short selling

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pages: 369 words: 128,349

Beyond the Random Walk: A Guide to Stock Market Anomalies and Low Risk Investing by Vijay Singal

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Andrei Shleifer, asset allocation, capital asset pricing model, correlation coefficient, cross-subsidies, Daniel Kahneman / Amos Tversky, diversified portfolio, endowment effect, index arbitrage, index fund, locking in a profit, Long Term Capital Management, loss aversion, margin call, market friction, market microstructure, mental accounting, merger arbitrage, new economy, prediction markets, price stability, profit motive, random walk, Richard Thaler, risk-adjusted returns, risk/return, Sharpe ratio, short selling, transaction costs, Vanguard fund

Large brokerage houses will generally disallow short selling of lowpriced stocks (less than $5) because they tend to be illiquid and highly volatile, increasing the risk for the broker. While the process of short selling is complicated, it becomes easier to implement once a short seller has executed a couple of trades. Note that short selling is also riskier than going long. In the arbitrage strategies described, the short position will always be hedged to minimize that risk, but the hedge may break. For example, in stock mergers, a short position on the bidder is hedged with a long position on the target. However, if the merger is called off, the long position ceases to be a hedge. 325 326 Appendix B: Short Selling RESTRAINTS ON SHORT SELLING There are several reasons why short selling is complicated and discouraged.

The evidence presented above supports the role of speculative short sellers in contributing to the weekend effect. Some other observed facts related to the weekend effect are also consistent with the short-selling explanation: • The weekend effect has been in existence for more than a hundred years: Short selling has been permitted on U.S. exchanges since 1858. After the stock market crash in 1929, there was an attempt to curb the practice. However, short selling was actually disallowed on only two days in 1931. New rules governing short selling were introduced by the SEC under the Securities and Exchange Act of 1934. • Friday returns are lower when there is Saturday trading: Consistent with the short selling explanation, short sellers may wait until Saturday to close their positions, reducing the Friday return. • The weekend effect is larger around long weekends: When the market is closed for a holiday weekend, more short sellers are likely to close short positions by buying back on the last trading day of the week and reopen their positions after the market reopens.

But investors must include foreign stocks. 13% to 15% per year Mutual funds Individual stocks; short selling is optional Individual stocks; shortselling is optional Individual stocks; short selling only for stock mergers Mutual funds; American Depository Receipts; ETFs Currency futures Easy with funds already identified; difficult to find new funds Not difficult without shortselling Easy without short-selling Easy for cash mergers; marginally difficult for stock mergers Easy Easy 30 minutes one hour two hours three hours one hour three hours 15–50 Many About 50 20 to 100 A few 10–12 *Abnormal return is the return in excess of the normal return associated with this level of risk. xiii xiv Preface Buying stocks or selling stocks that you own is easy. However, short selling (selling stocks that you do not own) is a somewhat different and more complex strategy and is described in that appendix.

 

pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

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algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, mortgage debt, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

—Bernard Baruch, testimony before the Committee on Rules, House of Representatives, 1917 Furthermore, short-selling comes with other benefits. It allows hedging. It makes markets far more liquid, reducing investors’ transaction costs. Short-selling makes markets more liquid by making market prices more informative, by increasing turnover, and by allowing market makers to provide liquidity on both sides of the market while hedging their risks. Hence, overall allowing short-selling is clearly the right decision as short-selling is for the better. Does this mean that short-selling can never be associated with misbehavior? Of course not. If short sellers are trying to manipulate the market, this is clearly wrong and illegal, but price manipulation is wrong and illegal both when traders are buying and when they are short-selling—so this is not specific to short-selling (e.g., “pump and dump” is price manipulation on the long side).

—David Einhorn Policy makers and the general public also sometimes want to fight short sellers: Policymakers and the general public seem to have an instinctive reaction that short selling is morally wrong. Short selling has been characterized as inhuman, un-American, and against God (Proverbs 24:17: “Do not rejoice when your enemy falls, and do not let your heart be glad when he stumbles”). Hostility against short selling is not limited to the United States. In 1995, the Finance Ministry in Malaysia proposed mandatory caning as the punishment for short sellers. —Lamont (2012) Lamont (2012) further documents how the U.S. Congress held hearings in 1989 on the problems with short-selling, during which a representative described short-selling as “blatant thuggery.” During the hearings, however, an SEC official testified that many of the complaints we receive about alleged illegal short selling come from companies and corporate officers who are themselves under investigation by the Commission or others for possible violations of the securities or other laws.

People start with the idea: How can you sell something you don’t own? And then once you start down that path, it’s much harder to get people to think about it, in the form of the marketplace. But then I point out to them that insurance is a giant short-selling scheme. Much of agriculture is a giant short-selling scheme. You’re selling forward what you don’t have yet, with the idea that you will replace it later at a profit. When an airline sells you an advance purchase ticket, they’re short-selling you a seat. All kinds of business are done on a short sell basis, where you get money up front, and you get the goods or services later. People often make the analogy that short-selling is like taking fire insurance out on someone else’s house, but there is an important difference. The difference is that if you imagine a person taking insurance out on someone else’s house, then you’re making the next leap of faith that the person is going to commit arson.

 

pages: 193 words: 11,060

Ethics in Investment Banking by John N. Reynolds, Edmund Newell

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accounting loophole / creative accounting, banking crisis, capital controls, collapse of Lehman Brothers, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, discounted cash flows, financial independence, index fund, invisible hand, margin call, moral hazard, Nick Leeson, Northern Rock, quantitative easing, shareholder value, short selling, South Sea Bubble, stem cell, the market place, The Wealth of Nations by Adam Smith, too big to fail

As neither (i) selling a share, nor (ii) being in a short position is in itself normally unethical, it is difficult to see the act of short-selling a share (or an index or a commodity) as intrinsically problematic from an ethical perspective, although this is not to say that shorting cannot be abusive for reasons already stated. It is likely that all major banks and investment banks participate in some of their activities either in short-selling or in facilitating short-selling. Short-selling: Market evidence Both the US and the UK implemented short-term bans on shortselling. Both bans were subsequently terminated. In September 2008, short-selling was seen as a contributing factor to undesirable market volatility in the US and subsequently was prohibited in the US by the SEC. The SEC banned for three weeks short-selling on 799 financial stocks to boost investor confidence and stabilise those companies.

These ethical problems are akin to unauthorised trading, in that they are clearly unethical, rather than being ethically more complex, as with short-selling. Short-selling At the time the financial crisis was unfolding, short-selling was presented by some politicians and parts of the media as one of the major “abuses” of the financial crisis. It was blamed by some banks and Governments for destroying, or attempting to destroy, (quoted) banks. As such, it is in a different position from other practices, in that it was not illegal in most jurisdictions at the time, although it had previously been subject to some ethical concerns. Recent Ethical Issues in Investment Banking 95 The ethical position of short-selling is straightforward: it is not, in itself, unethical. Shorting can be broken down into two clear component actions: selling a share, and owing a share.

To owe something is also not unethical. However, shorting as part of some other unethical activity, such as market manipulation or insider dealing, would normally be unethical from the perspective of both intention and consequences. The actual act of short-selling is no more than selling a share. It is difficult to consider this in itself as unethical. The driver for short-selling is to profit from share price movements. Profiting from a different investment view is a component of buying shares, as well as shorting, and is a well-understood fundamental basis of economic behaviour. It is true that short-selling can be abused: it can be used to move market prices for abusive reasons, for example in cases where an investor stands to profit from the insolvency of a company due to a short position (or holding credit default insurance such as CDS); it can be used to facilitate insider dealing; and it can be used to deliberately create distress in a company or for an investor.

 

Mathematics for Finance: An Introduction to Financial Engineering by Marek Capinski, Tomasz Zastawniak

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Black-Scholes formula, Brownian motion, capital asset pricing model, cellular automata, delta neutral, discounted cash flows, discrete time, diversified portfolio, interest rate derivative, interest rate swap, locking in a profit, London Interbank Offered Rate, margin call, martingale, quantitative trading / quantitative finance, random walk, short selling, stochastic process, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

Example 5.12 (3 securities without short selling) For the same three securities as in Examples 5.10 and 5.11, Figure 5.8 shows what happens if no short selling is allowed. All portfolios without short selling are represented by the interior and boundary of the triangle on the w1 , w2 plane and by the shaded area with boundary on the σ, µ plane. The minimum variance line without short selling is shown as a bold line in both plots. For comparison, the minimum variance line with short selling is shown as a broken line. 114 Mathematics for Finance Figure 5.8 Portfolios without short selling Exercise 5.14 For portfolios constructed with and without short selling from the three securities in Exercise 5.12 compute the minimum variance line parametrised by the expected return and sketch it a) on the w2 , w3 plane and b) on the σ, µ plane. Also sketch the set of all attainable portfolios with and without short selling. 5.3.2 Efficient Frontier Given the choice between two securities a rational investor will, if possible, choose that with higher expected return and lower standard deviation, that is, lower risk.

In this case the portfolio with minimum variance that corresponds to s0 involves short selling of security 1 and satisfies σV < σ1 . For s ≥ s0 the variance σV is an increasing function of s, which means that σV > σ1 for every portfolio without short selling. The above corollary is important because it shows when it is possible to construct a portfolio with risk lower than that of any of its components. In case 1) this is possible without short selling. In case 3) this is also possible, but only if short selling is allowed. In case 2) it is impossible to construct such a portfolio. Example 5.9 Suppose that σ12 = 0.0041, σ22 = 0.0121, ρ12 = 0.9796. Clearly, σ1 < σ2 and σσ12 < ρ12 < 1, so this is case 3) in Corollary 5.6. Our task will be to find the portfolio with minimum risk with and without short selling. 106 Mathematics for Finance Using Theorem 5.5, we compute s0 ∼ = −1.1663, smin = 0.

Exercise 4.5 Consider a market with a risk-free asset such that A(0) = 100, A(1) = 110, A(2) = 121 dollars and a risky asset, the price of which can follow three possible scenarios, Scenario ω1 ω2 ω3 S(0) 100 100 100 S(1) 120 120 90 S(2) 144 96 96 Is there an arbitrage opportunity if a) there are no restrictions on short selling, and b) no short selling of the risky asset is allowed? 4. Discrete Time Market Models 81 Exercise 4.6 Given the bond and stock prices in Exercise 4.5, is there an arbitrage strategy if short selling of stock is allowed, but the number of units of each asset in a portfolio must be an integer? Exercise 4.7 Given the bond and stock prices in Exercise 4.5, is there an arbitrage strategy if short selling of stock is allowed, but transaction costs of 5% of the transaction volume apply whenever stock is traded. 4.1.3 Application to the Binomial Tree Model We shall see that in the binomial tree model with several time steps Condition 3.2 is equivalent to the lack of arbitrage.

 

pages: 202 words: 66,742

The Payoff by Jeff Connaughton

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algorithmic trading, bank run, banking crisis, Bernie Madoff, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, desegregation, Flash crash, locking in a profit, London Interbank Offered Rate, London Whale, Long Term Capital Management, naked short selling, Plutocrats, plutocrats, Ponzi scheme, risk tolerance, short selling, Silicon Valley, too big to fail, two-sided market, young professional

But I laughed a few minutes later when I got a call from Ted’s press secretary, who was with him: “I’m glad most people still don’t know what Ted looks like. Two elderly ladies were standing nearby when he yelled that.” The pushback from the Blue Team was followed by pushback from The Blob. I received an e-mail from a lobbyist (and former Dodd staffer) who represented a large hedge fund well known for short selling. She warned me that it would be bad for my career if Ted and I went after short selling. She added that Ted and I looked like deranged conspiracy theorists for seeking to explore whether short selling had played a role in the downfall of firms like Lehman Brothers. Let me be clear: The Blob isn’t the mob. I didn’t fear for my kneecaps. But the hedge fund lobbyist was clearly trying to get me to back down by making me wonder whether not backing down would harm my career. Sometime later a friend of mine mentioned my name to a top member of The Blob, Mark Patterson, who used to be a lobbyist for Goldman Sachs and is now Treasury Secretary Geithner’s chief of staff.

They added that they couldn’t give us any details of the investigation but warned us that it’s almost impossible to prove intent under the current rule (that is, the reasonable-belief standard). Under this rule, anyone accused of naked short selling can simply say: “I reasonably believed I could find the stock in time.” In essence, the SEC lawyers confirmed our view that the rule against naked short selling was unenforceable and that they knew it. Most stock trades in the United States are cleared by a Wall Street backroom firm called the Depository Trust Clearing Corporation (DTCC). I suspected that the DTCC had extensive data on short selling. After a series of enquiries, I finally arranged for the DTCC’s general counsel (Larry Thompson) and one of its managing directors (Bill Hodash) to meet with me in Washington. We’d chatted for about fifteen minutes when Larry startled me by saying, “We want to be part of the solution, and we think we have a proposal that will work.”

Within a month of hearing about the DTCC’s idea, I’d helped Kaufman recruit seven other senators to write to the SEC endorsing the idea as a potential solution to abusive short selling. The letter was signed by Ted, Isakson, Levin, Jon Tester (D-MT), Sherrod Brown (D-OH), Orrin Hatch (R-UT), and Robert Menendez (D-NJ). Senator Arlen Specter (R-PA) wrote a follow-up letter concurring with it. Supremely confident (and a bit naïve), I said to Ted: “We’re going to change the way stocks are traded in this country.” Not long after receiving the letter, the SEC announced it would hold a public roundtable to discuss naked short selling and possible solutions on September 24, 2009. I was convinced we were making progress. We must have been. Because major banks like Goldman Sachs started lobbying furiously against any restrictions on short selling. The day before I was to meet with Goldman, an Isakson staffer told me that he’d received data from Goldman.

 

pages: 280 words: 73,420

Crapshoot Investing: How Tech-Savvy Traders and Clueless Regulators Turned the Stock Market Into a Casino by Jim McTague

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algorithmic trading, automated trading system, Bernie Madoff, Bernie Sanders, Bretton Woods, buttonwood tree, credit crunch, Credit Default Swap, financial innovation, Flash crash, High speed trading, housing crisis, index arbitrage, locking in a profit, Long Term Capital Management, margin call, market bubble, market fragmentation, market fundamentalism, naked short selling, pattern recognition, Ponzi scheme, quantitative trading / quantitative finance, Renaissance Technologies, Ronald Reagan, Sergey Aleynikov, short selling, Small Order Execution System, statistical arbitrage, technology bubble, transaction costs, Vanguard fund, Y2K

“I was just horrified at a whole series of things that they had done. One of them was their treatment of short selling. There’s nothing wrong with short selling. I’ve done it myself,” he said. But he was appalled that Cox had done away with the uptick rule, which made it more difficult to sell stocks short—and thus drive down prices when the market was in a free fall. Cox and the commission had eliminated the Depression-era Uptick Rule in 2007, arguing that the regulation had been ineffective since 2001 when the stock market under pressure from President Bill Clinton’s SEC Chairman Arthur Levitt had shifted from trading in eighths (12.5 cents) and sixteenths (6.25 cents) to decimals (1 cent). Under decimalization, an uptick of a mere penny would allow short-selling to begin. The rule had become obsolete, in Cox’s estimation. The creators of inverse exchange-traded funds, which increased in value as the market dropped, added that the uptick rule had interfered with the returns on their new, popular products.

The creators of inverse exchange-traded funds, which increased in value as the market dropped, added that the uptick rule had interfered with the returns on their new, popular products. As soon as the rule disappeared, traders began engaging in a practice known as “naked” short selling, where speculators sold short stocks they didn’t physically possess. Actual shares are supposed to be borrowed from other investors in a short-selling transaction and returned when the short seller closes out his position with a purchase, but some investors were bending the rules. With naked short selling, it was theoretically possible to short more shares than a particular company actually had outstanding. In effect, it was a license to print stock certificates. This also was a violation of the law. The SEC could have sued them. Instead, Cox urged the SEC to revisit the rule and change the uptick requirement to a nickel.

But beyond that, and more germane to present policies up for determination, is the condition of the markets during the pilot program. The SEC never tested the elimination of the Uptick Rule during the market sentiments that derived the origination of the Uptick Rule in the first place—the bear market.” Instead of reinstituting the rule, however, the SEC opted for a temporary ban in short selling of 799 financial stocks. Members of Congress wanted to prevent short sellers from driving down the stock prices of weak banks that were beneficiaries of federal bailout dollars. In October 2009, when the ban expired, program traders again engaged in naked short selling. In fact, the market plunged the day after the temporary ban was lifted. Connaughton came up with an idea for Kaufman to have a voice in reforming Wall Street even though he wasn’t a member of the Banking Committee: He convinced Kaufman to pretend that he was a member over the next two years.

 

Stock Market Wizards: Interviews With America's Top Stock Traders by Jack D. Schwager

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Asian financial crisis, banking crisis, barriers to entry, Black-Scholes formula, commodity trading advisor, computer vision, East Village, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John von Neumann, locking in a profit, Long Term Capital Management, margin call, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K

Another obstacle faced by shorts is that positions can be implemented only on an uptick (when the stock trades up from its last sale price)—a rule that can cause a trade to be executed at a much worse price that the prevailing market price when the order was entered. 59. The Why of Short Selling With all the disadvantages of short selling, it would appear reasonable to conclude that it is foolhardy to ever go short. Reasonable, but wrong. As proof, consider this amazing fact: thirteen of the fourteen traders interviewed in this book incorporate short selling! (The only exception is Lescarbeau.) Obviously, there must be some very compelling reason for short selling. The key to understanding the raison d'etre for short selling is to view these trades within the context of the total portfolio rather than as standalone transactions. With all their inherent disadvantages, short positions have one powerful attribute: they are inversely correlated to the rest of the portfolio (they will tend to make money when long holdings are losing and vice versa).

If a trader can make a net profit on short positions, then short selling offers the opportunity to both reduce risk and increase return. Actually, short selling offers the opportunity to increase returns without increasing risk, even if the short positions themselves only break even. * How? By trading long positions with greater leverage (using margin if the trader is fully invested)—a step that can be taken without increasing risk because the short positions are a hedge against the rest of the portfolio. It should now be clear why so many of the traders interviewed supplement their long positions with short trades: It allows them to increase their return/risk levels (lower risk, or higher return, or some combination of the two). If short selling can help reduce portfolio risk, why is it so often considered to be exactly the opposite: a high-risk endeavor?

For example, Lauer will typically hold long positions for six to twelve months, or even longer, but he will usually be out of short positions within a couple of weeks or less. 61. Identifying Short-Selling Candidates (or Stocks to Avoid for Long-Only Traders) Galante, whose total focus is on short selling, looks for the following red flags in finding potential shorts: > high receivables (large outstanding billings for goods and services); > change in accountants; > high turnover in chief financial officers; >• a company blaming short sellers for their stock's decline; *• a company completely changing their core business to take advantage of a prevailing hot trend. The stocks flagged must meet three additional conditions to qualify for an actual short sale: WIZARD LESSONS >• very high P/E ratio; > a catalyst that will make the stock vulnerable over the near term; > an uptrend that has stalled or reversed. Watson's ideal short-selling candidate is a high-priced, one product company.

 

pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

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Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Nash equilibrium, Network effects, passive investing, Paul Erdős, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

It’s only when the option holders do something to directly affect the value of the options that the lure of leverage turns lurid. Short-Selling, Margin Buying, and Familial Finances An old Wall Street couplet says, “He who sells what isn’t his’n must buy it back or go to prison.” The lines allude to “short-selling,” the selling of stocks one doesn’t own in the hope that the price will decline and one can buy the shares back at a lower price in the future. The practice is very risky because the price might rise precipitously in the interim, but many frown upon short-selling for another reason. They consider it hostile or anti-social to bet that a stock will decline. You can bet that your favorite horse wins by a length, not that some other horse breaks its leg. A simple example, however, suggests that short-selling can be a necessary corrective to the sometimes overly optimistic bias of the market.

The usual claim is that the money will enable them and their gullible respondents to share in enormous, but frozen foreign accounts. The bear market analogue to pumping and dumping is shorting and distorting. Instead of buying, touting, and selling on the jump in price, shorters and distorters sell, lambast, and buy on the decline in price. They first short-sell the stock in question. As mentioned, that is the practice of selling shares one doesn’t own in the hope that the price of the shares will decline when it comes time to pay the broker for the borrowed shares. (Short-selling is perfectly legal and also serves a useful purpose in maintaining markets and limiting risk.) After short-selling the stock, the scamsters lambast it in a misleading hyperbolical way (that is, distort its prospects). They spread false rumors of writedowns, unsecured debts, technology problems, employee morale, legal proceedings. When the stock’s price declines in response to this concerted campaign, they buy the shares at the lower price and keep the difference.

In general, who is going to buy the stock? It will generally be those whose evaluations are in the 7 to 10 range. Their average valuation will be, let’s assume, 8 or 9. But if those investors in the 1 to 4 range who are quite dubious of the stock were as likely to short sell X as those in the 7 to 10 range were to buy it, then the average valuation might be a more realistic 5 or 6. Another positive way to look at short-selling is as a way to double the number of stock tips you receive. Tips about a bad stock become as useful as tips about a good one, assuming that you believe any tips. Short-selling is occasionally referred to as “selling on margin,” and it is closely related to “buying on margin,” the practice of buying stock with money borrowed from your broker. To illustrate the latter, assume you own 5,000 shares of WCOM and it’s selling at $20 per share (ah, remembrance of riches past).

 

pages: 246 words: 74,341

Financial Fiasco: How America's Infatuation With Homeownership and Easy Money Created the Economic Crisis by Johan Norberg

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accounting loophole / creative accounting, bank run, banking crisis, Bernie Madoff, Black Swan, capital controls, central bank independence, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Brooks, diversification, financial deregulation, financial innovation, helicopter parent, Home mortgage interest deduction, housing crisis, Howard Zinn, Hyman Minsky, Isaac Newton, Joseph Schumpeter, Long Term Capital Management, market bubble, Martin Wolf, Mexican peso crisis / tequila crisis, millennium bug, moral hazard, mortgage tax deduction, Naomi Klein, new economy, Northern Rock, Own Your Own Home, price stability, Ronald Reagan, savings glut, short selling, Silicon Valley, South Sea Bubble, The Wealth of Nations by Adam Smith, too big to fail

Blum, From the Morgenthau Diaries, pp. 24-25. 27. Whaples, "Where Is There Consensus?" 28. Rothbard, America's Great Depression, pp. 219, 241. 29. Staley, Art of Short Selling, p. 247. 30. New York Times, "Shortselling." 31. Tsang, "Short Sellers under Fire." 32. Sorkin, "As No-Short-Selling List Grows." JMP Securities also asked to be struck from the list. 33. The Economist, "Shifting the Balance." 34. Lejland, "Finansravarna" (quotation translated). 35. Chanos, "Short Sellers Keep the Markets Honest"; Tsang, "Short Sellers under Fire." 36. Donovan, "Investment Bankers of the World, Unite!" 37. Oakley, "Short-Selling Ban Has Minimal Effect." 38. Younglai, "SEC's Cox Regrets Short-Selling Ban." 39. Nocera, "Alarm Led to Action." 40. For critical scrutiny of her book, see Norberg, "The Klein Doctrine" (and for more exhaustive treatment of the issue in Swedish, Benulic and Norberg, Allt oni Naomi Kleins nakenchock). 41.

An Inquiry into the Nature and Causes of the Wealth of Nations. Indianapolis: Liberty Fund, 1981. First published 1776. Solomon, Deborah, and David Enrich. "Devil Is in Bailout's Details." Wall Street Journal, October 15, 2008. Sorkin, Andrew Ross, ed. "As No-Short-Selling List Grows, Another Firm Chooses to Leave." Dealbook blog/New York Times, September 23, 2008. http://deal book.blogs.nytimes.com/2008/09/23 /as-no-short-selling-list-grows-another-firm- chooses-to-leave/?pagemode =print. Stafford, Philip. "Traders Blind to Mounting Worries." Financial Times, September 19, 2007. Staley, Kathryn. The Art of Short Selling. New York: John Wiley & Sons, 1997 Stelzer, Irwin M. "Do Deficits Matter?" Weekly Standard, February 15, 2005. Stevenson, Richard. "The Velvet Fist of Fannie Mae." New York Times, April 20, 1997. Stiglitz, Joseph.

The administration and the Fed had recently given out improvised electric shocks to get the economy beating again, but to no avail. Bernanke and Paulson now felt an overall approach was necessary. The program that they proposed to Congress-and that its leaders now quickly endorsed-was intended as a defibrillator working at maximum power. They wanted the government to guarantee the money-market funds and to ban the shorting (selling stocks you do not own) of shares in financial companies, and above all, they wanted $700 billion. The largest bailout package in history would enable the treasury secretary to buy bad mortgages from the banks, so that the markets would regain confidence in them and they would be able to start circulating again. The difficult question, of course, was how much the government should pay for the mortgages.

 

pages: 162 words: 50,108

The Little Book of Hedge Funds by Anthony Scaramucci

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Andrei Shleifer, asset allocation, Bernie Madoff, business process, carried interest, Credit Default Swap, diversification, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, fixed income, follow your passion, Gordon Gekko, high net worth, index fund, Long Term Capital Management, mail merge, margin call, merger arbitrage, NetJets, Ponzi scheme, profit motive, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, risk/return, Ronald Reagan, Saturday Night Live, Sharpe ratio, short selling, Silicon Valley, too big to fail, transaction costs, Vanguard fund, Y2K, Yogi Berra

In an effort to avoid the limelight, Jones relied on word-of-mouth advertising and dinner party referrals and avoided advertising or the public solicitation of business. As such, he is credited with having changed the entity from a general partnership to a limited partnership and having put on the hedge fund cloak of mystery. Short Selling + Leverage Perhaps most important, Jones’ most profound influence on the hedge fund industry is his alternative and contrarian strategy of using short selling + leverage to achieve profits regardless of market conditions. Often referred to as the redheaded stepchild, short selling, which involves speculating on the prospect of corporate failure was seen as un-American in 1950. And yet, Jones embraced this “little known procedure that scares away users for no good reason” and viewed it as “speculative means for conservative ends.”

This practice has become harder and harder to operate as government intervention in markets is making it harder for these sorts of managers to demonstrate their prowess. What Is Short Selling? As discussed in the beginning of this Little Book, one of the core features that defines hedge funds is short selling. Traditionally, money managers and investors take long positions in a stock, that is, they buy (hopefully undervalued) stocks with the expectation that the stock will increase in value. In simplistic terms, here’s how it works: Analyze a company, develop a predictive model on future cash flow streams, and then buy the stocks that you think are undervalued based upon the fundamentals of their future. Short selling is a completely different beast. Hedge funds managers who exercise the freedom to go short put the investing world in overdrive.

Investment Strategies: The Long and the Short of It As an alternative investment, hedge funds are able to operate in almost any type of market and use almost any type of investment strategy. Although the New York Times once referred to hedge funds’ use of these instruments as “exotic and risky,” it should be noted that most financial institutions use these “exotic” instruments . . . albeit in different capacities. Short Selling Generally, mutual fund managers are only able to hold “long” positions—in other words, they buy a security, such as a stock, bond, or any other money-market instrument, with the expectation that the asset will appreciate in value. They load up on “hot” stocks when the market is expected to go up and then sell these hot stocks when the market is expected to go down. Under this umbrella, investors usually shop a 60/40 portfolio—60 percent in stocks and 40 percent in bonds.

 

pages: 302 words: 86,614

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

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Asian financial crisis, asset allocation, asset-backed security, backtesting, Bernie Madoff, Bretton Woods, business process, call centre, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, fixed income, high net worth, interest rate derivative, Isaac Newton, Long Term Capital Management, Mark Zuckerberg, merger arbitrage, NetJets, oil shock, pattern recognition, Ponzi scheme, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, systematic trading

In a year or two he may lose one or two people on a team of 20 analysts. “Our analysts are analysts through and through,” he says. “We’re looking for people that love to do research.” The Secret Sauce of Short-Selling First, some basics about short-selling. It’s a tough business. In bull markets, where a rising tide lifts even the weakest performers to high valuation levels, shorts must be right more often than they are wrong. The stocks may be hard to borrow. Governments have been imposing restraints and bans on certain short-selling activity, using short-sellers as scapegoats for the implosion of investment banks and sovereign debt woes. While a percentage of short-selling is directional, meaning the investor has an adverse view of a company’s valuation based on an analysis of its financial statements or a sector outlook and hopes to profit when the stock falls or the sector weakens, hedging is another reason.

These returns got him noticed and the fund grew as investors sought out Third Point for its stellar returns. Along the way, Loeb made a name for himself in single-name short-selling, finding both value plays and specializing in what he calls the “Three Fs: fads, frauds, and failures.” As the tech bubble burst, Loeb was correctly positioned short and made a killing. In 2000, he beat the Standard & Poor’s (S&P) by 26.2 percent. In 2001, he beat the S&P by 26.8 percent. Today, Third Point has a dedicated team of short sellers who consistently generate alpha regardless of market conditions. Unlike many hedge funds that use shorting only as a method of hedging, Loeb instills the discipline of the art of alpha-generating short-selling in each of his team members and this approach has given the firm an important means of profit making throughout the years.

Contents Foreword: The Less Mysterious World of Hedge Funds Preface Disclaimer Chapter 1: The Global Macro Maven The Makings of a Maven Coming of Age through a Crisis Building Bridgewater Winning Over the World Bank Belly Up: Learning from the Bad Calculating Crises Foreseeing the Financial Crisis Extracting Alpha Bringing Home the Alpha Fund in Focus Procuring the Principles Watchful Eye on the World Today Going After What You Want Chapter 2: Man versus Machine Tim Wong: The Engineer Pierre Lagrange: The Money Maker Chapter 3: The Risk Arbitrageur The Making of a Risk Arbitrageur It’s Not All Numbers The Stuff of Legends Knowing What You Don’t Know “I’m Sort of an Independent Person” The Greatest Trade Ever Mispriced Risk: Dow/Rohm & Haas Jumping into the Deep End: Citigroup Good as Gold A Little Help from His Friends Fighting Back Chapter 4: Distressed Debt’s Value Seekers The Auto Bailout Brother-and-Sister Partnership Catching the Eye of Robert Bass Killer Combination Detecting Diamonds in the Rough Extracting the Value Chapter 5: The Fearless First Mover Gearing Up at Goldman Pulling in the Profits “A” for Appaloosa The Early Days No “A’s” in High School Learning and Earning Fierce and Fearless Titanic Track Record International Intrigue Russian Roulette Bullish on Bankruptcies Delphi Dilemma WaMu Winner The Force Behind Financials The ABC’s: AIG, BAC, and C Sizing Up the Sweet Spot Chapter 6: The Activist Answer Bright Beginnings Getting Gotham Going The School of Rock Making a Name for Himself Return on Invested Brain Damage Buying the Farm Rising from the Ashes Fast Food, Building Record Results Making Cents at McDonald’s Borders and Target: A Couple of Clunkers Zeroing in on Target MBIA A Dud The Greatest Trade A Penney for His Thoughts Canadian Pacific on the Rails What Makes an Activist Chapter 7: The Poison Pen The Young Whippersnapper Finds His Way Catching the Big Wave in the Storm Evolution and Revolution The Third Point Tao and Team Approach Chapter 8: The Cynical Sleuth Cause for Cynicism The Contrarian Investor The Secret Sauce of Short-Selling Defending an Investment Strategy China’s Coming Crisis Back to Business School Basics Chapter 9: The Derivatives Pioneer The Rise of a Trailblazer “Lehman Weekend” at the Fed The Technicalities of the Trade Afterword Appendix References Acknowledgments About the Author Index Copyright © 2012 by Maneet Ahuja. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

 

pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

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asset allocation, Bernie Madoff, Brownian motion, collateralized debt obligation, commodity trading advisor, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index arbitrage, index fund, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, pattern recognition, performance metric, pets.com, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, statistical arbitrage, statistical model, transaction costs, two-sided market, value at risk, yield curve

Jones felt that one of the flaws of conventional long-only investing was that it made it difficult for investors to hold on to their positions through steep market corrections. He saw that short selling could be used as a risk control tool. Jones referred to short selling as a “speculative technique for conservative ends.” For Jones, the attractiveness of short selling was not the potential gains it provided from stock market declines, but rather its role as a market hedge that made it more feasible to hold on to and profit from good long positions, since the short positions provided the investor with some protection on market declines. Jones’s ability to grasp that when used to counterbalance long positions, short selling was a risk-reducing rather than speculative tool demonstrated remarkable insight for a financial novice. Although short selling was an essential component of Jones’s strategy, he felt that short trades were inherently inferior to long trades for many reasons.

These reasons included the inability to get long-term gains on short trades, the necessity of paying dividends while holding shorts, the restriction of not being able to go short except on an uptick, and the paucity of research on short-selling ideas because of Wall Street’s almost exclusive focus on buy recommendations. For these reasons, Jones clearly preferred the long side, but his short trades were useful as an aid in profiting from his long positions. In a report Jones wrote to investors, he took aim at the prevailing notion that short selling was somehow “immoral or antisocial”—some things never change. Jones called this perspective “an illusion.” As Jones explained, “The successful short seller is performing a useful market function in that he arrests an unjustified market rise in a stock by selling it, and then later cushions its fall by buying it back, thus moderating its fluctuations.” Jones’s use of short selling to offset the risk of long positions gave him the ammunition to increase the magnitude of his long position vis-à-vis what it would have been without the short hedge, while still reducing the risk on balance.

Whereas mutual funds are highly homogeneous, consisting primarily of long equity or long bond investments (or a combination of the two), hedge funds encompass a broad range of strategies—a diversity made possible by the wide spectrum of financial instruments in which hedge funds can invest, combined with an ability to use the tools of short selling and leverage. The next section provides a synopsis of the major categories of hedge fund strategies. Ability to diversify a multifund portfolio. Creating a diversified mutual fund portfolio is virtually impossible, as nearly all mutual funds are highly correlated to either the stock market or the bond market. In contrast, the large number of different hedge fund strategies makes it possible to create a portfolio with significant internal diversification. The ability to meaningfully diversify a portfolio is the key reason why equity drawdowns in hedge funds of funds are muted compared with the magnitude of retracements witnessed in mutual funds. Shorting. Short selling is an integral component of most hedge funds. The incorporation of short selling means that the success of the hedge fund manager is no longer necessarily tied to a rising market (although it may be if the manager so chooses).

 

pages: 460 words: 122,556

The End of Wall Street by Roger Lowenstein

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Asian financial crisis, asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Brownian motion, Carmen Reinhart, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, fear of failure, financial deregulation, fixed income, high net worth, Hyman Minsky, interest rate derivative, invisible hand, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Martin Wolf, moral hazard, mortgage debt, Northern Rock, Ponzi scheme, profit motive, race to the bottom, risk tolerance, Ronald Reagan, savings glut, short selling, sovereign wealth fund, statistical model, the payments system, too big to fail, tulip mania, Y2K

The effect was highly constricting; as Russo noted, “banks will hoard capital unless and until they can borrow the money.” The surest sign of Wall Street’s unease was the prickliness with which Fuld and Russo, along with executives at other banks, responded to the phenomenon of short-sellers—hedge funds and others who were betting against their stocks. Short-selling is a legal and also a justifiable feature of markets, allowing traders to register negative as well as positive convictions. Indeed, Wall Street firms had been active promoters of short-selling, so long as the stocks being shorted were not their own. Now those same CEOs were haranguing the SEC, demanding a crackdown. In the CEOs’ defense, they had just seen Bear all but die, and the shorts’ campaigns against the other Wall Street firms—especially Lehman—had the same predatory edge. There were frequent charges of “naked shorting,” an abusive tactic with greater potential for manipulating prices.x Short-sellers publicized biting critiques of their targets, often involving complex accounting issues, the truth of which was difficult to determine.

He scoured the globe for capital, he vigorously lobbied Washington for help, and he retaliated against well-armed competitors. He protested to Jamie Dimon that JPMorgan was stealing his hedge fund clients; he made similar calls to swaps dealers. On the same Wednesday, he called Chris Cox at the SEC, as well as the two New York senators, Hillary Clinton and Charles Schumer, to demand that the SEC intervene against short-selling. He rang Lloyd Blankfein, who had maintained only a few days earlier that curbs on short-selling weren’t needed. Now, with Goldman’s stock plunging 14 percent on Wednesday, and his firm also suffering a degree of asset flight, Blankfein joined the lobbying campaign. Both banks also raised with Geithner the idea of converting to a commercial bank—another strategy once floated by Lehman. Officials were noticeably more receptive to Mack and Blankfein than they had been to Dick Fuld.

