Would a fly to safety benefit the US dollar?

For people who still believe in a strong dollar, there is little doubt Dubai's announce that it could default on its debt was a positive Black Swan event.

1) It was rather unpredicted: Amid the annoucement,  the Nikkei 225 lost 3.2 percent (its biggest one-day decline in almost eight months), the Korean Kospi fell 4.7 percent (a four-month low) Australia's S&P/ASX 200 lost 2.9 percent and Hong Kong's Hang Seng dropped 5.1 percent to 21,088.55

2) It involves systemic risks and could turn out to be the tipping point that brings us to descend the second slope of the crisis.

3)It triggered a (short-term) rally to the dollar, at a moment when Greenbak futures were plummetting an the dollar trade index continuing its slide.

Though, this rally was short lived, as shown below.



What we should apparently learn from this mini dollar rally is that even if Treasury debt was multiplied by 24 from US$0.5 Trillion to $12 Trillion and the US dollar Index  (NYBOT US$)  lost more than 16% since last March;  the fly to safety argument holds firm.
The fact that the financial community continues to lend back to the government QE money by buying T-bonds even in negative rates territory is another argument supporting the "safe heaven" greenback t(h)e(rr)orists.

Now, let's face the other aspect of the Dubai events: the possibility of living the infamous "double dip" because of a sovereign debt crisis.

As shown by the following chart (courtesy of Morgan Stanley), the Great Depression (the only crisis comparable in direness to the one we are experiencing) was prolonged by a sovereign debt crisis.


 
As visible in the rise of CDS spreads, premiums are already integrating sovereign debt risks concerns.

Currently, financial institutions are comparable to boxers going entering a new round after getting beaten up in the last one, still dizzy from the uppercut received before the bell but feeling better after the medics applied soothing balm on their wounds. At this point in the fight, a slight hit from the opponent in a sweet spot  would pave the way to knock out.

As measured by debt holding of countries with high sovereign defaulting risks, the US' exposure is less important than Europe's one, feeding bullish sentiment towards the dollar.





However, before jumping to the conclusion that the dollar will rally would Ukraine; Greece or Ireland announce they default there is at least one other aspect we should consider:  governments, worlwide, seem utterly concerned by monetary policy and a "currency war" scenario should not be banned. The unwinding of the QE fed carry trade bears too heavy a political brunt to happen in an orderly fashion.

If the plumetting dollar is considered as a major issue in Japan and Europe, the impacts of an unwinding of the dollar carry trade cannot be reduced to these countries alone.

The St Louis FED establishes two trade dollar weighted indexes : USD/Major Currencies; USD/Broad
As defined by its statements:

Broad currency index includes the Euro Area, Canada, Japan, Mexico, China, United Kingdom, Taiwan, Korea, Singapore, Hong Kong, Malaysia, Brazil, Switzerland, Thailand, Philippines, Australia, Indonesia, India, Israel, Saudi Arabia, Russia, Sweden, Argentina, Venezuela, Chile and Colombia.

Major currencies index includes the Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden

Emphasis mine. Bold shows countries present in both lists, I will call them "Emerging Currencies" from now on.
A quick glance shows us that from the countries included only in the "broad" index, none is European.
Japan and the Euro area are both included in the Major Currency Index.

When diversification from the dollar is the trend, "emerging currencies" appreciate faster against the dollar than "Major Currencies"."Fly to safety" events erase those gains meaning they follow the same evolution to the dollar than "major Currencies". This describes the situation that occured since the beggining of the crisis:

"Fly to safety" logic relies on a risk/reward tradeoff hypothesis.

The dollar rally ignited in q4 2008 occured mostly because fears of systemic risk pushed investors to short their holdings in both "major" and "Emerging" Currencies and go long the Dollar.
Fear that we would live another Argentina-style debt default domino effect or a repeat of Q4 08 volatility is turning out to push the dollar safe-heaven status to the point it masks US fundamentals.

As of today, we have no real clue as of if a sovereign debt crisis will be contained to 2nd rank European and Middle Eastern Countries or cause a systemic shake in the global economy.

On the other hand, since the trade weighted USD index peaked on March 9th this year at 115.094 (Major Currencies Index), most of the diversification strategy has been directed towards "Emerging Currencies" (which, as seen before, do not include European Countries).

From this situation, two conclusions arise:

- With Greece, Ukraine or Iceland at the first stage the epicenter of the sovereign debt crisis seems Euro-centered. Since most of the diversification away from the dollar has been directed towards non European economies, were a dollar rally to take place in the short term it should be rather moderate. In the long-term, we have too few insights at the moment to exclude another "fly to safety"

- Omitted this far, we cannot be blind to how gold is considered as a new hedge by investors. A dollar rally scenario relies on the fact that the greenback would continue to be considered as the only "safe heaven". Since Oct 2007, fly to safety benefitted the USD but also gold, Treasuries and German bunds. Gold, above all, has tracked the major events in the Credit crisis, respectively spiking and relieving in recessions and improvements.
In the case a global sovereign debt crisis occurs, laying bare the nocuous effects of the fiat currency printing policy, there is little doubt the dollar would be the naked king.

