conraddobler
I want my 2$
- Joined
- Sep 1, 2002
- Posts
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I know everyone's first thought about Japan is one of sympathy for the people there and mine is too, however as this third disaster at the plant unfolds it's likely IMO to put immense stress on the systems of the market.
Whenever you have a localized crash like this in Japan, chances are some portion of that market is used somewhere else as a hedge for our markets.
It's very complicated to explain but these geniuses at hedge funds constantly do what's called arbitrage, that is exploit tiny mathematically signifigant differences to make money.
This works reasonably well most of the time in normal markets but as markets do something odd like move great distances in one or two days, this skews the math that makes these arbitrage systems work.
You might for instance have some play on where you go long one currency and short the Yen or vice versa.
Your model may be based on decades of data, but just like the odds of a eartquake, Tsunami, then nuclear emergency all comming together at the same time are insanely low, the odds that the market could move X much in any given few days is also insanely low.
However in times like these markets move much faster and farther than anyone could ever imagine, this wipes people out and in turn those people may have been part of anothers position, ie I'm bankrupt and I owe you a pile of money so you're bankrupt and you owe another set of people a pile of money so they're bankrupt etc.
That's bad enough but it gets worse, I was say leveraged 10 times up, so for every real dollar I have invested, I borrowed 10 more and invested that, if something moves 20 percent against me I was bankrupt after the first 10 percent but now the guy I owe money to is also bankrupt.
When you add that phenom to something like this blowing out spreads on debt for a soverign nation, like the CDS numbers on Japan's debt, something no one could anticipate then someone using those CDS as part of an arbitrage could find that a weird one place move that is now NOT correlated like their model said it would to X move over here, then real risk is exposed and introduced to that person they did not factor in.
A good example would be say you model that if the Dollar strenghtens and you are short dollars, which would normally cause you losses, you can say also short Yen because you notice they correlate inversely nicely for a good time and when one goes up the other goes down so you are hedged and now you're just playing the small spaces inbetween and picking off minor idfferences using large amounts of leverage to amplify returns, this is all perfectly safe as the correlations hold.
But what happens if because of an outlier event like this the normal correlation turns backwards?
What if the dollar strenghtens at the SAME TIME the YEN strenghtens due to massive liquidity calls because of a carry trade unwind in the face of a massive stock market move and massive calls for liquidity due to funds needed in Japan?
Well then you are toast and you weren't looking like you had any risk at all.
The primary concern right now is for the people of Japan, but if this continues to get worse don't be surprised to see some fireworks on the global markets.
It's not the moves so much as the shattering of correlations a bizzare one time event can inadvertently cause that does all the damage.
Then you're getting destroyed.
It could also happen because the BOJ massively overshoots and destroys the YEN trying to avert this, the point is the amounts of stress this can apply to global markets are IMO unknowable in extent becasue of the complexity but IMO the dangers to the computer trading models are real.
The global markets are traded in the majority by machines, they don't panic, they just relentlessly reposition themselves and if they are not turned off the relentless nature of the order stream they can produce becomes a veritable deluge of orders on the wrong side of the trade.
There is a point of stress IMO in the global markets that can cause a positive feedback loop without escape.
Whenever you have a localized crash like this in Japan, chances are some portion of that market is used somewhere else as a hedge for our markets.
It's very complicated to explain but these geniuses at hedge funds constantly do what's called arbitrage, that is exploit tiny mathematically signifigant differences to make money.
This works reasonably well most of the time in normal markets but as markets do something odd like move great distances in one or two days, this skews the math that makes these arbitrage systems work.
You might for instance have some play on where you go long one currency and short the Yen or vice versa.
Your model may be based on decades of data, but just like the odds of a eartquake, Tsunami, then nuclear emergency all comming together at the same time are insanely low, the odds that the market could move X much in any given few days is also insanely low.
However in times like these markets move much faster and farther than anyone could ever imagine, this wipes people out and in turn those people may have been part of anothers position, ie I'm bankrupt and I owe you a pile of money so you're bankrupt and you owe another set of people a pile of money so they're bankrupt etc.
That's bad enough but it gets worse, I was say leveraged 10 times up, so for every real dollar I have invested, I borrowed 10 more and invested that, if something moves 20 percent against me I was bankrupt after the first 10 percent but now the guy I owe money to is also bankrupt.
When you add that phenom to something like this blowing out spreads on debt for a soverign nation, like the CDS numbers on Japan's debt, something no one could anticipate then someone using those CDS as part of an arbitrage could find that a weird one place move that is now NOT correlated like their model said it would to X move over here, then real risk is exposed and introduced to that person they did not factor in.
A good example would be say you model that if the Dollar strenghtens and you are short dollars, which would normally cause you losses, you can say also short Yen because you notice they correlate inversely nicely for a good time and when one goes up the other goes down so you are hedged and now you're just playing the small spaces inbetween and picking off minor idfferences using large amounts of leverage to amplify returns, this is all perfectly safe as the correlations hold.
But what happens if because of an outlier event like this the normal correlation turns backwards?
What if the dollar strenghtens at the SAME TIME the YEN strenghtens due to massive liquidity calls because of a carry trade unwind in the face of a massive stock market move and massive calls for liquidity due to funds needed in Japan?
Well then you are toast and you weren't looking like you had any risk at all.
The primary concern right now is for the people of Japan, but if this continues to get worse don't be surprised to see some fireworks on the global markets.
It's not the moves so much as the shattering of correlations a bizzare one time event can inadvertently cause that does all the damage.
Then you're getting destroyed.
It could also happen because the BOJ massively overshoots and destroys the YEN trying to avert this, the point is the amounts of stress this can apply to global markets are IMO unknowable in extent becasue of the complexity but IMO the dangers to the computer trading models are real.
The global markets are traded in the majority by machines, they don't panic, they just relentlessly reposition themselves and if they are not turned off the relentless nature of the order stream they can produce becomes a veritable deluge of orders on the wrong side of the trade.
There is a point of stress IMO in the global markets that can cause a positive feedback loop without escape.
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