82,503
edits
Tail event: Difference between revisions
no edit summary
Amwelladmin (talk | contribs) No edit summary |
Amwelladmin (talk | contribs) No edit summary |
||
| Line 54: | Line 54: | ||
:—Monty Python’s ''Life of Brian''}} | :—Monty Python’s ''Life of Brian''}} | ||
Our agency and our idiosyncrasies average out. We all want to eat, be warm and dry and have rewarding careers. That we all | Our agency and our idiosyncrasies average out. We all want to eat, be warm and dry and have rewarding careers. That we all go about this in subtly different ways doesn’t, to a data aggregator, much matter. ''Until it does''. | ||
For there is a ''third'' order of dissimilarities. In times of stress | For there is a ''third'' order of dissimilarities. In times of market stress, other people’s behaviour ''directly'' and ''directionally'' affects you and your transactions, and your behaviour affects theirs. This is not the ''irrationality'' of panic — if each decision were irrational, the effect would be random and the [[Brownian motion|Brownian]] cancellation effect would come into play and everything would be fine — but an instinctive ''imitation'' of whatever it is the surrounding community is doing. THOSE GUYS ARE RUNNING AWAY. I DO NOT KNOW WHY BUT I MUST PRESUME THEY HAVE A REASON. THEREFORE I AM RUNNING AWAY. | ||
This is “memesis”. Most of the time, thanks to the Dunning-Krueger-by-proxy<ref>I just made this up but it seems, for reasons I cannot now articulate, like a good and possibly profound idea. Possibly that reason is that I suffer from Dunning-Krueger-by-Proxy Syndrome</ref> effect or otherwise, we presume the perspective we can bring to the information we have gives us an edge over the crowd, and we are happy to make our own decisions, whose individual variances boil off into Brownian randomness that can be neatly fitted to a standard deviation from the mean. | |||
But there are moments — by nature unexpected — when that confidence vanishes. Suddenly our conscious models, theories and [[nomological machine]]s are less valuable than the tacit information we gather from the changed behaviour of everyone around us. ''There is something important we don’t know''. It is better to mimic the behaviour of those around us. We presume they know — or that they are imitating the behaviour of someone else who knows. | But there are moments — by nature unexpected — when that confidence vanishes. Suddenly our conscious models, theories and [[nomological machine]]s are less valuable than the tacit information we gather from the changed behaviour of everyone around us. ''There is something important we don’t know''. It is better to mimic the behaviour of those around us. We presume they know — or that they are imitating the behaviour of someone else who knows. | ||
| Line 65: | Line 67: | ||
We may be mesmerised but we are not surprised to see starlings perform their aerial magic. We would be go smacked if a cup of tea did this. | We may be mesmerised but we are not surprised to see starlings perform their aerial magic. We would be go smacked if a cup of tea did this. | ||
When the planet has suddenly gone into total lockdown as a result of an unexpected global pandemic, buying habits for toilet paper and, oddly, lentils, suddenly ''change''. The fact that there is only three tins of lentils left on the shelf leads you to grab them. The fact that there are none leads to a nation wide run on tinned pulses people | When the planet has suddenly gone into total lockdown as a result of an unexpected global pandemic, buying habits for toilet paper and, oddly, lentils, suddenly ''change''. The fact that there is only three tins of lentils left on the shelf leads you to grab them. The fact that there are none leads to a nation wide run on tinned pulses people don’t, in normal times, much like. | ||
This is not just the crowded theatre phenomenon, when everyone stampedes for the exits at once, and the narrow aperture makes the stampede all the more urgent, and therefore dramatic — but second order features. An investor long “on margin” might wish to, and be able to, ride out a short term crash by meeting margin calls. In most dislocations this is the obvious and — if you can manage it, correct — thing to do. The market usually recovers, at least in the short term. But meeting your margin call means drawing on your revolving credit facility and your bank is experiencing a liquidity crisis and unexpectedly pulls you lines, or suspends withdrawals, as a result of its ''own'' market exposure to the crash. Your prime broker, usually patient with you and tolerant of peripheral looseness in your margin operations, is also under pressure, has told you today there is no flex, and for good measure, it is jacking up your IM. | This is not just the crowded theatre phenomenon, when everyone stampedes for the exits at once, and the narrow aperture makes the stampede all the more urgent, and therefore dramatic — but second order features. An investor long “on margin” might wish to, and be able to, ride out a short term crash by meeting margin calls. In most dislocations this is the obvious and — if you can manage it, correct — thing to do. The market usually recovers, at least in the short term. But meeting your margin call means drawing on your revolving credit facility and your bank is experiencing a liquidity crisis and unexpectedly pulls you lines, or suspends withdrawals, as a result of its ''own'' market exposure to the crash. Your prime broker, usually patient with you and tolerant of peripheral looseness in your margin operations, is also under pressure, has told you today there is no flex, and for good measure, it is jacking up your IM. | ||
| Line 88: | Line 90: | ||
====Derivatives trading==== | ====Derivatives trading==== | ||
In the context of trading derivatives, things that (a) you | In the context of trading derivatives, things that (a) you didn’t reasonably expect and that . (b) bugger up your contract. | ||
=====Credit defaults===== | =====Credit defaults===== | ||
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”. | 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”. | ||
| Line 102: | Line 104: | ||
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, | 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, | ||
The remaining events are sketchy and unpopular, depending as they do on private information you most likely | 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. | ||
=====Externalities===== | =====Externalities===== | ||
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. | 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. | ||
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 | 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.” | ||
Customers have less incentive to break trades if it means realising | Customers have less incentive to break trades if it means realising | ||