Archivo del March, 2013

Beware of 27-year olds selling protection

Finance Lab students who have been to my lectures on tail risk, VaR, selling optionality, etc would appreciate the following recent comments by a leading US hedge fund manager making a bet on Japan getting in trouble:

“I have 27-year-old kids selling me one-year jump risk on Japan for less than 1bp – US$5bn at a time. You know why? Because it’s outside of a 95% VaR, it’s less than one year to maturity, so guess what the regulatory capital hit is for the bank? I’ll give you a clue – it rhymes with hero”

Of course, the 2007-08 crisis happened for similar reasons (substitute “Japan” with “Subprime bonds”). The risk was also considered impossible to materialize, the capital charge was also zeroish, the VaR was also negligible. It looked like free money. It looks like free money again. Like infinite ROE for the banks selling the protection.

Current 27-year olds saw/have heard about how their predecessors made a killing killing their employers through the unfettered sale of “no problem” tail risk. They know about Fabulous Fab. Why, they ask, should they show restraint now that it´s their chance to make dough by employing the simplest trick in the financial book, namely selling “unlikely” risk in massive amounts. A one-eyed monkey can sell “long odds” options and credit swaps. It doesn´t take much ingenuity or smartness. All it takes is a willing employer with the cah to hire some Russian Physics PhDs willing to declare that the premium collected upfront is free money with 99,999999% probability.

Of course, the key is to find someone eager to buy that optionality and protection. The best way to do that is to sell it very cheaply. And the best way to justify that is to have Boris and Nikolai build a computer model that yields a zero VaR.

And now you know why banks hire folks like Boris and Nikolai.


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Finance Edu at ESADE

Without a doubt, finance education has gone through a radical global revolution in the past twenty years. Perhaps the most profound revolution in the academic sphere ever. Tons of new programs in quantitative finance (first) and general finance (later) began to be offered by some of the world´s very best universities and b-schools. Today a good yardstick of innovation is whether a school has chosen to launch a finance degree. While the vast majority of US schools have yet to do so, things (as I humbly predicted many years ago) are changing even at the very top. Those institutions with a more rigid structure have been missing out, depriving their students with direct and easy access to some of the most exciting and remunerative jobs out there. Those visionary pioneers who in constrast chose to innovate are now global leaders in a key field, reaping substantial rewards in reputational and monetary terms.

How about ESADE? Well, we are doing quite fine, thanks very much. ESADE is one of the few schools to offer an MSc in Finance + an MBA Finance Lab + an EMBA with very substantial financial component. Most of the other schools don´t offer an MSc, have plain uber generalist MBAs, and even plainer EMBAs. If finance is important, then ESADE is on the right path.

Now, all we need to do is tell the world with a loud voice.

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