The war with hedge funds was Wall Street’s war with itself, a revolt against a financing stratagem that the banks had conceived and long exploited. After the meeting, Roach made a scheduled presentation to Julian Robertson, the legendary founder of Tiger Management. Robertson was livid over Mack’s drive to curtail short-selling. The courtly North Carolinian (born in Salisbury, a half-hour’s drive from what was to be Mack’s hometown) fumed at Roach: “Do you know a man named John Mack? Well you tell him his campaign against short-selling is going to cost him the goose that laid the golden egg. The hedge fund industry produced the revenues that drove Morgan Stanley’s prime brokerage business.” Roach coolly replied, “Correct me if I’m wrong, but in the stock market crash of 1987, a lot of hedge funds, including Tiger, had liquidity problems.

 

pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

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Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, labour market flexibility, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, means of production, Menlo Park, moral hazard, moveable type in China, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, We are the 99%, Wolfgang Streeck

Short sellers can likewise have an important social function. Consider the case of a financially stressed company that wants to raise capital. Many investors will be willing to buy its IOUs on the basis that they will hedge the risk of holding the debt by taking an offsetting short position in the company’s shares. If the company runs into trouble, the profit on the short-selling transaction will offset the losses on the debt. That would strike many people as morally acceptable. And most short selling, incidentally, consists of arbitrage trades like this rather than straight bets on companies performing badly. Yet it arouses passionate (and selective) criticism. The same people who are delighted if short sellers in the oil market bring down the price of oil will criticise those who go short of shares in an oil company. Chairmen and chief executives are among the more virulent because they hate the negative verdict on their own performance and fear that a sharp fall in the share price may undermine their job security.

They identified the weaknesses of Enron and Lehman, and the resulting slide in their share prices was an accurate reflection of economic reality as these sorely mismanaged outfits approached collapse. That fundamental point has, incidentally, been well understood by great novelists. The dramatic dénouement of Zola’s late nineteenth-century work L’Argent consists of a short-selling operation in which a brilliant financier realises that a rival’s bank is fraudulent, and brings about its demise. While Zola was anxious to convey the financial sleaze and corruption of the French Second Empire and to emphasise the terrible effects of speculation on ordinary people, he nonetheless showed how short selling could uncover the unpalatable truth. Milton Friedman, economist and great propagandist for free market capitalism, argued that speculation was a stabilising influence in markets generally. And there is widespread acceptance among economists that stabilising speculation can dampen volatility in markets because speculators are prepared to take a contrary view.

Speculators tried to corner stocks to create artificial scarcity and were adept at other forms of share manipulation, short selling and, with the help of corrupt journalists, false rumour mongering. It was not until the twentieth century that such practices were vigorously, but by no means completely, reined in by regulation. Much of the regulation was introduced in response to the 1929 crash. And it is worth noting, in passing, that Richard Whitney, the great defender of speculation, ultimately went to jail for embezzlement. As with capitalism itself, speculation has made progress towards a degree of respectability. This started, predictably enough, in the US, where the epitome of the respectable speculator was Bernard Baruch, who made a fortune in the sugar market around the start of the twentieth century. Baruch’s view on speculation and short selling, expressed before the Committee on Rules of the US House of Representatives in 1917, was that ‘to enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears.

 

pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

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Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, moral hazard, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, technology bubble, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs

If the market falls by 20 percent, and if the stocks selected by the two investors beat the market average by the same ten-point margin, the returns come out like this: In sum, the hedged fund does better in a bull market despite the lesser risk it has assumed; and the hedged fund does better in a bear market because of the lesser risk it has assumed. Of course, the calculations work only if the investors pick good stocks; a poor stock picker could have his incompetence magnified under Jones’s arrangement. Still, given the advantages of the hedged format, the question was why other fund managers failed to emulate it. The answer began with short selling, which, as Jones observed in his report to investors, was “a little known procedure that scares away users for no good reason.”30 A stigma had attached to short selling ever since the crash and was to survive years into the future; amid the panic of 2008, regulators slapped restrictions on the practice. But as Jones patiently explained, the successful short seller performs a socially useful contrarian function: By selling stocks that rise higher than seems justified, he can dampen bubbles as they emerge; by repurchasing the same stocks later as they fall, he can provide a soft landing.

In 1984, for example, the S&P 500 index rose just 6.3 percent while Tiger returned 20.2 percent; more than half of Robertson’s returns came from his short investments.18 The following year a portfolio manager named Patrick Duff began to suspect that a hotel chain called Prime Motor Inns was in a rather worse position than its accounts suggested. Duff did nothing about it, because he was working for a conventional pension fund at the time; but when he joined Tiger in 1989, he persuaded Robertson to short the company. Within a year, Prime Motor Inns fell from $28 to $1, demonstrating how profitable short selling could be. Robertson had an arrow in his quiver that conventional funds lacked. “It’s me and the patsies,” he once told an associate.19 But Tiger’s defiance of efficient-market presumptions cannot be explained entirely by short selling. In most years Robertson would have beaten the market even without the profits from his shorts, suggesting that he had an edge precisely where the theory said no edge was possible: in traditional stock buying. Moreover, Robertson’s record, like Buffett’s record, was not an isolated phenomenon.

As their stock prices cratered on Wednesday, the two firms worked the phones; and by the end of the day, both New York senators, Chuck Schumer and Hillary Clinton, were calling on the Securities and Exchange Commission to give Morgan and Goldman the short-selling ban that they demanded. On Thursday SEC chairman Christopher Cox expressed doubts about helping the bankers, but he found himself alone. “You have to save them now or they’ll be gone while you’re still thinking about it,” insisted the Treasury secretary Hank Paulson.29 At around 1:00 P.M., the Financial Services Authority in London announced a thirty-day ban on short selling of twenty-nine financial firms, signaling that the authorities would now do whatever it might take to save flagship companies. On Goldman’s trading floor, some three dozen traders greeted the news like infantrymen who have been rescued by air power: They stood up, placed their hands over their hearts, and sang along to “The Star-Spangled Banner,” which someone was playing over the loudspeaker system.30 Later that evening, the SEC went one better than London, banning the short selling of shares in about eight hundred financial companies.

 

pages: 468 words: 145,998

On the Brink: Inside the Race to Stop the Collapse of the Global Financial System by Henry M. Paulson

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asset-backed security, bank run, banking crisis, Bretton Woods, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Doha Development Round, fear of failure, financial innovation, housing crisis, income inequality, London Interbank Offered Rate, Long Term Capital Management, margin call, moral hazard, Northern Rock, price discovery process, price mechanism, regulatory arbitrage, Ronald Reagan, Saturday Night Live, short selling, sovereign wealth fund, technology bubble, too big to fail, trade liberalization, young professional

I wanted the SEC to investigate what looked to me to be predatory, collusive behavior as our banks were being attacked one by one. Chris was considering various steps the SEC could take, including a temporary ban on short selling, but his board was divided. He wanted Tim, Ben, and me to support him on the need for a ban. The short-selling debate was another of those issues where I found myself forced to do the opposite of what I had believed for my entire career. Short selling is a crucial element in price discovery and transparency—after all, David Einhorn, the hedge fund manager who shorted Lehman, had ultimately been proved right. I had long compared banning short selling to burning books, but now I recognized short selling as a big problem. I concluded that even though an outright ban would lead to all sorts of unintended consequences, it couldn’t be worse than what we were experiencing just then.

What he had predicted Sunday night had come to pass: investors were losing confidence, and the short sellers were after his bank. His cash reserves were evaporating, and he was doing everything he could to hold things together. “Hank,” John said, “the SEC needs to act before the short sellers destroy Morgan Stanley.” Since Monday he had been calling senators, congressmen, the White House, and me, trying to persuade everyone to push the SEC to do something about abusive short selling. He wasn’t alone. John Thain also called that afternoon to press about short selling. Shareholders had not yet approved Merrill’s deal with Bank of America, and he was taking nothing for granted. But his immediate concern was Morgan Stanley. The failure of another major institution, he knew, would be devastating. Ben and I had arranged to meet with congressional leaders that evening, but first Tim and I had to call AIG chief Bob Willumstad to confirm that the Fed was on track to make the loan—and to tell him that he was being replaced.

He didn’t know what I could do, but he said he felt obliged to tell me, point-blank, that he was not sure Morgan Stanley was going to make it. Coming from Bob, always calm and levelheaded, this was an alarming message. I alerted Tim Geithner and then called Chris Cox to urge him again to do something to end abusive short selling. I had been pressing Chris with increasing intensity since Monday. We’d spoken seven times Wednesday and would speak just as frequently Thursday on the subject. I implored him not to sit idly by while our financial system was destroyed by speculators. Any other time, I would have argued strongly against a ban, but my reasoning now was pragmatic: our short-selling rules hadn’t been written for these conditions, and whatever we chose to do couldn’t be worse than the panic we were now seeing. Chris worried about unintended consequences to the market. “If you wait any longer,” I said, “there won’t be a market left to regulate.”

 

pages: 326 words: 106,053

The Wisdom of Crowds by James Surowiecki

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AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, Joseph Schumpeter, knowledge economy, lone genius, Long Term Capital Management, market bubble, market clearing, market design, moral hazard, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, Yogi Berra

But the chances that the spread was wrong would be greater than if people were allowed to bet on both teams, because there’d be a greater chance that those who were betting would have similar biases, and therefore would make similar mistakes. And when bettors were wrong, they would be really wrong. The same is true of the stock market. Limiting short selling increases the chance that prices will be off, but what it really increases is the chance that if the price of a stock gets out of whack, it will get really out of whack. Internet stocks, for instance, were almost impossible to short, and that may have something to do with why their prices went into orbit. Short selling isn’t one of the “great commercial evils of the day.” The lack of short selling is. II Chanos’s assertion that one reason why there isn’t more short selling is that most people are not psychologically built to endure constant scorn struck me, when I first heard it, as correct. And most people would probably find the idea unexceptionable that emotion or psychology might affect the way individuals invest.

While the Malaysian minister’s suggestion that short sellers should be physically thrashed may have been novel, the hostility that provoked the suggestion was not. In fact, short sellers have been the target of investor and government anger since at least the seventeenth century. Napoleon deemed the short seller “an enemy of the state.” Short selling was illegal in New York State in the early 1800s, while England banned it outright in 1733 and did not make it legal again until the middle of the nineteenth century (though all indications are that the ban was quietly circumvented). The noisiest backlash against short selling came, perhaps predictably, in the wake of the Great Crash of 1929, when short sellers were made national scapegoats for the country’s economic woes. Shorting was denounced on the Senate floor as one of “the great commercial evils of the day” and “a major cause of prolonging the depression.”

Congress, too, weighed in, holding hearings into short sellers’ alleged nefarious activities. But the congressmen came away empty-handed, since it became clear that most of the real villains of the crash had been on the long side, inflating stock prices with hyped-up rumors and stock-buying pools and then getting out before the bubble burst. Nonetheless, the skepticism about short selling did not abate, and soon after, federal regulations were put in place that made short selling more difficult, including a rule that banned mutual funds from selling stocks short (a rule that stayed in place until 1997). In the decades that followed, many things about investing in America changed, but the hatred of short sellers was not one of them. In the popular imagination even today, short sellers are conniving sharpies, spreading false rumors and victimizing innocent companies with what Dennis Hastert, before he became Speaker of the House, called “blatant thuggery.”

 

pages: 153 words: 12,501

Mathematics for Economics and Finance by Michael Harrison, Patrick Waldron

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Brownian motion, buy low sell high, capital asset pricing model, compound rate of return, discrete time, incomplete markets, law of one price, market clearing, risk tolerance, riskless arbitrage, short selling, stochastic process

Definition 6.2.2 w is said to be a zero cost or hedge portfolio if its weights sum to 0 (w> 1 = 0). The vector of net trades carried out by an investor moving from the portfolio w0 to the portfolio w1 can be thought of as the hedge portfolio w1 − w0 . Definition 6.2.3 Short-selling a security means owning a negative quantity of it. In practice short-selling means promising (credibly) to pay someone the same cash flows as would be paid by a security that one does not own, always being prepared, if required, to pay the current market price of the security to end the arrangement. Thus when short-selling is allowed w can have negative components; if shortselling is not allowed, then the portfolio choice problem will have non-negativity constraints, wi ≥ 0 for i = 1, . . . , N . A number of further comments are in order at this stage. 1.

THE SINGLE-PERIOD PORTFOLIO CHOICE PROBLEM 6.3 The Single-period Portfolio Choice Problem 6.3.1 The canonical portfolio problem Unless otherwise stated, we assume that individuals: 1. have von Neumann-Morgenstern (VNM) utilities: i.e. preferences have the expected utility representation: v(z̃) = E[u(z̃)] Z = u(z)dFz̃ (z) where v is the utility function for random variables (gambles, lotteries) and u is the utility function for sure things. 2. prefer more to less i.e. u is increasing: u 0 (z) > 0 ∀z (6.3.1) u 00 (z) < 0 ∀z (6.3.2) 3. are (strictly) risk-averse i.e. u is strictly concave: Date 0 investment: • wj (pounds) in jth risky asset, j = 1, . . . , N • (W0 − P j wj ) in risk free asset Date 1 payoff: • wj r̃j from jth risky asset • (W0 − P j wj )rf from risk free asset It is assumed here that there are no constraints on short-selling or borrowing (which is the same as short-selling the riskfree security). The solution is found as follows: Choose wj s to maximize expected utility of date 1 wealth, W̃ = (W0 − X wj )rf + j = W0 rf + X j Revised: December 2, 1998 X wj r̃j j wj (r̃j − rf ) CHAPTER 6. PORTFOLIO THEORY 111 i.e. max f (w1 , . . . , wN ) ≡ E[u(W0 rf + {wj } X wj (r̃j − rf ))] j The first order conditions are: E[u0 (W̃ )(r̃j − rf )] = 0 ∀j

 

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

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Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business process, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Nick Leeson, P = NP, pattern recognition, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

We were also fully aware of the cost of constraints on short selling, but we did not think short selling would be acceptable to pension fund clients. Soon after we began managing portfolios, however, some clients asked about shorting stocks. With their encouragement, we ran analyses on the stocks at the bottom of our return prediction rankings and found that they did underperform the market. Jacobs Levy soon became one of the first money managers to exploit the potential of short selling within a disciplined framework when we began offering long-short portfolios in 1990. Engineered long-short portfolios offer the benefits of shorting within the risk-controlled environment of quantitative portfolio construction. The ability to sell stocks short can benefit both security selection and portfolio construction. To begin with, short selling expands the list of implementable ideas to include both “winning” and “losing” securities.

It also does not give the manager much leeway to JWPR007-Lindsey 276 May 28, 2007 15:46 h ow i b e cam e a quant distinguish between degrees of negative opinions; a stock about which the manager holds an extremely negative view is likely to have roughly the same underweight as a stock about which the manager holds only a mildly negative view. Short selling removes this constraint on underweighting. Significant stock underweights can be established as easily as stock overweights. The ability to short thus enhances the manager’s ability to implement all the insights from the investment process, insights about potential losers as well as winners. Short selling also improves the ability to control risk. Benchmark weights are the starting point for determining a long-only portfolio’s residual risk. Departures from benchmark weights introduce residual risk, so a long-only portfolio tends to converge toward the weights of the stocks in its underlying benchmark in order to control risk.

., 162 Sargent, Thomas, 188 Savine, Antoine, 167 Sayles, Loomis, 33 SBCC, 285 Scholes, Myron, 11, 88, 177, 336 input, 217 Schulman, Evan, 67–82 Schwartz, Robert J., 293, 320 Secret, classification, 16–18 Securities Act of 1933, 147 Securities Exchange Act of 1934, 147 Security replication, probability (usage), 122 SETS, 77 Settlement delays, 174 Seymour, Carl, 175–176 Shareholder value creation, questions, 98 Sharpe, William, 34, 254 algorithm, 257–258 modification, 258 Shaw, Julian, 227–242 Sherring, Mike, 232 Short selling, 275–276 Short selling, risk-reducing/returnenhancing benefits, 277 Short-term reversal strategy, 198–199 Shubik, Martin, 288–289, 291, 293 Siegel’s Paradox, 321–322 Sklar’s theorem, 240 Slawsky, Al, 40–41 Small-cap stocks, purchase, 268 Smoothing, 192–193 Sobol’ numbers, 173–173 Social Sciences Research Network (SSRN), 122 Social Security system, bankruptcy, 148 Society for Quantitative Analysis (SQA), 253 Spatt, Chester, 252 Spot volatility, parameter, 89–90 Standard & Poor’s futures, price (relationship), 75 INDEX Start-up company, excitement, 24–25 Statistical data analysis, 213–214 Statistical error, 228 Sterge, Andrew J., 317–327 Stevens, Ross, 201 Stochastic calculus, 239 Stock market crash (1987), 282 Stocks portfolio trading, path trace, 129 stories, analogy, 23–26 Strategic Business Development (RiskMetrics Group), 49 Sugimoto, E., 171 Summer experience, impact, 57 Sun Unix workstation, 22 Surplus insurance, usage, 255–256 Swaps rate, Black volatilities, 172 usage, 292–293 Sweeney, Richard, 190 Symbolics, 16, 18 Taleb, Nassim, 132 Tenenbein, Aaron, 252 Textbook learning, expansion, 144 Theoretical biases, 103 Theory, usage/improvement, 182–185 Thornton, Dan, 139 Time diversification, myths, 258 Top secret, classification, 16–18 Tracking error, focus, 80–81 Trading, 72–73 Transaction cost, 129 absence, 247 impact, 273–274 Transaction pricing, decision-making process, 248 Transistor experiment (TX), 11 Transistorized Experimental Computer Zero (tixo), usage, 86 Treynor, Jack, 34, 254 Trigger, usage, 117–118 Trimability, 281 TRS-80 (Radio Shack), usage, 50, 52, 113 Trust companies, individually managed accounts (growth), 79 Tucker, Alan, 334 Uncertainty examination, 149–150 resolution, 323–324 Unit initialization, 172 Universal Investment Reasoning, 19–20 Upstream Technologies, LLC, 67 U.S. individual stock data, research, 201–202 Value-at-Risk (VaR), 195. calculation possibility tails, changes, 100 design, 293 evolution, 235 measurement, 196 number, emergence, 235 van Eyseren, Olivier, 173–175 Vanilla interest swaptions, 172 VarianceCoVariance (VCV), 235 Variance reduction techniques, 174 Vector auto-regression (VAR), 188 Venture capital investments, call options (analogy), 145–146 Volatility, 100, 174, 193–194 Volcker, Paul, 32 von Neumann, John, 319 Waddill, Marcellus, 318 Wall Street business, arrival, 61–65 interest, 160–162 move, shift, 125–127 quant search, genesis, 32 roots, 83–85 Wanless, Derek, 173 Wavelets, 239 Weisman, Andrew B., 187–196 Wells Fargo Nikko Investment Advisors, Grinold (attachment), 44 Westlaw database, 146–148 “What Practitioners Need to Know” (Kritzman), 255 Wigner, Eugene, 54 Wiles, Andrew, 112 Wilson, Thomas C., 95–105 Windham Capital Management LLC, 251, 254 Wires, rat consumption (prevention), 20–23 Within-horizon risk, usage, 256 Worker longevity, increase, 148 Wyckoff, Richard D., 321 Wyle, Steven, 18 Yield, defining, 182 Yield curve, 89–90, 174 Zimmer, Bob, 131–132

 

pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

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Albert Einstein, asset allocation, Atul Gawande, backtesting, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam

Positive Outlier Trades as a Percent of Total Trades for the Year 80% 72% 70% 59% 60% 50% 44% 42% 43% 39% 40% 37% 36% 38% 35% 28% 30% 21% 20% 11% 11% 10% 9% 10% 12% 8% 6% 6% 3% 0% % Positive Outlier Trades 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 0% 318 Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets Short Selling For the purposes of this project, we decided against testing short-selling6 strategies. Our reasons for this have to do with the following issues. Forced Buy-Ins A short seller has to borrow shares before they can short sell them. Likewise, the short seller must return (deliver) the shares should the brokerage firm call them back. From the historical data available, there is no way to know when or if a short seller would have been subject to a forced buy-in.7 Borrowing Shares Short selling a security requires borrowing shares from an investor who holds them in a margin account. Not all stocks meet these criteria all the time; some never meet these criteria at all.

Foreword to the First Edition by Charles Faulkner . . . . . . . . . . . . . . . . 247 248 253 265 266 277 278 279 280 281 282 285 285 288 290 294 296 299 Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303 Introduction to Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A Trend Following for Stocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Does Trend Following Work on Stocks? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short Selling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Capitalism Distribution: Observations of Individual Common Stock Returns, 1983–2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Charts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305 307 307 318 318 331 338 xii Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets B Performance Guide . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Trend Following Historical Performance Data . . . . . . . . . . . . . . . . . . . . . . . . 347 Abraham Trading Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 347 Campbell & Company, Inc.

Not all stocks meet these criteria all the time; some never meet these criteria at all. There is no reliable method to determine what stocks from the investable universe would have been realistically shortable in the past. Limited Expectancy With respect to long-term trend following, short selling offers a severely limited mathematical expectancy. The price of a stock can decline only by a maximum of 100 percent. However, it can rise by an infinite amount. This is a significant disability to overcome. Tax Efficiency The average hold time for the average trade came in lower than the 12 months necessary to qualify for long-term capital gains treatment. However, due to the nature of trend following systems in general, this statistic is misleading. There was a significant correlation between trade length and profitability, showing that the vast majority of historical profits would have qualified for long-term capital gains treatment. 319 Appendix A • Trend Following for Stocks Average Trade Result Relative To Days in Trade 450% Average Return 350% Very few short term capital gains 250% Majority of profits are long term capital gains 150% 50% -50% - 360 720 1,080 1,440 1,800 2,160 2,520 2,880 3,240 Days in Trade Diversification The following table shows how many positions would have resulted from entering stocks at all time highs and exiting with a 10 ATR stop while honoring all data integrity and realistic universe issues.

 

pages: 338 words: 106,936

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall

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Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, butterfly effect, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, new economy, Paul Lévy, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, V2 rocket, volatility smile

The origins of this investment practice, known as short selling, are obscure, but it is at least three hundred years old. We know this because it was banned in England in the seventeenth century. Today, short selling is perfectly standard. But in the 1960s — indeed, for much of the practice’s history — it was viewed as dangerous at best, and perhaps even depraved or unpatriotic. The short seller was perceived as a blatant speculator, gambling on market moves rather than investing capital to spur growth. Worse, he had the nerve to take a financial interest in bad news. This struck many investors as déclassé. Views on short selling changed in the 1970s and 1980s, in part because of Thorp’s and others’ work, and in part because of the rise of the Chicago School of economics. As those economists argued at the time, short selling may seem crude, but it serves a crucial social good: it helps keep markets efficient.

If the only people who can sell a stock are the ones who already own it, people who have information that could be bad for the company often don’t have any way of affecting market prices. This would mean that information could be available that isn’t reflected in the stock price, because the people who have access to the information aren’t able to participate in the market. Short selling prevents this situation. Whatever the social impact, short selling does have real risks attached. When you buy a stock (sometimes called taking a “long” position, in contrast to the “short” position that short sellers take), you know how much money you stand to lose. Stockholders aren’t responsible for a corporation’s debts, so if you put $1,000 into AT&T, and AT&T goes under, you lose at most $1,000. But stocks can go up arbitrarily high.

If you sell $1,000 worth of AT&T short, when it comes time to buy the shares back to repay the person you borrowed them from, you might need to come up with a lot more money than you originally received in the sale in order to get the shares back. Still, Thorp was able to find a broker who was willing to execute the required trades. This solved one problem, of figuring out how to apply Kelly’s results in the first place. But even if Thorp could ignore the social stigma of short selling — and he could — the real dangers of unlimited losses remained. Here, though, Thorp had one of his most creative insights. His analysis of warrant pricing gave him a way of relating warrant prices to stock prices. Using this relationship, he realized that if you sell warrants short, but at the same time you buy some shares of the underlying stock, you can protect yourself against the warrant increasing in value — because if the warrant increases in value, according to Thorp’s calculations the stock price should also increase, limiting your losses on the warrant.

 

pages: 263 words: 75,455

Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle

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Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, Black Swan, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, systematic trading, The Myth of the Rational Market, time value of money, transaction costs

We go bargain hunting in Part Four, looking for the price ratios that best identify undervalued stocks and lead to the best risk-adjusted investment performance. We look at several unusual implementations of price ratios, including long-term average price ratios and price ratios in combination. Part Five sets out a variety of signals sent by other market participants. There we look at the impact of buybacks, insider purchases, short selling, and buying and selling from institutional investment managers like activists and other fund managers. Finally, in Part Six we build and test our quantitative value model. We study the best way to combine the research we've considered into a cohesive strategy, and then back-test the resulting quantitative value model. CHAPTER 1 The Paradox of Dumb Money “As they say in poker, ‘If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy.'”

If we also consider the ease of calculating it, it looks like the strongest candidate. With our examination of quality and price completed, we now move to the final phase of our investment checklist: finding stocks with signals that corroborate our valuation. In the next part, we consider several different signals sent by market participants to find those that forecast market-beating performance. We examine buy-backs, insider buying, activism, institutional investors, and short selling. NOTES 1. Benjamin Graham, and David Dodd, Security Analysis: The Classic 1934 Edition (McGraw-Hill, 1996). 2. J. Y. Campbell and R. J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook.” Journal of Portfolio Management (Winter 1998): 11–26. 3. John Y. Campbell and Robert J. Shiller, “Valuation Ratios and the Long-Run Stock Market Outlook: An Update (April 2001).” NBER Working Paper Series, Vol. w8221, 2001.

The second potential pitfall is in aggregating institutional investment manager stock purchases to the point that the target stocks are heavily concentrated with institutional investment managers. Some cloning services allow investors to create a portfolio that takes the most popular ideas from a number of institutional investment managers that have historically performed very well. SHORT MONEY IS SMART MONEY Short selling is the practice of selling a stock in anticipation of a decline in its price. The stock sold short is borrowed from another market participant and must eventually be bought back and returned to the lender, which is called covering. If the price declines as anticipated, the short seller covers to realize a profit. If the price advances, the short seller must still cover, but realizes a loss. Short interest (or the change in short interest) is measured by the short interest ratio (SIR), which is a monthly snapshot of the proportion of outstanding shares of any given stock sold short.

 

pages: 305 words: 69,216

A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

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Andrei Shleifer, banking crisis, Bernie Madoff, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, moral hazard, mortgage debt, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

And not all lenders to banks are fully insured, because until recently there were ceilings on federal deposit insurance; and checkable nonbank accounts, such as an account with a money market fund, were not insured at all. (They are now, and the ceiling on deposit insurance has been taken off.) Some investors anticipated the effect of the bursting of the housing bubble on mortgagebacked securities and made billions selling short the securities backed by low-rated mortgages. But there was not enough short selling to alert the market and the government to the weakness of the banks, in part because, as noted earlier, short selling is a risky investment strategy. Premature short sellers lose big, and there were many such because of the duration of the housing bubble. 5 The Government Responds The Government's Response to the crash has moved through four phases, with a fifth that at this writing is wending its way through Congress. The first three phases are collectively the "bailout"; the fourth (running simultaneously with the bailout) I'll call "easy money"; and the fifth will, when executed, be the "stimulus."

They did this by eliminating the limits on federal deposit insurance of bank deposits and by extending that insurance to checkable accounts in money market funds, but more important by bailing out failing firms deemed "too big to fail"—an incentive for corporate giantism and financial irresponsibility (which go hand in hand because the difficulty of controlling subordinates grows with the size of an organization). The government gratuitously disrupted the operations of hedge funds by limiting short selling—at the height of the banking crisis the Securities and Exchange Commission forbade short selling of financial stocks. And by substantially increasing the federal deficit, the government's responses to the crisis are sowing the seeds of a future inflation. But of these criticisms, the main ones — the creation of moral hazard and the planting of the seeds of a future inflation—concern the unavoidable side effects of any effective measures to limit a depression.

Moreover, investors can lower their risk by diversifying their portfolios, so the fact that they own stock in some firms that have a very high ratio of fixed to variable costs and are therefore at risk of bankruptcy needn't worry them. One might think a bubble would collapse before it got too big because investors who realized it was a bubble would sell short—in this case, sell interests in mortgage-backed securities short. But short selling in a bubble is very risky unless the bubble is expected to burst very soon. A short seller typically borrows securities that he thinks will lose value and contracts to sell them at a specified price (presumably close to the current market price) on a specified future date. If the market price has fallen by then, he buys the identical securities at that lower price and returns them to the lender.

 

pages: 368 words: 32,950

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile by Alexander Davidson

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accounting loophole / creative accounting, algorithmic trading, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Big bang: deregulation of the City of London, capital asset pricing model, central bank independence, corporate governance, Credit Default Swap, dematerialisation, discounted cash flows, diversified portfolio, double entry bookkeeping, Edward Lloyd's coffeehouse, Elliott wave, Exxon Valdez, forensic accounting, global reserve currency, high net worth, index fund, inflation targeting, interest rate derivative, interest rate swap, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Nick Leeson, North Sea oil, Northern Rock, pension reform, Piper Alpha, price stability, purchasing power parity, Real Time Gross Settlement, reserve currency, shareholder value, short selling, The Wealth of Nations by Adam Smith, transaction costs, value at risk, yield curve, zero-coupon bond

In October 2002, the Financial Services Authority issued a discussion paper on short selling. It considered it a legitimate activity but thought more transparency would be helpful, and, in the years since, it has not changed its position.  32 HOW THE CITY REALLY WORKS __________________________________ If an investment bank has a net short position in a stock, it may borrow from a lender to deliver the securities on the agreed settlement date. From the buyer’s perspective, there is no practical difference between borrowed and owned stock. If the bank has a net long position, it may lend the stock to borrowers for a fee. As a result of short trades, stock lending flourishes in bull markets, and improves market liquidity. Stock lending figures, available from Euroclear UK & Ireland and other sources, provide only a very loose indication of short selling levels as other factors must be considered as well.

Traders who use spread betting firms are almost entirely male, with a leaning towards the 25–35 year old age group, and those who work in information technology. As a trader, you may place a bet based on your belief that a share price, an index, or interest rates will move up or down. Spread betting and CFDs (see under the next heading) make it possible to take a short position, which is a position that will profit if the underlying instrument goes down. Short selling is effectively closed to private investors in conventional share trading, due to the short standard settlement period. Spread bets are geared and, as a trader, you need to put up only an initial margin, perhaps 10–15 per cent of the underlying value, but will need to top up the amount should the trading position move against you, on the same principle as for options or futures. You will gain or lose as a percentage of the underlying

Signatories must meet standards set in price transparency, access, interoperability and service unbundling, among other areas. The Code has set a deadline for each of the standards, with the final one on 1 January 2008. Through the Code, Commissioner McCreevy has given the market an opportunity to find its own solution, which is very much in the style of the UK Financial Services Authority, as when, for example, it investigated short selling and, without being more prescriptive, called for more transparency, a move that led to Euroclear & Ireland, then known as CRESTCo, making stock lending data available on its website. In January 2007, Euroclear chief executive Pierre Francotte said the success of the Code would depend on whether the parties involved implement it, and whether it was extended from only equities to bonds. He said that the Commission would have to stay actively involved to ensure immediate progress.

 

pages: 444 words: 151,136

Endless Money: The Moral Hazards of Socialism by William Baker, Addison Wiggin

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Andy Kessler, asset allocation, backtesting, bank run, banking crisis, Berlin Wall, Bernie Madoff, Black Swan, Branko Milanovic, Bretton Woods, BRICs, business climate, capital asset pricing model, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crony capitalism, cuban missile crisis, currency manipulation / currency intervention, debt deflation, Elliott wave, en.wikipedia.org, Fall of the Berlin Wall, feminist movement, fiat currency, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, housing crisis, income inequality, index fund, inflation targeting, Joseph Schumpeter, laissez-faire capitalism, land reform, liquidity trap, Long Term Capital Management, McMansion, moral hazard, mortgage tax deduction, naked short selling, offshore financial centre, Ponzi scheme, price stability, pushing on a string, quantitative easing, RAND corporation, rent control, reserve currency, riskless arbitrage, Ronald Reagan, school vouchers, seigniorage, short selling, Silicon Valley, six sigma, statistical arbitrage, statistical model, Steve Jobs, The Great Moderation, the scientific method, time value of money, too big to fail, upwardly mobile, War on Poverty, Yogi Berra, young professional

Certain of their brokers secured special regulations that unfairly advantaged large customers, many of which manipulated commodity prices. Their use of short selling was heavily directed against the financial sector itself, and by July 2008 Congress looked into the matter, triggering the SEC to ban “naked” short selling of the common stocks of 19 banks and brokers. By generating such a list, the government favored some companies over others, socialistically guiding where dollars may and may not flow, to the detriment of others not privileged enough to 140 ENDLESS MONEY make the list. In September, the list was expanded to cover 799 financial firms for which no short selling would be permitted, even when it would be done with borrowed shares.2 The Congressional hearings are reminiscent of the government’s scrutiny of capital pools in the early 1930s.

One can argue whether the restrictions placed on these activities is adequate or excessive, or for that matter, if they effectively serve the public good. But what is far more relevant is the SEC’s tacit allowance of naked short selling through what became known as the “Madoff Rule,” which exempted market makers from the same requirements to deliver stock after stock sales. This essentially provided broker-dealers with the ability to legally counterfeit securities, and to rent this resource out to hedge fund clients. Patrick Byrne, CEO of Overstock.com, a company victimized by relentless naked short selling, worked with reporter Mark Mitchell to reveal the extent of the naked short-selling problem through his web site www.deepcapture.com. Clearly this activity has been pernicious to the equity of some companies. However, it did not cause the downfall of the global economy or of the stock market.

If economic actors had been relatively debt free, they would have been strong enough to intercede in capital markets and take advantage of economic opportunities presented by illegitimately pummeled stock prices, somewhat akin to the soaking up of stock through corporate repurchases in the aftermath of the 1987 crash. Politicians demonize the hedging of risk with commodities and even the legitimate deployment of short selling, but the quasi-government entities they have chartered—the Fed and the mortgage agencies—have fostered the overexpansion of credit that is debasing the coin of the realm and brought us to the edge of systemic failure. Only a socialist government would single out those seeking to flee and penalize them as perpetrators. Wall Street knows where its bread is buttered. Goldman Sachs has had deep ties to both Democratic and Republican administrations Moral Hazard 141 through figures such as Henry Paulson (Treasury Secretary to George W.

 

pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

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affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, labour mobility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

“When Charlie and I finish reading the long footnotes detailing the derivatives activities of major banks, the only thing we understand is that we don't understand how much risk the institution is running.” This is still a problem, and not just for Buffett. Understanding net risk is genuinely difficult. The companies Buffett owns use derivatives, and Buffett’s Berkshire Hathaway sold Lehman Brothers lots of credit default swaps on municipal-bond debt. 2. See Chincarini (2010). 3. Investors short-sell when they promise to sell a security that they don’t already own. The brokerage house—Lehman Brothers, in this case—handles the logistics of short-selling. Short-selling can bring efficiency to the market. Think of buying and selling as ways to vote on a security’s appropriate price. If no one ever short-sold a security, stock prices might be higher than appropriate, because no investor could vote for them to be lower. 4. See Chapter 4. 5. Of course, if the borrower on a bond defaults, then even this income is variable.

Quantitative funds have a number of common attributes.12 Quantitative equity funds are usually market-neutral or enhanced index hedge funds or mutual funds that use computers to sort stocks by desirable and less desirable factors. They buy stocks with good factors and short sell stocks with bad factors, hoping to create a portfolio that is immune to overall market movements, but outperforms over time as desirable stocks perform better than less-desirable stocks. Many of these funds have a value tilt, believing that it’s better to own stocks that trade at low prices relative to forecast earnings. Thus, a fund might short sell stocks that trade at very high multiples to earnings (conditional on other information), while buying stocks with low prices relative to forecast earnings. Statistical arbitrage funds, on the other hand, use statistical and mathematical models to analyze short-term, sometimes high-frequency price movements, then try to profit from short-term deviations from expected value.

To do that, though, they would have to exercise the warrant in Switzerland, then sell the stock in Japan. It was easier to just sell the warrants in the Swiss market at a price that reflected the hassle of exercising them. As the warrants were trading at less than their intrinsic value, an arbitrage firm might have bought the warrants and short sold the related stocks. The strategy could have worked in the United States, but it was difficult to borrow these small-cap Japanese stocks, and to short sell a stock that it doesn’t own, a firm has to borrow it first. LTCM came up with an exact solution. It bought a basket of small-cap stocks in the JASDAQ (Japanese Association of Securities Dealers Automated Quotations Index) with cheap associated warrants and shorted the JASDAQ futures contract. The hedge wasn’t a perfect one, because LTCM’s short position was on the whole index, and the basket was only a subset of Japanese stocks.

