|Myths and legends of the market|
The JC’s guide to the foundational mythology of the markets.™
Credibility derivatives were once the principal means of hedging tail risk in fashion industry. They grew out of the popular pastime of taste arbitrage, a much simpler, physically-settled, contract on the spot hip market.
History has it that Hunter Barkley, an enterprising hipness analyst on the taste arbitrage desk at Wickliffe Hampton stumbled upon the idea of credibility derivatives when shopping for records in Essex one Sunday in the 1980s.
He noticed that his local record store in Chingford, which carried Rick Astley’s turgid debut Whenever You Need Somebody at its full price, had sold out of it, while fully fifteen copies of Keith Jarrett’s seminal, hard-to-find and unstintingly cool The Köln Concert lingered disregarded in a sale bin for a pound fifty each.
Not even realising what he was doing, this resourceful young fellow snapped up all fifteen copies of the jazz disc, on principle.
Later he happened by an avant-garde vinyl emporium in Soho and, remembering his earlier experience, popped in, just to compare prices. He was amazed to find a queue for The Köln Concert, advertised at £25.99, but only the single copy of Whenever You Need Somebody, in its own sale bin, for 50p. At that moment the shop announced that it had sold out of the Jarrett LP, provoking a commotion — feeble by ordinary standards but quite something in the place and time — amongst inconvenienced hipsters.
Nothing if not an opportunist, the analyst offloaded his inventory directly to disappointed jazz aficionados, for £40 a clip, and realised at once that he could earn a handsome risk-free yield, by setting up a term exchange between this emporium and SoundWavez Chingford — where Chingford supplied Jarrett and Soho supplied Astley. The Soho proprietor agreed and the first credibility swap transaction was executed.
Thus, also, was born on the first “credibility pair”. In an orderly and functioning market, “credibility pairs” are naturally negative preference-correlations, and such serve as a useful means for benchmarking internal plausibility curves to market. Notable exchange-traded credibility pairs include Keith Jarrett and Rick Astley (ticker: KJA:RAS); Billy Ray Cyrus and Radiohead (ticker: BRH:RHD), Toto and Grandmaster Flash (ticker: TOT:GMF) and, notoriously, Gary Glitter and Rolf Harris (ticker:GGL:ROL) — the last a long and apparently stable negative correlation which when it inverted unexpectedly in 2014 caused widespread poise dislocation.
Growth of market
Before long, credibility derivatives were big business in the clothing industry: a segment of the economy, of course, with significant exposure to sudden, arbitrary changes in the public’s opinion. At first record shops, and soon other sellers of goods largely dependent for their value on arbitrary public opinion, began methodically to hedge their risk to those changing tastes. A popular variation was the “credibility default swap” wherein a seller with significant exposure to inventory of questionable long-term hipness could but protection out to five years. Then, upon the occurrence of a publicly recognised “credibility event”, the proprietor (“Buyer”) could deliver that inventory to the “Seller” against payment of its notional hip value, struck as at the trade date of the contract.
Speculators in the City of London quickly saw the opportunity for levered plays on taste, and the synthetic credibility default swap market exploded. The spreads on credibility default swaps were huge and proved popular with real money managers looking to enhance yield.
But lurking below the surface was disaster in the form of fashion duration mismatch.
Desperate to find a fresh sources of loucheness to feed the demand flooding in from hedge funds and trading desks, fashion standards among originators taste products rapidly declined. Originators talk to layering credibility default risk upon credibility default. This, you would think, was a recipe for disaster, and so it turned out.
Great credibility crash of 1987
It all came to a juddering halt with the in acid-wash jeans crash of 1987. Unable to trade out of positions as the market turned, and unable to fund their obligations to term as liquidity drained from the commercial paper market, many storied couturiers found themselves having to close short enormous long positions. Those who could not care successful found themselves in receipt of container loads of unsellable white denim dungarees.
- Allegedly a requirement of the promoting record company to carry the number-one selling album of the time, which may explain why the boutique was having it at all: every man has his price.
- the yield curve briefly inverted in the summer of 1986 when Run DMC released their collaboration with Aerosmith, Walk This Way.