Confidence: What Google has to tell us

Throughout my reading of the financial news of the last two years, I have come across two main themes again and again:
-The subprime crisis and its aftermath
-The rising of Google, possibly the most scrutinized company of our time

A lot of people agree that the subprime mess stems from the irrational exuberance of markets, which has successively led the markets up, down, and up again.
The recovery from the March lows may only be due to confidence gaining ground.

I believe one reason we have trouble understanding and taming these "animal spirits" is reductionism. Can we consider the confidence surveys we follow with great attention to be relevant when they only consider a sample of the population and are limited to a single country? In our complex and interlinked economy, can we consider confidence to have territorial frontiers?

This is where Google and its worldwide presence comes into play. The ubiquity of the "Don't be evil" company could turn out to provide us with a great tool to assess Global Confidence, a worldwide prediction market without the biases and reductionism of traditional (and costly) surveys.

A lot of talks has taken place lastly on the different scenarios we
should expect.
Google can help us compare, through the search occurrences and
apparitions in Google News of the different terms, were we stand.




Not surprisingly, we observe a good fit between search occurrences and apparition in the news.
Now, assuming that the search volume index represents the global opinion and News reference volume the experts opinion, the global and experts thinking seem correlated.

Therefore, the recent increase in news articles mentioning a double dip recession could reach a Tipping Point, moment when the fear of a
 W shaped recovery could feed in the global opinion and entail a self fulfilling prophecy.

If, we are truly living a Confidence based recovery, the only thing we have to hope for is hope itself.

Confidence is also greatly influenced by people that, following Malcom Gladwell's definition, we should define as Mavens.
Example Investors Figures of these Mavens would include Warren Buffet, Bill Gross, Marc Faber and R.Prechter. These "information specialist are the people that "we rely upon to connect us with new information" and have the capacity to "start word to mouth epidemics".
Once again, the growing pessimism of these Mavens (Bill Gross' last newsletter expresses fear of Bubbles, for those who missed it) could feed into our global confidence Google Index.

The Google Search Volume for "Market Bubble" is currently reaching yearly highs.




No Indicator can predict how the markets will react.
Ironically, Google has been one of the pioneers in implementing a prediction markets for employees to assess variables as the company's future growth, on the assumptions that the higher the employees' confidence, the more they would strive to drive the future growth.

Google, with its worldwide presence and use, could turn out to be a great tool for trend analysis.
Maybe Google is the End of the World as we know it, but the picture it has to show us could be the World as we should know it.

La reprise est-elle au coin de la Rue?

Selon Ben BERNANKE, elle semble l'être.

Pourtant, peu de signes pointent aujourd'hui vers une sortie de crise rapide. Pour une analyse point par point du gap entre le scénario optimiste de la FED et la réalité des indicateurs, voir ici.

Peu de personnes remettent en cause le fait que depuis la mi-mars, l'économie mondiale semble avoir retrouve le chemin de la croissance économique. Cependant, encore moins paraissent l'attribuer a une amélioration des fondamentaux.

Se pencher sur le phénomène d'illusion monétaire offre une piste de compréhension du rally actuel.

Si il y a une leçon à retenir de la crise des subprimes, c'est que l'ensemble des scénarii possibles est beaucoup plus important que ce que les modèles, voire les individus, peuvent l'imaginer.

Les systèmes complexes, dont les marchés financiers font partie intégrante, sont caractérisés par des Marches Aléatoires. Le Mouvement Brownien utilisé pour représenter l'évolution des Marchés Financiers, comme son nom ne l'indique pas, est dérivé du mouvement pris par des particules de Pollen dans un liquide.

Ce phénomène de marche aléatoire rend obligatoire une analyse en termes de Scénarii. Nous devons apprendre à vivre avec, et exploiter, l'improbable.

“Better prepare for confrontation than hope that the enemy will not come;
Better ensure one’s defense is impenetrable than hope that the enemy will not attack.” – Sun-Tzu The Art of War 6th Century, B.C.

Développer plusieurs scénarii permet de développer des stratégies de couverture variées et de fait de bénéficier d'une couverture globale face aux chocs asymétriques.

Comme le prouve la publication le 20 Novembre par la Société Generale du Worst Case Scenario, cette méthodologie a gagne en reconnaissance au sein des établissements financiers.

Société Générale Worst Case Debt Scenario Fourth Quarter Nov 2009



Parmi les indicateurs pouvant nous renseigner sur les inquiétudes et tendances, Google se révèle être un outil puissant. Pouvoir analyser ce que les individus recherchent et publient, nous donne l'opportunité de dessiner une opinion collective et de pondérer la place accordée aux différentes formes de Reprise.

L'indicateur de confiance que constitue les recherches effectuées par les individus au niveau mondial semble pessimiste sur la pérénité de la reprise économique.
Alors que le scénario d'une reprise en "W" était le moins évoqué par la presse en Juin, il fait aujourd'hui partie du consensus.

L'opinion collective: Part des recherches effectuees sur GOOGLE (a date du 22 Novembre 2009) concernant les différents scénarii de reprise:

Si la reprise économique est, comme R.SHILLER le pense, une prophétie auto-réalisatrice alimentée par la confiance collective, l'augmentation depuis Juillet des recherches relatives a une (non) reprise en "L" peut être un indicateur a surveiller.

