There have been numerous article recently on the performance of the FTSE over the last decade

http://www.telegraph.co.uk/finance/markets/ftse100/6913344/FTSE-100s-recent-rally-fails-to-make-up-for-a-lost-decade.html

with only a few commenting on the effect that dividends have on returns

http://business.scotsman.com/economics/Dividends-help-investments-pay-off.5951967.jp

The FTSE 100 sans dividends is down 22% over the period

whereas if we included dividends, we would get a return of around 8%

This is still pretty poor compared to the (very approx) 45% you would've got if you had invested at the base rate

this emphasizes the point that to achieve returns in excess of risk free, one must take a risk. The longer the investment, the less chance of being underwater at maturity, but that risk will always be there.

Saw a leaflet in the FT today. Can't find it on the website, but found this

Wikipedia page

http://en.wikipedia.org/wiki/Eric_Rosenfeld

Good read

http://www.amazon.co.uk/When-Genius-Failed-Capital-Management/dp/1841155047/ref=sr_1_1?ie=UTF8&s=books&qid=1240932983&sr=8-1

I have mentioned before that there is a link between mortgage approvals and house prices six months from now

http://www.houseprices.uk.net/articles/house_price_predictor/

and I thought I would look at when approvals started heading south

BBA:

BOE

In July 2007, both BBA and BOE approvals dropped dramtically. That is not to say that they wouldn't pick up again, but couple this with the Goldman hedge fund

http://business.timesonline.co.uk/tol/business/industry_sectors/article2253691.ece

and the XOver breaking through 500

http://www.noelwatson.com/blog/PermaLink,guid,3a000888-e5df-4208-9515-01586f6332f2.aspx

indicated that as was not well. Did we know then that things were going to be as bas as they are? Probably not - see my comments on whether the XOver would break through 1000.

UK GDP numbers are released in theory a total of three times for a given quarter. For Q4 we have

23/01/2009: Advance

25/02/3009: Preliminary

27/03/2009: Final

Q3 final number (23/12/2008) was -0.6% (revised down from -0.5% (P)), and has subsequently been revised down to -0.7%

Today's Q4 preliminary number was unchanged at -1.5%

Looking at the bigger picture, things aren't quite as bad as the 90s recession. Yet.

http://www.ft.com/cms/s/0/fb6d3b8c-f8a6-11dd-aae8-000077b07658.html

"The world's most highly rated countries have for the first time been put into different categories reflecting their risks for credit downgrades, in a sign of the deepening financial crisis."

Reuters have done a little diagram

http://uk.reuters.com/article/UK_COMKTNEWS_MORE/idUKLB77042220090212

It appears that the UK is not best placed after all. Quelle surprise!

"Law firms offering graduates a median starting salary of £37,000 a year remained the highest payers. Investment banks were in second place, offering £35,000.

In third place, at £28,000 a year, were the business and financial services sectors"

Originally posted here

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

HYP capital is now underperforming by around 5%. Note that this is a simplication as it doesn't take into account

• RBS rights issue
• UU return of capital

http://www.unitedutilities.com/FAQsROC.htm

After Spain gets threatened with downgrade

http://www.telegraph.co.uk/finance/4224453/SandP-threatens-to-strip-Spain-of-top-AAA-rating.html

and then downgraded just over a week later

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/4292055/SandP-strips-Spain-of-its-AAA-credit-rating.html

I was wondering why the UK hadn't also been downgraded. The gradual nationalising of the banks is going to potentially give us large problems in years to come

"Assume the state takes ultimate responsibility for all of Britain’s banks. Further, assume that 15 per cent of those banks’ assets are worth nothing. The write-off would be equivalent to about £600bn or a third of GDP. Britain’s debt to GDP ratio is about 54 per cent; add in these and other bail-out costs and the ratio could easily double. That would make the UK comparable to Belgium, Greece and Italy – none of which, as Merrill Lynch notes, has a triple A credit rating"

especially when I read this

http://www.ft.com/cms/s/0/a5c6bfe2-e67b-11dd-8e4f-0000779fd2ac.html

For taxpayers, the prospect of taking on this risk may seem alarming. However, officials stress that the government is planning to insure only against extreme scenarios in which the bulk of a large pool of loans goes bad. That is similar to insurance bought by companies seeking to protect themselves against the remote possibility of being hit by a hurricane or an earthquake.