 

Commodity Trading Advisors: Risk, Performance Analysis, and Selection by Greg N. Gregoriou, Vassilios Karavas, François-Serge Lhabitant, Fabrice Douglas Rouah

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Asian financial crisis, asset allocation, backtesting, capital asset pricing model, collateralized debt obligation, commodity trading advisor, compound rate of return, constrained optimization, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, discrete time, distributed generation, diversification, diversified portfolio, dividend-yielding stocks, fixed income, high net worth, implied volatility, index arbitrage, index fund, interest rate swap, iterative process, linear programming, London Interbank Offered Rate, Long Term Capital Management, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, p-value, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk-adjusted returns, risk/return, Sharpe ratio, short selling, stochastic process, systematic trading, technology bubble, transaction costs, value at risk

We can calculate the cumulative performance improvement to the stock/bond/hedge fund of funds portfolio from downside risk protection and upside return enhancement by: (−1.90% × 42 months) − (−2.07 × 42 months) + [(0.92% − 0.91%) × 132 months] = 8.46% 225 60/40 US Stocks/ US Bonds 55/35/10 Stocks/ Bonds/FOF 55/35/10 Stocks/ Bonds/Equity L/S 55/35/10 Stocks/Bonds/ Convertible Arb 55/35/10 Stocks/Bonds/ Market Neutral 55/35/10 Stocks/Bonds/ Distressed Debt 55/35/10 Stocks/Bonds/ Event Driven 55/35/10 Stocks/Bonds/ Fixed Income Arb 55/35/10 Stocks/Bonds/ Global Macro 55/35/10 Stocks/Bonds/ Market Timing 55/35/10 Stocks/Bonds/ Merger Arbitrage 55/35/10 Stocks/Bonds/ Short Selling 2.54% 2.42% 2.40% 2.45% 2.49% 2.36% 2.51% 2.50% 2.43% 1.00% 0.93% 0.92% 0.95% 0.95% 0.90% 0.97% 0.95% 0.93% 2.02% 2.45% 0.92% 0.85% 2.60% 0.91% Standard Deviation 0.198 0.196 0.198 0.207 0.189 0.201 0.204 0.195 0.197 0.215 0.191 0.177 Sharpe Ratio 40 41 42 43 42 41 40 40 41 −2.03% −1.88% −1.83% −1.84% −1.91% −1.86% −2.04% −2.03% −1.90% 37 42 −1.90% −1.63% 42 Number of Downside Months −2.07% Average Downside Downside Risk Protection Using Hedge Funds Expected Portfolio Composition Return TABLE 11.2 26.63% 9.04% 5.74% 5.34% 10.68% 6.72% 8.25% 10.08% 9.86% 5.74% 7.14% N/A Cumulative Downside Protection −7.92% 3.57% 7.18% 9.86% −1.32% 5.28% 4.37% 1.32% 3.57% 13.88% 1.32% N/A Cumulative Upside Potential 18.71% 12.61% 12.92% 15.20% 9.36% 12.00% 12.62% 11.40% 13.43% 19.62% 8.46% N/A Cumulative Performance Improvement 226 RISK AND MANAGED FUTURES INVESTING The cumulative performance improvement of 8.46 percent may be split into two parts, the cumulative return earned from downside risk protection (7.14 percent) and the amount earned from upside return potential (1.32 percent).

A 25-year study recently conducted by Goldman Sachs (2003) concluded that a 10 percent allocation of a securities portfolio to managed 235 236 MANAGED FUTURES INVESTING, FEES, AND REGULATION 70 60 50 40 30 20 10 0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003* FIGURE 12.1 Growth of Managed Futures, 1988–2002 Source: Barclay Trading Group, Ltd. “Money Under Management in Managed Futures,” www.barclaygrp.com. Copyright © 2002–2004 Barclay Trading Group, Ltd. *First quarter 2003. –23.37% S&P 500 –31.52% NASDAQ –16.75 DJIA Composite Index –1.19% Short Selling Index Emerging Markets Macro Index Fixed Income 25.06% 4.58% 8.28% 6.75% Equity Market Neutral 1.80% Fund of Funds 1.11% Managed Futures –35 –30 –25 –20 –15 –10 –5 0 15.22% 5 10 15 20 25 FIGURE 12.2 Performance Comparison 2002 Source: Equities: International Traders Research (ITR), an affiliate of Altegris Investments; Hedge Funds; Hedge Fund Research, Inc. © HFR, Inc. [15 January 2003], www.hfr.com; Managed Futures; ITR Premier 40 CTA Index.

In addition, the National Association of Securities Dealers (NASD) has expressed concern that its members may not be fulfilling their legal obligations to customers, particularly retail customers, when promot- 259 260 MANAGED FUTURES INVESTING, FEES, AND REGULATION ing hedge funds and funds of hedge funds to them (see NASD 2003). More recently, the Securities and Exchange Commission (SEC) has raised concerns about the increasing retailization of hedge funds, commodity pools, and private equity funds, the unregulated nature of these products and the potential for fund managers to defraud investors, and the market impact of hedge fund investment strategies such as short selling (SEC 2003).1 The SEC’s concerns are usefully summarized in Wider and Scanlan (2003). In Australia, the Australian Prudential Regulation Authority (APRA), the prudential regulator of banks, insurance companies, and pension funds, recently has questioned the increasing allocation of funds by Australian pension funds to hedge funds and other alternative investments. APRA (2003) has explicitly stated that if it “is not satisfied that an investment in hedge funds is to the benefit of [pension] fund members, it will step in to protect their interests.”

 

pages: 372 words: 107,587

The End of Growth: Adapting to Our New Economic Reality by Richard Heinberg

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3D printing, agricultural Revolution, back-to-the-land, banking crisis, banks create money, Bretton Woods, carbon footprint, Carmen Reinhart, clean water, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, David Graeber, David Ricardo: comparative advantage, dematerialisation, demographic dividend, Deng Xiaoping, Elliott wave, en.wikipedia.org, energy transition, falling living standards, financial deregulation, financial innovation, Fractional reserve banking, full employment, Gini coefficient, global village, happiness index / gross national happiness, I think there is a world market for maybe five computers, income inequality, invisible hand, Isaac Newton, Kenneth Rogoff, late fees, money: store of value / unit of account / medium of exchange, mortgage debt, naked short selling, Naomi Klein, Negawatt, new economy, Nixon shock, offshore financial centre, oil shale / tar sands, oil shock, peak oil, Ponzi scheme, post-oil, price stability, private military company, quantitative easing, reserve currency, ride hailing / ride sharing, Ronald Reagan, short selling, special drawing rights, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, trade liberalization, tulip mania, working poor

But just how does one successfully go about investing to profit on assets whose value is declining? The answer: short selling (also known as shorting or going short), which involves borrowing the assets (usually securities borrowed from a broker, for a fee) and immediately selling them, waiting for the price of those assets to fall, buying them back at the depressed price, then returning them to the lender and pocketing the price difference. Of course, if the price of the assets rises, the short seller loses money. If this sounds dodgy, then consider naked short selling, in which the investor sells a financial instrument without bothering first to buy or borrow it, or even to ensure that it can be borrowed. Naked short selling is illegal in the US, but many knowledgeable commentators assert that the practice is widespread nonetheless.

In the boom years leading up to the 2007–2008 crash, it was often the wealthiest individuals who engaged in the riskiest financial behavior. And the wealthy seemed to flock, like finches around a bird feeder, toward hedge funds: investment funds that are open to a limited range of investors and that undertake a wider range of activities than traditional “long-only” funds invested in stocks and bonds — activities including short selling and entering into derivative contracts. To neutralize the effect of overall market movement, hedge fund managers balance portfolios by buying assets whose price is expected to outpace the market, and by short-selling assets expected to do worse than the market as a whole. Thus, in theory, price movements of particular securities that reflect overall market activity are cancelled out, or “hedged.” Hedge funds promise (and often produce) high returns through extreme leverage. But because of the enormous sums at stake, critics say this poses a systemic risk to the entire economy.

As long as paper notes were redeemable for gold or silver, the amounts of these substances existing in vaults put at least a theoretical restraint on the process of money creation. Paper currencies not backed by metal had sprung up from time to time, starting as early as the 13th century ce in China; by the late 20th century, they were the near-universal norm. Along with more abstract forms of currency, the past century has also seen the appearance and growth of ever more sophisticated investment instruments. Stocks, bonds, options, futures, long- and short-selling, credit default swaps, and more now enable investors to make (or lose) money on the movement of prices of real or imaginary properties and commodities, and to insure their bets — even their bets on other investors’ bets. Probably the most infamous investment scheme of all time was created by Charles Ponzi, an Italian immigrant to the US who, in 1919, began promising investors he could double their money within 90 days.

 

pages: 351 words: 102,379

Too big to fail: the inside story of how Wall Street and Washington fought to save the financial system from crisis--and themselves by Andrew Ross Sorkin

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affirmative action, Asian financial crisis, Berlin Wall, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Fall of the Berlin Wall, fear of failure, fixed income, Goldman Sachs: Vampire Squid, housing crisis, indoor plumbing, invisible hand, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, Mikhail Gorbachev, moral hazard, NetJets, Northern Rock, oil shock, paper trading, risk tolerance, rolodex, Ronald Reagan, savings glut, shareholder value, short selling, sovereign wealth fund, supply-chain management, too big to fail, value at risk, éminence grise

Mack was reviewing draft language for the statement he would publish the following day in support of Cuomo’s investigation into short selling. Though he knew full well that his language would infuriate his clients and send even more of them packing, Mack didn’t believe he had a choice but to lend his support: Morgan Stanley applauds Attorney General Cuomo for taking strong action to root out improper short selling of financial stocks. By initiating a wide-ranging investigation of this manipulative and fraudulent conduct, Attorney General Cuomo is showing decisive leadership in trying to help stabilize the financial markets. We also support his call for the SEC to impose a temporary freeze on short selling of financial stocks, given the extreme and unprecedented movements in the market that are unsupported by the fundamentals of individual stocks.

Hank Paulson believed he was fighting the good fight, a critical fight to save the economic system, but for his efforts he was being branded as little less than an enemy of the people, if not an enemy to the American way of life. He couldn’t understand why no one could see how bad the situation had really become. That afternoon another faction had joined the group of antagonists: The hedge funds were furious with him for having convinced Christopher Cox at the SEC to begin cracking down on improper short selling in the shares of Fannie and Freddie, as well as seventeen other financial firms, including Lehman. With Bob Steel gone, he felt he had been left on his own to confront the biggest challenge of his tenure. He valued his staff, whom he regarded as a remarkably intelligent group, but questioned whether he had enough firepower to wage what he could see was quickly becoming a heated war. That afternoon he left a message for Dan Jester, a forty-three-year-old retired Goldman Sachs banker who had been the firm’s deputy CFO and was now living in Austin, Texas, managing money, mostly his own.

Paulson was pleased to hear Fuld was now taking this seriously but afraid it was all too late. On Paulson’s television that moment, tuned to CNBC, the speculation among the network’s commentators was illuminating. “The stock is coming down at the rate it’s coming down because a number of people believe strongly that the company is headed for bankruptcy,” explained Dick Bove, a veteran banking analyst at Ladenburg Thalman. “I think that that belief is what is driving the short selling.” Erin Burnett, the anchor of Street Signs, countered: “But if people are still using the company as a counterparty, trusting the company, isn’t that a significant statement?” “The key thing you have to understand is it’s not in anyone’s interest for Lehman to fail,” replied Bove, who, oddly enough, had a buy on the stock and a $20 price target. “It’s not in the interest of its competitors—Goldman Sachs, Morgan, Citigroup, JP Morgan—because if Lehman were to fail, then the pressure moves to Merrill Lynch and then it moves to who knows who else?

 

pages: 819 words: 181,185

Derivatives Markets by David Goldenberg

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Black-Scholes formula, Brownian motion, capital asset pricing model, commodity trading advisor, compound rate of return, conceptual framework, Credit Default Swap, discounted cash flows, discrete time, diversification, diversified portfolio, en.wikipedia.org, financial innovation, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, law of one price, locking in a profit, London Interbank Offered Rate, Louis Bachelier, margin call, market microstructure, martingale, Norbert Wiener, price mechanism, random walk, reserve currency, risk/return, riskless arbitrage, Sharpe ratio, short selling, stochastic process, stochastic volatility, time value of money, transaction costs, volatility smile, Wiener process, Y2K, yield curve, zero-coupon bond

Certain precious metals like gold and silver can be short sold. It also depends who you are and what counterparties will agree to. J. P. Morgan can do a lot more than the private investor can on his own. Sometimes one can short an Exchange Traded Fund (ETF) related to the underlying 192 FORWARD CONTRACTS AND FUTURES CONTRACTS commodity as a proxy for short selling the actual underlying commodity, because there are short ETFs available in the market. Classical short selling a commodity, like an equity security, means borrowing it from a broker, selling it immediately, and placing the proceeds from that sale (in addition to required margins) in an account. The good news is that interest can be paid on that account, so in effect its opportunity cost is zero. The bad news is that eventually you have to ‘cover’ the short sale by replacing the borrowed stock.

We now have to figure out how to partially replicate the put option’s payoffs. Provided that we accomplish this with payoffs that are no larger than the payoffs to the put option, the dominance principle then will provide a lower bound to the put option’s current price. In order to partially replicate the long European put option position, we have to short sell less than one unit of underlying stock, because the short position in the spot market has to restitute the option seller for the dividends paid out over [t,T]. If we short sell e– units of underlying stock at time t, everything works out fine because, once again, e–St grows to S′T , by definition. Table 11.6 indicates the partial replication strategy. Note that Strategy A has payoffs at least as great as the payoffs to Strategy B in all states of the world. The payoff to Strategy B is E–S′T 0 if S′T E while the payoff to Strategy A is 0.

OTC MARKETS AND SWAPS 279 Each loan creates a financial instrument called a mortgage bond, a student loan (repayment) bond, or a car loan (repayment) bond. The forward (futures) markets permit future borrowing and lending at fixed rates determined today. What position in the bond is taken by the individual who takes out a loan either currently or in the future? The person would be issuing (shorting, selling) the financial instrument created as a result of the loan agreement. Then the individual would typically pay a fixed rate—unless the loan was a variablerate bond like a variable-rate mortgage. The same reasoning applies to forward loans. Note that ‘selling’ here doesn’t mean selling something you already own. It refers to what a hedger in an implicit long position would want to do in order to protect the anticipated sale of something they do not currently own.

 

pages: 455 words: 138,716

The Divide: American Injustice in the Age of the Wealth Gap by Matt Taibbi

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banking crisis, Bernie Madoff, butterfly effect, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, Edward Snowden, ending welfare as we know it, forensic accounting, Gordon Gekko, greed is good, illegal immigration, information retrieval, London Interbank Offered Rate, London Whale, naked short selling, offshore financial centre, Ponzi scheme, profit motive, regulatory arbitrage, short selling, telemarketer, too big to fail, War on Poverty

* * * *1 The Fairfax story is often included in with other legendary bear-raid stories involving companies like Overstock.com, Dendreon, Afinsa (a Spanish collectibles company), and Biovail, another Canadian firm, all of which were targeted by some of the same hedge funds described in this story, many of which ended up out of business and/or mired in scandal. Many of those tales revolve around the issue of naked short selling, a type of financial counterfeiting that allows short investors to artificially depress the stock prices of target companies. Whether naked short selling is a serious social contagion or meaningless conspiracy theory is a passionately debated topic on Wall Street, and to even broach the subject inspires strong emotions: right or wrong (and I believe wrong), in some quarters, if you bring it up at all, eyes roll automatically. One of the reasons I originally shied away from the Fairfax story was that it has a naked short-selling angle that makes some serious observers dismiss it out of hand as nutty conspiracy. So even though naked short selling was actually a factor in the Fairfax case, I’ve left it out of this narrative, because it’s the other craziness that went on in this case that’s really interesting

So if you’re putting a big short on, you usually need to see a serious drop to make a buck, not just a tick or two in the right direction. This is why the big short sellers tend to be wired differently from other Wall Street players. These men (and they’re mostly men) live for the thrill of the chase and the high of conquest when the target of their short finally rolls over and dies. Chanos perfectly embodies that spirit. “I’ll always understand the Schadenfreude aspect to short-selling,” he said early in his career. “I get that no one will always like it.” By the early 2000s, just those four men—Loeb, Chanos, Cohen, and Sender—collectively managed tens of billions of dollars and exerted enormous influence on the daily trading flow of the New York Stock Exchange. And here’s what we know. Sometime in 2002 this collection of high-profile, belligerent, letter-writing, art-collecting millionaires and billionaires, along with hotshots from a few other prominent hedge funds, began talking to one another about a new stock they might want to target: Fairfax Financial Holdings.

Though some of the discovery shows the bank cravenly trying to extract business from hedge funds that seemed to relish Gwynn’s conclusions, the bank also would eventually fire Gwynn (years later, it is true) for leaking information to those same funds. “Gwynn was discharged from Morgan Keegan for violation of a firm policy relating to his apparent advance disclosure of his pending research coverage of Fairfax Financial Holdings,” a Morgan Keegan spokeswoman would say a full five years later, amid the chaos of September 2008. Although negative press and analyst reports and high volumes of carefully timed short selling can definitely exert downward pressure on a stock, and can even “waterfall” a company into collapse, a firm with a solid enough foundation can stick it out for a good long time. But the shorts didn’t have time. The game these major hedge funds were playing was a high-stakes, high-risk totaler Krieg where there’s no room for patience, compromise, or pyrrhic victories. When you bet $50 million, $100 million, $200 million against a certain type of company, inflicting minor damage—like moving its stock down a few percentage points here and there—is not sufficient.

 

pages: 549 words: 147,112

The Lost Bank: The Story of Washington Mutual-The Biggest Bank Failure in American History by Kirsten Grind

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asset-backed security, bank run, banking crisis, big-box store, call centre, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, housing crisis, Maui Hawaii, mortgage debt, naked short selling, NetJets, shareholder value, short selling, Skype, too big to fail, Y2K

Killinger didn’t want to talk to Paulson just about Cramer’s Mad Money—he also wanted to see if Paulson would help protect WaMu from naked short sellers. Short selling is essentially betting that a company will do badly: investors sell shares of borrowed stock (from a broker, for example) and then buy new shares to replace the old ones. If the new shares were bought for less than the original borrowed stock, the investor makes money. Naked short selling means that original shares aren’t borrowed. Either way, both forms of trading were driving down WaMu’s stock, which was now hovering around $3. Killinger thought Paulson could use his influence at the Securities and Exchange Commission (SEC) to help WaMu get on a list of 19 financial institutions temporarily protected from naked short selling. The SEC had given JPMorgan, Bank of America, and Citigroup this privilege. “What’s interesting about that list,” noted the Seattle Post-Intelligencer at the time, “is one name conspicuous by its absence—Seattle-based Washington Mutual Inc., whose stock has been of more than passing interest to short-sellers.”

., 2, 113, 155, 264, 288, 298 California AIG complaint about WaMu to, 166 banking preferences in, 53 decline in home prices in, 157, 185, 187 impact of WaMu sale in, 331–32 Killinger brand rally in, 92–93 naming of WaMu in, 90n Option ARMs in, 197 real estate market in, 47 subprime lending in, 58, 64, 71 tracking of complex data and customers in, 165 CAMELS ratings, 176, 228, 248, 262, 300 Cantwell, Maria, 275, 293, 293n Capital Markets Group, WaMu, 158, 169 capital raise, WaMu Bair-JPM representatives discussion about, 232 Cathcart and, 201 deadline for, 262 disagreements among regulators and, 234 FDIC/Bair and, 262, 275, 294 Fishman-Frank letter to save WaMu and, 296 Fishman’s attempts at, 270, 294, 296 “Go It Alone” proposal and, 294 Killinger and, 188–90, 191, 199, 201, 202, 205, 234, 237 Moody’s-WaMu meeting and, 265–66 OTS enforcement order and, 258, 267, 270 OTS-FDIC relations and, 244 OTS-Fishman/WaMu meeting about, 273–74 OTS pressures on WaMu for, 228, 229, 234, 237, 244 potential sources for, 235 sale of WaMu and, 279, 301 shareholder relations and, 188–90, 191, 199, 202, 205, 245–46 TPG and, 189, 237, 238, 279 Casey, Tom attempts to sell WaMu and, 232–33, 269, 280, 287, 288, 301 board presentations of, 192, 193 Chapman (Fay) disagreements with, 179–80 concerns about decline in housing market of, 153 definition of subprime loan of, 179 FDIC seizure of WaMu and, 303 JPM negotiations and, 232–33 JPM severance of, 321 Killinger’s hiring of, 98 loan loss forecast of, 192 Moody’s downgrade news and, 261, 264, 265, 266 off-loading of subprime and Option ARMs and, 154 professional background of, 98–99, 107 Rotella’s relationship with, 107 shareholder lawsuits against, 178 “category killers,” 91, 92 Cathcart, Ron, 150–51, 151n, 153, 154, 163, 164, 176, 178, 200–201 Cavanagh, Michael, 232, 234, 266, 272, 316 CBS: IndyMac story on, 242 Centrust Savings and Loan, 28 Cerberus, 235 Chapman, Craig, 61–62, 66, 78, 96, 97, 101, 106, 123, 128 Chapman, Fay appraisal problems and, 178–79, 180–82, 181n financial crisis comment of, 333 hiring of, 19 housing market concerns of, 179–80 Killinger’s “higher-risk lending strategy” and, 123 Killinger’s relationship with, 30, 97, 107, 180, 181–82, 183, 205 Long Beach Mortgage concerns of, 56–58, 60–61, 62, 63, 72, 75–78 NYSE bell ringing and, 54 Pepper and, 19, 310 on Pepper’s leadership style, 20 personal and professional background of, 19, 61, 75 personality and character of, 57, 75 resignation/retirement of, 182–83, 309 Rotella’s relationship with, 180 settlement for, 182 WaMu acquisitions and, 49 WaMu Alumni Fund and, 310 WaMu responsibilities of, 49 at WaMu reunion, 307 Chase Bank. See JPMorgan Chase Chase Home Finance, 104 Chicago, Illinois Jenne’s delinquent homeowner tour and, 171–72 WaMu branches in, 86, 108, 109 chief operating officer (COO), WaMu Pepper’s advice to Killinger about, 103–4 Rotella hired as first, 104–5, 106 Chrysler Financial, 235 Citigroup Dimon at, 230 as largest U.S. bank, 104 naked short selling protection for, 247 near failure of, 314, 314n OTS defense of oversight and, 317, 318 as potential buyer of WaMu, 3, 271, 282, 283, 289, 290, 298 TARP and, 315 Clark, Susie, 224 Clinton, Bill, 64, 113, 155 CNBC, 212, 267 CNN, 267 Coburn, Tom, 135 Cohen, H. Rodgin, 232, 233 Collateralized Debt Obligations (CDOs), 158, 295, 295n commercial real estate loans, 26–27 community banks: closure of, 319–20 Community Fulfillment Centers, WaMu, 142–43, 144–45, 144n, 159, 166 Community Reinvestment Act, 59 compensation Countrywide-WaMu competition and, 160 five emissaries–Killinger discussion about, 204–5 for fixed-rate loans/mortgages, 128, 129, 197 for Goldman Sachs board members, 164 for loan consultants, 117, 128–29, 188, 196, 197 at Long Beach Mortgage, 69–70, 78, 166–67 for Option ARMs sales, 117, 197 Pepper’s advice to Killinger about, 103–4 for real estate agents, 143 for salespeople, 140, 166–67 shareholders concerns about WaMu, 187–88 for subprime loans, 197 for WaMu board members, 164 for WaMu senior executives, 131, 187–88 See also specific person Congress, U.S.

See secondary market; shareholders/investors, WaMu; type of investor irrational money lenders, Killinger’s comment about, 163, 170, 240 Jenne, Kevin, 112–18, 167–68, 170–72 Jiminez (Ramona and Gerardo) family: mortgage loan to, 154–57, 172–73, 331–32 Johnson, Earvin “Magic,” 141–42 JPMorgan Chase assets of, 229 Bair meetings with representatives from, 232–33, 266, 316 Bank One acquisition by, 104–5, 230 Bear Stearns acquisition by, 187, 232, 246, 325, 329 board of, 295 bundling of mortgage-backed securities by, 120 Dimon appointment as president and COO of, 105 FDIC-OTS relationship and, 251 FDIC relationship with, 232, 246, 316 Great Depression and, 212 high-risk mortgages at, 138 home equity loans at, 325 investor conference call at, 301, 304 as largest company in world, 329 lawsuits against, 326 losses at, 325 Morgan Stanley acquisition rumors and, 287, 293 OTS/Reich and, 233–35, 283 philanthropy of, 326–28 political connections of, 231 regulators’ meetings with, 232–34 Rotella hiring of employees from, 107 SEC protection from naked short selling of, 247 shareholders at, 325 subprime mortgages and, 325 TARP and, 315, 328 See also JPMorgan Chase, WaMu and; specific person JPMorgan Chase, WaMu and acquisition of WaMu by, 3, 4, 6, 7, 300, 321–22 bidding for WaMu by, 300, 316–17 Chapman’s (Fay) recommendation to sell WaMu to, 179 closure of WaMu and, 301, 316–17 conversion of WaMu by, 320–24 direct negotiations for JPM acquisition of WaMu and, 189, 195, 229–38, 238n FDIC sale of WaMu and, 274–75, 289–90, 292–93, 298, 300, 316–17 and Fishman attempts to sell WaMu to JPM, 271–72 and funding for WaMu acquisition, 301, 304, 304n hostile takeover of WaMu proposal by, 245–46 Moody’s downgrade of WaMu and, 290 Paulson’s views about WaMu offer from, 248 plans for acquisition of WaMu by, 266, 274–75, 275n, 283–84, 295 press conference of, 4 profits on WaMu purchase by, 328–29 renegotiation of WaMu borrowers with, 332 rumors about WaMu deal with, 267, 268 rumors about WaMu health and, 214 Santander-JPM bid-rigging allegations and, 282n and WaMu as government-assisted deal, 266 WaMu online data room and, 291, 322 and WaMu sale as “government assistance” transaction, 246, 246n WaMu stockholders and, 245–46 junk bonds, 28 Justice Department, U.S., 60, 332 Kashkari, Neel, 315 Kaufman, Ted, 126, 330 Kelly, Edward “Ned,” 289, 298 Keystone Holdings, 42 Kido, Ken, 209–10, 281 Killinger, Brad, 29, 33, 37, 45, 81 Killinger, Bryan, 29, 33, 35, 36, 37, 45, 81 Killinger, Debbie, 29, 30, 33, 34–36, 37, 43, 45, 46, 79, 80–84, 88, 311 Killinger, Karl, 33–34, 35, 37 Killinger, Kerry absence from Seattle office of, 93–94 as Alexander the Great, 88 appearance of, 88, 189 appointment as president and CEO of, 30, 309 Baker e-mail about housing to, 152 as “Banker of the Year,” 87 blame for WaMu problems and, 241, 330 board memberships of, 83 board regulators meeting and, 192–93 caricatures of, 49, 322 compensation for, 45, 94, 104, 174, 205 congressional testimonies of, 329–31 corporate jets and, 88–89, 97, 174, 205 demands for resignation of, 195, 205 dilemma of, 121–22 employee views about, 93–94, 177, 180, 201–2, 241–42 FDIC lawsuit against, 333–34 firing of, 3, 252–53, 254, 263 five emissaries meeting with, 203–6 hiring by, 98–99 Linda thanked by, 196 management style of, 52, 55, 57, 62–63, 87, 96, 123, 174–76, 177 marginalization and isolation of, 201–2 marital problems of, 80–83 McKinsey review and, 241–42 McMurray’s report and, 186–87, 201 media criticisms of, 102, 308 nickname for, 33 NYSE bell ringing and, 54 optimism of, 173–75 organization and structure of WaMu and, 67, 96, 101, 108 OTS pressures to replace, 255 Pepper’s advice to, 102–4, 133–35, 133n Pepper’s CD gift to, 30–31 Pepper’s hiring of, 18, 19 Pepper’s relationship with, 149, 309 as Pepper’s successor, 27–31, 205 Pepper’s views about, 29–30, 87, 102–4 Pepper’s visits to WaMu and, 148 personal life of, 33–38, 45–46, 52–53, 80–84, 94 personality and character of, 28–29, 36–37, 43, 44, 45–46, 47, 53, 87–88, 90–91, 102, 105, 132, 135, 173–75, 199–200 plans/vision for WaMu of, 67, 85, 86, 87, 88, 96, 108, 109, 122–23, 228–29, 240, 241 political connections of, 231 popularity of, 87, 93 potential successors to, 106, 107, 175, 202 professional background of, 18–19, 28, 29, 37, 38 reputation/image of, 43, 44, 88, 99 resignation thoughts of, 175 sale of WaMu and, 179, 330 Seattle office of, 32–33, 95 severance package for, 258 shareholder/investor relations and, 47, 55, 81–82, 102, 173, 188, 189–91, 193–200 shareholder lawsuits against, 102, 178 stress on, 190, 241 surprise birthday party for, 79–80 as WaMu board chairman, 30, 200, 239, 240–41, 309 WaMu board relationship with, 164–65, 170, 186–87, 239 WaMu as “category killer” and, 91 WaMu culture/values and, 94–95, 98, 107, 132–33 WaMu reunions and, 308–9, 311 wealth of, 37–38, 46, 82–83 work ethic of, 35 See also specific person, merger, acquisition, or topic Killinger, Linda Cottington, 83–84, 89–90, 94, 174, 196, 205, 231, 308, 309, 328, 333 Kohn, Donald, 250, 252, 275, 294, 295–96 Korea Development Bank (KDB), 261 Korszner, Randy, 275 Kovacevich, Richard, 297 Ladder Capital, 254 Lannoye, Lee Killinger–five emissaries meeting and, 203–6 Long Beach Mortgage acquisition and, 59–60, 62–63 retirement of, 62 at shareholders 2008 meeting, 197–99 Last Hurrah Party, WaMu, 322 Lehman Brothers as advisor to WaMu, 228 bankruptcy of, 270, 272, 273, 296 capital raise at, 187 concerns about survival of, 260, 261 decision not to bail out, 269 decline in stock price of, 260, 261 Financial Services Conference of, 87 Great Western acquisition and, 41, 44 impact on borrowing at Fed’s discount window of, 285 impact on WaMu of problems at, 268, 272, 273, 296 KDB deal and, 261 losses at, 261, 263 mortgage-backed securities sales at, 120 Lehman Investors Conference, 153, 173 Leonard, Andrew, 128 Leppert, Tom, 163 Lereah, David, 136, 152, 152n Levin, Carl: Senate Committee hearings and, 318, 329–31, 334 Lewis, Kenneth D., 125, 231 Lillis, Charles, 164 liquidity, WaMu Break the Bank model for, 215, 248, 278 Cantwell-Paulson conversation about, 293 closing of banks and ratio for, 215 closure of WaMu and, 299–300, 300n, 304–5 FDIC-OTS-WaMu discussion about, 244 Fishman capital raise plan and, 294 Fishman letter to customers about, 280 Moody’s-WaMu meeting about, 265 OTS press release about, 304–5 OTS report and, 300 regulators’ concerns about, 250 sale of WaMu and, 284, 290 WaMu reports to regulators about, 286, 299 See also bank runs, WaMu; credit lines The Little Prince (children’s book), 49 loan consultants/managers compensation for, 117, 128–29, 188, 196, 197 Countrywide-WaMu competition and, 126–28 fraud among, 145 Jenne’s Option ARMs focus groups and, 116–18 layoffs of, 188 at President’s Club meetings, 142–44 pressures on, 129 underwriting guidelines and, 125–26 See also Ramirez, Tom Long Beach Mortgage AIG report about, 166 Ameriquest loans compared with those of, 154n assets of, 58 audits of, 166, 167 California regulation of, 66 change from thrift to mortgage company of, 64–65 Chapman (Craig) as manager of, 66, 78, 101 Chapman (Craig)-Rotella relationship and, 128 Chapman’s (Fay) concerns about, 56–58, 60–61, 62, 63, 72, 75–78 compensation at, 69–70, 78, 129, 166–67 Countrywide-WaMu competition and, 127 culture at, 63–64 Davis (Craig) as head of, 75–76 defaults and delinquencies at, 137, 153 expansion of, 78, 136–37 founding of, 63 fraud and, 71–73, 76, 93, 154, 166 funding for mortgage brokers and, 129 Goldman Sachs relationship with, 121, 131, 157 “higher-risk lending strategy” and, 122 Home Loans Group and problems at, 167 Justice Department accusation against, 60 Killinger and, 57, 58, 62–63, 75, 76, 78, 137–38 Lannoye opposition to, 197–98 losses at, 66 mortgage-backed securities sales at, 67, 73–75 off-loading of risky loans and, 157 OTS concerns about, 223–24 oversight of, 65, 66, 137 paperwork problems at, 332 privatization of, 66 profits of, 64, 65, 71 proposal to shut down, 76, 78 public offering for, 65 repurchase of mortgage-backed securities by, 137 reputation of, 157, 176 Rotella and, 109–10, 128, 137–38 subprime mortgages at, 63, 69, 71, 75, 167–68 underwriting guidelines for, 56, 65–66, 67, 78, 125, 137–38, 167 WaMu acquisition of, 58, 59–60, 62, 63 WaMu reviews of, 57, 76–78 See also Jiminez (Ramona and Gerardo) family: mortgage loan to Longbrake, Bill end of savings and loan banks comment of, 318 hiring of, 18 housing market warnings of, 161–63 junk bond incident and, 28 Killinger as Pepper successor and, 28 NYSE bell ringing and, 54 Pepper appointment as temporary CEO and, 10–11 personal and professional background of, 28, 98 as potential Pepper successor, 27, 29, 205 WaMu departure of, 98 WaMu responsibilities of, 98 Los Angeles Times, 71, 242–43 Mad Money (TV show), 246–47 Magleby, Alan, 297 Maher, John, 40, 42, 43–44, 45, 60 Market Research Department, WaMu, 192 See also Jenne, Kevin Martinez, Melissa, 126 Matthews, Phillip, 164 McCain, John, 264, 301 McGee, Liam, 255 McKinsey Group, 241–42 McMurray, John, 186–87, 186n, 201–2, 260–61, 264, 266, 269, 270, 288, 301 media bailout reports by, 2 bank runs and, 2, 201, 207–8, 209, 211–12, 214, 215, 243, 279, 282 criticisms of Killinger by, 102, 308–9 Dimon’s Seattle address and, 326–27 end of modern Wall Street proclaimed by, 288 FDIC seizure of WaMu and, 300–301, 302, 303 Fishman appointment announced in, 258 IndyMac failure and, 207–8, 209, 242–43 JPM merger offer to WaMu and, 237–38 Kido interview with, 281 Killinger firing reported in, 254 Lehman problems and, 270 Paulson interview with, 284–85 Pepper and, 309–10 sale of WaMu rumors and, 279, 288, 289, 298–99, 300–301, 302 and WaMu failure as nonevent, 314 WaMu final hours and, 267–68, 272, 276, 279, 281, 282, 288, 289, 292, 298–99, 300–301, 302 WaMu information lockdown and, 281 WaMu layoffs and, 321 WaMu shareholder meetings and, 189 See also specific media organization Meola, Tony, 75, 76, 142, 144, 145 “Merge with Washington Mutual!”

 

pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, New Journalism, oil shock, p-value, passive investing, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond

In the past decade, disagreement models showed how differences in investor beliefs can influence financial markets through several channels: gradual information flow, limited attention, and heterogeneous views. Disagreement is especially important for explaining the high level of trading volume, but it also can help explain correlation or volatility risk premia as well as some cross-sectional patterns in equity returns. For example, high levels of disagreement and short-selling constraints together predict relatively low equity returns because overvalued stocks cannot be shorted and tend to be held by the most optimistic investors. Asymmetric information refers to situations in which one party is better informed than the other, leading to so-called principal–agent problems (including moral hazard, adverse selection, conflict of interest). Vayanos–Woolley (2010) show that delegated asset management can cause momentum patterns.

It is not surprising, then, that paper profits tend to be most consistent in illiquid assets (e.g., small-cap stocks) or in trading styles that involve high turnover (e.g., short-term reversal). Faced with evidence of profitable trading strategies, it is always reasonable to question whether trading cost estimates (including both direct costs and market impact) have been understated. Fortunately, newer studies increasingly adjust profits for trading costs, financing costs, short-selling constraints, and other market frictions. While the limits-to-arbitrage literature explains why speculative capital is generally scarce, these adjustments explain why certain paper regularities are harder to exploit in practice than others. Only market-makers and other efficient low-cost traders can take advantage of such opportunities, and even then, only on a limited scale. Changing world Past success can prove ephemeral without implying that potential predictable profits never were there in the first place (as other mirage explanations imply).