La théorie veut que les Marches Financiers ne soient que le reflet de l'économie réelle. Pourtant, que les interactions entre les deux sphères ne soient pas a sens unique, et que les Marches peuvent également influencer l'économie réelle.

Depuis des années, l'évolution de l'économie a été fortement influencée par l'appréciation des actifs par l'effet de richesse dont beneficiait les consommateurs.

De fait, vouloir redémarrer l'économie réelle par le levier des marches financiers (hautement plus réactifs que leur contrepartie réelle) fait sens.

La politique d'inflation des actifs que mène la FED se justifie:

• Au niveau des individus, l'effet de richesse dont ils bénéficient se traduisant par un regain de confiance et une incitation a consommer
• Au niveau des entreprises, en desserrant la contrainte de crédit a laquelle elles font face: a nombre d'actions flottantes stable, l'appréciation des actions engendre une hausse des capitaux propres des entreprises et restaure leur ratio Capitaux Propres/Dette.

Cependant, qui dit plus réactif dit aussi plus volatil.

 Plus les Marches s'apprécient, plus l'effet potentiel sur l'économie réelle est fort (les individus voyant leur Valeur Nette augmenter avec celle de leurs actifs). D'un autre cote, une valorisation trop forte et rapide des marches éveillent des doutes chez les investisseurs quant aux 'fondamentaux'.

Tendances de Recherche pour les termes 'Market Bubble' en 2009:

Que ce soit en profitant de l'illusion monétaire (provoque par l'augmentation de la masse monétaire, et la dévalorisation du dollar engendrée)  dont sont victimes les investisseurs, ou en communiquant sur les indicateurs chers aux marches financiers BERNANKE tente de déclencher un cercle vertueux  (positive feedblack loop) pouvant permettre un redémarrage rapide de l'économie américaine.

Le fait de maintenir des taux très bas rend le cout de détenir de l'argent en liquide fort (votre argent est moins rémunéré). De fait, les investisseurs sont directement incités à placer leur argent dans des véhicules plus risqués mais offrant un rendement bien supérieur: obligation, actions...

La Banque Centrale ne focalisant son objectif d'inflation que sur l'économie réelle, l'inflation des actifs financiers qu'elle génère par sa politique de taux bas ne fait pas partie de ses préoccupations, comme le montre l'absence de référence aux Marches Financiers au sein des indicateurs qu'elle surveille:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions,including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

La reprise dont nous sommes témoins depuis la mi-mars est essentiellement tributaire du regain de confiance des agents. Cette situation peut se perpétuer jusqu'à ce qu'un cercle vertueux entre Marches Financiers et economie reelle se mette en place. Néanmoins, l'ampleur et la rapidité de la reprise ont fait naitre des doutes sur la corrélation entre évolution des Marches Financiers et économie réelle. Si ces doutes se matérialisent par un retrait des investisseurs des Marches, un nouveau plongeon n'est pas a exclure.

Une Reprise au coin de la Rue? Peut être, mais quelle rue?

Brainstorming on How Complex system Fail

Richard I COOK comes up with a must read piece on how complex system fail.
Here are his 18 bullet points, and my thoughts on the subject:

1.Complex systems are intrinsically hazardous systems.


All of the interesting systems (e.g. transportation, healthcare, power generation) are inherently and unavoidably hazardous by the own nature. The frequency of hazard exposure can sometimes be changed but the processes involved in the system are themselves intrinsically and irreducibly hazardous. It is the presence of these hazards that drives the creation of defenses against hazard that characterize these systems.

what comes to my mind: Stock Market, Regulation, Behavioural Finance, Bonded Rationality

2.Complex systems are heavily and successfully defended against failure

The high consequences of failure lead over time to the construction of multiple layers of defense against failure. These defenses include obvious technical components (e.g. backup systems, ‘safety’ features of equipment) and human components (e.g. training, knowledge) but also a variety of organizational, institutional, and regulatory defenses (e.g. policies and procedures, certification, work rules, team training). The effect of these measures is to provide a series of shields that normally divert operations away from accidents.

what comes to my mind: Risk Analysis, FED, Reserves, Regulation, Technical Analysis, Creative Destruction


3. Catastrophe requires multiple failures – single point failures are not enough.

The array of defenses works. System operations are generally successful. Overt catastrophic failure occurs when small, apparently innocuous failures join to create opportunity for a systemic accident. Each of these small failures is necessary to cause catastrophe but only the combination is sufficient to permit failure. Put another way, there are many more failure opportunities than overt system accidents. Most initial failure trajectories are blocked by designed system safety components. Trajectories that reach the operational level are mostly blocked, usually by practitioners.

what comes to my mind: Complexity of Finance, Hindsight Bias, Systemic Failures, Feedback loops, Power Laws, Black Swans

4. Complex systems contain changing mixtures of failures latent within them


The complexity of these systems makes it impossible for them to run without multiple flaws being present. Because these are individually insufficient to cause failure they are regarded as minor factors during operations. Eradication of all latent failures is limited primarily by economic cost but also because it is difficult before the fact to see how such failures might contribute to an accident. The failures change constantly because of changing technology, work organization, and efforts to eradicate failures.

