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| {{freeessay|isda|tail events|}}{{d|Tail event||n|}} | | {{freeessay|isda|tail events|{{image|Tail event|jpg|}}}} |
| {{L1}}'''Statistics''': Of a range of possible independent events, one whose frequency is three or more [[Normal distribution|standard deviation]]s from the mean. An event with a low [[probability]]. <li>
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| '''Work life''': An unwanted outcome you didn’t expect, to which you weren’t paying attention, and, therefore, for which you don’t think you should be blamed.
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| </Ol>
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| Now here is the thing. When we calculate probabilities — when we roll dice — we are in situations of known risk. That average means something. It is not just that on some some dice the probability is more like ⅐, on others now like ⅕, but on average the dice work out at all about ⅙. It must be true of every individual die..
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| Rolling dice to ''determine'' an outcome is is quite
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| different. We do not build a statistical model that predicts a ⅙ probability: we build the dice to yield the that outcome. The dice are what [[Nancy Cartwright]] calls a “[[nomological machine]]”: a carefully designed, constrained, hermetically-sealed device, designed to generate a specific theoretical outcome. If over time the dice don’t yield a ⅙ outcome we don't chuck out our statistical model: we chuck out the ''dice''.
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| The “map” and territory ” are transposed: the dice are the map, the theoretical ⅙ probability is the territory. The map is, as far as engineering permits, ''identical'' to the territory. We could, indeed, generate the outcome we wanted without dice, by running the model with a random number generator.
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| The machined dice, the flat, constrained surface — these are a representation of the reality, which is the hypothetical model, and not the other way around. A loaded die is a ''flawed'' machine. You don't chuck out the theory: you chuck out the equipment.
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| Likewise, if, inside your nomological machine there is a mischievous imp who catches and places the die as it sees fit, the conditions for your probabilistic calculation do not prevail. There is an interfering causal agent.
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| “Nomological machines” are highly constrained, artificial environments. If all their conditions are not satisfied, we can expect the world to behave differently without validating the machine. This is how, as [[Nancy Cartwright]] put it “the laws of physics lie”.
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| In any case, these are the circumstances in which the rules of probability prevail. Should the universe “misbehave” then the conditions required for the nomological machine cannot be present.
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| Boy did I get sidetracked.
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| Normal distributions standard deviations, and confident probabilities require a complete nomological machine where all potential events are known, are independent, and there is no intervening agency that can upset the observed behaviour of the system. If you have all that all risks can be calculated and probabilities assigned.
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| Markets, in the abstract, look just like such a machine. There is a bounded environment, a finite trading day and a limited number of market participants and financial instruments which one can buy or sell. In the modern days of computerised trading everything is very clean, tidy observable, unitary and discrete.
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| ====Derivatives trading====
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| In the context of trading derivatives, things that (a) you didn't reasonably expect and that . (b) bugger up your contract.
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| =====Credit defaults=====
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| A swap being a private, bilateral affair, the most obvious category of tail events is “things which mean your counterparty cannot, or will not, or has not, performed its end of the deal”.
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| Straight out refusal to — repudiation — is rare, at least without the cloak of some kind of dispute as to whether the party was under such an obligation in the first place.
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| Inability is the main player here: generally captured by insolvency, and correlative defaults under other agreements.
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| Much of financial services being a play on [[leverage]] — the name of the game being to earn more, with other people’s money, than it costs you to borrow it — many market participants flirt with various formulations of [[insolvency]] as a basic business model, so there tend to be some pushback on the parameters of these correlative failures and “ostensible inabilities” to perform. Much of a [[negotiator]]’s life is spent haggling about them.
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| Where refusal or inability to perform cannot be proven, actual failure to pay or deliver ends all arguments. If you ''actually'' haven’t performed, it no longer matters ''why''.
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| There is therefore a sort of hierarchy of these events. Actual default is the safest, and most common, default trigger. Bankruptcy is the next — though there is more looseness around some of its limbs, an administrator actually being appointed, or a petition actually being filmed is clean, public and unlikely to prompt many arguments. Default Under Specified Transaction — that transaction being one to which you are directly a party,
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| The remaining events are sketchy and unpopular, depending as they do on private information you most likely won't have about thresholds you can't easily calculate. We may argue till we are hoarse about Cross Default. We will not invoke it.
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| =====Externalities=====
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| There are a category of events which make it impossible even for a solvent counterparty to perform. Change in law, for example — it is not beyond possibility that certain kinds of swaps might be restricted or outlawed altogether<ref>Not long ago the European Union proposed restricting the carbon market to “end users” to discourage financial speculation, for example. This would have rendered certain forward contracts in {{euaprov|Allowances}} involving delivery to non-users illegal.</ref> or Tax events that make the transaction uneconomic as originally envisaged.
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| Secondary events of this kind — things that limit a dealer’s ability to hedge, or materially increase its costs of doing so, tend not to be Termination Events partly this reflects a fact not often stated, but nonetheless true: there is a price at which the parties will agree to terminate any swap. Just because a party doesn't have an economic option to terminate the trade doesn't mean it can't terminate the trade. It always has an “at market” option. In liquid markets during times of fair weather this is a source of great comfort; in illiquid markets and at times of stress, less so. A dealer will say, “I will always show you a price. You just might not mind the price, is all.”
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| Customers have less incentive to break trades if it means realising
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| {{sa}}
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| *[[The map and the territory]]
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