Rallis–Miffre–Fuertes (2010) systematically review three approaches from the perspective of a long-only investor: overweighting upward-trending commodities, overweighting positive-roll commodities, and extending futures maturity to longer (deferred) contracts from the most liquid front contracts. All approaches appear to boost returns and Sharpe ratios but they also involve higher trading costs (and, likely, fees). 11.4 HEDGE FUNDS 11.4.1 Introduction Hedge funds (HFs) are pools of money run by HF managers, who face less regulation and have much greater flexibility than traditional managers, notably in their use of short selling, leverage, and derivatives. HFs face limited disclosure requirements, although transparency demands are growing both from customers and regulators. HF management contracts typically involve exceptional compensation arrangements with a large performance-related component; a 1.5% to 2% fixed management fee plus an incentive fee consisting of 20% of returns are the norm. Managers are further incentivized by holding significant parts of their wealth in their funds.

 

pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

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asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, Nick Leeson, Northern Rock, offshore financial centre, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve

A former Treasury minister, Kitty Ussher, recalls a briefing in July outlining bailout plans for banks whose names were replaced with animals or planets to preserve secrecy. They knew what was coming. Regulators in the United States were now playing a desperate game of catch-up, scrambling to do what little they could, even if that meant keeping investors in the dark. Lehman Brothers’s chief executive, Dick Fuld, panicked by David Einhorn’s famous short-selling campaign against his firm, persuaded the SEC to restrict short selling of large financial firms. A couple of months after Fannie Mae and Freddie Mac raised shareholder capital, Congress gave the Treasury Department new powers to take over the imploding mortgage behemoths. Those powers came not a moment too soon: Fannie and Freddie were placed in conservatorship by the Treasury Department in early September, stripping away once and for all the private sector fig leaf of what had always been a massive government housing subsidy scheme.

At Goldman, a key figure was Fabrice Tourre, a young French derivatives marketing wizard who had been posted to New York from Europe to work with Jonathan Egol. With Viniar’s orders to “get closer to home” ringing in his ears, Sparks had to find a mechanism to stop his growing short positions from getting too big. “Fab,” as everyone called him, had a marketing pitch: he proposed “renting” the Abacus platform to hedge funds like Paulson & Co. After overcoming opposition from Sparks’s traders, who wanted to earmark the Abacus platform for their own short-selling, in March 2007 Tourre arranged a synthetic CDO called Abacus 2007 AC-1 for the purpose of allowing Paulson to short a billion dollars worth of subprime. The detail that landed Goldman and Tourre in the SEC’s gunsights was a minor tweak to the static Abacus template: Tourre brought in a monoline insurance company called ACA to select the specific subprime bonds in the CDO while allowing Paulson extensive influence over the selection.

This department found it could earn extra money for shareholders by providing a service to Wall Street called securities lending. Traders at banks and hedge funds like to borrow stocks and bonds (for a fee) in order to sell them short. In other words, they speculate against falls in price, then buy the securities back again and return them to their rightful owners. Some pension funds and insurers object to short selling and refuse to lend their securities out, but most were happy to comply in return for a few points in fees.17 In the mid-2000s, Win Neuger, who ran the global investment group for AIG, had the bright idea of taking this notion further. Normally, securities lenders park the cash collateral received for lent securities in the safest possible Treasury bills or government bonds so that they can redeem the loans quickly, if necessary.

 

pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

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Albert Einstein, asset allocation, asset-backed security, Brownian motion, business process, capital asset pricing model, clean water, collateralized debt obligation, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, fixed income, implied volatility, index fund, interest rate swap, inventory management, London Interbank Offered Rate, margin call, market fundamentalism, mortgage debt, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

Investopedia explains Absolute Return Generally, mutual funds seek returns that are better than those of their peers, their fund category, and/or the market as a whole. This type of fund management is referred to as a relative return approach to fund investing. Absolute return funds seek positive returns by employing investment strategies that often are not permitted in traditional mutual funds, such as short selling, futures, options, derivatives, arbitrage, leverage, and unconventional assets. Alfred Winslow Jones is credited with forming the first absolute return fund in New York in 1949. Today, the absolute return approach to fund investing has become one of the fastest growing investment products in the world; it’s called a hedge fund. 3 4 The Investopedia Guide to Wall Speak Related Terms: • Mutual Fund • Return on Investment • Yield • Return on Assets • Total Return Accounts Payable (AP) What Does Accounts Payable (AP) Mean?

Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and typically can be purchased or redeemed as needed at the fund’s current net asset value (NAV) per share, which sometimes is expressed as NAVPS. Related Terms: • Closed-End Fund • Net Asset Value—NAV • Style • Diversification • Open-End Fund N naked shorting What Does Naked Shorting Mean? The practice of short selling shares that have not been confirmed to exist. Ordinarily, traders must borrow a stock or determine that it can be borrowed before they sell it short. However, as a result of various loopholes in the rules and discrepancies between paper and electronic trading systems, naked shorting continues to happen. Although no exact system of measurement exists, most point to the level of trades that fail to deliver from the seller to the buyer within the mandatory three-day stock settlement period as evidence of naked shorting.

The Investopedia Guide to Wall Speak 197 Related Terms: • Cost of Goods Sold—COGS • Gross Income • Operating Income • Economic Profit • Income Statement Net Long What Does Net Long Mean? A condition in which an investor has more long positions than short positions in a specific asset class, market sector, portfolio, or trading strategy. Investors who are net long will benefit when the price of the asset increases. Investopedia explains Net Long Many mutual funds are restricted from short selling; this means the funds are usually net long. In fact, most individual investors do not hold large short positions, making the net long portfolio a common and usually expected investing situation. A position that is net long is the opposite of a position that is net short. Related Terms: • Delta • Long (or Long Position) • Short (or Short Position) • Hedge • Overbought Net Operating Income (NOI) What Does Net Operating Income (NOI) Mean?

 

The Handbook of Personal Wealth Management by Reuvid, Jonathan.

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asset allocation, banking crisis, BRICs, collapse of Lehman Brothers, correlation coefficient, credit crunch, cross-subsidies, diversification, diversified portfolio, estate planning, financial deregulation, fixed income, high net worth, income per capita, index fund, interest rate swap, laissez-faire capitalism, land tenure, market bubble, merger arbitrage, new economy, Northern Rock, pattern recognition, Ponzi scheme, prediction markets, risk tolerance, risk-adjusted returns, risk/return, short selling, side project, sovereign wealth fund, statistical arbitrage, systematic trading, transaction costs, yield curve

Strategies that require leverage to perform, or that make investments based on fundamentals, have under-performed during this period. Long/short equity The major drag on performance has been aggressive sector rotations between financials and commodities. Long/short funds tend to invest in positions based on fundamentals, which have succumbed to indiscriminate selling. During 2008 many governments introduced temporary restrictions on the short selling of financial stocks. At the time the cost of borrowing such stocks to short sell had increased dramatically, in many cases making the trade prohibitive. Later on in the year, managers began to see shorting opportunities in consumer-related stocks. Due to the volatile environment, managers reduced their trade sizes, believing that this would not have a negative impact on returns as dispersion was so high. Indiscriminate selling is not conducive to this approach.

During 2008, managers took profits from longer-term themes, such as the rise in commodity prices and allocated more capital to shorter-term trends. Convertible bond arbitrage Poor performance has been the result of credit spreads widening and considerable distressed sell off as investors took flight to quality assets. The strategy involves purchasing the convertible bond and short selling the underlying equity. The restrictions on short selling in financials also impeded this strategy. Event driven The number and size of global mergers and acquisitions were significantly down during 2008 compared with the preceding years. This has meant that the opportunity set for this strategy was reduced. Deal spreads remained high, to compensate for the risk of deals failing to complete. The outlook for strategic M&A deals remains positive but the potential for leveraged buy-outs has reduced significantly.

 

pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John von Neumann, Joseph Schumpeter, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, naked short selling, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

In the ensuing modeling, Black and Scholes neglected taxation and transactions costs, and assumed an investor has perfect access to borrowing at the risk-free interest rate. One strategy they proposed and analyzed was what they called the zero-beta portfolio. Their idea was to The Black-Scholes Options Pricing Theory 111 hold low beta stocks long that they predicted would perform better than the market. The short selling of high beta stocks should then allow the purchase of the low beta stocks, with some profit left over and with very little or, ideally, zero risk. This higher risk-free return could then be used to buy and sell along a Markowitz security line with a higher risk-free return intercept. An investor could then earn a superior risk-return trade-off for any level of desired risk through leverage purchases of the market portfolio.

As early as 1963, at the age of 19, he gambled that a corporate merger would go through and calculated the optimal rate to buy one stock and sell the other in order to profit from the merger. His risk arbitrage strategy was successful, and his early successes induced him soon after his arrival at graduate school at the California Institute of Technology in the West Coast university town of Pasadena to hang out in the early morning at brokerage houses in anticipation of the market opening in New York. His trades, first in buying stocks, then in buying and shorting (selling stocks borrowed by the trader) stocks, and then in the increasingly sophisticated instruments of warrants (stock options issued by the corporations themselves), options, and bonds, taught him about the market and helped put himself through school. Merton also engaged in the somewhat risky practice of investing on margin. This strategy allows the investor to move further out on the Markowitz efficient securities market line to a point of higher reward but also magnified risk.

However, both the new and the very slightly aged bond would both be aged within a short time and would still have a very similar and long horizon. These differences in liquidity may be slightly more pronounced even between two trading centers located in different time zones and thousands of miles apart. Long Term Capital Management developed a strategy to capitalize on these differences. It could even do so with almost no invested capital, by buying the thinly traded slightly aged bonds and at the same time short selling the new issue bonds to raise the funds. This way, it could afford to trade very The Nobel Prize, Life, and Legacy 169 large volumes of each, and make perhaps only pennies per bond, but over millions of bond contracts. These strategies were wildly successful at first. Because Long Term Capital Management had to front little money on these covered transactions, its equity grew to almost $5 billion within four years and it had borrowed to purchase contracts worth almost $130 billion.

 

pages: 224 words: 13,238

Electronic and Algorithmic Trading Technology: The Complete Guide by Kendall Kim

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algorithmic trading, automated trading system, backtesting, corporate governance, Credit Default Swap, diversification, en.wikipedia.org, family office, financial innovation, fixed income, index arbitrage, index fund, interest rate swap, linked data, market fragmentation, natural language processing, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, short selling, statistical arbitrage, Steven Levy, transaction costs, yield curve

Exchange-listed options contracts Short Interest Rule Member organizations of the NYSE, AMEX, and NASD must report listed short sale positions held on a monthly basis, with the exception of AMEX, which must report them twice a month. Every member organization must file with the exchange all short positions on a bimonthly basis. The first is due within two business days after the 15th of each month, and the second is due the next business day after the last day of the month. The types of transactions that must be reported include short sells for equities and exchange traded funds. The key items of information required include 1. for NYSE: Bank Identifier, Symbol, Current Short Position; 2. for NASD: Bank Identifier, NASDAQ Security Symbol, Security Name, Current Short Position; 3. for AMEX: Bank Identifier, NASDAQ Security Symbol, Security Name, Current Short Position. NYSE Rule 123 Members who place exchange orders through a proprietary system are required to report all order and execution details to an exchange-provided database.

The main reason why prime brokers carry out custody activity is to facilitate margin-lending 1 Adam Sussman, Managing Risk in Real-Time Markets, Tabb Group Report, February 2005, http://www.tabbgroup.com/our_reports.php?tabbaction¼4&reportId¼87. 153 154 Electronic and Algorithmic Trading Technology activities and the associated movement of collateral. Prime brokers earn their revenue through cash lending to support leverage and stock lending to facilitate short selling. It is increasingly common for prime broker clients to structure trades, utilizing synthetic products and other different asset classes. In the stock-lending business, prime brokers act as an intermediary between institutional lenders and other hedge fund borrowers. In financing equity role, prime brokers act in the role of an intermediary. 14.2 Prime Broker Services The services that a prime broker provides include the following (see Exhibit 14.1): 1.

Prime brokerage has traditionally been dominated by niche players in the past, but larger banks are increasingly getting Strategy Do Not Use Low (<2.0:1) High (=>2.0:1) Aggressive Growth 20% 60% 20% Emerging Markets 20 50% 30% Equity Market Neutral 15% 50% 35% Event Driven 15% 60% 25% Income 35% 30% 35% Macro 10% 30% 60% Market Neutral Arbitrage 10% 25% 65% Market Timing 55% 35% 10% Multi-Strategy 10% 50% 40% Opportunistic 10% 60% 30% Short Selling 30% 40% 30% Value 20% 60% 20% Exhibit 14.2 Global hedge funds’ use of leverage. Source: Van Hedge Fund Advisors, Aite Group. 2 Sang Lee, ‘‘Shaking Up Prime Brokerage: Unbundling Securities Lending, Financing, and Derivatives Transactions,’’ Aite Group Report 200510171 (October 2005): 9–10. Trading Technology and Prime Brokerage 157 into fund servicing. Large banks figure this is an easy way to gain a foothold in global reach, technology, and personnel capabilities that smaller players cannot. 14.3 The Structure of Hedge Funds Hedge funds today have grown to more than $1.225 trillion in assets under management by the end of the second quarter of 2006 according to the recently released data by Chicago-based Hedge Fund Research Inc.

 

Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America by Matt Taibbi

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affirmative action, Affordable Care Act / Obamacare, Bernie Sanders, Bretton Woods, carried interest, clean water, collateralized debt obligation, collective bargaining, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, desegregation, diversification, diversified portfolio, Donald Trump, financial innovation, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, illegal immigration, interest rate swap, laissez-faire capitalism, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, medical malpractice, moral hazard, mortgage debt, obamacare, passive investing, Ponzi scheme, prediction markets, quantitative easing, reserve currency, Ronald Reagan, Sergey Aleynikov, short selling, sovereign wealth fund, too big to fail, trickle-down economics, Y2K, Yom Kippur War

In that same period, in late September 2008, both Goldman CEO Lloyd Blankfein and Morgan Stanley CEO John Mack lobby the government to impose restrictions on short sellers who were attacking their companies—and they get them, thanks to a decision by the SEC on September 21 to ban bets against some eight hundred financial stocks. Goldman’s share price rises some 30 percent in the first week of the ban. The short-selling ban was galling for obvious reasons: the same bank that just a year before had bragged about the fortune it had made shorting others in the housing market was now getting its buddies in the government to protect it from short sellers in a time of need. The collective message of all of this—the AIG bailout, the swift approval for its conversion to bank holding company status, the TARP funds, and the short-selling ban—was that when it came to Goldman Sachs, there wasn’t a free market at all. The government might let other players on the market die, but it simply would not allow Goldman Sachs to fail under any circumstances.

In his Neuger Notes back in December 2005, Neuger wrote, “There are still some people who do not believe in our mission … If you do not want to be on this bus it is time to get off … Your colleagues are tired of carrying you along.” How was he going to make that money? Again, just like Cassano, he was going to take a business that should have and could have been easy, almost risk-free money and turn it into a raging drunken casino. Neuger’s unit was involved in securities lending. In order to understand how this business makes money, one first needs to understand some basic Wall Street practices, in particular short selling—the practice of betting against a stock. Here’s how shorting works. Say you’re a hedge fund and you think the stock of a certain company—let’s call it International Pimple—is going to decline in value. How do you make money off that knowledge? First, you call up a securities lender, someone like, say, Win Neuger, and ask if he has any stock in International Pimple. He says he does, as much as you want.

So let’s say a month later, International Pimple is now trading not at 10 but at 7½. You then go out and buy a thousand shares in the company for $7,500. Then you go back to Win Neuger and return his borrowed shares to him; he returns your $10,000 and takes the stock back. You’ve now made $2,500 on the decline in value of International Pimple, less the $200 fee that Neuger keeps. That’s how short selling works, although there are endless nuances. It’s a pretty simple business model from the short seller’s end. You identify securities you think will fall in value, you borrow big chunks of those securities and sell them, then you buy the same stock back after the value has plummeted. But how does a securities lender like Neuger make money? Theoretically, with tremendous ease. The first step to being a successful securities lender is having lots and lots of securities.

 

pages: 586 words: 159,901

Wall Street: How It Works And for Whom by Doug Henwood

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accounting loophole / creative accounting, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, corporate governance, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, interest rate swap, Internet Archive, invisible hand, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, moral hazard, mortgage debt, mortgage tax deduction, oil shock, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

A sale made by someone who doesn't own the underlying asset — and this applies to bonds and stocks as well as wheat — is selling it "short," on the anticipation of buying it back at a lower price, or, in a pinch, buying it in the open WALL STREET market at whatever price prevails and delivering the goods.'"* Short-selling exposes the practitioner to enormous risks: w^hen you buy something — go long, in the jargon — your loss is limited to what you paid for it; when you go short, however, your losses are potentially without limit. In theory, brokers are supposed to be sure their clients have the credit rating to justify short-selling, though things don't always work out by the book. Options are similar. On April 18, 1995, the July wheat contract closed at $3.5175 per bushel for a contract covering 5,000 bushels, or $17,587.50 per contract. The typical player would have to put up 5% margin — a good faith cash deposit with the broker, who treats the other 95% as a loan, on which interest is charged — or $880.

But only in part, because the derivatives were a fancy-dress version of a classic strategy, borrowing lots of money to make bad investments. You don't need instruments WALL STREET jointly concocted by MBAs and theoretical physicists to lose at that game. 13. Anyone who thinks an option on a future is too abstract to exist is obviously not schooled in the higher financial consciousness. 14. An old Wall Street rhyme says of short-selling: "He who sells what isn't his'n/Buys it back or goes to prison." 15. What follows describes futures markets, but options markets are very similar. 16. Long before stock options were traded on exchanges, stock warrants were traded on the NYSE and other exchanges.Warrants are essentially long-term options to buy a stock, with maturities typically measured in years rather than months; they're frequently attached to new bond issues to make them more attractive. 17.

See debt deflation (Fisher) Delaney, Kevin, 265 Democratic Party, 87 deposit insurance, 88 Depository Intermediary Deregulation and Monetary Control Act of 1980, 87 depreciation, 140 Depression, 1930s financial mechanisms, 155-158 Friedman and Schwartz on, 200 derivatives, 28-41 custom, 34-37 defined, 28 early, 29 economic logic, 37-41 market-traded standardization and centralization, 32-33 technical details, 29 more complex strategies, 31 motives for, 31 and risk, individual and systemic, 40-41 short selling, 29-30 trading prowess, 32 winners, long-term, 32 development, 322 protectionism and, 300 Dickens, Edwin, 219 DiNapoli, Tom, 180 direct investment vs. portfolio investment, 109 Third World, 110-111 in U.S., dismal returns, 117 disclosure requirements, corporate, 91 discounting, interest rates and, 119-120 distribution Gini index, 115 income CEO vs. worker pay, 239 Manhattan's inequality, 79 polarization in 1920s, 200 wealth, 4, 64-68 dividends, 73, 135 changes in, and excess volatility, 175 payout ratios, and investment, 154 retention ratio, 75 unexpected changes in, 169 yields, 125 dollar, U.S.

 

pages: 452 words: 150,785

Business Adventures: Twelve Classic Tales From the World of Wall Street by John Brooks

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banking crisis, Bretton Woods, business climate, cuban missile crisis, Ford paid five dollars a day, invention of the wheel, large denomination, margin call, Marshall McLuhan, Plutocrats, plutocrats, short selling, special drawing rights, tulip mania, upwardly mobile, very high income

And in the days when corners were possible, the short seller’s sleep was further disturbed by the fact that he was operating behind blank walls; dealing only with agents, he never knew either the identity of the purchaser of his stock (a prospective cornerer?) or the identity of the owner of the stock he had borrowed (the same prospective cornerer, attacking from the rear?). Although it is sometimes condemned as being the tool of the speculator, short selling is still sanctioned, in a severely restricted form, on all of the nation’s exchanges. In its unfettered state, it was the standard gambit in the game of Corner. The situation would be set up when a group of bears would go on a well-organized spree of short selling, and would often help their cause along by spreading rumors that the company back of the stock in question was on its last legs. This operation was called a bear raid. The bulls’ most formidable—but, of course, riskiest—counter-move was to try for a corner. Only a stock that many traders were selling short could be cornered; a stock that was in the throes of a real bear raid was ideal.

Ryan achieved his corner and the Stock Exchange short sellers were duly squeezed. But Ryan, it turned out, had a bearcat by the tail. The Stock Exchange suspended Stutz dealings, lengthy litigation followed, and Ryan came out of the affair financially ruined. Then, as at other times, the game of Corner suffered from a difficulty that plagues other games—post-mortem disputes about the rules. The reform legislation of the nineteen-thirties, by outlawing any short selling that is specifically intended to demoralize a stock, as well as other manipulations leading toward corners, virtually ruled the game out of existence. Wall Streeters who speak of the Corner these days are referring to the intersection of Broad and Wall. In U.S. stock markets, only an accidental corner (or near-corner, like the Bruce one) is now possible; Clarence Saunders was the last intentional player of the game.

London opens an hour after the Continent (or did until February 1968, when Britain adopted Continental time), New York five (now six) hours after that, San Francisco three hours after that, and then Tokyo gets under way about the time San Francisco closes. Only a need for sleep or a lack of money need halt the operations of a really hopelessly addicted plunger anywhere. “It was not the gnomes of Zurich who were beating down the pound,” a leading Zurich banker subsequently maintained—stopping short of claiming that there were no gnomes there. Nonetheless, organized short selling—what traders call a bear raid—was certainly in progress, and the defenders of the pound in London and their sympathizers in New York would have given plenty to catch a glimpse of the invisible enemy. IT was in this atmosphere, then, that on the weekend beginning November 7th the leading central bankers of the world held their regular monthly gathering in Basel, Switzerland. The occasion for such gatherings, which have been held regularly since the nineteen-thirties except during the Second World War, is the monthly meeting of the board of directors of the Bank for International Settlements, which was established in Basel in 1930 primarily as a clearing house for the handling of reparations payments arising out of the First World War but has come to serve as an agency of international monetary coöperation and, incidentally, a kind of central bankers’ club.

 

pages: 514 words: 153,092

The Forgotten Man by Amity Shlaes

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anti-communist, bank run, banking crisis, collective bargaining, currency manipulation / currency intervention, Frederick Winslow Taylor, invisible hand, Mahatma Gandhi, Plutocrats, plutocrats, short selling, Upton Sinclair, wage slave, Works Progress Administration

He would eventually do prison time for covering up illegal loans with the aid of his loyal brother George. To have a Wiggin or a Whitney as their spokesman hurt defenders of the market at a time when their argument was crucial. For it was not wrong that a restriction on short selling would scare the market by depriving it of a vehicle for hedging its risks. That fear alone might even trigger big drops in stock prices. And there would no longer be the countervailing pressure of the short buyer. Mellon’s “liquidate” phrase sounded harsh but was far less constraining than the president’s restrictions on short selling. When a man marked your stocks to the market price and sold, everyone knew what everything was worth. The dread uncertainty of a further decline would diminish, and stocks might begin to move up again. Whitney’s colleagues outdid one another in their efforts to demonstrate to Hoover that they could handle matters without Washington.

This was what everyone expected in any case, for at that time Washington did not regulate the stock market; the exchange was a New York corporation. Still, Hoover could scold, and he did. In his first annual message to Congress, delivered in December 1929, Hoover railed against the “wave of uncontrolled speculation” that he saw as a cause of the crash. Over the course of the winter and the next year he would speak out, too, against short selling. In a short sale, a trader borrows a stock and sells it at a certain price, in the hopes that by the time he must deliver the stock, he can buy it himself even more cheaply. Hoover believed that this was not logic but roulette at its worst. The game was dangerous because it moved away from the value of the underlying asset—shares in a company—and into the racy world of betting. Without short contracts, he reckoned, the stock market would not experience such violence ructions.

Wall Street in the 1920s had felt like a gamble, and some of the players had been irresponsible or worse. One was Richard Whitney, the new president of the New York Stock Exchange. Whitney, a patrician, could make the free-market argument as well as any. At a meeting in October 1930 at the Stevens Hotel in Chicago, Whitney criticized the idea of blanket legislation to restrict short sales and other forms of speculation: “The Exchange is convinced that normal short selling is an essential part of a free market in securities.” How could a market exist if it was not allowed to place such bearish contracts? “Such a contract to deliver something in the future which a person does not own is common to many types of business. When a builder contracts to build a skyscraper he is literally short of every bit of material.” Yet no one, Whitney pointed out, considered that builder a criminal for signing the contract.

 

pages: 1,335 words: 336,772

The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance by Ron Chernow

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bank run, banking crisis, Big bang: deregulation of the City of London, Bolshevik threat, Boycotts of Israel, Bretton Woods, British Empire, California gold rush, capital controls, collective bargaining, Etonian, financial deregulation, German hyperinflation, index arbitrage, interest rate swap, margin call, Monroe Doctrine, North Sea oil, oil shale / tar sands, paper trading, Plutocrats, plutocrats, Robert Gordon, Ronald Reagan, short selling, strikebreaker, the market place, the payments system, too big to fail, transcontinental railway, Yom Kippur War, young professional

He said short sellers were preventing an economic rebound and warned that unless Whitney curbed them, he would ask Congress to investigate the Exchange and possibly impose Federal regulation. Whitney refused to admit any danger in short selling. Privately Morgan partners mocked Hoover’s obsession as absurd and fantastic, but they couldn’t dissuade him from his vendetta. Although fearing that public hearings would dredge up “discouraging filth” and sabotage recovery efforts, in 1932 Hoover asked the Senate Banking and Currency Committee to start an inquiry into short selling. Wall Street bankers were so upset that Lamont lunched at the White House with Hoover and Secretary of State Stimson, trying to spike the inquiry. Hoover said destructive short sellers had offset his beneficial measures, a remark that led to a heated exchange about the hearings.

Treasury Secretary Andrew Mellon wanted higher interest rates to stop the flow of gold to Europe. Many at the Fed saw austerity as a bitter but necessary medicine. “The consequences of such an economic debauch are inevitable,” said the Philadelphia Fed governor. “Can they be corrected and removed by cheap money? We do not believe that they can.”9 By the second half of 1930, the postcrash calm was gone. That fall, Hoover complained to Lamont about bear raids, short selling, and other unpatriotic assaults against national pride. The following year would be the worst in stock market history. While the Fed had assumed responsibility for the health of the entire financial system after the 1929 crash, the House of Morgan still played a part in specific, smaller crises. The Fed had no obligation to rescue individuals, banks, or companies; its concerns were more general.

Maybe they have settled German reparations but they did it the worst damned way they could.”14 He wouldn’t extend his one-year debt moratorium and rejected French and British proposals for deferring upcoming payments; he forced France to default. So on the eve of Hitler’s advent, the Allies were squabbling over moldy financial issues that had bedeviled them for years. The Morgan-Hoover feud over debt was mild compared with their debate over short selling on Wall Street. Moody and isolated, taciturn and stony-faced, Hoover now shared the average American’s view of Wall Street as a giant casino rigged by professionals. He saw the stock market as a report card on his performance, and it showed consistently failing grades. He came to believe in a Democratic conspiracy to drive down stocks by selling them short—that is, by selling borrowed shares in the hope of buying them back later at a cheaper price.

 

pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, merger arbitrage, Mikhail Gorbachev, Milgram experiment, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Naomi Klein, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, pets.com, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond

In reality, I, not Mailer, had analysed the proposed investment strategy, the script by which a trader or fund manager attempts to make money. Nonprofessionals are astonished as to how banal all investment strategies are when stripped of the marketing gloss that is used to sell them. A long-short strategy is where the investor buys something they expect to go up and short sells something that they expect to go down. It is called market neutral or relative value. Long-short is differentiated from long only where the investor can buy things that presumably they think will go up. Short selling involves selling something that you don’t own but hope to buy back at a lower price when the price goes down. You can sell tickets to a sought-after concert by the latest hot band for $200 for delivery in 1 week. You don’t own the tickets but you think that ticket prices will fall before you have to deliver them.

Black and Scholes built upon Kassouf and Thorp’s idea of hedging options using the underlying stock. The value of the option must be determined by the value of the stock. As the stock price changes, so should the price of the option. If a stock price moves from $10 to $11, then the price of the call option should also increase. The relationship allows the setting up of risk-free portfolios where you buy a call option and at the same time short sell a share. If the stock price goes up then the value of the call option increases but you suffer a loss on the shares, as you have to buy them back at the higher price. By adjusting the ratio of options to the shares, you can construct a portfolio where the changes in the value of the options and shares exactly offset, at least, for small movements in the stock price. Working as research assistant to Paul Samuelson, Robert Merton was also working on option pricing.

In contrast, hedge funds focused on absolute returns, trying to make money under all market conditions. In the early 1990s and again in the early 2000s, equity markets were moribund and interest rates were at record lows. Forced to look elsewhere, investors increased investment in hedge funds. Suspicious of new products, traditional institutions reluctantly entered new markets to boost declining returns. Not allowed to buy structured securities, short sell, leverage or use derivatives, conservative funds gave money to hedge funds that could. The new mantra was “hedge funds for everybody.” Style Gurus Hedge fund managers argued that only they knew what they do, reminiscent of a prospectus from the 1920s: “the credit and status of the company are so well known that it is scarcely necessary to make any public statement.”6 At a 2009 Congressional Inquiry, Citadel’s Ken Griffin argued against disclosure by comparing it to “asking Coca-Cola to disclose their secret formula to the world.”7 One manager explained his investment strategy as throwing light on “fragmented information” and “opaque” track records.

 

pages: 374 words: 114,600

The Quants by Scott Patterson

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Albert Einstein, asset allocation, automated trading system, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Nash: game theory, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, NetJets, new economy, offshore financial centre, Paul Lévy, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

The entire global credit market suffered a massive panic attack, threatening to bring down trading powerhouses such as Saba and Citadel in its wake. Another blow came from the federal government’s ban on short selling in the weeks following the Lehman-AIG debacle. Shares of financial firms across the board—even stalwarts such as Goldman Sachs and Morgan Stanley—were collapsing. To keep the situation from spiraling out of control, the Securities and Exchange Commission in September instituted a temporary ban on shorting about eight hundred financial stocks. Citadel, it turned out, had short positions in some of those companies as part of its convertible bond arbitrage strategy. Just as Ed Thorp had done in the 1960s, Citadel would buy corporate bonds and hedge the position by shorting the stock. With the short-selling ban, those shares surged dramatically in a vicious short squeeze that inflicted huge losses on hedge funds.

Over the next fifteen minutes before trading began on the NYSE, massive pressure built up on index futures, almost entirely from portfolio insurance firms. The big drop by index futures triggered a signal for another new breed of trader: index arbitrageurs, investors taking advantage of small discrepancies between indexes and underlying stocks. When trading opened in New York, a brick wall of short selling slammed the market. As stocks tumbled, pressure increased on portfolio insurers to sell futures, racing to keep up with the widely gapping market in a devastating feedback loop. The arbs scrambled to put on their trades but were overwhelmed: futures and stocks were falling in unison. Chaos ruled. Fischer Black watched the disaster with fascination from his perch at Goldman Sachs in New York, where he’d taken a job managing quantitative trading strategies.

Adams arranged a meeting in New York between Griffin and Frank Meyer, an investor in Triple I as well as Princeton/Newport. Meyer too was floored by Griffin’s broad understanding of technical aspects of investing, as well as his computer expertise, an important skill as trading became more mechanized and electronic. But it was his market savvy that impressed Meyer most. “If you’re a kid managing a few hundred thousand, it’s very hard to borrow stock for short selling,” Meyer recalled. “He went around to every major stock loan company and ingratiated himself, and because he was so unusual they gave him good rates.” Griffin set up shop in Chicago in late 1989 with his $1 million in play dough, and was quickly making money hand over fist trading convertibles with his handcrafted software program. In his first year of trading, Griffin posted a whopping 70 percent return.

 

pages: 349 words: 134,041

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

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accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, mutually assured destruction, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk-adjusted returns, risk/return, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

In currency markets, actual trade and investment flows make up a tiny portion of trading volume – around 3%. The rest is ‘capital flow’. This is just double-speak for speculative capital zooming around the globe at the speed of light along fibre-optic cables in search of profits. All this is aided and abetted by the turbo-charged power of cash settled derivatives. Derivatives also allow traders to short sell. You could sell something you don’t own. Confused? Well, if you don’t own something generally it is difficult to sell it. Even the most clueless buyer wouldn’t pay good boodle for something you can’t give him. Why can’t you deliver it to him? Well, you don’t own it – otherwise it would not be a short sale. Catch-22. The beauty of derivatives is that you sell forward. You don’t have to deliver it today.

Hedge funds charge a fee of 1% on AUM plus around 20% of profits, sometimes above an agreed benchmark; sought-after funds charge more. One ‘hot’ hedge fund charges more – 5% and 35% of profits. Most hedge funds are small and fund managers are owner managers – Performance-related fees mean that they get paid more than they ever would on the sell side. Hedge funds are not actually hedged. They can do certain things that traditional investors can’t, short sell to take advantage of falling prices and leverage to increase profits. The benefits of derivatives – access, customized risk-reward profiles, ability to short and leverage – mean they are essential to hedge funds. Hedge funds also trade a lot; dealers love it. Special desks to sell exclusively to hedge funds are now common. The money just keeps rolling in. These funds have many investment styles, the favourite being ‘market neutral’.

The weird nature of shares affects equity derivatives – there are many more moving parts. You have to watch the risk of dilution (changes in the number of shares on issue) and you especially have to watch out for dividends (how much, when and how they are taxed). Then there are all the DAS_C04.QXP 8/7/06 242 4:51 PM Page 242 Tr a d e r s , G u n s & M o n e y quaint rules of stock exchanges that apply to trading shares (when you could short sell). This is a world of new unknowns but for those in the know, it presents endless opportunities. Many of these opportunities are presented by the uninitiated as they blunder around in equityland. Recently I saw an interesting trade between two reputable and highlyregarded banks on a five year option on a stock. Both dealers booked a large profit on the deal, which in the zero sum world of derivative trading is not possible.

 

pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

The financial crisis gave hedge funds a bad name, probably a worse name than they deserved. They were depicted as predators for their short selling; as excessively leveraged, and therefore a source of financial fragility; and as facilitating herding behavior, both in the bubble and in the panic after the music stopped. Maybe even as unsavory gambling dens. Nobody, it seemed, loved hedge funds—except, of course, the people who ran them, many of whom had amassed, in the apt words of a popular book on hedge funds, “more money than God.” Surely anyone who had gained such an obscenely large fortune so fast must be guilty of something. But the facts did not support those harsh judgments, other than the charge of obscene rewards. First, short selling probably kept the housing and bond bubbles from blowing up even bigger than they did. Why?

The new Wall Street model looked shaky, and in the market’s view, Lehman was probably the next to go. On Bear Stearns Day, Lehman’s CEO Richard “Dick” Fuld knew that his company was in the crosshairs, and when the stock market opened on the next Monday, Lehman’s stock was, indeed, pummeled. As he later lamented to the FCIC, “Bear went down on rumors and a liquidity crisis of confidence. Immediately thereafter, the rumors and the naked short-selling came after us.” It certainly did. But Lehman managed to hold things together for another six months. Lehman’s primary regulator was the same as Bear’s: the somnolent SEC. After the Bear Stearns bailout, however, and especially after the Fed began lending to broker-dealers, the central bank started watching over Lehman Brothers and the other three Wall Street giants—with supervision, stress tests, requests for data, and the like.

“[as] fundamentally flawed”: FCIC Report, 323. “central to the financial crisis”: FCIC Report, 323. “‘save their ass’”: Paulson, On the Brink, 144. “you may not have to take it out”: Paulson, On the Brink, 151. “hardest thing I had ever done”: Paulson, On the Brink, 170. $200 billion worth of repos outstanding: FCIC Report, 326. “what we learned scared us”: Paulson, On the Brink, 121. “naked short-selling came after us”: FCIC Report, 326–27. better than they actually were: See Latman, “New York Accuses Ernst & Young of Fraud in Lehman Collapse,” New York Times. longer-term debt by June: FCIC Report, 326. rejected the idea as “gimmicky”: FCIC Report, 328. $55 billion loan from the Fed: FCIC Report, 328. Fannie and Freddie were taken over: Sorkin, Too Big to Fail, chapter 11. Paulson refused: Paulson, On the Brink, 190.