What comes to my mind: Optimization, Efficient Market Hypothesis, FAMA


5. Complex systems run in degraded mode


A corollary to the preceding point is that complex systems run as broken systems. The system continues to function because it contains so many redundancies and because people can make it function, despite the presence of many flaws. After accident reviews nearly always note that the system has a history of prior ‘proto-accidents’ that nearly generated catastrophe. Arguments that these degraded conditions should have been recognized before the overt accident are usually predicated on naïve notions of system performance. System operations are dynamic, with components (organizational, human, technical) failing and being replaced continuously.

What Comes to my mind: 



6. Catastrophe is always just around the corner.


Complex systems possess potential for catastrophic failure. Human practitioners are nearly always in close physical and temporal proximity to these potential failures – disaster can occur at any time and in nearly any place. The potential for catastrophic outcome is a hallmark of complex systems. It is impossible to eliminate the potential for such catastrophic failure; the potential for such failure is always present by the system’s own nature.


What Comes to my mind: Illusion of Control, Great Moderation illusion, Uncertainty principle, Prudential regulation


7. Post-accident attribution accident to a ‘root cause’ is fundamentally wrong.


Because overt failure requires multiple faults, there is no isolated ‘cause’ of an accident. There are multiple contributors to accidents. Each of these is necessary insufficient in itself to create an accident. Only jointly are these causes sufficient to create an accident. Indeed, it is the linking of these causes together that creates the circumstances required for the accident. Thus, no isolation of the ‘root cause’ of an accident is possible. The evaluations based on such reasoning as ‘root cause’ do not reflect a technical understanding of the nature of  failure but rather the social, cultural need to blame specific, localized forces or events for outcomes.


What Comes to my mind: Hindsight bias, Reductionism, KAHNEMAN, Subprime Crisis, Management Books


8. Hindsight biases post-accident assessments of human performance.


Knowledge of the outcome makes it seem that events leading to the outcome should have appeared more salient to practitioners at the time than was actually the case. This means that ex post facto accident analysis of human performance is inaccurate. The outcome knowledge poisons the ability of after-accident observers to recreate the view of practitioners before the accident of those same factors. It seems that practitioners “should have known” that the factors would “inevitably” lead to an accident.2 Hindsight bias remains the primary obstacle to accident investigation, especially when expert human performance is involved.


What comes to my mind: Forward Thinking, Opportunism, Survivorship Bias


9. Human operators have dual roles: as producers & as defenders against failure


The system practitioners operate the system in order to produce its desired product and also work to forestall accidents. This dynamic quality of system operation, the balancing of demands for production against the possibility of incipient failure is unavoidable. Outsiders rarely acknowledge the duality of this role. In non accident filled times, the production role is emphasized. After accidents, the defense against failure role is emphasized. At either time, the outsider’s view misapprehends the operator’s constant, simultaneous engagement with both roles.


What Comes to my mind: Complexity (and acknowledged lack of understanding) of Financial Instruments, VaR, Black Swans


10. All practitioner actions are gambles


After accidents, the overt failure often appears to have been inevitable and the practitioner’s actions as blunders or deliberate willful disregard of certain impending failure. But all practitioner actions are actually gambles, that is, acts that take place in the face of uncertain outcomes. The degree of uncertainty may change from moment to moment. That practitioner actions are gambles appears clear after accidents; in general,post hoc analysis regards these gambles as poor ones. But the converse: that successful outcomes are also the result of gambles; is not widely appreciated.


What comes to my mind: Reductionism of the complexity of Finance, Illusory importance given to Track Records, Survivorship Bias, Finance is considered too Serious.


11) Actions at the sharp end resolve all ambiguity


Organizations are ambiguous, often intentionally, about the relationship between production targets, efficient use of resources, economy and costs of operations, and acceptable risks of low and high consequence accidents. All ambiguity is resolved by actions of practitioners at the sharp end of the system. After an accident, practitioner actions may be regarded as ‘errors’ or ‘violations’ but these evaluations are heavily biased by hindsight and ignore the other driving forces, especially production pressure.


What Comes to my mind:


12. Human practitioners are the adaptable element of complex systems


Practitioners and first line management actively adapt the system to maximize production and minimize accidents. These adaptations often occur on a moment by moment basis. Some of these adaptations include: (1) Restructuring the system in order to reduce exposure of vulnerable parts to failure. (2) Concentrating critical resources in areas of expected high demand. (3) Providing pathways for retreat or recovery from
 expected and unexpected faults. (4) Establishing means for early detection of changed system performance in order to allow graceful cutbacks in production or other means of increasing resiliency.


What Comes to my mind: Risk Analysis, Management Reductionism, Holistic view of Business, Flaw of Averages




13. Human expertise in complex systems is constantly changing


Complex systems require substantial human expertise in their operation and management. This expertise changes in character as technology changes but it also changes because of the need to replace experts who leave. In every case, training and refinement of skill and expertise is one part of the function of the system itself. At any moment, therefore, a given complex system will contain practitioners and trainees with varying degrees of expertise. Critical issues related to expertise arise from (1) the need to use scarce expertise as a resource for the most difficult or demanding production needs and (2) the need to develop expertise for future use.


