bbmac
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I've just read the book 'When Genius Failed' the account by Roger lowenstein on the Rise and fall of Long Term Capital Management. (LCTM.)
It is of course the account of how the principles of the fund both miscalculated the volatility of their traded instruments in determining risk and therefore leverage, and also how, to some extent, they moved outside their own fields of expertise (bond arbitrage) seeking out fresh markets,in an attempt to hedge further through diversification, not realising that they were in fact placing the same bet over and over again. Undone by the liquidity squeeze that followed the Asian crisis of the mid 90's followed by Russias' debt default, It succumbed to the fatal temptation ...to put it's money somewhere regardless.
As the author puts it;
'...LTCM put supreme trust in diversification-one of the key shiboleths of modern investing, but an overrated one. As keynes noted, one bet soundly considered is preferable to many poorly undertood. The same economist also noted that 'markets can remain irrational longer than you can remain solvent.'
The author goes on to conclude;
'...LTCM fooled itself into thinking it had diversified in substance when in fact it had done so only in form.' and that '..it was inexperienced and highly leveraged...a lethal combination.'
The fund was of course rescued then effectively liquidated by a consortium of 14banks at the instigation of the Fed, (lest it's collapse have wider ramifications on the financial system.) These banks themselves being huge creditors of the fund, and as the author noted '..Though it is seldom realised, a creditor is also beholden to the debtor.'
He goes on; '...They had programmed the market for a cold predictability that it had never had; they had forgotten the predatory acquisitive and overwhelmingly protective instincts that govern real-life traders. They had forgotten that you cannot programme the human factor'
This crisis resonates somewhat in the Northern Rock crisis, both caused by a flight from risk and a liquidity squeeze...... Just because you can measure volatility doesn't mean you can predict it.
This fund was composed of nobel winning economists, and the stars of Wall Street, and some of the brightest sparks in academe, yet it was the most spectacular collapse...and this gives rise to my question
1. Can you be too clever for your own good?
It is of course the account of how the principles of the fund both miscalculated the volatility of their traded instruments in determining risk and therefore leverage, and also how, to some extent, they moved outside their own fields of expertise (bond arbitrage) seeking out fresh markets,in an attempt to hedge further through diversification, not realising that they were in fact placing the same bet over and over again. Undone by the liquidity squeeze that followed the Asian crisis of the mid 90's followed by Russias' debt default, It succumbed to the fatal temptation ...to put it's money somewhere regardless.
As the author puts it;
'...LTCM put supreme trust in diversification-one of the key shiboleths of modern investing, but an overrated one. As keynes noted, one bet soundly considered is preferable to many poorly undertood. The same economist also noted that 'markets can remain irrational longer than you can remain solvent.'
The author goes on to conclude;
'...LTCM fooled itself into thinking it had diversified in substance when in fact it had done so only in form.' and that '..it was inexperienced and highly leveraged...a lethal combination.'
The fund was of course rescued then effectively liquidated by a consortium of 14banks at the instigation of the Fed, (lest it's collapse have wider ramifications on the financial system.) These banks themselves being huge creditors of the fund, and as the author noted '..Though it is seldom realised, a creditor is also beholden to the debtor.'
He goes on; '...They had programmed the market for a cold predictability that it had never had; they had forgotten the predatory acquisitive and overwhelmingly protective instincts that govern real-life traders. They had forgotten that you cannot programme the human factor'
This crisis resonates somewhat in the Northern Rock crisis, both caused by a flight from risk and a liquidity squeeze...... Just because you can measure volatility doesn't mean you can predict it.
This fund was composed of nobel winning economists, and the stars of Wall Street, and some of the brightest sparks in academe, yet it was the most spectacular collapse...and this gives rise to my question
1. Can you be too clever for your own good?
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