade. And your last deal or your last trade had much more to do with you being in the right place at the right time—being in the right seat—than with your charm, skill, or intelligence. And none of us know when the right deal is going to hit.

[T]here is nothing about your charm or intelligence that will distinguish you from the line of a hundred identical eager valedictorians waiting outside our hiring office. If anything, they’re probably hungrier and more naïve (hence more malleable) than you. Intelligence is table stakes.

The Epicurean Dealmaker (@EpicureanDeal)


Mega admire him for saying this.


I like this concept of “low volatility, interrupted by occasional periods of high volatility”. I think I will call it “volatility”.

Daniel Davies

via nonergodic


(PS: If you didn’t see it before: try plotting this in R:

vol.of.vol <- function(x) {
    dpois(x, lambda=dpois(x, 5)

… and so on, to your heart’s content.


Fun, right?)

99 Plays • Download

Pierre Bourdieu: “The way élites stay in power is not only by controlling the means of production, but by controlling ideas.”

Gillian Tett: “What if—just as I had studied the gap between rhetoric and reality among Tajik Muslims living in an atheist state (USSR)—I pretended I was a foreigner who had just landed in London,and in the same way looked at the gap between rhetoric in finance, and actual practice?”

  • the things we don’t talk about

Bourdieu: “The most powerful form of ideological effects, are those which need nothing more than a complicit silence.”

Upton Sinclair: “The hardest thing to get a man to understand, is what his job depends upon not understanding.”

  • a lot of media discussion of stock markets
  • some media discussion of currency markets
  • no discussion of bond markets
  • no discussion of the derivatives market

Gillian Tett: ”By studying the other, we can sometimes figure out something about ourselves.”

(Source: BBC)

I’m bored of #ff meaning follow Fridays. Let’s do Failure Friday instead and talk about things we’e failed at.

  • I failed an arithmetic test.
  • I failed judo class.
  • I failed to attract interest with my CV.
  • I failed to be married or have a stable job by my 30th birthday.
  • I failed an entrance exam.
  • I failed most of my writing assignments.
  • I lost an important contest.
  • I lost a race. Badly.
  • I lost a client I thought I had secured.
  • I failed a client I thought I could help.
  • I failed to get paid what I thought I was worth.
  • I failed to be honest in a romantic relationship.
  • I failed to do anything cool for a few years.
  • I couldn’t walk on a mountain because I was so out of shape.
  • I failed to wear sunscreen.
  • I failed to read the prospectus.
  • I failed to get into my preferred university.
  • I failed to get someone to fall for me.
  • I didn’t know what I wanted or how to get it.
  • I failed to keep in touch with old friends.
  • I failed to impress people.
  • I failed to advocate for myself.
  • I failed to do things on time.
  • I lost Other People’s Money.
  • I failed to come up with good ideas.
  • I failed to give it my all.
  • I failed to lose weight.
  • I failed to meet expectations.
  • I failed to look “put together”.
  • I failed to stay organised.
  • I failed to Get Things Done.
  • I failed to cook a good dinner.
  • I failed to recognise the obvious signs.
  • I failed to learn what I was trying to learn.
  • Things did not go according to plan.

NB: I don’t intend Failure Friday as a pity party. It just bugs me when people try to act flawless and successful. Infinitely wise with inerrant self-command. Even apparent failures are successes in disguise. Sorry stories modulate into major key as the lessons learned were invaluable rungs on the ladder of upward progress so in the end it all worked out for the best.

What is that? You’ll probably just make people who are already down feel worse by doing that. And not make anyone feel better.