BLACK SWAN ALERT!

Looking at the CDS market (10Y, Spain and UK have been trading pretty much in line over the last few months, only over the last few days has Spain moved wider after the downgrade

My fantasy portfolio  buy of UK 5Y @67 is looking good

http://www.noelwatson.com/blog/PermaLink,guid,0c5c8ee2-cafe-4a5f-9f55-e0a0af90dc9e.aspx

I think it is only a matter of time before S&P put the UK on rating watch

EDIT: Forget to include the FT weather map

http://www.ft.com/cms/s/0/d99064aa-e65c-11dd-8e4f-0000779fd2ac.html

UPDATE:

Talking of tail risk, I wonder if the Government have taken this into account

http://online.wsj.com/article/SB123241510486096355.html

Analyst reports issued by Morgan Stanley and Royal Bank of Scotland Group PLC last week each said derivatives were pricing a peak-to-trough fall of 45% in U.K. house prices from August 2007 to the end of 2010. RBS's estimated that such a substantial fall would put 60% of HBOS's mortgage book into negative equity, more than half on Lloyds TSB's books and more than a third at Barclays PLC and RBS. HBOS and Lloyds this week merged into Lloyds Banking Group PLC.

UPDATE 2:

Couple of articles in weekend FT

#1

http://www.ft.com/cms/s/0/41827e52-e9bb-11dd-9535-0000779fd2ac.html

"He also points out that in previous emerging market currency crises - Argentina in 2002, Russia in 1998 and Indonesia in 1997/8 - wholesale selling of bank shares quickly translated into wholesale selling of the country itself. Unlike those countries, of course, the vast majority of UK debt is sterling denominated.

However, that could quickly change if RBS were nationalised. Morgan Stanley thinks half or more of RBS's £1,700bn of liabilities could be denominated in currencies other than sterling."

#2

http://www.ft.com/cms/s/0/92011204-e988-11dd-9535-0000779fd2ac.html

But the prime minister cannot be so definitive on Britain having no possibility of defaulting. After all, the country has form.

As Kenneth Rogoff and Carmen Reinhart have documented in their history of sovereign defaults, England’s monarchs regularly refused to pay their debts. Edward III defaulted on debt to Italian lenders in 1340 after a failed invasion of France that set off the 100 years war. Henry VIII seized the Roman Catholic Church’s lands. “While not strictly a bond default, such seizures, often accompanied by executions, qualify as reneging on financial obligations,” professors Rogoff and Reinhart observe drily.

England defaulted in 1672 in the “Stop of the Exchequer” and, in the last century, Britain in effect defaulted in 1932 in a “voluntary” reduction on the interest it paid on war loans.

http://www.publicpolicy.umd.edu/news/This_Time_Is_Different_04_16_2008%20REISSUE.pdf

What a surprise!

http://www.timesonline.co.uk/tol/money/pensions/article5355194.ece

Thought I would post a few screenshots to see what the markets think of Brown's claim that we are well placed to ride out the downturn.

• CDS: Gone from 7bps to 120bps in the space of a year. Admittedly, all sovereigns (and indeed all CDS markets) have suffered, but U.S. started the year at around 15bps, and is now only 66bps

• FX:

GBPEUR: Started the year at 1.36, now at record low of 1.14

http://www.telegraph.co.uk/finance/economics/3700755/Sterling-tumbles-to-record-low-against-the-euro-as-UK-economic-woes-mount.html

"The pound fell to a new record low against the euro today after a stark warning that the pace of economic decline in Britain is accelerating as the country moves into a deep recession."

GBPUSD: Similar picture - started year at approx 2:1, now at thirteen year low

http://www.telegraph.co.uk/finance/economics/interestrates/3548142/Interest-rates-cut-sterling-recovery-unlikely.html

"The pound has fallen against the dollar from a high of $2.0334 in March to below $1.45 yesterday, the lowest levels for 13 years. However, sterling launched a mini-rally after the interest rate announcement – rising from $1.4470 to $1.4677 shortly after noon."