What Comes to my mind:

 Too much time is spent trying to find out more and more about less and less, until we know everything about nothing,'' MONTIER says. ``Rarely, if ever, do we stop and ask what do we actually need to know

14. Change introduces new forms of failure.


The low rate of overt accidents in reliable systems may encourage changes, especially the use of new technology, to decrease the number of low consequence but high frequency failures. These changes maybe actually create opportunities for new, low frequency but high consequence failures. When new technologies are used to eliminate well understood system failures or to gain high precision performance they often introduce new pathways to large scale, catastrophic failures. Not uncommonly, these new, rare catastrophes have even greater impact than those eliminated by the new technology. These new forms of failure are difficult to see before the fact; attention is paid mostly to the putative beneficial characteristics of the changes. Because these new, high consequence accidents occur at a low rate, multiple system changes may occur before an accident, making it hard to see the contribution of technology to the failure.


What Comes to my mind: Backlash of the Rationalization Era, Pattern recognition illusion, VaR, Risk Hedging, Illusion of Forecasting Black Swans




15. Views of ‘cause’ limit the effectiveness of defenses against future events


Post-accident remedies for “human error” are usually predicated on obstructing activities that can “cause” accidents. These end-of-the-chain measures do little to reduce the likelihood of further accidents. In fact that likelihood of an identical accident is already extraordinarily low because the pattern of latent failures changes constantly. Instead of increasing safety, post-accident remedies usually increase the coupling and complexity ofthe system. This increases the potential number of latent failures and also makes the detection and blocking of accident trajectories more difficult.


What comes to my mind: Inference is illusory, the increase in car accidents related deaths after 9/11, Don't give credit to people who were right about past events

Do not repeat the tactics which have gained you one victory, but let your methods be regulated by the infinite variety of circumstances. SUN TZU

16. Safety is a characteristic of systems and not of their components


Safety is an emergent property of systems; it does not reside in a person, device or department of an organization or system. Safety cannot be purchased or manufactured; it is not a feature that is separate from the other components of the system. This means that safety cannot be manipulated like a feedstock or raw material. The state of safety in any system is always dynamic; continuous systemic change insures that hazard and its management are constantly changing.


What comes to my mind: Current atomicity of Financial regulation, FED, ECB, cooperation and NASH's Equilibrium

For should the enemy strengthen his van, he will weaken his rear; should he strengthen his rear, he will weaken his van; should he strengthen his left, he will weaken his right; should he strengthen his right, he will weaken his left. If he sends reinforcements everywhere, he will everywhere be weak SUN TZU (again)

17. People continuously create safety


Failure free operations are the result of activities of people who work to keep the system within the boundaries of tolerable performance. These activities are, for the most part, part of normal operations and superficially straightforward. But because system operations are never trouble free, human practitioner adaptations to changing conditions actually create safety from moment to moment. These adaptations often amount to just the selection of a well-rehearsed routine from a store of available responses; sometimes, however, the adaptations are novel combinations or de novo creations of new approaches.


What Comes to my mind: Moderation principle, Staying away of what you don't understand, Marathon runners and Sprinters / BUFFET and Day Traders


18. Failure free operations require experience with failure


Recognizing hazard and successfully manipulating system operations to remain inside the tolerable performance boundaries requires intimate contact with failure. More robust system performance is likely to arise in systems where operators can discern the “edge of the envelope”. This is where system performance begins to deteriorate, becomes difficult to predict, or cannot be readily recovered. In intrinsically hazardous systems, operators are expected to encounter and appreciate hazards in ways that lead to overall performance that is desirable. Improved safety depends on providing operators with calibrated views of the hazards. It also depends on providing calibration about how their actions move system performance towards or away from the edge of the envelope.


What comes to my mind: !Not finding books on Amazon telling the story of Failure.

Black Swans, Les Oubliés de la Grande Modération

Dans la première partie, nous avons considéré les failles des modèles traditionnels fondés sur une distribution Gaussienne: Une des limites de ces modèles est la place centrale accordée à la valeur moyenne de l’échantillon.


Illustration de la faiblesse de la Moyenne au sein de valeurs ne suivant pas une distribution normale :


On considère un échantillon de 10 personnes dont on calcule le Revenu Moyen (Somme des Revenus individuels / 10) , et le Revenu médian (Valeur pour laquelle 5 personnes gagneront moins, et 5 plus). Une fois ces deux valeurs acquises, remplacer une des personnes par Warren BUFFET.
Le Revenu Médian restera inchangé, alors que l’échantillon des personnes deviendra « en moyenne » milliardaire.

