Derivatives Event Fallout Part III
Michael Panzner's excellent missive The Coming Disaster at Financial Sense Online regarding the dangers of derivatives gives me cause to issue a redux of our previous derivatives missives.
In Risk Management Part I & Part II, we explored the dangers of "monkey see, monkey do" risk management.
The use of similar risk management techniques by an increasing proportion of the financial system (asset managers, hedge funds, mutual funds, banks, insurance companies, etc.) leads, in times of crisis, to similar reactions by market participants to financial catastrophes.
The majority of institutional investors have similar investment goals, utilize similar risk models, react similarly to adverse conditions, and are subject to the same "vicious circle" of liquidity when a sell off occurs.
In In Yo Junk Bond My Ride & Derivatives Event Fallout Part I, we mused on the Ford & GM bond debacle and how most hedge funds could be driving on the wrong side of the road by betting on GM & GMAC debt diverging rather than converging.
We also commented on how GM & Ford's downgrades sent the least secured tranche the so-called "equity" tranche tumbling. As a result, equity tranche holders (many of them hedge funds) have been scrambling for cover, hedging their exposure. Rumor had it that some funds were struggling to meet margin calls.
The complex trades made by many hedge funds mean that any troubles, risk drawing in the counter parties, particularly banks, with which they conducted the trades.
In Derivatives Event Fallout Part II we discussed how Andrew Lo had calculated that returns for investors in hedge funds were anything but smooth and safe.
In fact, the calculations showed that the catastrophic losses of 1998 were preceded by a noticeable series of months of mediocre performance.
Mr. Lo's calculations further indicate that earlier this year the hedge fund industry may have already entered a period of lower returns that could be signaling a prelude to crisis.
In Risk Management Part I & Part II, we explored the dangers of "monkey see, monkey do" risk management.
The use of similar risk management techniques by an increasing proportion of the financial system (asset managers, hedge funds, mutual funds, banks, insurance companies, etc.) leads, in times of crisis, to similar reactions by market participants to financial catastrophes.
The majority of institutional investors have similar investment goals, utilize similar risk models, react similarly to adverse conditions, and are subject to the same "vicious circle" of liquidity when a sell off occurs.
In In Yo Junk Bond My Ride & Derivatives Event Fallout Part I, we mused on the Ford & GM bond debacle and how most hedge funds could be driving on the wrong side of the road by betting on GM & GMAC debt diverging rather than converging.
We also commented on how GM & Ford's downgrades sent the least secured tranche the so-called "equity" tranche tumbling. As a result, equity tranche holders (many of them hedge funds) have been scrambling for cover, hedging their exposure. Rumor had it that some funds were struggling to meet margin calls.
The complex trades made by many hedge funds mean that any troubles, risk drawing in the counter parties, particularly banks, with which they conducted the trades.
In Derivatives Event Fallout Part II we discussed how Andrew Lo had calculated that returns for investors in hedge funds were anything but smooth and safe.
In fact, the calculations showed that the catastrophic losses of 1998 were preceded by a noticeable series of months of mediocre performance.
Mr. Lo's calculations further indicate that earlier this year the hedge fund industry may have already entered a period of lower returns that could be signaling a prelude to crisis.
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