• House prices: Fallen almost 20% in just over a year

http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5284863.ece

"British house prices tumbled at a record 16.1 per cent in November, marking the sharpest drop in property values for a quarter of a century.

Figures released this morning by Halifax revealed that prices fell 2.6 per cent in November compared with October, and are 16.1 per cent lower than in November 2007.

The year-on-year decline is deeper than falls recorded during the last recession in the early 1990s, and is the biggest drop since 1983. "

Note: I think they meant to say since records began, as the market was rising in 1983

• Mortgage approvals: Record lows

http://www.telegraph.co.uk/finance/economics/houseprices/3538545/UK-mortgage-approvals-down-72pc-from-peak-Bank-of-England-figures-show.html

"The number of UK mortgage approvals dropped again in October, equalling their lowest low and 72pc down on their peak in 2007, according to the latest figures from the Bank of England."

• PMI (Purchasing Manager Index) - below 50 indicates outlook worsening

Services:

http://www.guardian.co.uk/business/2008/dec/03/recession-economics

"Britain's dominant services sector is shrinking at a record pace, a new survey showed this morning, suggesting the economy is heading into a deep recession."

 Manufacturing:

http://www.telegraph.co.uk/finance/economics/3538439/UK-manufacturing-shrank-to-record-low-in-November-PMI-report-shows.html

"The closely watched manufacturing Purchasing Managers' Index (PMI), which combines orders and output levels in British factories, was 34.4 - the lowest level since the series began in 1992 and the biggest ever one-month fall."

Construction:

http://www.guardian.co.uk/business/2008/dec/02/construction-recession-economy

"Further grim news on the economy emerged this morning as a survey showed the country's once-booming construction sector contracted for the ninth month running in November - and at the fastest pace on record"

No graph as Bloomberg only has a few months of data

• Unemployment: Highest level for 11 years

http://news.bbc.co.uk/1/hi/business/7724084.stm

• Manufacturing Production:

http://www.telegraph.co.uk/finance/financetopics/recession/3688680/Manufacturing-and-mining-drags-UK-industrial-production-down-more-than-expected.html

"Figures from the Office for National Statistics showed that manufacturing output fell by 1.4pc in October - the eighth monthly fall in a row and the longest run of falling output since 1980."

• Industrial Production:

http://www.guardian.co.uk/business/2008/dec/09/recession-interest-rates

"Britain's economy may be deeper in recession than previously thought after official data showed that industrial output plummeted at the fastest rate in nearly six years in October, with previous months also weaker than estimated."

 

Conclusion: It would appear that the pre budget report's claim that the economy will grow in the second half of 2009 may be a tad optimistic.

http://news.bbc.co.uk/1/hi/business/7775802.stm

This Scientific American article seems to think so

http://ftalphaville.ft.com/blog/2008/11/26/18734/quant-blame-me/

I put my comments on FT -  do the people writing these articles have any experience whatsoever about what goes on in an investment bank?

"These lapsed physicists and mathematical virtuosos were the ones who both invented these oblique securities"

The quants don't invent anything - they get told what to do by the traders/structures.

An article in defence of the humble quant

http://tbm.thebigmoney.com/articles/judgments/2008/12/01/model-made-me-do-it?page=0,1

UPDATE: Wilmott talks quants

http://us.ft.com/ftgateway/superpage.ft?news_id=fto113020081732485262

"One of the many heuristics that affect our investment decisions is representativeness, or simply stereotyping. Our tendency to chase performance is an example of the representativeness heuristic, as we misjudge past performance to be representative of future performance. Computers tell us past performance has little to do with future performance, yet most plan sponsors and fund of funds managers will only hire investment advisers whose past performance has been superb"

Discussed here

and here

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

I didn't get round to shorting them in my fantasy portfolio as I was originally filtering for BBB names

http://www.noelwatson.com/blog/PermaLink,guid,0c5c8ee2-cafe-4a5f-9f55-e0a0af90dc9e.aspx

but this would've been one of the names in the next sweep.

