Comments on: Financial Complexity http://www.airs.com/blog/archives/75 Ian Lance Taylor Tue, 18 Nov 2008 21:53:02 +0000 http://wordpress.org/?v=1.5.2 Comment on Financial Complexity by: Airs - Ian Lance Taylor » Financial Complexity 2 http://www.airs.com/blog/archives/75#comment-12325 Sat, 12 Apr 2008 01:31:43 +0000 http://www.airs.com/blog/archives/75#comment-12325 [...] Almost six months later, I’ll look back at my earlier post about financial complexity. Considering the continuing troubles of the financial markets, it seems clear that I underestimated the degree of the problem. But I think I was generally correct in pointing out that the complexity of modern markets helped hide the nature of the bets that institutions were making. Many institutions thought that they had only a controlled amount of exposure to the mortgage market, only to find out that they were wrong. They had lent money to other institutions, which had made derivative bets, which were founded on the mortgage market, and problems rebounded back to institutions which thought they were acting soundly. [...] […] Almost six months later, I’ll look back at my earlier post about financial complexity. Considering the continuing troubles of the financial markets, it seems clear that I underestimated the degree of the problem. But I think I was generally correct in pointing out that the complexity of modern markets helped hide the nature of the bets that institutions were making. Many institutions thought that they had only a controlled amount of exposure to the mortgage market, only to find out that they were wrong. They had lent money to other institutions, which had made derivative bets, which were founded on the mortgage market, and problems rebounded back to institutions which thought they were acting soundly. […]

]]> Comment on Financial Complexity by: Ian Lance Taylor http://www.airs.com/blog/archives/75#comment-5662 Mon, 22 Oct 2007 23:53:07 +0000 http://www.airs.com/blog/archives/75#comment-5662 I think you are generally right on the ability of banks to put a value on financial instruments. My concern is slightly different: are banks (and other large investors) properly evaluating the risks? Some errors in evaluating risk are inevitable. Random errors are not problematic. Systematic errors can be very serious. I'm concerned that there are systematic errors in pricing in the market, which will not be revealed until some unusual event occurs. Thanks for the pointer to the blog. I think you are generally right on the ability of banks to put a value on financial instruments. My concern is slightly different: are banks (and other large investors) properly evaluating the risks? Some errors in evaluating risk are inevitable. Random errors are not problematic. Systematic errors can be very serious. I’m concerned that there are systematic errors in pricing in the market, which will not be revealed until some unusual event occurs.

Thanks for the pointer to the blog.

]]> Comment on Financial Complexity by: ncm http://www.airs.com/blog/archives/75#comment-5653 Mon, 22 Oct 2007 19:55:07 +0000 http://www.airs.com/blog/archives/75#comment-5653 By the way, the best place I know to learn often astonishing minutiae of economics is Cal professor Brad Delong's blog, "Grasping Reality with Both Hands", at http://delong.typepad.com/ . Delong also aggregates links to relevant political coverage from more other blogs than I can conceive of following. By the way, the best place I know to learn often astonishing minutiae of economics is Cal professor Brad Delong’s blog, “Grasping Reality with Both Hands”, at http://delong.typepad.com/ . Delong also aggregates links to relevant political coverage from more other blogs than I can conceive of following.

]]> Comment on Financial Complexity by: ncm http://www.airs.com/blog/archives/75#comment-5628 Mon, 22 Oct 2007 01:11:59 +0000 http://www.airs.com/blog/archives/75#comment-5628 From what I've read, the banks are astonishingly successful at valuing the most arcane of instruments (astonishing to me, anyway) but are structurally unable to apply their understanding. This is because the punishment for passing up a potential profit, when everybody else is taking a profit (even if it's just "on paper"), is enormously greater than for taking a loss when everybody else is also. In other words, fund managers, Institutionally, are obliged to take great risks or be replaced by somebody else who will. Lots of people were predicting the Crash in 1999, but anybody who acted on it was excoriated in the financial press for missing out on the gains of 2000. From what I’ve read, the banks are astonishingly successful at valuing the most arcane of instruments (astonishing to me, anyway) but are structurally unable to apply their understanding. This is because the punishment for passing up a potential profit, when everybody else is taking a profit (even if it’s just “on paper”), is enormously greater than for taking a loss when everybody else is also. In other words, fund managers, Institutionally, are obliged to take great risks or be replaced by somebody else who will.

Lots of people were predicting the Crash in 1999, but anybody who acted on it was excoriated in the financial press for missing out on the gains of 2000.

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