 

pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

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Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, buy low sell high, capital controls, central bank independence, Chance favours the prepared mind, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, diversification, diversified portfolio, family office, fixed income, glass ceiling, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, Long Term Capital Management, margin call, market bubble, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, new economy, Nick Leeson, oil shale / tar sands, oil shock, out of africa, paper trading, Peter Thiel, price anchoring, purchasing power parity, reserve currency, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

I couldn’t believe how calm they were, considering the amount of money we lost. It was an out-of-control hit but because of the spare capital, we weren’t backed into a corner and were never forced sellers.They were able to be rational about it and actually bought more shares. It turned out to be a great buying opportunity. What was your next job? I went to work with Jim Chanos, who just did short selling. It was interesting going to work with him after the family, who were always optimistic and incredibly bullish. Jim was always trying to go against the crowd. He constantly picked things apart and looked for what “the market” had wrong. One thing Jim was never great at was figuring out why it would end. He never really looked for the catalyst that would change the market’s focus. He was usually right, but what I’ve learned since is that it’s more important to be there when a mania ends, than spotting it early.

He was usually right, but what I’ve learned since is that it’s more important to be there when a mania ends, than spotting it early. What I came away with from my time with Chanos was that you don’t have to be skeptical about everything. Maybe the guys at Starbucks really are good managers and it really is one of the greatest concepts ever. Maybe eBay is the perfect business model. Short sellers can’t think that way. Short selling is a unique and specific mind-set. According to them, every Internet stock had to go bankrupt. Jim’s always betting against the house but, working with him, I learned that the house usually wins.That’s part of the short seller’s problem. Another problem is that it’s harder now because there are a lot more people doing it. There are also other inherent problems with shorting.There is a difference between investing or buying stocks and shorting.

Also, when a short goes against you, it becomes a bigger percentage of your portfolio, but when it’s working, it becomes a smaller percentage. So with a short, your risk increases as its goes against you. What distinguishes Jim Chanos as a short seller? Jim has been very successful and has caught some great shorts, like Enron recently. The great thing about Jim is that he is the presentable, educated face of short selling. He’d gone to Yale and is very articulate and thoughtful. He wasn’t one of these guys from a strange religion who crawled out from under a rock.We weren’t squeezing little trades and constantly fighting with the Vancouver Stock Exchange to borrow stocks. A lot of what he did was to catch the big shorts. He actually sat there and did a lot of homework. When I was there, the firm went from $20 million in assets under management to $500 million.

 

A Primer for the Mathematics of Financial Engineering by Dan Stefanica

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asset allocation, Black-Scholes formula, capital asset pricing model, constrained optimization, delta neutral, discrete time, Emanuel Derman, implied volatility, law of one price, margin call, quantitative trading / quantitative finance, Sharpe ratio, short selling, time value of money, transaction costs, volatility smile, yield curve, zero-coupon bond

The change in the value of the portfolio is II(B + dB) - II(B) O(B + dB) - ~. (B + dB) - (O(B) O(B + dB) - O(B) - ~ dB. ~. B) (3.98) We look for ~ such that the value of the portfolio is insensitive to small changes in the price of the underlying asset, i.e., such that II(B + dB) - II(B) ~ O. From (3.98) and (3.99), and solving for ~ ~ 0 (B ~, we find that + dB) dB (3.99) 0 (B) . 7To explain short selling, consider the case of equity options, i.e., options where the underlying asset is stock. Selling short one share of stock is done by borrowing the share (through a broker), and then selling the share on the market. Part of the cash is deposited with the broker in a margin account as collateral (usually, 50% of the sale price), while the rest is deposited in a brokerage account. The margin account must be settled when a margin call is issued, which happens when the price of the shorted asset appreciates beyond a certain level.

The cash from the brokerage account can be invested freely, while the cash from the margin account earns interest at a fixed rate, but cannot be invested otherwise. The short is closed by buying the share (at a later time) on the market and returning it to the original owner (via the broker; the owner rarely knows that the asset was borrowed and sold short). We will not consider here these or other issues, such as margin calls, the liquidity of the market and the availability of shares for short selling, transaction costs, and the impossibility of taking the exact position required for the "correct" hedge. 106 CHAPTER 3. PROBABILITY. BLACK-SCHOLES FORMULA. By letting dS -+ 0, we find that the appropriate position .6. in the underlying asset in order to hedge a call option is ac .6. = as' which is the same as .6.(C), the Delta of a call option defined in (3.61) as the rate of change of the value of the call with respect to changes in the price of the underlying asset.

Assume that the return of one of the assets is independent of the returns of the other three assets. Also, assume that not all assets have the same expected rate of return. i=l We assume it is possible to take arbitrarily large short positions in any of the assets. Therefore, the weights Wi are not required to be positive 7 . Let ~ be the rate of return (over a fixed period of time) of asset i, and let jLi = E[~] and eJ'f = var(Ri) be the expected value and variance of ~, 7If short selling is not allowed, then all assets must have positive weights, i.e., Wi ::::: 0, i = 1 : n. These inequality constraints make the portfolio optimization problem a quadratic programming problem which cannot be solved using Lagrange multipliers. For notation purposes, assume that asset 4 is the asset with uncorrelated return, i.e., Pi,4 = 0, for i = 1 : 3. Let Wi be the weight of asset i in the BFinding efficient portfolios is one of the fundamental problems answered by the modern portfolio theory of Markowitz and Sharpe; see Markowitz [17] and Sharpe [25] for seminal ~apers.

 

pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

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accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, merger arbitrage, new economy, passive investing, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, statistical arbitrage, the market place, transaction costs, Y2K, yield curve

Long-Short Equity strategies invest mainly in equities and derivative instruments. The manager uses short selling, but maintains a position in the neutral stock. Equity Market Neutral strategies attempt to exploit inefficiencies in the market through balanced overvalued securities buying and selling so that either a neutral-beta (that is, risk) or a neutral-dollar (that is, amounts invested) approach is obtained. Merger Arbitrage funds invest in companies involved in the mergersand-acquisitions process. Typically, they go long on targeted companies and sell short the acquiring companies. Relative Value strategies look to take advantage of the relative price differentials between related instruments. Short Selling strategies maintain a net or simple short exposure relative to the market. Chapter 12 Keeping the Wheels on the Hedge-Fund ATV 227 The potential downside of hedge-fund strategies is, if misapplied, they can bring disastrous results.

Alpha Strategies 1997 1998 1999 2000 2001 2002 Convertible Arbitrage 14.81% 3.11% CTA Global 12.27% 14.30% 1.82% Distressed Securities 16.70% –2.26% 19.75% 4.81% 14.65% 5.86% 27.34% Emerging Markets 22.57% –26.66% 44.62% –3.82% 12.52% 5.76% Equity Market Neutral 15.43% 10.58% 13.15% 15.35% 8.18% 4.71% Event Driven 20.98% 1.00% 22.72% 9.04% 9.32% –1.08% 20.48% Fixed-Income Arbitrage 12.43% –8.04% 12.63% 5.70% 7.81% 7.56% Long/Short Equity 21.35% 14.59% 31.40% 12.01% –1.20% –6.38% 19.31% 16.08% 17.77% 13.78% 8.60% 7.32% 3.52% 2003 2004 Average Return Standard Deviation Sharpe Ratio 10.61% 6.09% 1.08 8.73% 5.01% 0.94 17.89% 12.73% 9.58% 0.91 31.27% 14.30% 10.56% 21.82% 0.30 6.29% 4.71% 4.49% 1.27 12.43% 11.54% 9.07% 0.83 6.26% 6.41% 6.45% 0.37 8.62% 11.87% 12.22% 0.64 10.80% 1.10% 14.57% 11.64% 8.35% 5.17% 9.72% Alpha Strategies 1997 1998 1999 2000 2001 Merger Arbitrage 17.44% 7.77% 17.97% 18.10% 2.87% Relative Value 16.51% 5.27% 17.15% 13.35% 8.63% Short Selling 3.07% 2002 2003 2004 Average Return Standard Deviation Sharpe Ratio –0.90% 8.34% 4.83% 9.33% 7.44% 0.72 2.77% 5.71% 10.08% 5.40% 1.13 20.76% –0.05 12.15% 27.07% –22.55% 22.80% 10.20% 27.27% –23.87% –4.66% 3.01% Chapter 14 Every Strategy Has Its Day Average Return 15.78% 4.25% 15.88% 11.13% 8.21% 6.25% 12.01% 6.94% 9.98% 4.36% 1.37 Funds of Funds 17.39% 4.20% 28.50% 7.84% 3.52% 1.26% 11.45% 7.08% 9.85% 8.98% 0.65 Hurdle Rate* 9.30% 10.44% 7.72% 5.76% 5.20% 5.54% 7.88% 9.67% 9.55% * The hurdle rate is defined as the average of one month LIBOR plus 400 basis points.

 

pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

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algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business process, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, diversification, equity premium, fault tolerance, financial intermediation, fixed income, high net worth, implied volatility, index arbitrage, interest rate swap, inventory management, law of one price, Long Term Capital Management, Louis Bachelier, margin call, market friction, market microstructure, martingale, New Journalism, p-value, paper trading, performance metric, profit motive, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, trade route, transaction costs, value at risk, yield curve

(9.3) Diamond and Verrecchia (1987) and Easley and O’Hara (1992) were the first to suggest that the duration between subsequent data arrivals carries information. The models posit that in the presence of short-sale constraints, inter-trade duration can indicate the presence of good news; in markets of securities where short selling is disallowed, the shorter the inter-trade duration, the higher is the likelihood of unobserved good news. 122 HIGH-FREQUENCY TRADING The reverse also holds: in markets with limited short selling and normal liquidity levels, the longer the duration between subsequent trade arrivals, the higher the probability of yet-unobserved bad news. A complete absence of trades, however, indicates a lack of news. Easley and O’Hara (1992) further point out that trades that are separated by a time interval have a much different information content than trades occurring in close proximity.

Naik and Robert Radcliffe, 1998. “Liquidity and Asset Returns: An Alternative Test.” Journal of Financial Markets 1, 203–219. References 309 Demsetz, Harold, 1968. “The Cost of Transacting,” Quarterly Journal of Economics, 33–53. Dennis, Patrick J. and James P. Weston, 2001. “Who’s Informed? An Analysis of Stock Ownership and Informed Trading.” Working paper. Diamond, D.W. and R.E. Verrecchia, 1987. “Constraints on Short-Selling and Asset Price Adjustment to Private Information.” Journal of Financial Economics 18, 277–311. Dickenson, J.P., 1979. “The Reliability of Estimation Procedures in Portfolio Analysis.” Journal of Financial and Quantitative Analysis 9, 447–462. Dickey, D.A. and W.A. Fuller, 1979. “Distribution of the Estimators for Autoregressive Time Series with a Unit Root.” Journal of the American Statistical Association 74, 427–431.

 

pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

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Albert Einstein, anti-communist, asset allocation, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John von Neumann, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, New Journalism, Norbert Wiener, offshore financial centre, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond

Part of the notebook is devoted to the roulette device and part to a wildly disconnected set of stock market musings. Shannon wondered about the statistical structure of the market’s random walk and whether information theory could provide useful insights. He mentions such diverse names as Bachelier, (Benjamin) Graham and (David) Dodd, (John) Magee, A. W. Jones, (Oskar) Morgenstern, and (Benoit) Mandelbrot. He considered margin trading and short-selling; stop-loss orders and the effects of market panics; capital gains taxes and transaction costs. Shannon graphs short interest in Litton Industries (shorted shares vs. price: the values jump all over with no evident pattern). He notes such success stories as Bernard Baruch, the Lone Wolf, who ran about $10,000 into a million in about ten years, and Hetty Green, the Witch of Wall Street, who ran a million into a hundred million in thirty years.

By buying the stock and selling the option, you create a “horse race” where one side of the trade has to win and the other side has to lose. And if you know the “true” odds better than everyone else and use your beliefs to adjust your bets, you can expect a profit. It can be shown that these long-short trades are Kelly-optimal. They were in use in the stock market long before Kelly, though. Thorp’s innovation was to calculate exactly how much of the stock he had to buy to offset the risk of short-selling the warrant. This technique is now called “delta hedging,” after the Greek letter used to symbolize change in a quantity. In delta hedging, the paper profit (or loss) of any small change in the price of the stock is offset by the change in the price of the warrant. You make money when the “irrational” price of the warrant moves into line with the price of the stock. John Maynard Keynes is famous for remarking that the market can remain irrational longer than you can remain solvent.

That term goes back to 1949. Alfred Winslow Jones, a sociologist and former Fortune magazine writer, started a “hedged fund.” The final d in hedged was later dropped. When Jones liked a stock, he would borrow money to buy more of it. The leverage increased his profits and risk. To counter the risk, Jones sold short stocks that he felt were overpriced. This was “hedging” the fund’s bets. Jones called the leverage and short-selling “speculative tools used for conservative ends.” By 1968 there were about two hundred hedge funds competing for the finite pool of wealthy investors. Many who became well-known managers had started hedge funds, among them George Soros, Warren Buffett, and Michael Steinhardt. In the process, the term “hedge fund” drifted from its original meaning. Not all hedge funds hedge. The distinction between a hedge fund and a plain old mutual fund is now partly regulatory and partly socioeconomic.

 

Mathematical Finance: Core Theory, Problems and Statistical Algorithms by Nikolai Dokuchaev

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Black-Scholes formula, Brownian motion, buy low sell high, discrete time, fixed income, implied volatility, incomplete markets, martingale, random walk, short selling, stochastic process, stochastic volatility, transaction costs, volatility smile, Wiener process, zero-coupon bond

Definition 5.43 The fair price at time t=0 of the European option with payoff ψ is the minimal wealth X(0) such that there exists an admissible self-financing strategy (β(·), γ(·)) such that X(T)≥ψ a.s. for the corresponding wealth X(·). 5.9.2 The fair price is arbitrage-free Starting from now and up to the end of this section, we assume that a continuous time market is complete with constant r and σ. Let us extend the definition of the strategy by assuming that a strategy may include buying and selling bonds, stock and options. Short selling is allowed but all transactions must be self-financing; they represent redistribution of the wealth between different assets. There are no outputs or inputs of wealth. For instance, a trader may borrow an amount of money x to buy k options with payoff ψ at time t=0, then his/her total wealth at time T will be kψ−erTx. Assume that Definition 5.29 is extended for these strategies. Proposition 5.44 Assume that an option seller sells at time t=0 an option with payoff ψ for a price c+ higher than the fair price cF of the option.

We assume that F(x) is a given function such that F(x)≥0. If the option holder has to fulfil the option obligations at time τ, we say that he or she exercises the option, and τ is called the exercise time. Sub (super) martingale properties for non-arbitrage prices Similarly to Section 5.9, we shall use the extended definition of the strategy assuming that a strategy may include buying and selling bonds, stock, and options. Short selling is allowed for stocks and bonds and not allowed for options. All transactions must be selffinancing; they represent redistribution of the wealth between different assets. For instance, a trader may borrow an amount of money x to buy k American options at time t with payoff then his/her total wealth at exercise time s is kF(S(s))−er(s−t) x. We assume that Definition 5.29 is extended for these strategies.

 

pages: 670 words: 194,502

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

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accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, buy low sell high, capital asset pricing model, corporate governance, Daniel Kahneman / Amos Tversky, diversified portfolio, Eugene Fama: efficient market hypothesis, hiring and firing, index fund, Isaac Newton, Long Term Capital Management, market bubble, merger arbitrage, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, the market place, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

This usually means buying stocks when the market has been advancing and selling them after it has turned downward. The stocks selected are likely to be among those which have been “behaving” better than the market average. A small number of professionals frequently engage in short selling. Here they will sell issues they do not own but borrow through the established mechanism of the stock exchanges. Their object is to benefit from a subsequent decline in the price of these issues, by buying them back at a price lower than they sold them for. (As our quotation from the Wall Street Journal on p. 19 indicates, even “small investors”—perish the term!—sometimes try their unskilled hand at short selling.) 2. SHORT-TERM SELECTIVITY. This means buying stocks of companies which are reporting or expected to report increased earnings, or for which some other favorable development is anticipated. 3.

See also dividends; interest; performance; return on invested capital (ROIC); yield; specific company or type of security return on invested capital (ROIC) revenue bonds Riley, Pat risk: and advice; and aggressive investors; Buffett’s comments about; and defensive investors; and factors that characterize good decisions; foolish; and formula trading; and Graham’s business principles; and history and forecasting of stock market; and inflation; and investment vs. speculation; managing of; and margin of safety; and market fluctuations; and price; and return/reward; and security analysis; and short selling; and speculation; and value; what is; Zweig’s comments about. See also specific company or type of security Risk Management Association Ritter, Jay Roche Pharmaceutical Co. Rockefeller family Rodriguez, Robert Rogers, Will Rohm & Haas Rosen, Jan M. Ross, Robert M. DEL Roth, John Rothschild, Nathan Mayer Rothschild family roulette Rouse Corp. Rowan Companies Royce, Charles Ruane, Bill Ruettgers, Michael “Rule of 72,” “rule of opposites,” “safety of principle,” safety tests: for bonds San Francisco Real Estate Investors Sanford C.

Market” (see Chapter 8) send prices wildly out of whack. † Graham launched Graham-Newman Corp. in January 1936, and dissolved it when he retired from active money management in 1956; it was the successor to a partnership called the Benjamin Graham Joint Account, which he ran from January 1926, through December 1935. * An “unrelated” hedge involves buying a stock or bond issued by one company and short-selling (or betting on a decline in) a security issued by a different company. A “related” hedge involves buying and selling different stocks or bonds issued by the same company. The “new group” of hedge funds described by Graham were widely available around 1968, but later regulation by the U.S. Securities and Exchange Commission restricted access to hedge funds for the general public. * In 2003, an intelligent investor following Graham’s train of thought would be searching for opportunities in the technology, telecommunications, and electric-utility industries.

 

The Concepts and Practice of Mathematical Finance by Mark S. Joshi

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Black-Scholes formula, Brownian motion, correlation coefficient, Credit Default Swap, delta neutral, discrete time, Emanuel Derman, implied volatility, incomplete markets, interest rate derivative, interest rate swap, London Interbank Offered Rate, martingale, millennium bug, quantitative trading / quantitative finance, short selling, stochastic process, stochastic volatility, the market place, time value of money, transaction costs, value at risk, volatility smile, yield curve, zero-coupon bond

Note that the speculators and traders in the banks are actually providing a public service - their frenetic buying and selling increases the liquidity of markets thus ensuring that the ordinary investor can buy or sell at anytime he wishes, rather than being forced to wait until a counteiparty can be found. 2.4.3 Shorting The third is the assumption that one can go `short' at will. That is, one can have negative amounts of an asset by selling assets one does not hold. Whilst there are some restrictions on short-selling assets in the market, it is allowed. The opposite of going `short,' holding an asset, is sometimes called being `long' in it. Similarly, buying an asset is called `going long.' 2.4.4 Fractional quantities The fourth assumption is the ability to purchase fractional quantities of assets. Whilst one can clearly not do this in the markets, when one is dealing in quantities of millions, which trading banks generally do, this is not so unreasonable the smallest unit one can hold is a millionth of the typical amount held, so any error is pretty small in comparison. 2.4.5 No transaction costs The fifth assumption is that there are no transaction costs.

For example, at the time of writing, NatWest made an offer for Legal and General shares at an offer price of 210p a share. The share price for Legal and General reacted to this information by immediately jumping to about 200p. So there was an `arbitrage opportunity' to purchase Legal and General shares for 200p and sell them for 210p to NatWest. Many `arbitrage houses' therefore bought lots of Legal and General shares and financed the purchase by short-selling NatWest. However there was a good reason for the market's pricing the shares at 200p - there was a still a possibility that the deal would fall through. Indeed, Bank of Scotland launched a bid for NatWest and urged the shareholders to reject the Legal and General merger. The NatWest share price jumped up, the Legal and General one fell and the arbitrage houses had their fingers badly burnt. (The final outcome was that the Royal Bank of Scotland launched a second bid, and took over NatWest.)

Indeed, it can be perfectly hedged in a static model-independent fashion. In this section, we define and price swaps. In general, 13.2 The simplest instruments 303 the best way to analyze an interest rate derivative is in terms of the cashflows involved, and we illustrate this here. All pricing of interest rate derivatives assumes the existence of a continuum of zero-coupon bonds which can be freely bought and sold, including short-selling as necessary. We will return to why it makes sense to make this assumption later but for now note that the bonds in question do not exist. The zero-coupon bonds will always have notional one. They will almost always be worth less than their face value as a bigger value is equivalent to negative interest rates, and so their values will be less than 1. In fact, as a function of maturity we will obtain a function which is monotone decreasing and ranges from 1 at T = 0 to 0 as T becomes infinite.

 

pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

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accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, mortgage tax deduction, new economy, Own Your Own Home, passive investing, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, The Myth of the Rational Market, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

It is clear that arbitrage trades to correct a perceived price bubble are inherently risky. And there are also times when short selling is not possible or at least severely constrained. Typically in selling short, the security that is shorted is borrowed in order to deliver it to the buyer. If, for example, I sell short 100 shares of IBM, I must borrow the securities to be able to deliver them to the buyer. (I must also pay the buyer any dividends that are declared on the stock during the period I hold the short position.) In some cases it may be impossible to find stock to borrow, and thus it is technically impossible even to execute a short sale. In some of the most glaring examples of inefficient pricing, technical constraints on short selling prevented arbitrageurs from correcting the mispricing. Arbitrages may also be hard to establish if a close substitute for the overpriced security is hard to fund.

If Royal Dutch sells at a 10 percent premium to Shell, the appropriate arbitrage is to sell the overpriced Royal Dutch shares short and buy the cheap Shell shares. The arbitrage is risky, however. An overpriced security can always become more overpriced, causing losses for the short seller. Bargains today can become better bargains tomorrow. It is clear that one cannot rely completely on arbitrage to smooth out any deviations of market prices from fundamental value. Constraints on short selling undoubtedly played a role in the propagation of the housing bubble during the end of the first decade of the 2000s. When it is virtually impossible to short housing in specific areas of the country, only the votes of the optimists get counted. When the optimists are able to leverage themselves easily with mortgage loans, it is easy to see why a housing bubble is unlikely to be constrained by arbitrage.

 

pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

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Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, Corn Laws, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, interest rate swap, Isaac Newton, iterative process, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour mobility, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Naomi Klein, Nick Leeson, Northern Rock, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, value at risk, Washington Consensus, Yom Kippur War

The next step was for banks to lend money so that shares might be purchased with credit. Company, bourse and bank provided the triangular foundation for a new kind of economy. For a time it seemed as if the VOC’s critics, led by the disgruntled ex-director le Maire, might exploit this new market to put pressure on the Company’s directors. A concerted effort to drive down the price of VOC shares by short selling on the nascent futures market was checked by the 1611 dividend payment, ruining le Maire and his associates.22 Further cash dividends were paid in 1612, 1613 and 1618.23 The Company’s critics (the ‘dissenting investors’ or Doleanten) remained dissatisfied, however. In a tract entitled The Necessary Discourse (Nootwendich Discours), published in 1622, an anonymous author lamented the lack of transparency which characterized the ‘self-serving governance of certain of the directors’, who were ensuring that ‘all remained darkness’: ‘The account book, we can only surmise, must have been rubbed with bacon and fed to the dogs.’24 Directorships should be for fixed terms, the dissenters argued, and all major shareholders should have the right to appoint a director.

securitization 4 of debt 10 federal government and 260 perils of 261 private bond insurers and 260 segregation 250-51 Self, Beanie 268 Senegal Company 141 Serbia 2 sexual language 351 shadow banking see banks Shakespeare, William, The Merchant of Venice 33-4 Shanghai 303 shanty towns 274 shares (or stocks or equities): as collateral 132 displacement 143-4 features of 120-26 Law’s System and 143 shareholders’ meetings 120 and First World War 302 see also options; stock markets Sharpe, William 323 Shaw-Stewart, Patrick 302 shells 30 Shettleston 38-40 Shiller, Robert 281 Shining Path 276 ships/shipping 127-8. see also marine insurance short positions 316 short selling 137 Shylock 33-5 sidecars 227 Siena 69 Silicon Valley see dot.com silver 19-26 and Mississippi Bubble 149-50 Spanish and 1 Simons, James 330 Singapore 337n. SIVs see structured investment vehicles Skilling, Jeffrey K. 169 slavery: and home ownership 267 Rothschilds and 93 slave trading 25 Sloan, Alfred 160 Slovenia 2 Smith, Adam 53 socialists: and bond markets 89-90 and liberalization 312 and welfare state 200-202 Socialist Standard 17-18 Song Hongbing 86 Soros, George 314-19 income 2 on ‘market fundamentalism’ 337 Sourrouille, Juan 112 South America 18-26 gas pipelines 119 property law 274-6 see also Latin America Southern Rhodesia 295 South Korea 233 South Sea Bubble see bubbles sovereign wealth funds 9 Soviet-style economics 213 Soviet Union see Russia/USSR Spain 36 declining empire 26 and gold and silver 1 property price boom 10 royal funding 52 Spanish Succession, War of the 156 special-purpose entitities (SPEs) 172-3 speciation 53 speculators 122. see also futures contracts Spencer, Herbert 351 spices 127 spreads 241 squatters 276-7 squirrel skins 25 Sri Lanka 134 stagflation 211 Standard and Poor’s (S&P) 268 Standard and Poor’s 500: 124n.

bd Since the term was first used, in 1966, to describe the long-short fund set up by Alfred Winslow Jones in 1949 (which took both long and short positions on the US stock market), most hedge funds have been limited liability partnerships. As such they have been exempted from the provisions of the 1933 Securities Act and the 1940 Investment Company Act, which restrict the operations of mutual funds and investment banks with respect to leverage and short selling. be Technically, according to the US Securities and Exchange Commission, a short sale is ‘any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller’. bf A swap is a kind of derivative: a contractual arrangement in which one party agrees to pay another a fixed interest rate, in exchange for a floating rate (usually the London interbank offered rate, or Libor), applied to a notional amount.

 

pages: 459 words: 118,959

Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff by Christine S. Richard

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Asian financial crisis, asset-backed security, banking crisis, Bernie Madoff, cognitive dissonance, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, family office, financial innovation, fixed income, forensic accounting, glass ceiling, Long Term Capital Management, market bubble, moral hazard, Ponzi scheme, profit motive, short selling, statistical model, white flight

During a Barclay’s Capital conference call on the financial guarantors earlier in the month, one caller prefaced his question by stating that he believed those writing and speaking negatively about the bond insurers were “financial terrorists.” For years Ackman had asked regulators, reporters, and just about everyone he spoke to about MBIA to see no contradiction in shorting a company and being a decent person. It is an idea that many people simply can’t accept. When Ackman had testified at the Securities and Exchange Commission in 2003, this issue of doing good by short selling had come up. Ackman had said it was one reason he decided to short Farmer Mac. “I prefer investments where I’m not fighting against the country. You know, where there’s public policy on my side instead of against me,” Ackman had told the investigators. But the SEC attorneys had been skeptical. Wasn’t he really interested in Farmer Mac because he was seeking to profit from the company’s collapse?

Chapter Nineteen Ratings Revisited To keep the music playing required increasingly egregious excesses—ever greater quantities of increasingly risky loans, structures and leveraging —DOUG NOLAND, DAVID TICE & ASSOCIATES, DECEMBER 2007 IN DECEMBER 2007, Bill Ackman went door to door with his presentation on the bond insurers, launching perhaps the most aggressive “short” campaign in the history of Wall Street. Activist investors typically buy a stake in a company and then pressure management to make changes that will drive up the stock price. Short selling and activism are a much more complex pairing. An activist can’t exactly advocate for changes that will cause the company’s share price to collapse or cause it to file for bankruptcy. At least not very often. Ackman, however, saw his short position in MBIA as a cause. He believed his interests were aligned with those of MBIA’s policyholders because both would benefit if MBIA’s publicly traded holding company had less cash.

ON JANUARY 30—the day Gasparino at CNBC broadcast Ackman’s loss estimates—the Federal Open Market Committee announced another rate cut, taking its benchmark rate to 3 percent from 3.5 percent. The magic worked but only briefly. Fears about bond insurance were weighing on stocks and on corporate bonds. Ackman’s startling high loss numbers were not helping matters. Some people thought Ackman had gone too far. Critics of short selling coined a phrase to describe the very public and unsettling analysis issued by some money managers during the credit crisis: “Short and distort.” The charge was leveled at Ackman and later at David Einhorn, who had begun to point to problems at Lehman Brothers. As Madame de Villefort, one of the nobles caught up in the Count of Monte Cristo’s acts of revenge, tells her friends, “It’s quite simple.

 

pages: 289 words: 113,211

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

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affirmative action, Albert Einstein, asset allocation, backtesting, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commodity trading advisor, computer age, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, Jeff Bezos, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, new economy, Nick Leeson, oil shock, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, yield curve, zero-coupon bond

There were no rusting plants, no fire sales of equipment, no tumbleweed rolling past abandoned warehouses; this was a bubble with no soapy residue. Besides isolating the most optimistic investors and setting a market price that reflects their views, the small float sets secondary forces in motion that accentuate the price appreciation. With a small float, investor demand for shares ends up being accommodated in a costly manner: through short selling and through high turnover. Short selling accommodates demand by creating virtual float. This requires a concession in price. Shorting a stock, especially a stock that has seen such price appreciation 172 ccc_demon_165-206_ch09.qxd 7/13/07 2:44 PM Page 173 T H E B R AV E N E W W O R L D OF HEDGE FUNDS and that is subject to widely differing views of valuation, requires sophistication, capital, and a risk appetite beyond that required from the buyers.

They put in orders to sell at the market price at the open, under the assumption that the open would be close enough to the Friday close to still make the discount in the futures contracts a profitable trade. That was a big bet and a far cry from the relatively low-risk enterprise of the usual cash-futures trade. And in this environment, it was even more risky because when the stock market did open, it was almost certain to open down. The execution of the program trade would then be complicated by the downtick rule, which proscribes short-selling a falling stock. The arbitrageurs wanted to buy the futures and sell the stocks short against them. If the market is in free fall, upticks are few and far between, and there are many short sellers trying to squeeze in their execution. It can take a long time to get a trade off. In the meantime, the long futures position is being held unhedged. If the market drops, the trader loses. The portfolio insurance hedgers found the other side of the market for their trades in the cash-futures traders and market makers.

 

pages: 504 words: 143,303

Why We Can't Afford the Rich by Andrew Sayer

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accounting loophole / creative accounting, Albert Einstein, asset-backed security, banking crisis, banks create money, Bretton Woods, British Empire, call centre, capital controls, carbon footprint, collective bargaining, corporate social responsibility, credit crunch, Credit Default Swap, crony capitalism, David Graeber, David Ricardo: comparative advantage, debt deflation, decarbonisation, declining real wages, deglobalization, deindustrialization, delayed gratification, demand response, don't be evil, Double Irish / Dutch Sandwich, en.wikipedia.org, Etonian, financial innovation, financial intermediation, Fractional reserve banking, full employment, Goldman Sachs: Vampire Squid, high net worth, income inequality, investor state dispute settlement, Isaac Newton, James Dyson, job automation, Julian Assange, labour market flexibility, laissez-faire capitalism, low skilled workers, Mark Zuckerberg, market fundamentalism, Martin Wolf, means of production, moral hazard, mortgage debt, neoliberal agenda, new economy, New Urbanism, Northern Rock, Occupy movement, offshore financial centre, oil shale / tar sands, patent troll, payday loans, Plutocrats, plutocrats, predatory finance, price stability, pushing on a string, quantitative easing, race to the bottom, rent-seeking, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, Steve Jobs, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transfer pricing, trickle-down economics, universal basic income, unpaid internship, upwardly mobile, Washington Consensus, Winter of Discontent, working poor, Yom Kippur War

They may use hedging to protect themselves against losses, but they mostly use financial instruments aggressively rather than defensively, profiting from leveraged speculation on changes in the prices of assets, whether they be stocks, bonds, currencies, commodities like gold, copper or oil, or derivatives, and by buying up bankrupt and undervalued companies. They seek to profit from both rises and falls in prices, by buying assets in the hope that they will rise in price, or short-selling where they expect prices to fall. These are not merely responses to market shifts but ways of influencing those shifts, for example by inflating bubbles: they are weapons, not tools, as Ewald Engelen and co-researchers argue.137 On ‘Black Wednesday’, 16 September 1992, multi-billionaire George Soros made £1 billion by short-selling sterling – in anticipation of its being ejected from the European Exchange Rate Mechanism. In effect, he saw that the pound was overvalued, took on the Bank of England when it made frenzied efforts to defend the currency, and won.138 When the previously much-lauded Northern Rock bank got into trouble in 2008, hedge funds short-sold its shares and then bought them up when they’d hit rock bottom.139 When, in 2013, the UK’s Royal Mail was privatised by issuing shares at far below the market price, it was an aggressive hedge fund that became the largest shareholder.

This may benefit borrowers in the former case – or stimulate predatory lending. In the countries where interest rates are low, perhaps as a matter of policy for supporting investment, the carry trade switches funds away, undermining such policies. Attempts at national self-determination of economic development are frustrated. Speculators can make money on both sides of a bubble – not only buying in order to sell on the upside, but ‘short-selling’ on the downside. The latter practice works like this Imagine that prices of certain common, frequently traded shares, such as those of an oil company are expected to fall or already falling. The short-seller agrees to borrow some shares from an existing owner for a period of time, say six months, for a fee. If he (usually he) then sells them straightaway for, say, £10 each, and then later, when the price has fallen to £7, buys the same number of shares back at that price, he will then be able to return them to the original owner having made £3 per share minus the fee for borrowing them.

 

pages: 593 words: 189,857

Stress Test: Reflections on Financial Crises by Timothy F. Geithner

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Affordable Care Act / Obamacare, asset-backed security, Atul Gawande, bank run, banking crisis, Basel III, Bernie Madoff, Bernie Sanders, Buckminster Fuller, Carmen Reinhart, central bank independence, collateralized debt obligation, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, David Brooks, Doomsday Book, eurozone crisis, financial innovation, Flash crash, Goldman Sachs: Vampire Squid, housing crisis, Hyman Minsky, illegal immigration, implied volatility, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, Martin Wolf, McMansion, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Nate Silver, Northern Rock, obamacare, paradox of thrift, pets.com, price stability, profit maximization, pushing on a string, quantitative easing, race to the bottom, RAND corporation, regulatory arbitrage, reserve currency, Saturday Night Live, savings glut, short selling, sovereign wealth fund, The Great Moderation, The Signal and the Noise by Nate Silver, Tobin tax, too big to fail, working poor

Its liquidity pool had shrunk from $130 billion to $55 billion in a week; it was borrowing nearly $70 billion from the Fed to make up the difference. Its stock price fell 60 percent before word of the short-selling ban leaked. One New York Fed bank examiner reported in an email that a Citi executive had told her: “Morgan is the deer in the headlights.… It’s looking like Lehman did a few weeks ago.” And everyone on Wall Street knew that if Morgan went the way of Lehman, Goldman would be next. That would be more stress than the system could handle. WE WERE under no illusions that the short-selling ban or even the prospect of broad congressional relief would magically stop the run on the investment banks. Morgan and Goldman needed immediate solutions. As Blankfein put it later, this would be their “existential weekend.”

In May, the hedge fund manager David Einhorn, who had bet heavily against Lehman, publicly accused the firm of overly optimistic accounting, and in June, Lehman announced a $2.8 billion second-quarter loss, prompting Dick Fuld to oust his longtime deputy and demote his chief financial officer. Lehman’s stock price dropped nearly 75 percent below its peak. Fuld urged Hank and me to push the SEC to ban short selling, but that seemed like a shoot-the-messenger solution. The markets could see that Lehman was carrying assets at 80 or 90 cents on the dollar that other firms had written way down. And they were justifiably worried about what they couldn’t see. One thing we saw when our monitors dug into Lehman and the other investment banks was that their internal stress tests had not been very stressful. Most of them had never imagined that their repo funding could be vulnerable to a run, obviously a faulty assumption after Bear.

In fact, Hank’s guarantees were so powerful that FDIC chair Sheila Bair called him to say they could trigger a run on the banking system and threaten her agency’s insurance fund, by encouraging bank depositors with more than $100,000 in their accounts to shift their uninsured cash into money market funds. She was right—and to her credit, she had an alternative plan. She suggested Treasury should guarantee only investments that were in money funds before September 19, removing the incentive to shift cash out of FDIC-insured banks. Hank agreed. In yet another announcement that busy Friday, the SEC temporarily banned the short selling of 799 financial stocks, a heavy-handed effort to stop the stampede of speculation and rumor mongering. We all had reservations about this. It seemed to signal a debilitating lack of confidence in those 799 firms. I thought there was some risk that preventing investors from hedging their exposures would actually accelerate the flight to safety through other mechanisms. It felt like trying to ban risk aversion, or the expression of negative opinions about firms that often deserved them.