Here is the 5Y CDS displayed in non-upfront format

Moody's predicted surge in defaults last week

http://www.noelwatson.com/blog/PermaLink,guid,6767fd28-27f6-4207-8989-4f61579fad6b.aspx

Happened last week

http://www.ft.com/cms/s/0/0f8c0216-b193-11dd-b97a-0000779fd18c,dwp_uuid=e8477cc4-c820-11db-b0dc-000b5df10621.html

http://www.guardian.co.uk/business/2008/nov/13/useconomy-congress-hedge-fund-managers

but only stumbled upon transcripts today

http://oversight.house.gov/story.asp?ID=2271

Soros made a fortune in 1992

Simmons runs RennTech

http://en.wikipedia.org/wiki/Renaissance_Technologies

Paulson shorted ABX indices

http://www.businessweek.com/investor/content/mar2007/pi20070308_900631.htm?chan=investing_investing+funds

Falcone is (was?) shorting Santander (they appear to have a very low CDS spread - even after recent rights issue)

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4926277.ece

Griffin's Citadel is in the news

http://www.bloomberg.com/apps/news?pid=20601087&sid=axLc1BT2ZXbA&refer=home

http://www.ft.com/cms/s/0/477331c6-b0e0-11dd-8915-0000779fd18c.html

"Company default rates could rise to levels not seen since the Great Depression because of the rapid deterioration in the global economic outlook since the collapse of Lehman Brothers."

In my fantasy portfolio (posted soon), I will be selling ITRAXX Europe as soon as the first European index name (either XOver or main) goes pop.

Some Moody links here

http://www.noelwatson.com/blog/PermaLink,guid,e4d4de0b-75ea-4f20-a45e-85c8c5b86ffd.aspx

Commented on this the other week

http://www.noelwatson.com/blog/PermaLink,guid,4201f9f3-e07d-4a32-ab5c-90d85c4f0465.aspx

and at the end wondered how accurate the predictions would be as I feel the market is not pricing in the pain the UK is yet to suffer

http://uk.reuters.com/article/businessNews/idUKTRE4AA1X720081111

First WPP. I looked at these last week

http://www.noelwatson.com/blog/PermaLink,guid,5b8b455a-122a-4434-9c94-b207983b0a15.aspx

when looking at BBB rated entities with the highest CDS spreads. Note that I was not looking at the +/- after the BBB, as my investigation was concerned with seeing which names were likely to be downgraded to junk. WPP have been downgraded from BBB+ to BBB by S&P

At the time, WPP were trading with a 5Y mid of 287 and share price of 400.5. They are now 310 and 356. of course, this doesn't really tell us much as

• We have a small sample size
• Stock could be a high beta, and FTSE is down 10% over last week
• Noise

However, it will be worth monitoring to see if it gets downgraded again.

DSGI have been cut by Fitch to BB- from BB+. They were part of a high yield portfolio I looked at recently

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

CDS is now 850 compared to 750 in the above link

I talked about outperforming fund managers over two years ago

http://www.noelwatson.com/blog/PermaLink,guid,2060fb25-5d11-4a30-93b1-9c257651b104.aspx

Those that dispute the Efficient markets Theorem (EMH)

http://en.wikipedia.org/wiki/Efficient_market_hypothesis

argue that the fact that there are fund managers that have outperformed the index for several years indicate that the theory must be false. One example of these small band of investors was Bill Miller

but his fund suffered in the first half of 2008. Buffett is another of the market outperformers

but even Berkshire Hathaway report losses (partly due to derivatives - Buffett intends to hold these positions to maturity so will show a loss only because he is MTM rather than realised loss). Buffett recently announced that he is buying U.S. shares,

http://www.guardian.co.uk/business/2008/oct/17/warren-buffett-shares-markets

but could it be that we are suffering a market downturn not seen since the Great Depression, and markets have a lot further to go.

