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Tail event (view source)

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But meeting the margin call means drawing on your standby [[revolving credit facility]] — you don’t keeps a yard of spare cash off the table for emergencies, right? — but it turns out your bank is, like everyone else, suffering a liquidity squeeze. It evokes some obscure market conditions [[CP]] buried in the docs and suspends drawdowns on the RCF as a result. This is nothing to do with you: the bank is managing its ''own'' cash position. It needs the money more than you.  
But meeting the margin call means drawing on your standby [[revolving credit facility]] — you don’t keeps a yard of spare cash off the table for emergencies, right? — but it turns out your bank is, like everyone else, suffering a liquidity squeeze. It evokes some obscure market conditions [[CP]] buried in the docs and suspends drawdowns on the RCF as a result. This is nothing to do with you: the bank is managing its ''own'' cash position. It needs the money more than you.  


At the same time your margin lenders — usually so patient with you, generally genial, good for a knees-up at Ascot and tolerant of peripheral looseness in your margin operations — have had a sense of humour failure. They are apologetic, but they are shipping a shower of grief from risk management and have been told to tell you that you today there is no flex, today the money must be there without fail —and for good measure they are jacking up your IM. You tell them this is absurd, that everything is fine, ''but today they don’t know what to believe''. Normal conditions of trust are suspended. This could be the final round. Anything they can’t see unaided with their own naked eyes could be fake news. The one thing they can see is that ''everyone else is running for the door''.
At the same time your margin lenders — usually so patient with you, generally genial, good for a knees-up at Ascot and tolerant of peripheral looseness in your margin operations — have had a sense of humour failure. They are apologetic, but they are shipping a shower of grief from the head of risk and have been told to tell you that you today there is no flex. Today the money must be there on time without fail — and for good measure they are jacking up your IM.  


The value of all that near-perfect market information evaporates and ''other'' information, which the market ''doesn’t'' have, but until now took for granted — such as the essential viability of systemically important financial institutions — is suddenly ''much'' more important. All at once, no-one fancies “taking a view” on ''anyone’s'' credit.
You say this is absurd, that everything is fine, but appeals to their better nature and your solid, five-year track record fall upon deaf ears. ''Today they don’t know what to believe''. Normal conditions of trust and amity are suspended. ''This could be the final round of the [[prisoner’s dilemma]]''.<ref>According to [[game theory]] it is rational to cooperate in non-zero sum games as long as you expected them to repeat. If you expect them not to repeat, it is rational to defect. This is the [[traitor’s dilemma]].</ref> Anything they can’t see unaided with their own naked eyes could be fake news. The one thing they can see is that ''everyone else is running for the door''.


Cash is King, Queen, Jack and Ace. There are people on the TV in sharp suits wandering dazedly around outside their buildings clutching [[Iron Mountain]] boxes.
The value of all that near-perfect market information evaporates and ''other'' information, which the market ''doesn’t'' have, but until now took for granted — such as the essential viability of systemically important financial institutions and the strength of the [[commercial imperative]] — is suddenly ''much'' more important. All at once, no-one fancies “taking a view” on ''anyone’s'' credit.
 
Cash is King, Queen, Jack and Ace. There are dazed people in sharp suits wandering around Canary Wharf clutching [[Iron Mountain]] boxes.


All indicators are going one way, across the board, in all markets and all asset classes.
All indicators are going one way, across the board, in all markets and all asset classes.


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 our model has stopped being largely right, or ''broadly'' right, or even ''vaguely'' right. It is flat-out ''wrong''.
 
=====Twenty-five sigma events=====
If a coin lands tails a hundred times in a row it is either a unique moment in the life of the cosmos or a dicky coin.


Advice. If you are the CFO of a bulge bracket [[Vampire Squid]] you will find there is limited tolerance for blaming your performance on a statistical model an absolutely none for blaming it on the essential misbehaviour of the universe, as if your model was right but the atoms and molecules were wrong. Do not say things like:  
If you are the CFO of a bulge bracket [[Vampire Squid]] you will earn limited sympathy if you blame your losses on a statistical model, but absolutely ''none'' if you blame it on the misbehaviour of the universe. Do not say things like:  


{{Viniarquote}}
{{Viniarquote}}


This was not a twenty six sigma event. ''Your model did not work''.
Twenty-five sigma events do not happen ''once'', let alone several days in a row. ''Your model did not work''.


This is a tail event. This is what all the meaningful terms in your legal agreements are designed to protect you against.
This is a tail event. This is what all the meaningful terms in your legal agreements are designed to protect you against.
{{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. See: [[Brownian motion]]<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====
In the context of trading derivatives, things that (a) you didn’t reasonably expect and that . (b) bugger up your contract.
=====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”.  


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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''.
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''.


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 — {{isdaprov|Failure to Pay or Deliver}} — is the safest, and most common, default trigger. {{Isdaprov|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.
 
Inasmuch as a {{isdaprov|Failure to Pay or Deliver}} arises because of a cashflow crisis — you don’t have available funds to meet your obligations — it likely counts as a “soft” {{isdaprov|Bankruptcy}} too: an “inability to pay debts as they fall due”. This shouldn’t usually matter but bear in mind it might trigger a carelessly articulated (1987-style) {{isdaprov|Automatic Early Termination}}. Also, if you have carefully provided for some disincentive to failure, such as a penal close-out methodology on {{isdaprov|Failure to Pay or Deliver}} (''why'' anyone would do this heaven only knows, but JC has seen it so let’s say) then if it is a bankruptcy (or even leads to one within a preference period you may find you have written a [[voidable preference]] into your swap,even if it isn’t an unenforceable penalty.
 
{{Isdaprov|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 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.
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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