Quotes Of The Day: Hedge Fund Interview
Jan 24, 2008 12:10

There is a great interview with an anonymous Hedge Fund manager in n+1 magazine. The interviewee is obviously a really smart person, and explains some of what just went on in the subprime commercial paper bubble and meltdown of the last while. There are a lot of great quotes here.


The problem is that the DNA of a lot of these [computerized statistical arbitrage] models is very, very similar, it’s like an ecosystem with no biodiversity because most of the people who do stat-arb can trace their lineage, their intellectual lineage, back to four or five guys who really started the whole black box trading discipline in the ’70s and ’80s. And what happened is, in August, a few of these funds that have big black box trading books suffered losses in other businesses and they decided to reduce risk, so they basically dialed down the black box system. So the black box system started unwinding its positions, and every black box is so similar that everybody was kind of long the same stocks and short the same stocks. So when one fund starts selling off its longs and buying back its shorts, that causes losses for the next black box and the people who run that black box say, “Oh gosh! I’m losing a lot more money than I thought I could. My risk model is no longer relevant; let me turn down my black box.” And basically what you had was an avalanche where everybody’s black box is being shut off, causing incredibly bizarre behavior in the market.

Takeaway: A lack of diversity can compound problems. Also, be careful when trusting automated systems - their efficiency and power means they can get into trouble very quickly.

But we had a loss over the course of like three days that was like a ten-sigma event, meaning, you know, it should never happen based on the statistical models that underlie it. Why? Because the model doesn’t assume that everybody else is trading the same model as you are. So that’s sort of like a meta-model factor. The model doesn’t know that there are other black boxes out there.

Takeaway: The ridiculously unlikely may be more likely than you think. Especially when automated systems are involved.

The interview also explained what was at the heart of the problem: heavy demand for rated paper:


So what happened is this machine—let’s call it, it’s a big machine that wanted to gobble up, you know, rated paper—needed to be fed. So there were people who could make a lot of money feeding the machine, and they were like, you know, “We need to keep originating mortgages, and feeding them to the machine,” and if you have a robot bid, you tend to get a bubble. Someone is hungry for paper, paper will be created. And that’s almost never a good thing that lending decisions are being driven by the fact that many, many steps down the chain there’s just someone who wants to buy paper.

Takeaway: When there's heavy demand for something, supply will somehow - anyhow - be created to match the demand - but the heavier the demand, the more suspicious you should be about the supply.

[H]ere was a guy who knows the market really, really well, who is a real expert in the nuts and bolts of mortgage lending, and really knew the collateral really well—but he was a true believer ... And there were other people at the firm, say, at the middle of last year, who were not mortgage experts, who were saying, you know, “I see the run-up in housing prices in some of these geographies, and I just don’t really get it. I go down to Florida and see the forest of cranes, and I just really wonder, who’s going to be in all those apartments? ... and I see these commercials on TV, you know, about low-doc, no-doc mortgages—and there is no way, there is no way that this is not going to end badly. And I see that these mortgages are being created by this massive demand for CDO paper, by this robotic bid, and this is the perfect example of a bubble—and we should be short, we should be short sub-prime paper." ... But he’s the expert, right? It’s a tough thing. If you have somebody who’s really trained in the mortgage business, he’s been in the mortgage business for fifteen years, in equilibrium he’ll do a great job. ... But in terms of detecting the paradigm shift, the guy who’s just buried in the forest... he’s not going to see the big picture, he’s not going to catch the paradigm shift.

Takeaway: The value of being an expert relates inversely to how much things change. In areas like technology and finance, where the game is changing all the time, expertise can actually be a liability.