 

pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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asset allocation, collateralized debt obligation, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, mortgage debt, new economy, Occupy movement, passive investing, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam

The Rules of the Game The rules of the game and the appropriate behavior of its players also must be regulated. However, I hold as a general principle that government should, under nearly all circumstances, keep its hands off the free functioning of the marketplace. I wince when the Federal Reserve states its intention to raise asset prices—including “higher stock prices”—apparently irrespective of the level of underlying intrinsic stock values. Substantive limits on short selling are another nonstarter for me. The overriding principle should be: Let the markets clear, at whatever prices that willing and informed buyers agree to pay to willing and informed (but often better-informed) sellers. Individual investors need to wake up. Adam Smith–like, they need to look after their own best interests. Of course, that would mean that individual investors must demand much better, clearer, and more pointed disclosures.

If that principle holds in the ETF field—as it has done thus far in its relatively brief history—the substantially higher volatility of the ever-narrower sectors bodes ill for the returns that ETF investors actually earn. ETFs have continued to move away from simplicity and toward complexity. As this trend accelerates (I assume to no one’s surprise), obvious problems have arisen. While leveraged ETFs were designed to multiply the stock market’s gain for the bulls (or multiply its gains for the short-selling bears), it turns out that while the multiplier (now usually triple leverage) works well on a daily basis, it fails to deliver on that goal as days turn to months and then years. For example, the ProShares Ultra S&P 500 ETF seeks to double the return of the S&P 500 on a daily basis. But over the last five years, the ETF has produced a total return of −25 percent, while the index itself provided a return of 10.5 percent.

 

pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, Black Swan, Bretton Woods, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, market bubble, market clearing, Martin Wolf, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, savings glut, short selling, structural adjustment programs, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, unorthodox policies, value at risk, Washington Consensus

Rather than simply rely on passive correlations that are out there in the world to ensure your safety, such as the inverse relationship that typically prevails between the USD and the euro, banks can adopt particular strategies, or trade derivative instruments with specific characteristics, so that the gains from one set of exposures covers (hedges) any losses in another.23 In principle then, a combination of portfolio diversification and hedging—if appropriately executed in a given market environment—will at the very least keep your investments safe. Think the market will go down? Short sell one asset (profit from a stock price falling by borrowing the stock for a fee, selling it, and then buying it back when its cheaper), and take a long position (buy and hold) in an uncorrelated asset as cover. Want to benefit from the market going up? Use options (the right to buy or sell an asset at a predetermined price) to increase leverage (amplify the bet) while taking a short position as cover.

See risk-management techniques Portugal, 3, 4 bailout in, 71–73 Eurozone Current Account Imbalances, 78 fig. 3.1 Eurozone Ten-Year Government Bond Yields, 80 fig. 3.2 government debt 2006–2012, 47 fig. 2.3 slow growth crisis, 68–71 “Positive Theory of Fiscal Deficits and Government Debt in a Democracy, A” (Alesini), 167 Posner, Richard, 55 Prescott, Edward, 55, 157 President’s Conference on Unemployment, 120 Prices and Production (Hayek), 144 Principles of Political Economy (Mill), 116 Quiggin, John, 55 and Australian expectations-augmented austerity, 209 “zombie economics”, 10, 234 Rand, Ayn Atlas Shrugged, 130 rational expectations hypothesis, 42 Real Business Cycle school, 157 real estate “collateralized debt obligation”, 28 “tranching the security”, 28, 30–31 equity, 28 mezzanine, 28 senior, 28 “uncorrelated within their class”, 27–28 REBLL alliance, 103, 178–180, 179–180, 205, 216–226, 217 fig. 6.1 GDP and consumption growth in 2009, 221 table 6.1 See also names of countries recapitalization, 45, 52 Reinhardt, Carmen, 11, 73, 241 Ricardian equivalence, 41, 49 Ricardo, David, 115–117, 117–119, 171 in Germany, 195 risk-management techniques, 49 hedging, 32 long position, 32 options, 32 portfolio diversification, 31 short sell, 32 Ritschl, Albrecht, 193 Road to Serfdom, The (Hayek), 144 Robins, Lionel, 144 Robinson, Joan, 122, 126 Rodrik, Dani, 162, 163 Rogoff, Kenneth, 11, 73 Romania austerity in, 18, 103, 190, 216–226, 217 fig. 6.1, 221 Romney, Mitt, 243 Roosevelt, Franklin Delano, 126 administration policies, 128 balancing the budget, 188 Röpke, Wilhelm, 138 Rothbard, Murray, 148 Sachs, Jeffrey, 60 Saez, Emanuel, 243 Say’s law, 137 Sbrancia, M.

 

pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

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bank run, banking crisis, banks create money, Basel III, Bretton Woods, call centre, capital controls, cashless society, central bank independence, credit crunch, David Graeber, debt deflation, double entry bookkeeping, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, informal economy, land reform, London Interbank Offered Rate, market bubble, market clearing, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Northern Rock, price stability, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, risk-adjusted returns, seigniorage, shareholder value, short selling, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, unorthodox policies

When applied to economics and banking, disaster myopia explains the psychological reasons why bankers are unable to incorporate the risk of asset prices falling into their lending decisions. An example of disaster myopia can be seen in Herring and Wachter’s (2002) model, in which real estate markets are prone to bubbles because the supply of real estate is fixed (in the short term) and difficult to short sell. As a result house prices rarely fall, and this leads to disaster myopia amongst bankers, who therefore lend more money than they otherwise would into the property market, pushing up prices in the process. Disaster myopia also occurs during a crash. The occurrence of a low frequency shock (such as a bubble bursting in the housing market) in the recent past leads decision makers to overestimate the probability of a similar shock occurring soon after.

A recent working paper by economists at the IMF unpicks this common interpretation of events: “The Reichsbank president at the time, Hjalmar Schacht, put the record straight on the real causes of that episode in Schacht (1967). Specifically, in May 1922 the Allies insisted on granting total private control over the Reichsbank. This private institution then allowed private banks to issue massive amounts of currency, until half the money in circulation was private bank money that the Reichsbank readily exchanged for Reichsmarks on demand. The private Reichsbank also enabled speculators to short-sell the currency, which was already under severe pressure due to the transfer problem of the reparations payments pointed out by Keynes (1929). It did so by granting lavish Reichsmark loans to speculators on demand, which they could exchange for foreign currency when forward sales of Reichsmarks matured. When Schacht was appointed, in late 1923, he stopped converting private monies to Reichsmark on demand, he stopped granting Reichsmark loans on demand, and furthermore he made the new Rentenmark non-convertible against foreign currencies.

 

pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, joint-stock company, Kenneth Rogoff, labour market flexibility, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce

The theory assumes that news is automatically reflected in share prices, that there are no constraints on investors and that the market is populated (or at least dominated) by rational investors poring over each company’s accounts. In fact, investors can be shown to have a number of biases, such as selling their winning stocks and hanging on to their loss-makers. Efficient markets would allow investors to be able to sell short (i.e., bet on falling prices) as easily as they can bet on rising ones, but in fact regulators impose a host of restrictions on short-selling. History is also full of market anomalies, such as the over-performance of stocks in the month of January or the better performance of smaller companies. It is also hard to argue that markets are always efficiently priced when stocks were worth 23 per cent less on 20 October 1987 than they were worth at the start of trading the day before. Nevertheless, Alan Greenspan stuck to this view pretty consistently, even during the dot.com bubble, when companies with no declared profits or dividends were being valued at billions of dollars.

Rubin, Robert Rueff, Jacques Rumsfeld, Donald Russia Sack, Alexander St Augustine Saint-Simon, duc de Salamis (city) Santelli, Rick Sarkozy, Nicholas Saudi Arabia savings savings glut Sbrancia, Belen Schacht, Hjalmar Scholes, Myron shale gas Second Bank of the United States Second World War Securities and Exchange Commission seignorage Shakespeare, William share options Shiller, Robert short-selling silver Singapore Sloan, Alfred Smith, Adam Smith, Fred Smithers & Co Smithsonian agreement Snowden, Philip Socialist Party of Greece social security Société Générale solidus Solon of Athens Soros, George sound money South Africa South Korea South Sea bubble sovereign debt crisis Soviet Union Spain special drawing right speculation, speculators Stability and Growth pact stagnation Standard & Poor’s sterling Stewart, Jimmy Stiglitz, Joseph stock markets stop-go cycle store of value Strauss-Kahn, Dominque Strong, Benjamin sub-prime lending Suez canal crisis Suharto, President of Indonesia Sumerians supply-side reforms Supreme Court (US) Sutton, Willie Sweden Swiss franc Swiss National Bank Switzerland Sylla, Richard Taiwan Taleb, Nassim Nicholas taxpayers Taylor, John tea party (US) Temin, Peter Thackeray, William Makepeace Thailand Thatcher, Margaret third world debt crisis Tiernan, Tommy Times Square, New York tobacco as currency treasury bills treasury bonds Treaty of Versailles trente glorieuses Triana, Pablo Triffin, Robert Triffin dilemma ‘trilemma’ of currency policy Truck Act True Finn party Truman, Harry S tulip mania Turkey Turner, Adair Twain, Mark unit of account usury value-at-risk (VAR) Vanguard Vanity Fair Venice Vietnam War vigilantes, bond market Viniar, David Volcker, Paul Voltaire Wagner, Adolph Wall Street Wall Street Crash of 1929 Wal-Mart wampum Warburton, Peter Warren, George Washington consensus Weatherstone, Dennis Weimar inflation Weimar Republic Weinberg, Sidney West Germany whales’ teeth White, Harry Dexter William of Orange Wilson, Harold Wirtschaftswunder Wizard of Oz, The Wolf, Martin Women Empowering Women Woodward, Bob Woolley, Paul World Bank Wriston, Walter Xinhua agency Yale University yen yield on debt yield on shares Zambia zero interest rates Zimbabwe Zoellick, Robert Philip Coggan is the Buttonwood columnist of the Economist.

 

Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals by David Aronson

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Albert Einstein, Andrew Wiles, asset allocation, availability heuristic, backtesting, Black Swan, capital asset pricing model, cognitive dissonance, compound rate of return, Daniel Kahneman / Amos Tversky, distributed generation, Elliott wave, en.wikipedia.org, feminist movement, hindsight bias, index fund, invention of the telescope, invisible hand, Long Term Capital Management, mental accounting, meta analysis, meta-analysis, p-value, pattern recognition, Ponzi scheme, price anchoring, price stability, quantitative trading / quantitative finance, Ralph Nelson Elliott, random walk, retrograde motion, revision control, risk tolerance, risk-adjusted returns, riskless arbitrage, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, statistical model, systematic trading, the scientific method, transfer pricing, unbiased observer, yield curve, Yogi Berra

A similar logic applies to the costs of acting on information (e.g., commissions, slippage, bid-asked spreads). Unless investors were compensated for incurring trading costs there would be no point to their trading activities, which are required by EMH to move the price to its rational level. The bottom line is that any factor that limits trading—costs to trade, costs to generate information, the rule that impairs short-selling, and so forth—limits the ability of the market to attain efficiency. It simply does not hold logically that there would be no compensation to those engaged in trading. The Assumptions of EMH To appreciate the arguments made by EMH’s critics, it is necessary to understand that EMH rests on three progressively weaker assumptions: (1) investors are rational, (2) investors’ pricing errors are random, and 344 METHODOLOGICAL, PSYCHOLOGICAL, PHILOSOPHICAL, STATISTICAL FOUNDATIONS (3) there are always rational arbitrage investors to catch any pricing errors.

As envisioned by efficient market advocates, an arbitrage trade goes something like this: Consider two financial assets, stocks X and Y, which sell at equal prices and which are equally risky. However, they have different expected future returns. Obviously, one of the two assets is improperly priced. If asset X has a higher future return, then to take advantage of the mispricing, arbitrageurs would buy asset X while short-selling Y. With the activities of like-minded arbitrageurs, the price of each stock will converge to its proper fundamental value.29 Market efficiency attained in this manner assumes there are always arbitrageurs ready, willing, and able to jump on these opportunities. The better ones become very wealthy, Theories of Nonrandom Price Motion 345 thereby enhancing their ability to drive prices to proper levels, while the irrational investors eventually go broke losing their ability to push prices away from equilibrium levels.

If the observations are serially correlated, as might be the case in a time series, the variance reduction is slower than the square root rule suggests. 36. The population has a finite mean and a finite standard deviation. 37. The general principle that bigger samples are better applies to stationary processes. In the context of financial market time series, which are most likely not stationary, old data may be irrelevant, or even misleading. For example, indicators based on short selling volume by NYSE specialists seem to have suffered a decline in predictive power. Larger samples may not be better. 38. The Central Limit Theorem applies to a sample for which observations are drawn from the same parent population, which are independent, and in which the mean and standard deviation of the parent population are finite. 39. This figure was inspired by a similar figure in Lawrence Lapin, Statistics for Modern Business Decisions, 2nd ed.

 

pages: 430 words: 140,405

A Colossal Failure of Common Sense: The Inside Story of the Collapse of Lehman Brothers by Lawrence G. Mcdonald, Patrick Robinson

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asset-backed security, bank run, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, diversification, fixed income, high net worth, hiring and firing, if you build it, they will come, London Interbank Offered Rate, Long Term Capital Management, margin call, moral hazard, mortgage debt, naked short selling, new economy, Ronald Reagan, short selling, sovereign wealth fund, value at risk

Just as crooked financial officers in now-bankrupt corporations had sought to bamboozle their accountants and investors, now the Wall Street elite, the lawyers and bankers, set out to bamboozle the SEC regulators. We suddenly had a commando squad of MIT- and Harvard-educated multimillionaires preparing to go into combat against $120,000-a-year civil service regulators. It never did seem like an even match to me. What Wall Street’s financial maestros came up with while the SEC guys were consumed with backdated options, insider trading, and naked short-selling was something brand-new—a fee-generating machine hereinafter referred to as the dreaded credit derivatives, also known as securitization. They invented a method of turning a thousand mortgages into a bond with an attractive coupon of 7 or 8 percent. This high-yield bond could be traded, and hence turned into a profit generator; it would enable the mortgage brokers, investment banks, and bondholders to reap a very nice annual reward—just so long as the homeowners kept right on paying on time every month, and the U.S. housing market held up the way it always had.

Whatever the hell else happened in this great financial man-o’-war, where no one could see the hand that held the tiller, I was among the safest possible company. I thought back to my dad’s old alma mater, Notre Dame, and the legend of the most famous college folklore in the world. I even made my own rewrite: Outlined against sunny New York autumn skies, the Four Horsemen rode again. In financial lore, their names were Debt, Bankruptcy, Short Selling, and Fraud. Their real names were Kirk, Gelband, Gatward, and McCarthy. The backup battalions, which surrounded them every step of the way, were no less accomplished. Especially Christine Daley, for it was she who administered my first serious test of character and knowledge in the first week of my employment at Lehman. The subject was one of the largest energy producers in the United States, the wholesale electricity giant Calpine, out of San Jose, California.

 

pages: 443 words: 51,804

Handbook of Modeling High-Frequency Data in Finance by Frederi G. Viens, Maria C. Mariani, Ionut Florescu

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algorithmic trading, asset allocation, automated trading system, backtesting, Black-Scholes formula, Brownian motion, business process, continuous integration, corporate governance, discrete time, distributed generation, fixed income, Flash crash, housing crisis, implied volatility, incomplete markets, linear programming, mandelbrot fractal, market friction, market microstructure, martingale, Menlo Park, p-value, pattern recognition, performance metric, principal–agent problem, random walk, risk tolerance, risk/return, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process

This process consists of a stopping time τ ∈ S, a consumption process c(·) positive and F−progressively measurable, and an Fτ measurable random variable ξ : → [0, ∞) representing the lump-sum consumption at time τ . We regard πi (t) as the proportion of an agent’s wealth invested in stock i at time t; the remaining proportion 1 − π ∗ (t)1m = 1 − m i=1 πi (t) is invested in the money market. These proportions are not constrained to take values in the interval [0, 1]; in other words, we allow both short selling of stocks and borrowing at the interest rate of the bond. For a given, nonrandom, initial capital x > 0, let X (·) = X x,π ,C (·) denote the wealth process corresponding to a portfolio/consumption pair (π(·), C(·)) as above. This wealth process is defined by the initial condition X x,π ,C (0) = x and the equation dX (t) = m m πi (t)X (t){bi (t)dt + i=1 σij (t)dWj (t)} (11.10) i=1 + {1 − m πi (t)}X (t)r(t)dt − dC(t) i=1 = r(t)X (t)dt + X (t)π ∗ (t)σ (t)dW0 (t) − dC(t), X (0) = x > 0, where we have set t W0 (t) W (t) + θ(s)ds, 0 ≤ t ≤ T

This process consists of a stopping time τ ∈ S0 , a consumption process c(·) positive and F−progressively measurable, and an Fτ measurable random variable ξ : → [0, ∞) representing the lump-sum consumption at time τ . We regard πi (t) as the proportion of an agent’s wealth invested in stock i at time t; the remaining proportion 1 − π ∗ (t)1m = 1 − m i=1 πi (t) is invested in the money market. These proportions are not constrained to take values in the interval [0, 1]; in other words, we allow both short selling of stocks and borrowing at the interest rate of the bond. For a given, nonrandom, initial capital x > 0, let X (·) = X x,π ,C (·) denote the wealth process corresponding to a portfolio/consumption pair (π(·), C(·)) as above. This wealth process is defined by the initial condition X x,π ,C (0) = x and the equation dX (t) = m πi (t)X (t){bi (t)dt + m i=1 σij (t)dWj (t)} i=1 + {1 − m πi (t)}X (t)rdt − dC(t) i=1 = rX (t)dt + X (t)π ∗ (t)σ (t)dW0 (t) − dC(t), X (0) = x > 0, (11.38) where we have set W0 (t) W (t) + t θ(s)ds, 0 ≤ t < ∞

 

pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

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Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, Long Term Capital Management, Louis Pasteur, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, means of production, Mikhail Gorbachev, millennium bug, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, open economy, Plutocrats, plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Washington Consensus, working poor, éminence grise

He is a classic productive entrepreneur, creating wealth, challenging incumbents and now having to compete with copycat versions of his product as his patents expire. Contrast his contribution to wealth generation with Goldman Sachs’ ‘Fabulous’ Fab Tourre, the executive who is alleged to have invented a financial instrument at the instigation the Paulson hedge fund to make a billion dollars by short selling. Goldman rebut the accusation; but even if it is disproved, something similar will certainly have been concocted by someone in the run-up to the financial crash. Over the past generation, Britain has created the conditions for other ‘Fabulous’ investors to make fortunes by fair means or foul, while neglecting the innovation ecosystem that might have had made it easier for Ritchie and others like him to grow their companies.

., 64, 65 Rowthorn, Robert, 292, 363 Royal Bank of Scotland (RBS), 25, 150, 152, 157, 173, 181, 199, 251, 259; collapse of, 7, 137, 150, 158, 175–6, 202, 203, 204; Sir Fred Goodwin and, 7, 150, 176, 340 Rubin, Robert, 174, 177, 183 rule of law, x, 4, 220, 235 Russell, Bertrand, 189 Russia, 127, 134–5, 169, 201, 354–5, 385; fall of communism, 135, 140; oligarchs, 30, 65, 135 Rwandan genocide, 71 Ryanair, 233 sailing ships, three-masted, 108 Sandbrook, Dominic, 22 Sands, Peter (CEO of Standard Chartered Bank), 26 Sarkozy, Nicolas, 51, 377 Sassoon, Sir James, 178 Scholes, Myron, 169, 191, 193 Schumpeter, Joseph, 62, 67, 111 science and technology: capitalist dynamism and, 27–8, 31, 112–13; digitalisation, 34, 231, 320, 349, 350; the Enlightenment and, 31, 108–9, 112–13, 116–17, 121, 126–7; general-purpose technologies (GPTs), 107–11, 112, 117, 126–7, 134, 228–9, 256, 261, 384; increased pace of advance, 228–9, 253, 297; nanotechnology, 232; New Labour improvements, 21; new opportunities and, 33–4, 228–9, 231–3; new technologies, 232, 233, 240; universities and, 261–5 Scotland, devolving of power to, 15, 334 Scott, James, 114–15 Scott Bader, 93 Scott Trust, 327 Second World War, 134, 313 Securities and Exchanges Commission, 151, 167–8 securitisation, 32, 147, 165, 169, 171, 186, 187, 196 self-determination, 85–6 self-employment, 86 self-interest, 59, 60, 78 Sen, Amartya, 51, 232, 275 service sector, 8, 291, 341, 355 shadow banking system, 148, 153, 157–8, 170, 171, 172, 187 Shakespeare, William, 39, 274, 351 shareholders, 156, 197, 216–17, 240–4, 250 Sher, George, 46, 50, 51 Sherman Act (USA, 1890), 133 Sherraden, Michael, 301 Shiller, Robert, 43, 298, 299 Shimer, Robert, 299 Shleifer, Andrei, 62, 63, 92 short selling, 103 Sicilian mafia, 101, 105 Simon, Herbert, 222 Simpson, George, 142–3 single mothers, 17, 53, 287 sixth form education, 306 Sky (broadcasting company), 30, 318, 330, 389 Skype, 253 Slim, Carlos, 30 Sloan School of Management, 195 Slumdog Millionaire, 283 Smith, Adam, 55, 84, 104, 112, 121, 122, 126, 145–6 Smith, John, 148 Snoddy, Ray, 322 Snow, John, 177 social capital, 88–9, 92 social class, 78, 130, 230, 304, 343, 388; childcare and, 278, 288–90; continued importance of, 271, 283–96; decline of class-based politics, 341; education and, 13, 17, 223, 264–5, 272–3, 274, 276, 292–5, 304, 308; historical development of, 56–8, 109, 115–16, 122, 123–5, 127–8, 199; New Labour and, 271, 277–9; working-class opinion, 16, 143 social investment, 10, 19, 20–1, 279, 280–1 social polarisation, 9–16, 34–5, 223, 271–4, 282–5, 286–97, 342; Conservative reforms (1979-97) and, 275–6; New Labour and, 277–9; private education and, 13, 223, 264–5, 272–3, 276, 283–4, 293–5, 304; required reforms for reduction of, 297–309 social security benefits, 277, 278, 299–301, 328; contributory, 63, 81, 283; flexicurity social system, 299–301, 304, 374; to immigrants, 81–2, 282, 283, 284; job seeker’s allowance, 81, 281, 298, 301; New Labour and ‘undeserving’ claimants, 143, 277–8; non-contributory, 63, 79, 81, 82; targeting of/two-tier system, 277, 281 socialism, 22, 32, 38, 75, 138, 144, 145, 394 Soham murder case, 10, 339 Solomon Brothers, 173 Sony, 254–5 Soros, George, 166 Sorrell, Martin, 349 Soskice, David, 342–3 South Korea, 168, 358–9 South Sea Bubble, 125–6 Spain, 123–4, 207, 358–9, 371, 377 Spamann, Holger, 198 special purpose vehicles, 181 Spitzer, Matthew, 60 sport, cheating in, 23 stakeholder capitalism, x, 148–9 Standard Oil, 130–1, 132 state, British: anti-statism, 20, 22, 233–4, 235, 311; big finance’s penetration of, 176, 178–80; ‘choice architecture’ and, 238, 252; desired level of involvement, 234–5; domination of by media, 14, 16, 221, 338, 339, 343; facilitation of fairness, ix–x, 391–2, 394–5; investment in knowledge, 28, 31, 40, 220, 235, 261, 265; need for government as employer of last resort, 300; need for hybrid financial system, 244, 249–52; need for intervention in markets, 219–22, 229–30, 235–9, 252, 392; need for reshaping of, 34; pluralism, x, 35, 99, 113, 233, 331, 350, 394; public ownership, 32, 240; target-setting in, 91–2; threats to civil liberty and, 340 steam engine, 110, 126 Steinmueller, W.

 

pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy

Mr Garber concluded that ‘As long as some doubt remains about the permanence of Stage III exchange rates [i.e. the currency union], the existence of the currently proposed structure of the ECB and Target does not create additional security against the possibility of an attack. Quite the contrary, it creates a perfect mechanism to make an explosive attack on the system.’39 Such an attack could take the form of a run on banks in a vulnerable country or actions (short-selling of bank stock, for example) that would cause such a run. Thus the creation of gigantic creditor and debtor positions inside the ECB might destroy the credibility of the system. Figure 11. Current Account Balances (per cent of GDP) Source: IMF World Economic Outlook Database The actions of the central banks helped countries in difficulty. But they have not provided much, if any, direct support for public debt.

That is roughly a thousand times larger than its closest legislative cousin, Glass-Steagall. Dodd-Frank makes Glass-Steagall look like throat-clearing. The situation in Europe, while different in detail, is similar in substance. Since the crisis, more than a dozen European regulatory directives or regulations have been initiated, or reviewed, covering capital requirements, crisis management, deposit guarantees, short-selling, market abuse, investment funds, alternative investments, venture capital, OTC derivatives, markets in financial instruments, insurance, auditing and credit ratings. These are at various stages of completion. So far, they cover over 2000 pages. That total is set to increase dramatically as primary legislation is translated into detailed rule-writing. For example, were that rule-making to occur on a US scale, Europe’s regulatory blanket would cover over 60,000 pages.

 

pages: 506 words: 146,607

Confessions of a Wall Street Analyst: A True Story of Inside Information and Corruption in the Stock Market by Daniel Reingold, Jennifer Reingold

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barriers to entry, Berlin Wall, corporate governance, estate planning, Fall of the Berlin Wall, George Gilder, high net worth, informal economy, margin call, new economy, pets.com, rolodex, Saturday Night Live, shareholder value, short selling, Silicon Valley, stem cell, Telecommunications Act of 1996, thinkpad, traveling salesman

In the Qwest–US West deal, I thought the decision to dramatically cut US West’s dividend was wise, since it freed up money to invest in cell-phone service and high-speed Internet access, among other things. Plus the stocks had fallen so far that they were now good values. Based on my models, I saw Qwest shares rising as much as 33 percent and US West’s 28 percent. But I wasn’t totally sanguine either. “Our rating is Accumulate instead of Buy,” I wrote. “Despite such attractive upside, we anticipate the usual pressure from short-selling arbs and the approximate one year wait until merger close. We are also concerned about increasing wholesale [long distance] pricing pressure and new initiative startup costs at both companies.” Megan and I immediately started to work on a similar report on Global Crossing and Frontier. But, within a few days, I began to have second thoughts. Merrill was going to make about $20 million, but most of the fee depended on the deal actually being consummated.

Assurance of Discontinuance in the Matter of Citigroup Global Markets, April 22, 2003, Exhibit 2, “Undertakings,” p. 14. 4. U.S. Securities and Exchange Commission, 17 CFR Part 242, approved February 20, 2003. 5. Mark Pincus, “Will SEC Ever Make Corporate Insiders Pay for Fraud,” http://markpincus.typepad.com/markpincus/2005/03/will_the_sec_ev_html. Glossary arbitrage, general—The practice of buying securities in one market and shorting (selling) them in another, with the goal of capturing as profit any price discrepancies between the two markets. arbitrage, merger—The practice of seeking to make a profit on the difference between the stock prices of companies involved in a merger. In most cases, arbs bet that the merger will be completed within a certain time frame and that the acquiree’s (target’s) stock price will eventually rise to the offered takeout price as the deal nears completion.

 

Investment: A History by Norton Reamer, Jesse Downing

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Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, moral hazard, mortgage debt, Network effects, new economy, Nick Leeson, Own Your Own Home, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

He then went on to attend the Detroit College of Law, where no undergraduate degree was needed, and married Seema Silberstein, whose father, Ben Silberstein, was wealthy from real estate investments.128 Ben Silberstein never thought particularly highly of Ivan, calling him “Ivan the Bum.”129 Soon Ivan found himself in the securities business. He did not exactly have successful opening acts to his career. In his third finance job, one of his investments lost $20,000, and he was asked to leave. In his next job, he manipulated stock prices by buying up large volumes and received a $10,000 fine from the SEC for illegal short selling.130 Time and again, Boesky seems to have sought the quick way to gain. Fraud, Market Manipulation, and Insider Trading 185 Boesky soon launched his own investment firm, the equity of which was funded primarily by his wife’s family’s money. This time Boesky found success. He was soon taking a limousine to work, living in a tenbedroom home in Westchester County, New York, on 200 acres, and spending lavishly.

Others invest in mortgage-backed securities, like those packaged by Fannie Mae and Freddie Mac. Macro hedge funds seek to anticipate major structural changes in an economy, either because of natural market forces (perhaps the market is grossly overheated and is due for a correction) or because of political circumstances. John Paulson of Paulson & Co., for instance, cashed in on the events that led the US economy into crisis by short selling subprime mortgage–backed securities. Because they seem to be predicting the future, many of the most successful macro hedge fund managers find themselves propelled meteorically into fame. However, there are abundant examples of macro managers who experience stumbling blocks to their prescience. John Paulson himself, for instance, experienced very poor returns in one of his funds in 2011, prompting some to question the persistence of the returns in the years that immediately followed.23 Other macro managers—like Louis Bacon, who generated substantial returns in 1990 with a thesis that Saddam Hussein would attack Kuwait but that this would have minimal long-term effect on the market—found it difficult to maintain returns.

 

pages: 433 words: 125,031

Brazillionaires: The Godfathers of Modern Brazil by Alex Cuadros

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affirmative action, Asian financial crisis, big-box store, BRICs, cognitive dissonance, crony capitalism, Deng Xiaoping, Donald Trump, Elon Musk, facts on the ground, family office, high net worth, index fund, invisible hand, Jeff Bezos, Mark Zuckerberg, NetJets, offshore financial centre, profit motive, rent-seeking, risk/return, savings glut, short selling, Silicon Valley, sovereign wealth fund, stem cell, The Wealth of Nations by Adam Smith, too big to fail, transatlantic slave trade, transatlantic slave trade, We are the 99%

Of course, Esteves had also helped to make Eike possible. Pactual underwrote all of Eike’s stock offerings since MMX in 2006. (And later, when crisis struck, it would engulf Esteves too.) Eike and Esteves hadn’t always gotten along. Eike once called up Esteves to yell at him when one of his analysts wrote a negative report on OGX. More recently, Eike believed that Esteves’s traders had been short-selling OGX’s shares. But he was desperate, and the investing class loved Esteves. The first thing Esteves did was to announce a billion-dollar credit line for EBX, a sign of his confidence in Eike’s empire. The markets reacted as hoped. OGX’s stock price jumped sixteen percent in a single day. Reportedly, Eike went around the office saying, in English, “The magic Eike is back!” Esteves’s competitors, though, seemed to take the deal as a sign they wouldn’t be first in line for future fees—and thus had less of an incentive to hedge their criticism.

I interviewed Esteves on August 1, 2012. Details on his life are from press reports and reporting for Alex Cuadros and Cristiane Lucchesi, “BTG’s Esteves Drives ‘Better Than Goldman’ Rise in Bank’s Clout,” Bloomberg Markets, September 10, 2012. 219“would sell his own mother to gain power.” From Consuelo Dieguez, “De elefante a formiga,” Piauí, November 2006. 220Eike believed that Esteves’s traders had been short-selling. From Gaspar, Tudo ou Nada, 395. 220“The magic Eike is back!” From Lauro Jardim, “Auto-confiança máxima,” Veja, March 10, 2013. CHAPTER 9: THE BACKLASH 221Esteves had just given an interview. David Friedlander, Raquel Landim, and Ricardo Grinbaum, “‘É natural que a participação do Eike nas empresas caia de 60% para 30%,’” O Estado de S. Paulo, March 23, 2013. People call this newspaper Estadão for short. 221a colleague of mine uncovered more secret guarantees.

 

Trade Your Way to Financial Freedom by van K. Tharp

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asset allocation, commodity trading advisor, compound rate of return, computer age, Elliott wave, high net worth, margin call, market fundamentalism, pattern recognition, prediction markets, random walk, risk tolerance, short selling, statistical model, transaction costs

The difficulty people have with the stock market is that (1) there are times when very few stocks are trending up so that the best opportunities are only on the short side; (2) people don’t understand shorting so they avoid it; and (3) the exchange regulators make it difficult to short (i.e., you have to be able to borrow the stock to short and you have to short on an uptick). Nevertheless, if vou plan for short selling, then it can be very lucrative under the right market conditions. FUNDAMENTAL ANALYSIS I’ve asked another friend, Charles LeBeau, to write the section on fundamental analysis. LeBeau is well known as a former editor of a great newsletter entitled the Technicnl Traders Bulletin. He is also a coauthor of an excellent book, Co?nputer Analysis of the Futures Market. Chuck is a talented speaker, and he frequently gives talks at Dow-Jones/Telerate Conferences and at AIQ meetings.

Key Terms Defined Scalping This term refers to the actions, usually of floor traders, who buy and sell quickly to get the bid and ask price or to make a quick profit. Seasonal Trading Trading based upon consistent, predictable changes in price during the year due to production cycles or demand cycles. Set-up This terms refers to a part of one’s trading system in which certain criteria must be present before you look for an entry into the market. Short Selling an item in order to be able to buy it later at a lower price. When you sell before you have bought the item, you are said to be “shorting” the market. Slippage The difference in price between what you expect to pay when you enter the market and what you actually pay. For example, if you attempted to buy at 15 and you end up buying at 15.5, then you have a half point of slippage. Specialist A floor trader assigned to fill orders in a specific stock when the order has no offsetting order from off-the-floor.

 

pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

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Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business process, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, The Great Moderation, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve

The Bank of England has been the most dramatic flip-flopper in terms of how to approach the process, whereas the Fed and ECB have been more consistent, each with different results and different aims. This mismatch creates opportunity for an alpha-seeking macro fund. Broadening the discussion to government policy makers, things such as TARP getting voted down and then voted for, or the banning of short selling, or allowing Lehman to go bust and then bailing out AIG a few days later—these things seemed pretty random. They were far from random—many were quite predictable. But this is not the same as saying they were easy. It was clear the week before it happened that Lehman would be let go. Our fund had battened down the hatches the week before, so we did not have a single deal open with Lehman. We cut leverage in preparation for the big impending storm because U.S.

