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Now we find the model we were using has stopped being largely right, or broadly right, or even vaguely right. It is flat out wrong. | Now we find the model we were using has stopped being largely right, or broadly right, or even vaguely right. It is flat out wrong. | ||
You will find at this stage limited tolerance for blaming a model. If you say things like {{ | You will find at this stage limited tolerance for blaming a model. If you say things like, {{Viniarquote}}. This is not a good look for the CFO of a bulge bracket [[Vampire Squid]]. | ||
Using normal distributions as a heuristic to model interdependent events is generally effective if a few conditions pertain. | |||
{{L1}}The market is generally diversified. If you carve out all the personal idiosyncrasies — stochastic modelling requires — that might explain why one rational person is prepared to sell what another is prepared to buy, it stands to reason that a buyer’s gain is a seller’s loss. In a diversified market, a sudden collapse in value for some traders means an appreciation for others, and all kinds of other effects. Like the Brownian motion in a cup of tea: not only is a spontaneous lurch of all participants on one direction at once unlikely, it is impossible. The Brownian collision that sends one molecule to the left must send another to the right. For every molecule to go left at once defies the laws of physics. Physics requires interacting independently particles to move in offsetting directions. Hence the [[emergent]] stability of a a stationary cup of tea. A <li> | |||
No individual participant, or group of participants with correlated interests dominate the market <li> | |||
Information about the market, and any “crowded” positions in the market, is widely held. Of course individual positions are private, proprietary and confidential, so this last condition is usually satisfied by the general assumption of liquidity: in a sufficiently deep market, no-one is big enough to have such a concentrated position, so we can take it as a given that no-one does. (In some markets there are materiality thresholds over which positions must be reported too.)</ol> | |||
But in the modern market, where scale and leverage are so important, these are not always safe assumptions. Lenders only know what they know. | |||
====Derivatives trading==== | ====Derivatives trading==== | ||