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0 pointsthanatropism6y ago0 comments

The title is terrible.

The fundamental problem he seems to be pointing at is that notional replicating portfolios can work like an engineering marvel in good times and become inoperable in bad (liquidity) times.

There were many elements to the CDO crisis -- including bad faith by the rating agencies and a prolonged asset-price mania much beyond this stock-market rally. The simpler metaphor is the emission of vanilla stock options. In principle, a bank is only able to offer options because he has the ability to replicate it and neutralize his risk. But if market conditions diverge from the asset replication model, then boom you get LTCM.

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notyourday6y ago

> The fundamental problem he seems to be pointing at is that notional replicating portfolios can work like an engineering marvel in good times and become inoperable in bad (liquidity) times.

He is confused. That was the problem with the synthetic OTC instruments that he used which nearly tripped his winning position because no one wanted to actually trade with them. And even that was largely the case because he was buying not even CDOs but synthetic instruments that were derivatives of the CDOs.

Index funds on the other hand own the shares in companies that publicly trade where the market markers must provide liquidity hence a single trade at +/- 10% will not only move the quote but would trigger other buyers and sellers to decide to want to play.

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