Part of the motivation for inventing complex new derivatives is to create things that look conservative to the model but are actually risky.
Nailed it. Things like FX, commodities and equities are closed systems. These markets make their money by volume and it's not particularly interesting.
Take something like a CDS where you don't really know what the risks are and it becomes easier to set prices fairly arbitrarily. Maybe some cpty has a stellar rating. Does that mean they'll always be stellar? Who knows?!
But this is still missing the real killer. Leverage. Everyone forgot the lesson of LTCM.
It was a bitter irony that the only bank to tell LTCM "fah q!" was the first to go. It's not so ironic now that Lehman, Merrill and possibly Morgan are gone now too.
Nailed it. Things like FX, commodities and equities are closed systems. These markets make their money by volume and it's not particularly interesting.
Take something like a CDS where you don't really know what the risks are and it becomes easier to set prices fairly arbitrarily. Maybe some cpty has a stellar rating. Does that mean they'll always be stellar? Who knows?!
But this is still missing the real killer. Leverage. Everyone forgot the lesson of LTCM.
It was a bitter irony that the only bank to tell LTCM "fah q!" was the first to go. It's not so ironic now that Lehman, Merrill and possibly Morgan are gone now too.