Au sein d’une distribution normale, les évènements de l’échantillon ont une probabilité d’occurrence inversement proportionnelle à leur écart avec la valeur Moyenne. Pourtant, certaines variables aléatoires (comme la valeur nette des individus) laissent apparaitre des outliers (évènements à probabilité faible, mais non nulle possédant un impact majeur)

In the first months of 1998, markets were smooth. ... The mood at Long-Term was relaxed, too. Though the fund's leverage was up, and though the partners had taken out huge personal loans, their exposure seemed tolerable. ... According to their models, the maximum that they were likely to lose on any single trading day was $45 million—certainly tolerable for a firm with a hundred times as much in capital. According to these same models, the odds against the firm's suffering a sustained run of bad luck—say, losing 40 percent of its capital in a single month—were unthinkably high. (So far, in their worst month, they had lost a mere 2.9 percent.) Indeed, the figures implied that it would take a so-called ten-sigma event—that is, a statistical freak occurring one in every ten to the twenty-fourth power times—for the firm to lose all of its capital within one year. 1 R. Lowenstein, "When Genius Failed: The Rise and Fall of Long-Term Capital Management," Random House, 2001, pp. 126–127.

Comme nous l’avons évoqué, selon la loi Normale, plus un évènement est écarté de la valeur moyenne plus sa probabilité d’existence est faible. L’unité de mesure de la distance qui sépare moyenne et évènement communément retenue est le sigma (écart type). Au sein d’une distribution Normale, plus le sigma est fort, plus la courbe est censée « recouvrir » l’ensemble des éventualités.

Un évènement sera donc caractérisé par son sigma d’écart avec la valeur moyenne de l’échantillon, et la VaR correspondante sera proportionnelle à ce sigma. Plus l'écart avec la moyenne est élevé, plus on risque de perdre ou gagner gros. 
Dans l'hypothèse d’une distribution normale des risques, ces éventualités sont considérées comme statistiquement insignifiantes, et doivent être retirées de l’échantillon.  Les modèles destinés à effectuer des prévisions sont de fait invalides, non seulement car le futur n'est jamais une simple extrapolation du passé, mais aussi car le passé s’est vu « gommé » d’évènements ne « fittant » pas l’hypothèse de distribution normale.

Selon leur définition par TALEB, les Black Swans ou Cygnes Noirs sont des évènements difficiles à prévoir, d'une forte rareté mais aussi possédant un impact majeur. 
Vouloir lisser les queues des distributions est une abbération, car en gommant de notre échantillon ces évènements, nous faussons entièrement la situation.

Les institutions financières ont vu la totalité des profits réalisés sur les périodes précédentes effacées par la crise. Peut-on gommer ces retours négatifs sous l'excuse qu'ils ne sont que des anormalités statistiques?

La stratégie de trading de TALEB (qui se concentre sur les options) devient alors compréhensible: en pariant sur des évènements improbables, la probabilité de perdre est forte mais l'importance de ces pertes est faible (Bleed). En revanche, si l'évènement se réalise, le payoff est très important. Il s'agit de l'inverse de la stratégie adoptée par les investisseurs et résumée par la Figure 2 (blow) (tirée de l'annexe statistique fournie par TALEB destinée aux détracteurs de son Black Swan)

Selon la Loi Normale, il existe sur les Marchés Financiers un grand nombre d'évènements proches de la moyenne  (à sigma faibles). En revanche, la probabilité d'occurrence d'évènements éloignées de la moyenne (a sigmas élevés) est plus forte que celle supposée par la Loi Normale. Ces évènements restent rares, mais beaucoup moins que prévu.

Certains évènements se déroulant sur les marchés Financiers ne possèdent aucun sens à la lumière de la distribution Normale. En réalité, les retours enregistrés sur les ces memes marchés suivent des Lois de Puissance, comme démontré pour le DAX.


Les Lois de Puissance (ou Power Laws) sont utilisées pour caractériser la fréquence d'apparition d'un grand nombre d'évènements générés par des systèmes complexes: Taille des Villes, Fréquence et Amplitude de Tremblements de Terre, et donc Marchés Financiers.

Gaussian distributions tend to prevail when events are completely independent of each other. As soon as you introduce the assumption of interdependence across events, Paretian distributions tend to surface because positive feedback loops tend to amplify small initial events. For example, the fact that a website has a lot of links increases the likelihood that others will also link to this website

Une des applications des lois de puissance les plus connues est sans doute la  Loi de PARETO, ou principe du 80/20.
Celle-ci, appliquée depuis un certain nombres d'années aux principes du management comme à la distribution de musiques en ligne, énonce par exemple qu'il est probable que 20% des Produits Vendus par la Firme A génère 80% de ses Revenus. 
Dans le conseil en stratégie, il est commun d'entendre que les recommandations ne constituent que 20% du livrable final mais 80% de la valeur ajoutée.


Selon MCKELVEY et ANDRIANI, l'exacerbation des tensions compétitives et l'écroulement des couts de transaction engendrés par la globalisation ont transformé les distributions Gaussiennes en Distributions de Pareto.
Sous l'influence de ces 2 vecteurs, l'architecture des marchés financiers a gagné en complexité, nourrissant effets de second tour et explosion des flux d'information. De plus, les distributions de Pareto sont gouvernées par la logique du Winner Takes All: Il existe au sein de la distribution un nombre restreint d'évènements au possédant un nombre de connexions supérieurs à la moyenne avec le reste du système,et ceux-ci sont présents dans la queue de la distribution. C'est l'effet Boule de Neige: plus un évènement possède de connections, plus son nombre de points de contacts avec le reste des évènements est élevé et plus la probabilité d'accumuler de nouveaux contacts est forte. Pensez à vos amis Facebook.