See Risk premia payment Price/earnings (P/E) multiples, exchange rate valuation (relationship) Primary Dealer Credit Facility, placement Prime broker risk Princeton University (endowment) Private equity cash flow production tax shield/operational efficiency arguments Private sector debt, presence Private-to-public sector risk Probability, Bayesian interpretation Professor, The bubble predication capital loss, avoidance capital management cataclysms, analysis crowding factor process diversification efficient markets, disbelief fiat money, cessation global macro fund manager hedge fund space historical events, examination idea generation inflation/deflation debate interview investment process lessons LIBOR futures ownership liquidity conditions, change importance market entry money management, quality opportunities personal background, importance portfolio construction management positioning process real macro success, personality traits/characteristics (usage) returns, generation risk aversion rules risk management process setback stocks, purchase stop losses time horizon Titanic scenario threshold trades attractiveness, measurement process expression, options (usage) personal capital, usage quality unlevered portfolio Property/asset boom Prop shop trading, preference Prop trader, hedge fund manager (contrast) Protectionism danger hedge process Public college football coach salary, public pension manager salary (contrast) Public debt, problems Public pensions average wages to returns endowments impact Q ratio (Tobin) Qualitative screening, importance Quantitative easing (QE) impact usage Quantitative filtering Random walk, investment Real annual return Real assets Commodity Hedger perspective equity-like exposure Real estate, spread trade Real interest rates, increase (1931) Real macro involvement success, personality traits/characteristics (usage) Real money beta-plus domination denotation evolution flaws hedge funds, differentiation impacts, protection importance investors commodity exposure diversification, impact macro principles management, change weaknesses Real money accounts importance long-only investment focus losses (2008) Real money funds Commodity Hedger operation Equity Trader management flexibility frontier, efficiency illiquid asset avoidance importance leverage example usage management managerial reserve optimal portfolio construction failure portfolio management problems size Real money managers Commodity Investor scenario liquidity, importance long-term investor misguidance poor performance, usage (excuse) portfolio construction valuation approach, usage Real money portfolios downside volatility, mitigation leverage, amount management flaws Rear view mirror investment process Redemptions absence problems Reflexivity Rehypothecation Reichsmarks, foreign holders (1922-1923) Relative performance, inadequacy Reminiscences of a Stock Operator (Lefèvre) Renminbi (2005-2009) Repossession property levels Republic of Turkey examination investment rates+equities (1999-2000) Reserve currency, question Resource nationalism Returns forecast generation maximization momentum models targets, replacement Return-to-worst-drawdown, ratios (improvement) Reward-to-variability ratio Riksbank (Sweden) Risk amount, decision aversion rules capital, reduction collars function positive convexity framework, transition function global macro manager approach increase, leverage (usage) measurement techniques, importance parameters Pensioner management pricing reduction system, necessity Risk-adjusted return targets, usage Risk assets, decrease Risk-free arbitrage opportunities Risk management Commodity Hedger process example game importance learning lessons portfolio level process P&L, impact tactic techniques, importance Risk premia annualization earning level, decrease specification Risk/reward trades Risk-versus-return, Pensioner approach Risk-versus-reward characteristics opportunities Roll yield R-squared (correlation) Russia crisis Russia Index (RTSI$) (1995-2002) Russia problems Savings ratio, increase Scholes, Myron Sector risk, limits Securities, legal lists Self-reinforcing cycles (Soros) Sentiment prediction swings Seven Sisters Sharpe ratio increase return/risk Short-dated assets Short selling, ban Siegel’s Paradox example Single point volatility 60-40 equity-bond policy portfolio 60-40 model 60-40 portfolio standardization Smither, Andrew Socialism, Equity Trader concern Society, functioning public funds, impact real money funds, impact Softbank (2006) Soros, George self-reinforcing cycles success Sovereign wealth fund Equity Trader operation operation Soybeans (1970-2009) Special drawing rights (SDR) Spot price, forward price (contrast) Spot shortages/outages, impact Standard deviation (volatility) Standard & Poor’s 500 (S&P500) (2009) decrease Index (1986-1995) Index (2000-2009) Index (2008) shorting U.S. government bonds, performance (contrast) Standard & Poor’s (S&P) shorts, coverage Stanford University (endowment) State pension fund Equity Trader operation operation Stochastic volatility Stock index total returns (1974-2009) Stock market increase, Predator nervousness Stocks hedge funds, contrast holders, understanding pickers, equity index futures usage shorting/ownership, contrast Stops, setting Stress tests, conducting Subprime Index (2007-2009) Sunnies, bidding Super Major Survivorship bias Sweden AP pension funds government bond market Swensen, David equity-centric portfolio Swiss National Bank (SNB) independence Systemic banking crisis Tactical asset allocation function models, usage Tactical expertise Tail hedging, impact Tail risk Take-private LBO Taleb, Nassim Tax cut sunset provisions Taxes, hedge Ten-year U.S. government bonds (2008-2009) Theta, limits Thundering Herd (Merrill Lynch) Time horizons decrease defining determination shortening Titanic funnel, usage Titanic loss number Titanic scenario threshold Topix Index (1969-2000) Top-line inflation Total credit market, GDP percentage Total dependency ratio Trade ideas experience/awareness, impact generation process importance origination Traders ability Bond Trader hiring characteristics success, personality characteristics Trades attractiveness, measurement process hurdle money makers, percentage one-year time horizon selection, Commodity Super Cycle (impact) time horizon, defining Trading decisions, policy makers (impact) floor knowledge noise level ideas, origination Tragedy of the commons Transparency International, Corruption Perceptions Index Treasury Inflation-Protected Securities (TIPS) trade Triangulated conviction Troubled Asset Relief Program (TARP) Turkey economy inflation/equities (1990-2009) investment rates+equities (1999-2000) stock market index (ISE 100) Unconventional Success (Swensen) Underperformance, impact Undervaluation zones, examination United Kingdom (UK), two-year UK swap rates (2008) United States bonds pricing debt (1991-2008) debt (2000-2008) home prices (2000-2009) hyperinflation listed equities, asset investment long bonds, market pricing savings, increase stocks tax policy (1922-1936) trade deficit, narrowing yield curves (2004-2006) University endowments losses impact unlevered portfolio U.S.

 

pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

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algorithmic trading, asset-backed security, bank run, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, collateralized debt obligation, computer age, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, large denomination, Long Term Capital Management, market bubble, Martin Wolf, Menlo Park, mobile money, Monroe Doctrine, moral hazard, mortgage debt, new economy, oil shale / tar sands, oil shock, peak oil, Plutocrats, plutocrats, Ponzi scheme, profit maximization, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, The Chicago School, Thomas Malthus, too big to fail, trade route

Few senators, congressmen, and treasury officials, however happy to bluster on the fiscal ramparts attacking federal deficits, showed any parallel disturbance over private sector debt and fiscal legerdemain—at least not before August opened the private debt sector equivalent of Pandora’s box. Before long, scrutiny had exposed the largest array of financial abuses since congressional hearings on 1920s practices amplified the basis for an eventual barrage of New Deal statutes. Some of these had involved regulating securities markets, undocumented securities issuance, short selling, margin trading, and housing loans; others called for requiring federal deposit insurance and the divorce of commercial banking from the securities business; and still others specified prohibiting open-market operations by individual Federal Reserve banks, the operation of “pools” within exchanges, so-called bucket shops, the private ownership of gold, and more. The seventy-year-old list itself is less important than its strong hint of yet another regulatory wave.

One pioneer, Professor Merton Miller, for years a board member of the Chicago Mercantile Exchange, enthused over derivatives as “essentially industrial raw materials” created to deal with uncertainty and volatility. He argued that “contrary to the widely held perceptions, derivatives have made the world a safer place, not a more dangerous one.”7 But professors frequently go overboard. In 1990, when U.S. economist William Sharpe, in accepting his Nobel Prize, insisted that unrestricted short selling was necessary for efficient markets, wags pointed out that it was restricted even in the United States.8 Over the years, a handful of critical academicians and several billionaire investors—Warren Buffett, George Soros, and William H. (Bill) Gross—would emerge as relentless critics of derivatives, bubbles, and alleged market efficiency. Yale’s Robert Shiller scoffed at the Efficient Market Hypothesis, commenting after the 1987 crash that the “efficient market hypothesis is the most remarkable error in the history of market theory.

 

Quantitative Trading: How to Build Your Own Algorithmic Trading Business by Ernie Chan

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algorithmic trading, asset allocation, automated trading system, backtesting, Black Swan, Brownian motion, business continuity plan, compound rate of return, Elliott wave, endowment effect, fixed income, general-purpose programming language, index fund, Long Term Capital Management, loss aversion, p-value, paper trading, price discovery process, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Ray Kurzweil, Renaissance Technologies, risk-adjusted returns, Sharpe ratio, short selling, statistical arbitrage, statistical model, systematic trading, transaction costs

T 115 P1: JYS c07 JWBK321-Chan September 24, 2008 14:4 116 Printer: Yet to come QUANTITATIVE TRADING MEAN-REVERTING VERSUS MOMENTUM STRATEGIES Trading strategies can be profitable only if securities prices are either mean-reverting or trending. Otherwise, they are randomwalking, and trading will be futile. If you believe that prices are mean reverting and that they are currently low relative to some reference price, you should buy now and plan to sell higher later. However, if you believe the prices are trending and that they are currently low, you should (short) sell now and plan to buy at an even lower price later. The opposite is true if you believe prices are high. Academic research has indicated that stock prices are on average very close to random walking. However, this does not mean that under certain special conditions, they cannot exhibit some degree of mean reversion or trending behavior. Furthermore, at any given time, stock prices can be both mean reverting and trending depending on the time horizon you are interested in.

 

pages: 209 words: 13,138

Empirical Market Microstructure: The Institutions, Economics and Econometrics of Securities Trading by Joel Hasbrouck

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barriers to entry, conceptual framework, correlation coefficient, discrete time, disintermediation, distributed generation, experimental economics, financial intermediation, index arbitrage, interest rate swap, inventory management, market clearing, market design, market friction, market microstructure, martingale, price discovery process, price discrimination, quantitative trading / quantitative finance, random walk, Richard Thaler, second-price auction, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, two-sided market, ultimatum game

The trade price is simply pt = mt (there is no transient price impact). Show that for T = 3 with s1 + s2 + s3 = 1 the optimal order sizes are s1 = 1 + 2λ1 λ3 λ1 λ1 (λ2 − 2λ3 ) ; s3 = − . ; s2 = λ2 (λ2 − 4λ3 ) λ2 − 4λ3 λ22 − 4λ2 λ3 Note that depending on how λt evolves, the optimal purchase may involve an initial sale (!). For example, when {λ1 = 2, λ2 = 1, λ3 = 1/2}, {s1 = −1, s2 = 0, s3 = 2}. The buyer is initially short selling (to drive the price down) and then purchasing to cover the short and establish the required position when price impact is low. Caution is warranted, however, because counterparties (and regulatory authorities) may view the intent of the initial sale as establishment of an “artificial” (i.e., “manipulative”) price. 157 158 EMPIRICAL MARKET MICROSTRUCTURE 15.2 Models of Order Placement The next analysis also deals with a purchase under a time constraint but with different emphasis.

 

pages: 239 words: 68,598

The Vanishing Face of Gaia: A Final Warning by James E. Lovelock

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Ada Lovelace, butterfly effect, carbon footprint, Clapham omnibus, cognitive dissonance, continuous integration, David Attenborough, decarbonisation, discovery of DNA, Edward Lorenz: Chaos theory, Henri Poincaré, mandelbrot fractal, megacity, Northern Rock, oil shale / tar sands, phenotype, planetary scale, short selling, Stewart Brand, University of East Anglia

Kahn was good at predicting the way the human world would go but wholly ignorant about the Earth and the consequences of the rapid growth of population, agriculture and energy‐intensive industry. As confident as Kahn, our politicians now talk with conviction about a world in 2050 fit for 8 billion people living on a 2°C hotter Earth with the temperature stabilized and emissions regulated. I wonder if an Intergovernmental Panel on Economic Change will be as sanguine about 2050. We deplore the clever manipulators who ‘trash and cash’ by short‐selling a bank, but praise governments who provide subsidies for the snake‐oil remedies for climate ills and easy money for the firms that sell them. We still seem to think that by mid century we will enjoy a well‐run and comfortable world under human management and stewardship. In the 1960s we were wholly unaware that we inhabit a live planet whose needs are in conflict with our own. It is too easy to make guesses about the future when we all imagine that life will be much the same as now but with a few interesting or unpleasant details bolted on.

 

pages: 287 words: 81,970

The Dollar Meltdown: Surviving the Coming Currency Crisis With Gold, Oil, and Other Unconventional Investments by Charles Goyette

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bank run, banking crisis, Ben Bernanke: helicopter money, Berlin Wall, Bernie Madoff, Bretton Woods, British Empire, Buckminster Fuller, California gold rush, currency manipulation / currency intervention, Deng Xiaoping, diversified portfolio, Elliott wave, fiat currency, fixed income, Fractional reserve banking, housing crisis, If something cannot go on forever, it will stop, index fund, Lao Tzu, margin call, market bubble, McMansion, money: store of value / unit of account / medium of exchange, mortgage debt, oil shock, peak oil, pushing on a string, reserve currency, rising living standards, road to serfdom, Ronald Reagan, Saturday Night Live, short selling, Silicon Valley, transaction costs

REALITY: In January 1980 the Board of the Commodities Exchange adopted a rule limiting trading in the surging silver market to “liquidation only.” That meant that silver investors could only sell their positions. The board that made the sudden decision included four members representing major short positions in the market. REALITY: In September 2008, the SEC, under pressure from the Treasury and the Fed, issued a ban on short-selling stock in 799 financial companies. Before long it added another couple hundred companies to the list. The ban was an attempt to prop up the market and interfered with the market’s function of price discovery in assessing very real toxic mortgage risks held by financial companies, risks that every investor would want known. SPECULATION: In a monetary breakdown the government may try to stop you from moving your money out of the country or investing it abroad.

 

pages: 192 words: 75,440

Getting a Job in Hedge Funds: An Inside Look at How Funds Hire by Adam Zoia, Aaron Finkel

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backtesting, barriers to entry, collateralized debt obligation, commodity trading advisor, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, family office, fixed income, high net worth, interest rate derivative, interest rate swap, Long Term Capital Management, merger arbitrage, offshore financial centre, random walk, Renaissance Technologies, risk-adjusted returns, rolodex, short selling, side project, statistical arbitrage, systematic trading, unpaid internship, value at risk, yield curve, yield management

This is a very quantitative and systematic trading strategy that uses advanced software programs. Note: These funds typically hire PhDs, mathematicians, and/or programming experts. Emerging Markets This strategy involves equity or fixed income investing in emerging markets around the world. As emerging markets have matured so too has investing in them. Whereas until recently most emerging markets funds were long only, some of these same funds may now incorporate the use of short selling, futures, or other derivative products with which to hedge their investments. Equity Strategies There are several types of hedge funds whose strategies focus on investing in equities. While some of these may use seemingly more traditional strategies, others are quite complex and require very specific skills. Long/Short Equity This strategy involves equity-oriented investing on both the long and the short sides of the market.

 

pages: 244 words: 70,369

Tough Sh*t: Life Advice From a Fat, Lazy Slob Who Did Good by Kevin Smith

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glass ceiling, McJob, Saturday Night Live, short selling

Getting stoned while alone in the home we owned on the Fourth of July not only sounded sexy and naughty, I imagined it’d have the same disconnected, vaguely patriotic feeling I got whenever I watched Saving Private Ryan. So five years into our marriage, Schwalbach and I rolled really bad joints and set about getting stoned together in our empty house. To say it was glorious, dear reader, is to short-sell an orgasm as feeling about as good as a stretching yawn: There’s just no comparison. We smoked and had amazing conversations full of humor, love, and truth. We called a cab and ate tons of cotton candy at the Simon L.A. restaurant, making out under the stars on the outdoor couches like we were sophomores at the lunch table who’d spent last period apart. Then we fucked. Lots. And it rocked. It was an inhibition-free, total surrender to married carnality.

 

pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

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Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, mortgage debt, mortgage tax deduction, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

The end of the structured investment vehicle (SIV), an off-balance-sheet instrument invented to take advantage of loopholes in bank regulations, is not much lamented. The motives behind new products are not always spotless. I remember being with a very senior Lehman banker in London just a few weeks before his employer went bankrupt in September 2008. As we were discussing the latest restrictions imposed against short-selling the shares in banks, a measure designed to protect his own industry, he jerked his head across Canary Wharf in the direction of the regulator’s office. “Whatever rule those fucking idiots come up with on Monday, I’ll have found a thousand ways around it by Friday,” he said. (Not if you’ve gone bankrupt, you won’t.) But even now it is hard to find fault with the concept, as opposed to the practical application, of many of the most demonized products of the recent past.

 

pages: 840 words: 202,245

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

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accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, Mont Pelerin Society, moral hazard, mortgage debt, new economy, North Sea oil, Northern Rock, oil shock, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

Yet Enron’s stock remained high. As much of the high-technology and telecom market fell, Enron could not buck the tide of falling stock prices indefinitely. Then, in early 2001, Fortune published a piece questioning how Enron made its money. This was the first serious criticism from a mainstream journal, the reporting largely based on research done by the hedge fund manager Jim Chanos, who specialized in short selling. Six months later, in August, Skilling resigned as CEO and a midlevel accountant, Sherron Watkins, wrote Ken Lay a letter pointing out that Fastow’s partnerships were about to sink the company. Over the preceding two years, the partnerships had hidden over $1 billion in losses through accounting gimmicks. Yet Arthur Andersen still insisted the accounting methods were fine. Enron’s prestigious Texas lawyers, Vinson & Elkins, confirmed to Lay that the accounting was aboveboard and asserted that Watkins was simply wrong.

., 10.1, 11.1, 11.2, 14.1, 14.2, 16.1 September 11th attacks (2001) Servan-Schreiber, Jean-Jacques service sector, 3.1, 12.1 Setting Limits (Uhler), prl.1 Shah of Iran, Mohammad Reza Pahlavi, 6.1, 6.2, 9.1 Shakespeare, William, 2.1, 2.2 Shapiro, Irving shareholders, 4.1, 4.2, 4.3, 4.4, 4.5, 5.1, 5.2, 5.3, 8.1, 11.1, 12.1, 12.2, 12.3, 12.4, 12.5, 12.6, 13.1, 15.1, 16.1, 17.1, 17.2, 17.3, 17.4, 18.1, 19.1 Shearson Hayden Stone, 16.1, 17.1 Shearson Loeb Rhoades, 6.1, 16.1, 16.2, 19.1 Sherman, Steve Shiller, Robert, 14.1, 14.2, 17.1, 17.2 Shorenstein, Walter short selling, 5.1, 15.1, 15.2, 15.3, 15.4, 15.5, 19.1, 19.2, 19.3, 19.4, 19.5 Showtime, 8.1, 8.2 Shultz, George, 3.1, 3.2, 3.3, 3.4, 6.1, 6.2, 9.1 Siegel, Herb Siegel, Martin, 4.1, 4.2, 5.1, 5.2, 12.1, 13.1, 13.2 Silberstein, Ben Silberstein, Muriel Silicon Valley, 12.1, 17.1 silver, 1.1, 6.1, 15.1, 15.2 Simon, William, 3.1, 3.2, 3.3, 6.1, 6.2, 18.1 Simons, Henry, 2.1, 2.2, 2.3, 2.4, 2.5, 2.6 Simons, James Sinatra, Frank Sirower, Mark Siva-Jothy, Christian Six Crises (Nixon), 3.1 Skilling, Jeffrey, 17.1, 17.2, 17.3, 17.4, 17.5 Slater, Robert Smith, Adam, 1.1, 2.1, 5.1, 7.1 Smith, Howard K.

 

pages: 829 words: 186,976

The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

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airport security, availability heuristic, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, Carmen Reinhart, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Freestyle chess, fudge factor, George Akerlof, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, new economy, Norbert Wiener, PageRank, pattern recognition, pets.com, prediction markets, Productivity paradox, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, wikimedia commons

I don’t think we’re ever going to bat 100 percent, or even 50 percent, but I think we can get somewhere. Some of the bubbles of recent years, particularly the housing bubble, were detected by enormous numbers of people well in advance. And tests like Shiller’s P/E ratio have been quite reliable indicators of bubbles in the past. We could try to legislate our way out of the problem, but that can get tricky. If greater regulation might be called for in some cases, constraints on short-selling—which make it harder to pop bubbles—are almost certainly counter-productive. What’s clear, however, is that we’ll never detect a bubble if we start from the presumption that markets are infallible and the price is always right. Markets cover up some of our warts and balance out some of our flaws. And they certainly aren’t easy to outpredict. But sometimes the price is wrong. 12 A CLIMATE OF HEALTHY SKEPTICISM June 23, 1988, was an unusually hot day on Capitol Hill.

September 11, 2001, terrorist attacks, 247–48, 247, 248, 412, 417, 419, 421, 425–28, 429, 431–32, 436, 438, 444, 449, 510–11 as ambitious, 422–23 as unpredicted, 10–11 service sector, 189 Shakespeare, William, 4–5, 418, 460 Shannon, Claude, 265–66 Sharma, Deven, 22, 25 Shaw, Brian, 237 Shiller, Robert, 22, 30, 31, 32, 347–48, 349, 353, 354, 369, 500 shopping malls, 228, 440 short-selling, 355, 360, 361, 501 shortstops, 446, 447 signals, 175, 186 in climatology, 371–73 competing, 416–18, 417 noise vs., 8, 13, 17, 60, 81, 133, 145, 154, 162, 163, 173, 185, 196, 285–86, 295, 327, 340, 371–73, 388–89, 390–91, 404, 448, 451, 453 in predictive models, 388–89 in stock market, 368 of terrorism, 438, 442–45 similarity scores, 84–85 sine wave, 416–17 Singapore, 210 SIR model, 220–21, 221, 223, 225, 389 skill, 79, 312 luck vs., 321–23, 322, 338–39 Skynet, 290 Slate, 353 slowplaying, 304 smallpox, 214, 229, 436, 485 Smith, Adam, 332 Smith, Ozzie, 446 snow, 391, 399, 473 Snowpocalypse, 474 Soaring Eagle Indian Casino, 296–97 Solar Cycle 24, 392, 393 Solow, Robert, 7 Sornette, Didier, 368, 369 Soros, George, 356, 370 South Korea, 372 Soviet Union, 467 disintegration of, 50–51, 66 economy of, 51–52 Spain, 210 Spanish flu, 205, 211, 214, 224, 229 Spanish Inquisition, 4 sports, 63 see also baseball, basketball Stairs, Matt, 92 Standard & Poor’s (S&P), 1, 19, 20–21, 22, 24, 25–26, 41, 43, 45, 463 see also S&P 500 standard deviation, 322 staph infections, 227 statheads, 87–88 biases of, 91–93 scouts vs., 86, 88, 128 statistical significance test, 251, 253, 256, 372n statistics, context and, 79, 84, 91, 100–102, 105, 234, 240 Stenson, Dernell, 85 Stephen, Zackary “ZakS,” 292–93 stereotypes, 298–99 Stiglitz, Joseph, 363 stimulus package, 14, 40, 184, 194, 379, 398, 466–67 stock market, 19, 185–86, 253, 256, 329–70 Bayesian reasoning and, 259–60 competition in, 313, 352, 364 correlations in price movements in, 358 crashes in, 354–56, 354 dynamic group behavior in, 335 fast track in, 368 forecasting service for, 337–38 future returns of, 330–31, 332–33 lack of predictability in, 337–38, 342, 343–46, 359, 364–66 long run vs. short run in, 404 as 90 percent rational, 367 noise in, 362–64 overconfidence in, 359–60, 367 P/E (price-to-earnings) ratio of, 348, 349, 350, 354, 365, 369 public sentiment on, 364–65, 365 signal track in, 368 technical analysis of, 339–40, 341 velocity and volume of trading on, 329–30, 330, 336 see also efficient-market hypothesis stocks, see stock market StormPulse.com, 471–72 strategy, tactics vs., 273–76, 278, 284 stress, effect on decision making, 97–98, 449 strikeouts, 79–80, 91 strike zone, 102 strong efficient-market hypothesis, 341–42 structural uncertainty, 393 structure-finance ratings, 24 subduction zone, 143–44 subjectivity, 14, 64, 72–73, 100, 252, 253, 255, 258-59, 288, 313, 403, 453 subprime mortgages, 27, 33, 464 suburbs, 31 suckers, in gambling, 56, 237, 240, 317–18, 320 suicide attacks, 423–24, 424 see also September 11, 2001, terrorist attacks suited connectors, 301, 306 sulfur, 392, 399–400, 400, 401 Sulmona, Italy, 143, 145 Sumatra, Indonesia, 161, 171, 172 Summers, Larry, 37–38, 39, 40, 41, 466 sunspots, 392, 401 Super Bowl, 185, 371 superstition, 5 Super Tuesday, 336 surveillance, in credit ratings, 23–24 Survey of Professional Forecasters, 33, 179–83, 191, 197–98, 199, 200–201, 466–67, 480, 481, 482 Suzuki, Ichiro, 101 swine flu, 208, 209–12, 218–19, 224–25, 228–29 Sydney, Australia, 222 syphilis, 222, 222, 225 tactics, strategy vs., 273–76, 278, 284 Taleb, Nassim Nicholas, 368n tape, in credit ratings, 24 taxes, 481 Taylor, Brien, 92 technical analysis, 339–40 technological progress, 112, 243, 292–93, 410–11 technology, 1, 313 tectonic plates, 16, 144, 148, 173 Tehran, 147, 151–53 Tejada, Miguel, 99 telescope, 243 television pundits, 11, 47–50, 49, 73, 314, 448 hedgehogs as, 55 temperature records, 393–95, 394, 397–98, 403–4, 404, 405, 506 Tenet, George, 422, 424–25, 510 tennis, 496 Terminator series, 290n terrorism, 511–12 definition of, 428 depth vs. breadth problem in prevention of, 273 frequency vs. death toll of, 429–30, 430, 431, 432–33, 437, 439, 441, 442, 442 in Israel, 440–42 mathematics of, 425–32 see also September 11, 2001, terrorist attacks Tetlock, Philip E., 11, 51, 52–53, 56–57, 64, 67, 100, 157, 183, 443, 450, 452, 467 Texas, 464 Texas hold ’em, 298–302, 464 limit, 311, 322, 322, 324n no-limit, 300–308, 309–11, 315–16, 316, 318, 324n, 495 Texas Rangers, 89 Thailand, 209 Thaler, Richard, 361–62 theory, necessity of, 9, 197, 372-73 Thirty Years’ War, 4 This Time Is Different: Eight Centuries of Financial Folly (Reinhart and Rogoff), 39–40, 43 Thomas Aquinas, Saint, 112 Thomas J.

 

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Bernie Madoff, the Wizard of Lies: Inside the Infamous $65 Billion Swindle by Diana B. Henriques

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accounting loophole / creative accounting, airport security, Albert Einstein, banking crisis, Bernie Madoff, British Empire, centralized clearinghouse, collapse of Lehman Brothers, diversified portfolio, Donald Trump, dumpster diving, financial deregulation, forensic accounting, Gordon Gekko, index fund, locking in a profit, mail merge, merger arbitrage, Plutocrats, plutocrats, Ponzi scheme, Potemkin village, random walk, Renaissance Technologies, riskless arbitrage, Ronald Reagan, short selling, Small Order Execution System, sovereign wealth fund, too big to fail, transaction costs, traveling salesman

., pp. 57–58. 28 “I realized I never should have sold them those shares”: First BLM Interview. 28 He simply erased those losses from his clients’ accounts: Ibid. 28 “I felt obligated to buy back my clients’ positions”: Letter from BLM to author, Oct. 3, 2010. 29 “a large amount to me in those days”: Ibid. In 2009 dollars, Madoff owed his father-in-law more than $200,000. 30 high-risk “short sales”: In its orthodox form, short-selling is the practice of borrowing shares of stock (specifically, ones you think are going to decline in price) and selling them. If the price falls as you anticipated, you can buy cheaper shares to replace the ones you borrowed and pocket the difference as your profit. If the price goes up, you wind up buying more expensive shares to replace the borrowed ones and you incur potentially open-ended losses.

But as a bona fide market maker, Madoff was allowed to sell short without borrowing the shares first—a practice known as “naked shorting,” which he said he sometimes deployed for clients. Without the stock-borrowing fee, the potential profit was greater. But without an assured supply of stock to cover the borrowed shares, the risks were even higher. A short-seller might find that there simply are no shares to be had except at an astronomical price—a ruinous situation known as a short squeeze. Another form of short-selling Madoff said he frequently employed was “shorting against the box.” In this strategy, a trader shorts the shares of a stock he himself already owns. His holdings protect him against a short squeeze if the price goes up; if the price goes down, his short sale locks in his accrued profits without his actually having to sell the shares, which could have tax consequences. Legislation later reduced the tax benefits of this strategy. 30 His grandparents on both sides: The most extensive research into Madoff’s genealogy is included in Arvedlund, Too Good to Be True, pp. 14–15.

 

pages: 554 words: 168,114

Oil: Money, Politics, and Power in the 21st Century by Tom Bower

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Ayatollah Khomeini, banking crisis, bonus culture, corporate governance, credit crunch, energy security, Exxon Valdez, falling living standards, fear of failure, forensic accounting, index fund, interest rate swap, kremlinology, LNG terminal, Long Term Capital Management, margin call, Mikhail Gorbachev, millennium bug, new economy, North Sea oil, offshore financial centre, oil shale / tar sands, oil shock, passive investing, peak oil, Piper Alpha, price mechanism, price stability, Ronald Reagan, shareholder value, short selling, Silicon Valley, sovereign wealth fund, transaction costs, transfer pricing, éminence grise

In 1983 the market became murkier when Marc Rich remained in Switzerland and escaped facing criminal charges including tax evasion. Despite the scandal, Phibro and others continued to trade with him and Glencore, his corporate reincarnation in Zug. Phibro’s aggression invited retaliation. During that year, Shell took exception to Phibro squeezing Gatoil, a Lebanese oil trader based in Switzerland. Gatoil had speculated by short-selling Brent oil without owning the crude. Subsequently unable to obtain the oil to fulfill its contracts because Phibro had bought all the consignments, it defaulted on contracts worth $75 million. Refusing to bow out quietly, Gatoil reneged on the contracts and sent telexes to all its customers blaming Hall’s squeeze. Shell’s displeasure was made clear at the annual Institute of Petroleum conference in London, where every trader was warned not to attend Phibro’s party featuring Diana Ross.

No other traders appeared to believe that OPEC would cut production. Then prices began to fall. “Buy more,” Deuss ordered, to shore up his position. To achieve a squeeze, he simultaneously also bought Brent oil from rival traders for delivery in the same period. Those traders, unaware of Deuss’s plot, had expected to buy those cargoes from BP and Shell once they were produced. In the common usage, the traders were “short” — selling oil without owning it. As the moment of delivery approached, Deuss demanded delivery of the oil. The unsuspecting traders discovered that no oil was available. Deuss expected to hear screams appealing for mercy. The traders faced two options: either pay Deuss a penalty for defaulting on their contracts, or buy their cargoes from Deuss in order to resell them to him, inevitably suffering a hefty loss.

 

pages: 364 words: 101,286

The Misbehavior of Markets by Benoit Mandelbrot

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Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, new economy, paper trading, passive investing, Paul Lévy, Plutocrats, plutocrats, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, volatility smile

It was about the money-grubbing form of speculation, the trading of government bonds on the Paris exchange, or Bourse, a thriving den of capitalism modeled after a Greek temple and located on the opposite river bank, geographically and intellectually, from the famed Sorbonne. Then as now in France, unbridled speculation had an unsavory reputation. While investment was socially desirable, pure gaming, or agiotage, was not. Futures trading on the exchange had been legalized only fifteen years earlier. And “shorting”—selling securities with borrowed money, to profit from a falling price— was beyond the pale. While there had been some books on financial markets by 1900, its study was not yet an academic discipline, much less an appropriate topic for a provincial seeking approval and patronage from the great Faculté des Sciences de l’Université de Paris. The professors were underwhelmed. Poincaré, reporting on the dissertation, observed that “the subject chosen by M.

 

pages: 342 words: 99,390

The greatest trade ever: the behind-the-scenes story of how John Paulson defied Wall Street and made financial history by Gregory Zuckerman

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1960s counterculture, banking crisis, collapse of Lehman Brothers, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, financial innovation, fixed income, index fund, Isaac Newton, Long Term Capital Management, margin call, Mark Zuckerberg, Menlo Park, merger arbitrage, mortgage debt, mortgage tax deduction, Ponzi scheme, Renaissance Technologies, rent control, Robert Shiller, Robert Shiller, rolodex, short selling, Silicon Valley, statistical arbitrage, Steve Ballmer, Steve Wozniak, technology bubble

Later, when regulatory changes forced Paulson to reveal these positions, he became something of a public enemy in corners of the United Kingdom. “"So I’'m eating my cornflakes and I read that John Paulson, the New York hedge fund king, has made £PS270 million betting that the Royal Bank of Scotland share price would fall over the last four months,”" Chris Blackhurst wrote in London’'s Evening Standard in February 2009. “"Prison isn’'t good enough for the short-selling fiend! He should be paraded down Fifth Avenue, naked, and then tied to a lamp-post so we can all take out our anger and despair on the grasping monster!”" Paulson was uncomfortable shorting these stocks—--not so much because of any guilt about profiting from falling shares but because there was more downside to wagering against stocks, which can soar an unlimited amount, than in owning them.

 

pages: 358 words: 106,729

Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

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accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, market bubble, Martin Wolf, medical malpractice, microcredit, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

JP Morgan Katz, Lawrence keiretsus Kenya, government expenditures in Keynes, John Maynard labor force: migration of mobility of, protective legislation and resilience of skills of training women in, See also employment; income inequality; wages labor unions. See unions late developers Lee Kuan Yew Lehman Brothers: board members of CEO of, collapse of risks taken by salaries in short selling by subsidiaries of Lenin, Vladimir liquidity See also monetary policy liquidity risk livelihood insurance Lucas, Robert E., Jr. Madoff, Bernard Malaysia: economic growth of export-led growth strategy of investment in managed capitalism: in Asia challenges of export-led growth strategies and investment and success of Mandeville, Bernard, The Fable of the Bees markets.

 

pages: 261 words: 103,244

Economists and the Powerful by Norbert Haring, Norbert H. Ring, Niall Douglas

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accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, bank run, barriers to entry, Basel III, Bernie Madoff, British Empire, central bank independence, collective bargaining, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, diversified portfolio, financial deregulation, George Akerlof, illegal immigration, income inequality, inflation targeting, Jean Tirole, job satisfaction, Joseph Schumpeter, knowledge worker, labour market flexibility, law of one price, Long Term Capital Management, low skilled workers, market bubble, market clearing, market fundamentalism, means of production, minimum wage unemployment, moral hazard, new economy, obamacare, open economy, pension reform, Ponzi scheme, price stability, principal–agent problem, profit maximization, purchasing power parity, Renaissance Technologies, rolodex, Sergey Aleynikov, shareholder value, short selling, Steve Jobs, The Chicago School, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, union organizing, working-age population, World Values Survey

The attack on Hong Kong was accompanied by numerous pessimistic reports on Hong Kong, on its exchange rate peg and on China. There were many planted rumors that the Hong Kong government planned to give up the dollar peg and that the Chinese Renminbi would soon be devalued (Yam 2000). George Soros apparently tried something similar to Hungary. In March 2009, his fund was fined by a Hungarian regulator for “sending out false and misleading signals” on the shares of Hungary’s largest bank, OTP. Short selling of OTP shares had caused them to drop 14 percent in the last 30 minutes of trading on October 9, 2008. According to the regulator, this was part of a “significant and strong attack on Hungarian money and capital markets.” The central bank had to raise its benchmark interest rate to the highest in the European Union to defend the national currency, the forint. Soros accepted the fine and apologized for the wrongdoing of his employees (Simon 2009).

 

pages: 292 words: 88,319

The Infinite Book: A Short Guide to the Boundless, Timeless and Endless by John D. Barrow

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Albert Einstein, Andrew Wiles, anthropic principle, Arthur Eddington, cosmological principle, dark matter, Edmond Halley, Fellow of the Royal Society, Georg Cantor, Henri Poincaré, Isaac Newton, mutually assured destruction, Olbers’ paradox, prisoner's dilemma, Ray Kurzweil, short selling, Stephen Hawking, Turing machine

Clearly, if time travel becomes routinely possible at no cost to the traveller, then the interest rates through history would need to be 0% or time travellers could use the banking and investment system as a perpetual money machine. $1 × (1 + 0.04)1000 = 108 million billion dollars !! Notice that negative rates of return are also inconsistent with no-cost time travel. Suppose an investment is worth $1 at first and then falls to 50 cents in value subsequently. Again, time travellers could build a money machine. They could short-sell their investment in the first period (when it is worth $1), teleport in time to the epoch when it is worth 50 cents and repurchase it. Alternatively, they could just buy it when it is worth 50 cents and travel back in time to sell when it is worth $1. Either way, time travellers earn a profit of 50 cents. Again, these profits only disappear when the interest rates are zero. Someone once said that Einstein proved that time is money.

 

Monte Carlo Simulation and Finance by Don L. McLeish

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Black-Scholes formula, Brownian motion, capital asset pricing model, compound rate of return, discrete time, distributed generation, finite state, frictionless, frictionless market, implied volatility, incomplete markets, invention of the printing press, martingale, p-value, random walk, Sharpe ratio, short selling, stochastic process, stochastic volatility, the market place, transaction costs, value at risk, Wiener process, zero-coupon bond

Substituting from 2.33, (2.36) dVt = ut dSt + wt dBt = [ut a(St , t) + wt rt Bt ]dt + ut σ(St , t)dWt If Vt is to be exactly equal to the price V (St , t ) of an option, it follows on comparing the coefficients of dt and dWt in 2.34 and 2.36, that ut = ∂V ∂S , called the delta corresponding to delta hedging. Consequently, Vt = ∂V St + wt Bt ∂S and solving for wt we obtain: wt = 1 ∂V [V − St ]. Bt ∂S The conclusion is that it is possible to dynamically choose a trading strategy, i.e. the weights wt , ut so that our portfolio of stocks and bonds perfectly replicates the value of the option. If we own the option, then by shorting (selling) delta= ∂V ∂S units of stock, we are perfectly hedged in the sense that our portfolio replicates a risk-free bond. Surprisingly, in this ideal word of continuous processes and continuous time trading commission-free trading, the perfect hedge is possible. In the real world, it is said to exist only in a Japanese garden. The equation we obtained by equating both coefficients in 2.34 and 2.36 is; −rt V + rt St ∂V σ 2 (St , t) ∂ 2 V ∂V = 0. + + ∂S ∂t 2 ∂S 2 (2.37) MODELS IN CONTINUOUS TIME 81 Rewriting this allows an interpretation in terms of our hedged portfolio.

