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I don't believe that LTCM was insuring anything. What they were doing is identifying pairs of securities whose values had diverged and they believed would even

by btilly 4y ago

I don't believe that LTCM was insuring anything. What they were doing is identifying pairs of securities whose values had diverged and they believed would eventually converge. They would short the more expensive one and buy the cheap one. When they converged they would sell the no longer cheap one, use the money to close out the no longer expensive one, and collect a profit. However usually the reason why one was more expensive is that it had a more liquid market. So people could safely invest in it with money that they might need back quickly. This shouldn't matter if you planned to buy and hold though..at least in theory. But in the wake of the Russian default, liquidity became more valued. So people sought to get rid of illiquid securities and buy liquid ones. This meant that LTCM had shorted things that were rising in value, and bought things that were falling in value. So they had a loss. And as the shorts got higher, they wound up having to sell assets at a loss to cover their shorts. And now the temporary losses became very real ones, and drove them bankrupt. However, infamously, their investments made money in the end. They just weren't able to last long enough to benefit from it.

Scoundreller 4y ago
> I don't believe that LTCM was insuring anything. While most of their strategy was convergence arbitrage, if I recall from the book, they thought of selling short equity options as a form of selling insurance. People buy these options to insure against some event and they expected more buyers than sellers, so LTCM figured they would profitably be the provider of it. Well-structured insurance is always a loss to the buyer (they take in more than they pay out).
- edmundsauto 4y ago
  Been a while since I read the book as well, but wasn’t part of the narrative that their backstop as insurance enabled traders to take bigger and bigger bets, because they were hedged with LTCM?
  - djsavvy 4y ago
    Which book are your referring to?
    - 400thecat 4y ago
      When genius failed. there is no other book
  - seanhunter 4y ago
    I don't think any trader at a broker/dealer would think that, but it's possible people on the buyside thought that. There are plenty of funds who have a strat of just allocating say 95% of their holdings to the Russell or something and then putting the remaining 5% into some high-vol bets (like putting them into LTCM or whatever). They don't see it as a hedge exactly, but it means that they hardly need to work at all and when these pay off they say "look this is alpha" and when they don't they say "look, your error vs the Russell is less than 5%". Some funds (eg big pensions) have enough AUM that this risky piece is a very significant amount of money. I was working in the city shortly after LTCM failed and one of the interesting things I heard is that several large European institutions were using LTCM for overnight treasury. So at cob in Europe they would sweep funds into LTCM and then move them out the next morning for trading. If that was actually the case it would have caused massive fluctuations in their assets during the day which would be extremely hard to manage.
- AndyMcConachie 4y ago
  [flagged]
  - seanhunter 4y ago
    How has that got anyhing whatsoever to do with the thread or indeed TFA? Did you perhaps post this in the wrong thread or something? This literally is a thread about finance in response to an article about US credit default swaps. The fact that we don't talk about any of the great tragedies that have happened throughout history is due to a policy of trying to keep conversations on topic.
  - SideQuark 4y ago
    That paper explicitly states this is not the result of "capitalist raping", and it's sad to see such nonsense injected into a paper explicitly stating the opposite. Did you read it or just see a tweet? "In sum, according to the dysfunctional culture approach, self-destructive health behaviour - in the case of the post-socialist mortality crisis primarily referring to hazardous drinking - is not a result of the radical economic policies adopted during the transition from socialism to capitalism but of a dysfunctional, anomie-laden culture inherited from the socialist past whose effect was made worse by low alcohol prices during the transition" In short, socialism had for so long ruined the economy that the country imploded, and the transition to a better working capitalism brought about deaths as a result of the wider destruction that caused the implosion. Deindustrialization is the opposite of capitalism.
- wjnc 4y ago
  Insurance works because people, companies, shareholders etc are risk-averse and thus value paying a little for reducing variance a lot. That’s not a loss to the buyer. NPV isn’t the only measure of value.

by btilly 4y ago

Scoundreller 4y ago

> I don't believe that LTCM was insuring anything. While most of their strategy was convergence arbitrage, if I recall from the book, they thought of selling short equity options as a form of selling insurance. People buy these options to insure against some event and they expected more buyers than sellers, so LTCM figured they would profitably be the provider of it. Well-structured insurance is always a loss to the buyer (they take in more than they pay out).

edmundsauto 4y ago
Been a while since I read the book as well, but wasn’t part of the narrative that their backstop as insurance enabled traders to take bigger and bigger bets, because they were hedged with LTCM?
- djsavvy 4y ago
  Which book are your referring to?
  - 400thecat 4y ago
    When genius failed. there is no other book
- seanhunter 4y ago
  I don't think any trader at a broker/dealer would think that, but it's possible people on the buyside thought that. There are plenty of funds who have a strat of just allocating say 95% of their holdings to the Russell or something and then putting the remaining 5% into some high-vol bets (like putting them into LTCM or whatever). They don't see it as a hedge exactly, but it means that they hardly need to work at all and when these pay off they say "look this is alpha" and when they don't they say "look, your error vs the Russell is less than 5%". Some funds (eg big pensions) have enough AUM that this risky piece is a very significant amount of money. I was working in the city shortly after LTCM failed and one of the interesting things I heard is that several large European institutions were using LTCM for overnight treasury. So at cob in Europe they would sweep funds into LTCM and then move them out the next morning for trading. If that was actually the case it would have caused massive fluctuations in their assets during the day which would be extremely hard to manage.
AndyMcConachie 4y ago
[flagged]
- seanhunter 4y ago
  How has that got anyhing whatsoever to do with the thread or indeed TFA? Did you perhaps post this in the wrong thread or something? This literally is a thread about finance in response to an article about US credit default swaps. The fact that we don't talk about any of the great tragedies that have happened throughout history is due to a policy of trying to keep conversations on topic.
- SideQuark 4y ago
  That paper explicitly states this is not the result of "capitalist raping", and it's sad to see such nonsense injected into a paper explicitly stating the opposite. Did you read it or just see a tweet? "In sum, according to the dysfunctional culture approach, self-destructive health behaviour - in the case of the post-socialist mortality crisis primarily referring to hazardous drinking - is not a result of the radical economic policies adopted during the transition from socialism to capitalism but of a dysfunctional, anomie-laden culture inherited from the socialist past whose effect was made worse by low alcohol prices during the transition" In short, socialism had for so long ruined the economy that the country imploded, and the transition to a better working capitalism brought about deaths as a result of the wider destruction that caused the implosion. Deindustrialization is the opposite of capitalism.
wjnc 4y ago
Insurance works because people, companies, shareholders etc are risk-averse and thus value paying a little for reducing variance a lot. That’s not a loss to the buyer. NPV isn’t the only measure of value.