Previous:
TSOT Ruby / Rails Presentation Night - Part 1
Jan 20, 2008 16:03
Next:
Starting Up: The Logo
Jan 31, 2008 12:40
Other Blog Posts
This Is Nowhere: Bloomsday Halifax This Is Nowhere: Why an HTML/JavaScript Single-Page App With GPS Is A Bad Idea This Is Nowhere: GPS and Wayfinding and More UX This Is Nowhere: The Single-Button UX This Is Nowhere: Don’t Just Stand There! This Is Nowhere: Finding My Duck Finding Burgers Fast: My DIY Halifax Burger Week Site "This is Nowhere" at PodCamp Halifax 2018 The Diary Diaries: Fixing Remembary's Facebook Connection Special Leap Day Edition of "Some Weird Things About Time" What's Up With Remembary Can't get pg_dump To Work Now That Heroku Has Upgraded Postgresql to 9.4? The Best Thing I Ever Did To Promote My App If You Build It, They WON'T Come #deployaday, My Big Hairy Plan for 2015 Extracting Plain Text from an NSAttributedString My Year of "Hits" Part 2: Remembary Rolling My Year of "Hits" Part 1: Remembary Rises (and Stumbles) Handy Little Test Method to Check for Translations in Rails Apps My Suddenly Slow-Waking MacBook Air Indie App PR: Keeping Control of Your Tone A Quick Note on 'clone' in Rails 3.2 My eBook Apps 2: iOS, JavaScript, and Ruby My eBook Apps 1: Introduction Quick Tip: No Sound on Mountain Lion My Upcoming Talk at PodcampHFX 2012: My Year of "Hits" starshipsstarthere.ca: Building at the Speed of Funny Screencast Tips Remembary's Cool New Picture Support Indie App PR 2: Keeping On Top Of User Feedback Indie App PR 1: How to Handle an App Disaster Giles Bowkett Diary Project 2 Remembary Video Congratulations! Welcome to Your Nightmare! How My iPad App Remembary Took Off Why You Should Have an App in the App Store (Even If You Probably Won't Make Any Money) PodCampHFX Remembary Presentation - Part 3 How I Used MailChimp Autoresponders to Promote Remembary PodCampHFX Remembary Presentation Part 2 PodCampHFX Remembary Presentation Part 1 Why AdWords Ads Don't Work for iPad Apps Remembary is Sponsoring PodcampHFX Why Can't I Resize my Views in Interface Builder? Momento and Remembary Concerning Remembary iPad-Friendly eBooks of Gracian's Art of Worldly Wisdom Project Report: PTOS2 A Quick Note on Encryption We're all LUsers Thoughts on HAML Friday Afternoon Hack - Getting Beyond the Basics Halifax Friday Hack and Back to Basics Quote from Wil Shipley FutureRuby Make Web Not War Busy Week I: Toronto Ruby Job Fair Employment.nil - the Toronto Ruby Job Fair Code Count: Ruby on Rails vs. C#/ASP.NET A Brief Note on Twitter The Hub Halifax and Mobile Tech for Social Change Deep Thoughts on Microsoft From The Accordion Guy The Two Kinds of Defensive Programming Presentation - Fixing Careerious: From C#/.NET to Ruby on Rails Enterprise! Presenting at Ruby on Rails Project Night - May 7th New Name and New Look for Careerious/Clearfit FutureRuby and More From Unspace Health Tips for Programmers This tables meme won't die Careerious - Ruby and Rails vs. C#/.NET Yeah I Use Tables For Layout, So Sue Me The Different Kinds of Done Giles Bowkett's RubyFringe presentation OfficeTime: Great Time-Tracking App for OS X Back With A New Look Non-DRY Feed torontorb Keeping Your Sanity With The Command Design Pattern shindigital Is All Grown Up! (according to the spambots) Startup Stars? I'm so bored! The Magic Words for RMagick Jennifer from Operations You see? Naming is HARD Business Software as Process Documentation Deployment note: 'execve failed' Steve Jobs on Market Research Why Canada Is Better for Entrepreneurs "Program first and blog second" Toronto Tech Collage The MacBook Air Is A Roadster RubyFringe! Quote of the Week: Steve Yegge Starting Up: Cards Great design tool: browsershots.org Starting Up: The Logo Quotes Of The Day: Hedge Fund Interview TSOT Ruby / Rails Presentation Night - Part 1 Moneyworks: Accounting Software for Canadians on OS X Starting Up: The Name Nice logo, but why is your site so bland? Welcome to shindigital.com