Ce nombre de liens élevés avec le reste du système caractérisant les évènements improbables est responsable du risque systémique. C'est en partie pour cela qu'il nous est difficile d'attribuer les crises à des évènements précis. Une multitude de facteurs créé la possibilité d'un évènement si improbable. Comme dans tout système complexe, la somme des conséquences et risques individuels de chacun de ces évènements est différente des risques et conséquences de l'évènement.

Une bulle résulte d'un système complexe de facteurs. Plus de nouveaux facteurs rentrent en jeu, plus la bulle grossit. En Revanche, plus la Bulle est grosse et plus elle touche d'aiguilles:

A crash occurs because the market has entered an unstable phase toward the culmination of a bubble and any small disturbance or process may reveal the existence of the instability. SORNETTE, 2008

Analyse de la crise des Subprimes a travers le concept de Black Swan:


Les changements de paradigme sont traditionnellement issus de moments de crise. A ce titre, la crise des subprimes a donne naissance a de nouveaux schémas d'analyse économique et stratégique. De nouveaux termes de recherches émergent actuellement, dont la majorité sont lies a la prise en compte de phénomène improbables et de fait l'analyse de risque.


La popularité grandissante de l'Econophysique illustre cette tendance a considérer toute crise économique comme crise de la pensée économique.


L'econophysique est une tentative de compréhension des phénomènes économiques a travers le filtre des évènements complexes, et plus particulièrement ceux appartenant au domaine de recherche de la Physique.


Issue du dernier McKINSEY Quarterly, cette représentation de la relation entre fréquence et ampleur des crises bancaires comparée a celles de tremblements de terre montre a quel point ces phénomènes peuvent être compares, et ouvre des pistes de recherches passionnantes.  

Money Market Black Swan

Principaux Indicateurs des Marches Financiers en un Coup d'oeil

Visualisez en temps réel l'évolution des principaux indicateurs macroéconomiques:



CAC 40



Dow Jones:


NASDAQ:



Dollar Trade Index:


Or (spot):


Commodities:

Euro Dollar:

• Economic Data from the St. Louis Fed
  
  
  
• Economagic
  
  

The Subprime Flu - Acknowledging the Complexity of Finance -

I do not know, or can possibly imagine, where the current economic situation is going to lead us.

My only conviction is that such events arouse theoretical debates regarding economic policies or measures that shall be implemented to prevent future crisis from happening. This is why I believe such times are worth living: Only in such timeframes is conventional knowledge questioned.

Most people are currently focusing on the "what went wrong" side of the problem. In my opinion, this behavior is flawed.

Flocks of new theories and opinions regarding what led to the subprime crisis  will appear  in the forthcoming years. Some people (Peter Schiff for example), will say "I told you so", others will derive from data the possible causes of the financial collapse.

However, I seriously question our ability to understand the complexity of the system we designed, and therefore the patterns that will emerge from this brainstorming.

Does this mean I think explanations to the current crisis are wrong? I don't think they are. What I believe is that each individual explanation can solely grasp one particular aspect in the system that led to the situation we know:

Was the subprime crisis triggered by the mark to market valuation of assets? It certainly played a role; but one as important as the banks' skyrocketing debt/equity ratio, the incentives for brokers to sell subprime mortgages whether it be to insolvent households, or the tendency for American consumers to see a greener grass in China's products compared to their American counterparts.
Such drivers did contribute to the financial situation we know, but none accounts for the Tipping Point that brought us where we are.

To illustrate this need to consider our system as complex, let's consider this sentence:

"The subprime crisis is a function of the banks, the financial products they structured, and the environment of sheer confidence that home prices were ever-rising. "

Does this describe the events that occured? Could these sentences be extracted from a recent piece of news?

In fact, how you might rightfully suppose, they are not.

This affirmations are inspired by  Malcom GLADWELL's delectable Tipping Point:

"Epidemics are a function of the people who transmit infectious agents, the infectious agent itself, and the environment in which the infectious agent is operating. And when an epidemic tips, when it is jolted out of equilibrium, it tips because something has happened, some change has occured in one (or two or three) of those areas"

I only switched the words "Epidemics", "Infectious Agents" and "Environment". If you want to give a try, please consider this (non exhaustive) list to play Make your own Financial Crisis explanation sentence:

The lesson to be learnt from this little example does not have to do with Banking institutions, Global Imbalances or Confidence.
It deals with the fact that financial crisis, as epidemics, are Complex and Evoluting Systems. Some epidemics have already been compared to the subprime crisis, Crack for example.


Complex, because studying them would imply studying Finance but also Psychology, Technology or Religion.
Evoluting, as the perpetual motion of the Financial Market Environment blurs the comprehension we have of the causes/transmission channels/ impacts of Crisis.