 

pages: 317 words: 106,130

The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

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asset allocation, backtesting, Bernie Madoff, Black Swan, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index fund, interest rate swap, invisible hand, market microstructure, merger arbitrage, moral hazard, passive investing, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, statistical model, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve

Moreover, this is before consideration is made for additional operational issues of a manager based vehicle relative to an algorithmic replication product. 125 Core and Satellite Investment: Market/Manager Based Alternatives EXHIBIT 6.7 Comparison Fund and Replication Product Fees Managed Accounts FOF Replication .20% 2.00% 20.00% 1.10% .40% 12.80% .20% 2.00% 25.00% 1.10% .40% 13.50% .10% 1.00% 0.00% .70% .35% 9.00% Trading Costs Management Fee Performance Fee Wrap/CPPI Administrative Break-even Return The purpose of this replication approach is to: ■ ■ ■ Directly capture the changing strategy emphasis of the benchmark Provide both low cost and low counterparty risk Provide high transparency and trading liquidity Exhibit 6.8 reflects the performance of the noninvestable CISDM Equity Long Short (ELS) index, a mutual fund ELS Hybrid Benchmark, and an ETF based replication process with volatility targeted to that of the Mutual Fund ELS Hybrid Benchmark. It should come as no surprise, given the relative restrictions on short selling for mutual fund products, that the mutual fund hybrid ELS benchmark has a higher volatility than that of the EXHIBIT 6.8 Comparison Benchmark, Mutual Fund, and Replication Performance 5/2007–5/2009 CISDM Equity Long/Short Index Mutual Fund ELS Hybrid Benchmark ELS Replication ELS Rep Half Vol/MF Return Annual Std Dev Annual Information Ratio Correlation CISDM ELS −2.2% 8.4% −0.27 1.00 −13.1% −7.4% 14.6% 15.1% −0.89 −0.49 0.65 0.81 1.00 0.98 −0.09 0.76 0.98 −0.62% 7.23% Correlation MF Based Hybrid ELS 126 THE NEW SCIENCE OF ASSET ALLOCATION VAMI: CISDM ELS, Mutual Fund ELS Hybrid, ELS Replication, ELS Replication (Risk Adjusted - Half Volatility) 110 100 90 80 70 M ay -0 Ju 7 n0 Ju 7 lA u 07 gS e 07 p0 O 7 ct N 07 ov D 07 ec -0 Ja 7 nFe 08 bM 08 ar -0 Ap 8 r-0 M 8 ay Ju 08 n0 Ju 8 lA u 08 gS e 08 p0 O 8 ct -0 N 8 ov D 08 ec -0 Ja 8 nFe 09 bM 09 ar -0 Ap 9 rM 09 ay -0 Ju 9 n09 60 CISDM Equity Long/Short Index ELS Replication EXHIBIT 6.9 Mutual Fund (ELS) Hybrid Funds ELS Rep HV/MF Comparison VAMI representative CISDM ELS Index.

 

pages: 318 words: 87,570

Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street Are Destroying Investor Confidence and Your Portfolio by Sal Arnuk, Joseph Saluzzi

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algorithmic trading, automated trading system, Bernie Madoff, buttonwood tree, corporate governance, cuban missile crisis, financial innovation, Flash crash, Gordon Gekko, High speed trading, latency arbitrage, locking in a profit, Mark Zuckerberg, market fragmentation, Ponzi scheme, price discovery process, price mechanism, price stability, Sergey Aleynikov, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, transaction costs, two-sided market

Senator Ted Kaufman I didn’t know a great deal about high frequency trading and the negative effect it was having on the financial markets and the economy when I became a United States Senator early in 2009, taking the seat vacated by Vice President-elect Joe Biden. But thanks to Sal Arnuk and Joseph Saluzzi of Themis Trading, I learned quickly. During the Bush II administration, I became concerned about changes in the rules on short selling. Along with Republican Senator Johnny Isaakson, I wrote to SEC Chair Mary Schapiro, asking her to follow up on her confirmation hearing pledge to look into reinstating the “uptick rule,” which had been removed in what former SEC Chair Chris Cox admitted had been a mistake. Short sellers play an important role in maintaining an orderly market. But there also are predatory bears. If not policed, they could have a devastating effect by creating a never-ending, negative feedback loop.

 

pages: 311 words: 99,699

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe by Gillian Tett

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accounting loophole / creative accounting, asset-backed security, bank run, banking crisis, Black-Scholes formula, Bretton Woods, business climate, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, easy for humans, difficult for computers, financial innovation, fixed income, housing crisis, interest rate derivative, interest rate swap, locking in a profit, Long Term Capital Management, McMansion, mortgage debt, North Sea oil, Northern Rock, Renaissance Technologies, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical model, The Great Moderation, too big to fail, value at risk, yield curve

On Thursday 18, British authorities unveiled a shotgun marriage of their own. Lloyds TSB, one of the stronger British banks, announced it was taking over the operations of ailing HBOS. The same day, central banks unveiled yet more coordinated liquidity injections, including a deal between the Bank of England and the Fed to pump dollar liquidity into London. British regulators also announced a ban on short selling of bank shares, in an effort to stem the collapse of shore prices. On the other side of the Atlantic, on the same day, the Treasury unveiled a safety net for money-market funds. Once again, this used Fed money to stave off a run. Then, at the end of the week, Henry Paulson announced a bold plan by which the Treasury would earmark up to $700 billion in funds to purchase “troubled assets” from the banks, such as their super-senior holdings.

 

pages: 357 words: 99,684

Why It's Still Kicking Off Everywhere: The New Global Revolutions by Paul Mason

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back-to-the-land, balance sheet recession, bank run, banking crisis, Berlin Wall, capital controls, centre right, citizen journalism, collapse of Lehman Brothers, collective bargaining, credit crunch, Credit Default Swap, currency manipulation / currency intervention, currency peg, eurozone crisis, Fall of the Berlin Wall, floating exchange rates, Francis Fukuyama: the end of history, full employment, ghettoisation, illegal immigration, informal economy, land tenure, low skilled workers, means of production, megacity, Mohammed Bouazizi, Naomi Klein, Network effects, New Journalism, Occupy movement, price stability, quantitative easing, race to the bottom, rising living standards, short selling, Slavoj Žižek, Stewart Brand, strikebreaker, union organizing, We are the 99%, Whole Earth Catalog, WikiLeaks, Winter of Discontent, women in the workforce, working poor, working-age population, young professional

Those countries’ currencies would have to rise against the dollar, or they would have to tolerate rampant inflation, or both. Some countries resisted. Brazil responded to a 40 per cent rise of the real against the dollar with a tax designed to suppress the flow of capital into Brazil. It spent tens of billions of dollars in the foreign exchange markets buying its own currency to depress the exchange rate, and slapped a ban on short-selling the dollar inside Brazil. But other countries could not, or would not, use capital controls. The outcome speaks for itself: the UN’s global Food Price Index, which had been set at 100 in 2004, rocketed from 180 in July 2010 to an all-time high of 234 in February 2011. In spring 2011, after Bernanke vigorously denied that QEII had had the slightest impact on the Arab Spring, UK economist Andrew Lilico produced a graph showing the almost exact correlation between Federal Reserve money-printing operations and global commodity prices.

 

pages: 394 words: 85,252

The New Sell and Sell Short: How to Take Profits, Cut Losses, and Benefit From Price Declines by Alexander Elder

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Atul Gawande, backtesting, buy low sell high, Checklist Manifesto, double helix, impulse control, paper trading, short selling, systematic trading, The Wealth of Nations by Adam Smith

Second, when a stock is in a severe decline, short-sellers are among the first to step in and buy, cushioning that decline. Buyers tend to grow skittish and hang back during severe drops. It is short-sellers, flush with profits, who step in to buy in order to cover and turn paper profits into real money. Their covering slows down the decline, and that’s when the bargain hunters step in. Next thing you know, a bottom is in place and the stock is rising again. Short-selling dampens excessive price swings and benefits the public. I do not want to imply that short-sellers are a bunch of social workers. We aren’t. But as the great economist Adam Smith showed two centuries ago, people in the free market help others by doing what is best for themselves. Bears help the markets, as long as there is no collusion between them—no “bear raids.” This caveat applies equally to buying, to manipulating stocks upward.

 

pages: 447 words: 104,258

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues by Alain Ruttiens

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algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, discrete time, diversification, fixed income, implied volatility, interest rate derivative, interest rate swap, margin call, market microstructure, martingale, p-value, passive investing, quantitative trading / quantitative finance, random walk, risk/return, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond

Financial markets are efficient; in other words, market prices are always perfectly reflecting all the market information and thus always updated in accordance with this market information. Efficiency also implies, practically speaking, enough market liquidity. Market prices are assumed to be continuous, like the Wiener process used to model the underlying (cf. Chapter 8, Sections 8.1 and 8.2). Market prices and interest rates are assumed to be traded at the mid: no bid–offer spread is taken into account. Short selling is always available, at no cost. There are no taxes or brokerage fees applicable to the transactions. The prevailing risk-free interest rate – the rate applicable to non-defaultable sovereign debt – corresponding to the maturity of the option is well determined and remains constant during the whole life of the option. Also, it is always possible to borrow at this rate. The Black–Scholes formula will be introduced with respect of a call price C, the passage to a put P being straightforward.

 

pages: 265 words: 93,231

The Big Short: Inside the Doomsday Machine by Michael Lewis

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Asperger Syndrome, asset-backed security, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, facts on the ground, financial innovation, fixed income, forensic accounting, Gordon Gekko, high net worth, housing crisis, illegal immigration, income inequality, index fund, interest rate swap, London Interbank Offered Rate, Long Term Capital Management, medical residency, moral hazard, mortgage debt, pets.com, Ponzi scheme, Potemkin village, quantitative trading / quantitative finance, short selling, Silicon Valley, too big to fail, value at risk, Vanguard fund

All over the world corporations began to yank their money out of money market funds, and short-term interest rates spiked as they had never before spiked. The Dow Jones Industrial Average had fallen 449 points, to its lowest level in four years, and most of the market-moving news was coming not from the private sector but from government officials. At 6:50 on Thursday morning, when Danny arrived, he learned that the chief British financial regulator was considering banning short selling--an act that, among other things, would put the hedge fund industry out of business--but that didn't begin to explain what now happened. "All hell was breaking loose in a way I had never seen in my career," said Danny. FrontPoint was positioned perfectly for exactly this moment. By agreement with their investors, their fund could be 25 percent net short or 50 percent net long the stock market, and the gross positions could never exceed 200 percent.

 

pages: 1,178 words: 388,227

Quicksilver by Neal Stephenson

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Danny Hillis, dark matter, en.wikipedia.org, Eratosthenes, Fellow of the Royal Society, Isaac Newton, joint-stock company, out of africa, Peace of Westphalia, retrograde motion, short selling, the scientific method, trade route, urban planning

Frequently a group of bears will come together and form a secret cabal—they will spread false news of pirates off the coast, or go into the market loudly selling shares at very low prices, trying to create a panic and make the price drop.” “But how do they make money from this?” “Never mind the details—there are ways of using options so that you will make money if the price falls. It is called short selling. Our investor—once we tell him about your invasion plans—will begin betting that V.O.C. stock will drop soon. And rest assured, it will. Only a few years ago, mere rumors about the state of Anglo/Dutch relations were sufficient to depress the price by ten or twenty percent. News of an invasion will plunge it through the floor.” “Why?” Monmouth asked. “England has a powerful navy—if they are hostile to Holland, they can choke off shipping, and the V.O.C. drops like a stone.”

“Until the true situation becomes generally known,” Eliza said, patted his arm firmly, and drew back. Gomer Bolstrood seemed to relax further. “During that interval,” Eliza continued, “our investor will have the opportunity to reap a colossal profit, by selling the market short. And in exchange for that opportunity he’ll gladly buy you all the lead and powder you need to mount the invasion.” “But that investor is not Mr. Sluys—?” “In any short-selling transaction there is a loser as well as a winner,” Eliza said. “Mr. Sluys is to be the loser.” “Why him specifically?” Bolstrood asked. “It could be any liefhebber.” “Selling short has been illegal for three-quarters of a century! Numerous edicts have been issued to prevent it—one of them written in the time of the Stadholder Frederick Henry. Now, if a trader is caught short—that is, if he has signed a contract that will cause him to lose money—he can ‘appeal to Frederick.’”

“But Frederick Henry died ages ago,” Monmouth protested. “It is an expression—a term of art. It simply means to repudiate the contract, and refuse to pay. According to Frederick Henry’s edict, that repudiation will be upheld in a court of law.” “But if it’s true that there must always be a loser when selling short, then Frederick Henry’s decree must’ve stamped out the practice altogether!” “Oh, no, your grace—short selling thrives in Amsterdam! Many traders make their living from it!” “But why don’t all of the losers simply ‘appeal to Frederick’?” “It all has to do with how the contracts are structured. If you’re clever enough you can put the loser in a position where he dare not appeal to Frederick.” “So it is a sort of blackmail after all,” Bolstrood said, gazing out the window across a snowy field—but hot on Eliza’s trail.

 

pages: 484 words: 136,735

Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

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bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, bonus culture, Bretton Woods, BRICs, Carmen Reinhart, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, F. W. de Klerk, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, global rebalancing, Hyman Minsky, income inequality, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Rogoff, laissez-faire capitalism, Long Term Capital Management, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, oil shock, paradox of thrift, peak oil, pets.com, Ponzi scheme, post-industrial society, price stability, profit maximization, profit motive, quantitative easing, Ralph Waldo Emerson, random walk, rent-seeking, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, Washington Consensus

Back in New York, meanwhile, Morgan Stanley and Wachovia were now on the brink of failure and Bank of America, which had only just saved Merrill Lynch the preceding weekend, was under renewed speculative attack. At last Henry Paulson, pressured by the Fed37 and by foreign governments, realized that he had no alternative to large-scale and systemic public intervention. The plan for a $700 billion Troubled Asset Relief Program (TARP) was agreed that Thursday at lunchtime and deliberate leaks about its gigantic scale, combined with a temporary ban on short selling, triggered a near-record rally on stock markets around the world that evening and the following day. The banks threatened with insolvency just a few hours earlier were suddenly reprieved. Even at this point, however, it emerged that the U.S. treasury secretary had not grasped the nature of the problem—as was all too apparent in his disastrous interactions with the Congress during the following two weeks, which turned out even worse, in terms of financial losses, than the immediate aftermath of Lehman.

 

pages: 402 words: 110,972

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

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AI winter, algorithmic trading, asset allocation, banking crisis, barriers to entry, Big bang: deregulation of the City of London, butterfly effect, buttonwood tree, buy low sell high, capital asset pricing model, citizen journalism, collateralized debt obligation, corporate governance, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, Emanuel Derman, en.wikipedia.org, experimental economics, financial innovation, Gordon Gekko, implied volatility, index arbitrage, index fund, information retrieval, Internet Archive, John Nash: game theory, Khan Academy, load shedding, Long Term Capital Management, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, moral hazard, mutually assured destruction, natural language processing, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Renaissance Technologies, Richard Stallman, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, semantic web, Sharpe ratio, short selling, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, too big to fail, transaction costs, Turing machine, Upton Sinclair, value at risk, Vernor Vinge, yield curve, Yogi Berra

The remarkable message that follows contains much of the same material, updated for the Internet, 320 years later.6 * Painting the tape is the illegal practice in which traders buy and sell a specific security among themselves, in order to create an illusion of high trading volume. Traders profit when unsuspecting investors, lured in by the unusual market volume, buy the stock. Thr ee Hundr ed Years of Stock Market Manipulations Goat . . . here’s the short’s handbook by:Tel212 (M/NY, NY) 3/11/00 2:48 AM Msg: 16909 of 17535 Message boards Guidelines, used by shorters that short sell stock. 1. Be anonymous, of course. 2. Use 10% fact and 90% suggestion in one’s posts. Facts give credibility, while suggestion does the “sell.” 3. Let others “help” you learn about a stock thereby developing rapport and a support base. 4. Use multiple handles, but develop a unique style for each. 5. Use multiple ISPs. 6. Start each new handle slowly to build acceptance. 7. Occasionally, use two handles to “discuss” an issue. 8.

 

pages: 481 words: 120,693

Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else by Chrystia Freeland

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Albert Einstein, algorithmic trading, banking crisis, barriers to entry, Basel III, battle of ideas, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Branko Milanovic, Bretton Woods, BRICs, business climate, call centre, carried interest, Cass Sunstein, Clayton Christensen, collapse of Lehman Brothers, conceptual framework, corporate governance, credit crunch, Credit Default Swap, crony capitalism, Deng Xiaoping, don't be evil, double helix, energy security, estate planning, experimental subject, financial deregulation, financial innovation, Flash crash, Frank Gehry, Gini coefficient, global village, Goldman Sachs: Vampire Squid, Gordon Gekko, Guggenheim Bilbao, haute couture, high net worth, income inequality, invention of the steam engine, job automation, joint-stock company, Joseph Schumpeter, knowledge economy, knowledge worker, linear programming, London Whale, low skilled workers, manufacturing employment, Mark Zuckerberg, Martin Wolf, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, NetJets, new economy, Occupy movement, open economy, Peter Thiel, place-making, Plutocrats, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, postindustrial economy, Potemkin village, profit motive, purchasing power parity, race to the bottom, rent-seeking, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, self-driving car, short selling, Silicon Valley, Silicon Valley startup, Simon Kuznets, Solar eclipse in 1919, sovereign wealth fund, stem cell, Steve Jobs, The Spirit Level, The Wealth of Nations by Adam Smith, Tony Hsieh, too big to fail, trade route, trickle-down economics, Tyler Cowen: Great Stagnation, wage slave, Washington Consensus, winner-take-all economy

The redbrick mansion was once home to Princess Diana and today is a home for her sons, but the most lavish celebration held on its grounds in the summer of 2011 was the annual gala auction hedge fund manager (and supermodel-dater) Arpad Busson organizes to raise money for ARK, the children’s charity he founded. Busson is a vocal proponent of philanthro-capitalism. ARK stands for Absolute Return for Kids, a play on the language of the hedge funds and their pursuit of absolute returns, often using aggressive techniques such as short selling, in contrast with generally more conservative mutual funds and their pursuit of relative returns, which is to say they aim to keep abreast of the wider investment pack. Busson thinks ARK needs to be run like a hedge fund. “If we can apply the entrepreneurial principles we have brought to business to charity, we have a shot at having a really strong impact, to be able to transform the lives of children,” he told The Observer.

 

pages: 543 words: 157,991

All the Devils Are Here by Bethany McLean

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Asian financial crisis, asset-backed security, bank run, Black-Scholes formula, call centre, collateralized debt obligation, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Exxon Valdez, fear of failure, financial innovation, fixed income, high net worth, Home mortgage interest deduction, interest rate swap, laissez-faire capitalism, Long Term Capital Management, margin call, market bubble, market fundamentalism, Maui Hawaii, moral hazard, mortgage debt, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative trading / quantitative finance, race to the bottom, risk/return, Ronald Reagan, Rosa Parks, shareholder value, short selling, South Sea Bubble, statistical model, telemarketer, too big to fail, value at risk

He concluded, “We may have encouraged financial institutions to grow in ways that do not directly facilitate or enhance the reason for having a financial system in the first place.” If only that were the worst of it. But it wasn’t. The invention of synthetics may well have both magnified the bubble and prolonged it. Take the former first. Synthetic CDOs made it possible to bet on the same bad mortgages five, ten, twenty times. Underwriters, wanting to please their short-selling clients, referenced a handful of tranches they favored over and over again. Merrill’s risk manager, John Breit, would later estimate that some tranches of mortgage-backed securities were referenced seventy-five times. Thus could a $15 million tranche do $1 billion of damage. In a case uncovered by the Wall Street Journal, a $38 million subprime mortgage bond created in June 2006 ended up in more than thirty debt pools and ultimately caused roughly $280 million in losses.

 

pages: 464 words: 116,945

Seventeen Contradictions and the End of Capitalism by David Harvey

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accounting loophole / creative accounting, bitcoin, Branko Milanovic, Bretton Woods, BRICs, British Empire, business climate, California gold rush, call centre, central bank independence, clean water, cloud computing, collapse of Lehman Brothers, colonial rule, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Deng Xiaoping, deskilling, falling living standards, fiat currency, first square of the chessboard, first square of the chessboard / second half of the chessboard, Food sovereignty, Frank Gehry, future of work, global reserve currency, Guggenheim Bilbao, income inequality, informal economy, invention of the steam engine, invisible hand, Isaac Newton, Jane Jacobs, Jarndyce and Jarndyce, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Just-in-time delivery, knowledge worker, low skilled workers, Mahatma Gandhi, market clearing, Martin Wolf, means of production, microcredit, new economy, New Urbanism, Occupy movement, peak oil, phenotype, Plutocrats, plutocrats, Ponzi scheme, quantitative easing, rent-seeking, reserve currency, road to serfdom, Robert Gordon, Ronald Reagan, short selling, Silicon Valley, special economic zone, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, Tyler Cowen: Great Stagnation, wages for housework, Wall-E, women in the workforce, working poor, working-age population

This made the booms and the busts particularly helpful to long-term investors, who could purchase assets at fire-sale prices in the wake of a crash with the prospects of making a long-term killing. This is what many of the banks and foreign investors did during the South-East Asian crisis of 1997–8 and what investors are now doing as they buy up masses of cheap foreclosed housing in, for example, California to rent out until the property market revives. This is what the hedge funds do, though under very different conditions, when they short-sell in fictitious capital markets. But what this means is that more and more capital is being invested in search of rents, interest and royalties rather than in productive activity. This trend towards a rentier form of capital is reinforced by the immense extractive power that increasingly attaches to rents on intellectual property rights to genetic materials, seeds, licensed practices and the like.

 

pages: 457 words: 128,838

The Age of Cryptocurrency: How Bitcoin and Digital Money Are Challenging the Global Economic Order by Paul Vigna, Michael J. Casey

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3D printing, Airbnb, altcoin, bank run, banking crisis, bitcoin, blockchain, Bretton Woods, California gold rush, capital controls, carbon footprint, clean water, collaborative economy, collapse of Lehman Brothers, Columbine, Credit Default Swap, cryptocurrency, David Graeber, disintermediation, Edward Snowden, Elon Musk, ethereum blockchain, fiat currency, financial innovation, Firefox, Flash crash, Fractional reserve banking, hacker house, Hernando de Soto, high net worth, informal economy, Internet of things, inventory management, Julian Assange, Kickstarter, Kuwabatake Sanjuro: assassination market, litecoin, Long Term Capital Management, Lyft, M-Pesa, Mark Zuckerberg, McMansion, means of production, Menlo Park, mobile money, money: store of value / unit of account / medium of exchange, Network effects, new economy, new new economy, Nixon shock, offshore financial centre, payday loans, peer-to-peer lending, pets.com, Ponzi scheme, prediction markets, price stability, profit motive, RAND corporation, regulatory arbitrage, rent-seeking, reserve currency, Robert Shiller, Robert Shiller, Satoshi Nakamoto, seigniorage, shareholder value, sharing economy, short selling, Silicon Valley, Silicon Valley startup, Skype, smart contracts, special drawing rights, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, supply-chain management, Ted Nelson, The Great Moderation, the market place, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, Turing complete, Tyler Cowen: Great Stagnation, Uber and Lyft, underbanked, WikiLeaks, Y Combinator, Y2K, Zimmermann PGP

As in the developed world, one hope is that if big firms or institutions whose relationships run deep in the economy start using bitcoin, they can create incentives for their suppliers and customers to use it. Patrick Byrne, the CEO of Salt Lake City–based online retailer Overstock.com, which began accepting bitcoin in early 2014 to become what was then the biggest revenue-earning merchant to do so, believes his firm can play such a catalytic role creating a bitcoin “ecosystem” in the developing world. Byrne’s belief in bitcoin was forged during the financial crisis, when hedge funds began short-selling Overstock’s shares, a practice in which borrowed securities are dumped on the market so as to profit when they fall to a lower price. The hedge funds said they didn’t trust the company’s accounting; Byrne saw it as purely manipulative speculation, all facilitated and encouraged by Wall Street’s centralized systems for buying, selling, lending, and borrowing securities. Cryptocurrency, he believes, is a weapon to combat this because it brings willing buyers and sellers of assets together, without the brokers and investment banks acting as fee-grabbing middlemen.

 

pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, laissez-faire capitalism, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund

In expounding the noise trader approach, he and his colleagues provided reams of algebraic and statistical data, but the essence of their argument can be conveyed with the help of a simple hypothetical example. Imagine it is 1999 and you are a hedge fund manager considering whether to speculate against Amazon.com’s stock by shorting it. (The stock quintupled in 1998 and was, to all appearances, grossly overvalued.) To carry out the short trade, you will first have to find somebody willing to lend you as many Amazon shares as you want to short. (That is how short-selling works: the speculator sells a stock he doesn’t own by borrowing some stock to give to the buyer. Then he buys back the stock in the market, hopefully at a lower price, and delivers it to the party he borrowed from.) Finding a lender won’t be easy. In 1999, Amazon and many other Internet companies, being new to the market, didn’t have very many shares outstanding. Apart from this practical issue, you face “noise trader risk.”

 

pages: 442 words: 39,064

Why Stock Markets Crash: Critical Events in Complex Financial Systems by Didier Sornette

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Asian financial crisis, asset allocation, Berlin Wall, Bretton Woods, Brownian motion, capital asset pricing model, capital controls, continuous double auction, currency peg, Deng Xiaoping, discrete time, diversified portfolio, Elliott wave, Erdős number, experimental economics, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, global village, implied volatility, index fund, invisible hand, John von Neumann, joint-stock company, law of one price, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, market design, market fundamentalism, mental accounting, moral hazard, Network effects, new economy, oil shock, open economy, pattern recognition, Paul Erdős, quantitative trading / quantitative finance, random walk, risk/return, Ronald Reagan, Schrödinger's Cat, short selling, Silicon Valley, South Sea Bubble, statistical model, stochastic process, Tacoma Narrows Bridge, technological singularity, The Coming Technological Singularity, The Wealth of Nations by Adam Smith, Tobin tax, total factor productivity, transaction costs, tulip mania, VA Linux, Y2K, yield curve

It is clear from our analysis in chapters 4 and 5 and from the lessons of the two previous bubbles ending in October 1987 and in early 1994 that those assumptions naively overlooked the contagion, leading to overinvestments in the build-up period preceding the crash and resulting instability, which left the Hong Kong market vulnerable to so-called speculative attacks. Actually, hedge funds in particular are known to have taken positions consistent with a possible autopsy of major c r a s h e s 249 crisis on the currency and on the stock market, by “shorting” (selling) the currency to drive it down, forcing the Hong Kong government to raise interest rates to defend it by increasing the currency liquidity, but as a consequence making equities suffer and making the stock market more unstable. As we have already emphasized, one should not confuse the “local” cause with the fundamental cause of the instability. As the late George Stigler—Nobel laureate economist from the University of Chicago— once put it, to blame “the markets” for an outcome we don’t like is like blaming restaurants waiters for obesity.

 

pages: 422 words: 131,666

Life Inc.: How the World Became a Corporation and How to Take It Back by Douglas Rushkoff

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affirmative action, Amazon Mechanical Turk, banks create money, big-box store, Bretton Woods, car-free, colonial exploitation, Community Supported Agriculture, complexity theory, computer age, corporate governance, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, death of newspapers, don't be evil, Donald Trump, double entry bookkeeping, easy for humans, difficult for computers, financial innovation, Firefox, full employment, global village, Google Earth, greed is good, Howard Rheingold, income per capita, invention of the printing press, invisible hand, Jane Jacobs, John Nash: game theory, joint-stock company, Kevin Kelly, laissez-faire capitalism, loss aversion, market bubble, market design, Marshall McLuhan, Milgram experiment, moral hazard, mutually assured destruction, Naomi Klein, new economy, New Urbanism, Norbert Wiener, peak oil, place-making, placebo effect, Ponzi scheme, price mechanism, price stability, principal–agent problem, private military company, profit maximization, profit motive, race to the bottom, RAND corporation, rent-seeking, RFID, road to serfdom, Ronald Reagan, short selling, Silicon Valley, Simon Kuznets, social software, Steve Jobs, Telecommunications Act of 1996, telemarketer, The Wealth of Nations by Adam Smith, Thomas L Friedman, too big to fail, trade route, trickle-down economics, union organizing, urban decay, urban planning, urban renewal, Vannevar Bush, Victor Gruen, white flight, working poor, Works Progress Administration, Y2K, young professional

Homebuyers Have Negative Equity: Report,” CBC News, posted on February 12, 2008, www.cbc.ca/money/story/2008/ 02/12/homeequity.html (accessed February 14, 2008). 70 Mr. Greenspan and the federal government Edmund L. Andrews, “Fed and Regulators Shrugged as the Subprime Crisis Spread,” The New York Times, December 18, 2007, front page. 71 While Goldman Sachs was underwriting The Daily Reckoning website has the best narrative accounts of Goldman Sachs’s short-selling strategy during the subprime-mortgage meltdown: Adrian Ash, “Goldman Sachs Escaped Subprime Collapse by Selling Subprime Bonds Short,” Daily Reckoning, October 19, 2007, http://www.dailyreckoning.com.au/goldman-sachs-2/2007/10/19. 71 For help predicting the extent Gregory Zuckerman covered the Paulson-Greenspan relationship for The Wall Street Journal. Start with Gregory Zuckerman, “Trader Made Billions on Subprime,” The Wall Street Journal, January 15, 2008, Business section. 72 Membership in civic organizations Robert D.

 

pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

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bank run, banking crisis, barriers to entry, Bernie Madoff, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, full employment, fundamental attribution error, George Akerlof, income inequality, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, Zipcar

The price uctuations from day to day were widely noted, and this in turn generated increased interest in the investment. The freedom to get in or out of the investment day by day built a sense of excitement. This advance both democratized and humanized nance: it brought many more people into the market even as it respected their demand for liquidity and need for pride of ownership while they held shares. The Amsterdam stock market became regulated when short selling (the sale of borrowed shares, not even owned by the seller) in 1609 led to market turmoil and the temporary abolition of that practice. The invention of the newspaper came soon after, and it was not long before the prices of the East India Company’s shares were reported regularly, spurring immense public interest in the investment. The issuance of shares in joint stock companies (companies owned jointly by a number of people through shares) was limited at rst.

 

pages: 413 words: 117,782

What Happened to Goldman Sachs: An Insider's Story of Organizational Drift and Its Unintended Consequences by Steven G. Mandis

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algorithmic trading, Berlin Wall, bonus culture, BRICs, business process, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, diversification, Emanuel Derman, financial innovation, fixed income, friendly fire, Goldman Sachs: Vampire Squid, high net worth, housing crisis, London Whale, Long Term Capital Management, merger arbitrage, new economy, passive investing, performance metric, risk tolerance, Ronald Reagan, Saturday Night Live, shareholder value, short selling, sovereign wealth fund, The Nature of the Firm, too big to fail, value at risk

Tourre says that he and Goldman did not have a duty to give investors details that the SEC says they should have disclosed and that the SEC did not show that he acted with the intention of defrauding investors. Goldman starts to shut down several proprietary trading groups, and many proprietary traders begin to leave as the SEC fines Goldman $225,000 for violating a rule aimed at regulating short selling (R). The Financial Industry Regulatory Authority (FINRA) says it is fining Goldman $650,000 for failing to disclose that the government was investigating two of its brokers. One of the brokers was Goldman vice president Fabrice Tourre. FINRA says Goldman did not have the proper procedures in place to make sure that this disclosure was made (R). 2011: In March, former Goldman board member Rajat Gupta is charged by the SEC with insider trading for passing information to the hedge fund Galleon Group that he learned in his capacity as a board member.

 

pages: 464 words: 117,495

The New Trading for a Living: Psychology, Discipline, Trading Tools and Systems, Risk Control, Trade Management by Alexander Elder

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additive manufacturing, Atul Gawande, backtesting, Benoit Mandelbrot, buy low sell high, Checklist Manifesto, deliberate practice, diversification, Elliott wave, endowment effect, loss aversion, mandelbrot fractal, margin call, offshore financial centre, paper trading, Ponzi scheme, price stability, psychological pricing, quantitative easing, random walk, risk tolerance, short selling, South Sea Bubble, systematic trading, The Wisdom of Crowds, transaction costs, transfer pricing, traveling salesman, tulip mania

See also Alcoholics Anonymous (AA) principles Self-sabotage Self-test, of readiness for trading Sellers expectations of and open interest of options Selling. See also specific trading vehicles based on fear emotional commitment in indicators for, see specific indicators by insiders not being able to sell Sell orders: Force Index indicator for and Stochastic signals SentimenTrader.com Shapiro, Roy “Shark bite” losses “Shopping for indicators” Short interest Short Percent of Float Short sellers, rallies/declines and Short selling: Force Index indicator for making money with Stochastic signals for stops with Triple Screen indicators for value zone in Shortsqueeze.com Short-term Force Index Short-term price cycles Short-term timeframe Short-term trading “Shoulders” Sibbet, James H. Signal(s). See also Indicators confidence in in market moves Signal line (MACD) crossover of MACD line and difference between MACD line and and MACD-Histogram Simple moving averages 6% Rule and concept of available risk as guideline for pyramiding 65-day New High–New Low Index Size of trades Iron Triangle of risk control for risk associated with 2% Rule for Skills, learning Slater, Tim “Slicing the bid-ask spread” technique Slippage and open interest overnight gaps in quiet markets Slow Stochastic Small traders CFDs for COT reports of options Smoothed Directional Lines (+DI13, −DI13) Social psychology Stock Market Barometer, The (William Hamilton) Soft stops Soros, George Source of money, in markets S&P 500 index applying OBV to and beta in scanning for trades Specialist Short Sale Ratio Speculative trading, in currencies Speculators farmers and engineers as institutional investors as position limits of Spikes Spike bounce signal Spikers SpikeTrade.com Spreads: bid-ask with CFDs with forex trades “slicing the bid-ask spread” technique futures Spreadsheet, for pre-open routine Spread trading Standard deviation channels (Bollinger bands) Steidlmayer, J.

 

pages: 388 words: 125,472

The Establishment: And How They Get Away With It by Owen Jones

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anti-communist, Asian financial crisis, bank run, battle of ideas, Big bang: deregulation of the City of London, bonus culture, Bretton Woods, British Empire, call centre, capital controls, Capital in the Twenty-First Century by Thomas Piketty, centre right, citizen journalism, collapse of Lehman Brothers, collective bargaining, don't be evil, Edward Snowden, Etonian, eurozone crisis, falling living standards, Francis Fukuyama: the end of history, full employment, glass ceiling, hiring and firing, housing crisis, inflation targeting, investor state dispute settlement, James Dyson, laissez-faire capitalism, market fundamentalism, Monroe Doctrine, Mont Pelerin Society, moral hazard, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, open borders, Plutocrats, plutocrats, profit motive, quantitative easing, race to the bottom, rent control, road to serfdom, Ronald Reagan, shareholder value, short selling, sovereign wealth fund, stakhanovite, statistical model, The Wealth of Nations by Adam Smith, transfer pricing, union organizing, unpaid internship, Washington Consensus, Winter of Discontent

This was put into very sharp relief at the end of 2011, when David Cameron vetoed an EU treaty dealing with the crisis in the Eurozone. He was lauded by his party and much of the mainstream media for displaying a ‘bulldog spirit’. This ‘bulldog spirit’, however, was summoned to defend the interests of the City; these interests were conflated with those of the nation as a whole. The EU’s proposals had included reforming the damaging behaviour of hedge funds such as short-selling, as well as introducing a financial transactions tax, which did not just raise revenue but also promoted economic stability. Similarly the Chancellor, George Osborne, took legal action against the European Union to prevent a cap being imposed on bankers’ bonuses. Patriotism was used to rally support behind the interests of the wealthy and powerful. These battles were fought because the government feared aspects of the EU represented a threat to Establishment mantras and practices.

 

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, new economy, oil shock, passive investing, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

New York Stock Exchange officials decided to keep the U.S. exchange open but also braced for panic selling. The suspension of gold payments by Britain, the second-greatest industrial power, raised fears that other industrial countries might be forced to abandon gold. Central bankers called the suspension “a world financial crisis of unprecedented dimensions.”3 For the first time ever, the New York Exchange banned short selling in an effort to shore up stock share prices. But much to New York’s surprise, stocks rallied sharply after a short sinking spell, and many issues ended the day higher. Clearly, British suspension was not seen as negative for American equities. Nor was this “unprecedented financial crisis” a problem for the British stock market. When England reopened the exchange on September 23, prices soared.

 

pages: 432 words: 127,985

The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry by William K. Black

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accounting loophole / creative accounting, affirmative action, Andrei Shleifer, business climate, cognitive dissonance, corporate governance, Donald Trump, fear of failure, financial deregulation, friendly fire, George Akerlof, hiring and firing, margin call, market bubble, moral hazard, offshore financial centre, Ponzi scheme, race to the bottom, Ronald Reagan, short selling, The Market for Lemons, transaction costs

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