As epidemics, Financial Crisis now spread like wildfire because of the flattening the World has undergone in the last 50 years. As epidemics, they hit stakeholders via a network effect but, unlike them, there  are no short-term geographical bulwark to contamination.

The importance of the too big to fail issue: Switching from a strongly Centralized Network to a Distributed Network.

"On Monday, March 17, 2008, global financial markets opened to news of a Federal Reserve-enabled rescue of Bear Stearns by JPMorgan Chase. We learned, in the days that followed, of a weekend marathon meeting conducted by Federal Reserve officials to find a buyer for Bear Stearns. Urgency was warranted such that the hyper-connected global financial system might escape the effects of a medium-sized U.S. investment bank filing for bankruptcy and risking reverberations to thousands, nay, millions, of counterparties that were connected to it. Speculation grew of which institutions could be next, and more importantly, of which institutions comprised the Federal Reserve’s “too connected to fail” list. In reality, there was no such list at the ready; however, we can think of several universal banks and investment banks that, by virtue of the network age, play a significantly connected role in global finance such that bankruptcy of one or more would multiply the effects on financial markets globally in a cross-defaulting negative feedback loop." PIMCO AUGUST 2008 Report

It may seem a paradox, but Globalisation has fostered a Hubs and Spoke Network Model in Financial Services where a a few big banks (hubs) concentrate a meaningful share of customers (spokes) (see Network Model b).

Hence, a modelisation of the financial  landscape would show similarities with the one of an Epidemic (SARS in this example)

Globalisation has, more than anything, leveled the playing field and linked every domino in the game. In good times, the rising sea lifts all the boats. In bad ones, a butterfly's wing flap can produce a worlwide recession.

In more scientific terms, Globalisation has given birth to a Financial Ecosystem:

• which is simulateously robust and fragile - a property exhibited by other complex adaptive networks, such as tropical rainforests;
• whose feedback effects under stress (hoarding of liabilities and fire-sales of assets) added to these fragilities - as has been found to be the case in the spread of certain diseases;
• whose dimensionality and hence complexity amplified materially Knightian uncertainties in the pricing of assets - causing seizures in certain financial markets;
• where financial innovation, in the form of structured products, increased further network dimensionality, complexity and uncertainty; and
• whose diversity was gradually eroded by institutions’ business and risk management strategies, making the whole system less resistant to disturbance - mirroring the fortunes of marine eco-systems whose diversity has been steadily eroded and whose susceptibility to collapse has thereby increased.

To understand events leading to Financial Crisis, Researchers are to look at long time series as  Market Cooperativity (as defined by SORNETTE in 2003: the growth of correlation between investors' decision process, driven by feedback loops) is built on the long-term. 

 Let's consider the two most important types of transmission channels:

• Common Shocks: Affecting simulateneously  Financial Sectors worldwide, they were mostly linked with the over exposure of investors and Financial institutions to increased risk of securities to the US Sub-Prime Market. This is where the flawed VaR measurement of exposure to risk certainly played a role. Another form of Common shock was provided by the liquidity shortage on Financial Markets and the shared risk aversion of investors. 

• Spillover, or Contagion Effect: Financial shocks affecting one particular geographical location are likely to spread, or spillover, to other areas. Feedback loops between the real economy and worlwide financial markets are an example of Spillover Effect: gloomier Growth forecasts for the US economy will easily be transmitted to equity prices worlwide. Yet Another example of Spillover Effect provided by financial markets is transmitted via arbitrage opportunities: Changes in asset prices in one market entail portfolio adjustments by intermediaries and investors in other markets until one global price for the asset emerges. Foreign Banks holding US mortgages and US mortgage backed securities that were sold to them by Freddie Mac or Fannie Mae had to report significant losses, sometimes even before their american counterparts.

The subprime crisis has shown every sign of an epidemic: "Spreading rapidly and extensively by infection and affecting many individuals in an area or a population at the same time"


As R.SHILLER argues in his The Subprime Solution:

"Every disease has a contagion rate (the rate at which it is spread from person to person) and a removal rate (the rate at which individuals recover from or succumb to the illness and so are no longer contagious). If the contagion rate exceeds the removal rate by a necessary amount, an epidemic begins. The contagion rate varies through time because of a number of factors. For example, contagion rates for influenza are higher in the winter, when lower temperatures encourage the spread of the virus in airborne droplets after infected individuals sneeze. So it is in the economic and social environment. Sooner or later, some factor boosts the infection rate sufficiently above the removal rate for an optimistic view of the market to become widespread. There is an escalation in public knowledge of the  arguments that would seem to support that view, and soon the epidemic spirals up and out of control. Almost everyone appears to think—if they notice at all that certain economic arguments are more in evidence—that the arguments are increasingly heard only because of their true intellectual merit. The idea that the prominence of the arguments is in fact due to a social contagion is hardly ever broached, at least not outside university sociology departments."

We know epidemics to be complex, and that several diseases can stem from a common core but not be cured by the same treatment.
The Subprime Crisis may  produce a paradigm shift, or it may not. The race to specialization, and the clustering of knowledge it fomented, certainly played a strong role in how the situation rolled out.
Tackling Global issues, such as future financial crisis, will certainly imply more Global thinking.