Someone that believes in EMH will go for a cheap (and accurate) index tracker rather than employing a fund manager to add value

http://www.investopedia.com/articles/mutualfund/03/070203.asp

The same may also be true for commodity future funds

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1279594

The pound has been whacked against the dollar recently

as people realised that while the U.S is suffering, the U.K. isn't far behind. In fact the EU say that the UK will suffer more than any mature EU economy.

http://www.guardian.co.uk/business/2008/nov/03/recession-economicgrowth

This will come as a surprise to those that believed Gordon's claim that Britain was better prepared than most to deal with the global downturn that started in the U.S. (never forget to omit global and U.S!)

http://www.guardian.co.uk/politics/2008/jan/06/uk.economy

FX analysts are predicting that GBPUSD will creep upwards over the next few years

but will their predictions be as bad as the equity analysts, and have they fully priced in the upcoming UK downturn?

http://www.noelwatson.com/blog/PermaLink,guid,6ff32223-b54c-4ac6-b1e3-6baf7d232c07.aspx

BT was one of the constituents in the HY portfolio discussed a few days ago

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

On Friday it issued a profits warning, so I thought I would see if it would trigger any reasons for selling

Reasons to sell

• Entity gets downgraded below BBB (probably too late to save majority of the fall in share price)
• CDS spread is greater than 2.5 times ITRAXX, or spreads goes above 500bps.
• Entity gets included in XOver on index roll

S&P placed BT on negative watch on Friday, but it is still BBB. The CDS spread was around 190 in early morning trading compared to the ITRAXX at around 150. So it hasn't given us a reason to see. However, I think a profits warning may well be reason to sell (if I didn't operate a hold forever portfolio), so I will be adding that to my reason to sell list. BT closed at 115 on Friday compared to FTSE at 4377. Will revisit to see whether selling would've been a good idea.

original post

http://www.noelwatson.com/blog/PermaLink,guid,e3de871d-7c56-437d-bd33-239b97de44e8.aspx

and some more

http://www.cnbc.com/id/15840232?video=921233906

I've spoken about the CPI target in the past

http://www.noelwatson.com/blog/PermaLink,guid,3f7c123f-446d-4e2a-8c96-c9d104c29373.aspx

but thought I would investigate further. The CPI was introduced in December 2003

http://www.hm-treasury.gov.uk/monetary_policy_uk.htm

replacing the RPIX. The new target was 2% vs 2.5% for the old. It follows that the historical gap of RPIX vs CPI should be 0.5% if we are to avoid monetary easing/tightening due to the new target. The average difference between the two from 31/03/1989 to 30/11/03 is 0.7%. However, at the extremes, the highest RPIX is 1% greater than CPI (9.5% vs 8.5%, 1.5% vs 0.5%), so it would appear CPI tends to underestimate the further we are from trend. Furthermore, at the time of introduction, there was 1.2% difference between the two.

CPI

RPIX

We can see the same info here. Note median of 0.9

I picked 31/03/1989 as the start date as it was the earliest that CPI went back. If we cut our filter to 30/11/93, we see a mean of 0.85. Maybe the period in 1991 when CPI was above RPIX was an anomoly.

If we look at the period since CPI was introduced, we see a mean of 0.7, and median of 0.8

So assuming we were forced to stick with CPI, one could argue that a target of 1.75% would reflect an RPIX of 2.5% more accurately. This would've set the alarm bells off slightly quicker, but maybe CPI is the wrong measure completely. Maybe RPI (not RPIX) with a target of 2% would've prevented this unprecendented boom

The problem here is that it is targeting mortgage repayment, and not asset prices. So for example

Using FSA calculator

http://www.moneymadeclear.fsa.gov.uk/tools.aspx?To...

Mortgage: £200000
Repayment period: 25
Interest rate: 7%

Monthly repayments: £1413

Cut rates to 3%, and the same person can now borrow £300000 and his monthly payments are still the same, yet his debt levels are 50% higher, and need to be repaid at some point. The problem here is, either:

a). We are in a new paradigm, and inflation is permanently low. This means that interest rates can stay at the low 3%. Unfortunately, wage deals tend to be closely related to inflation, so our man is getting 3% pa wage increases. The debt burden will be hanging round his neck for many years to come (unlike people in the late 80s/early 90s where wage increases peaked at 10%)
b). Alternatively, interest rates go back to 7%, and our man finds payments impossible.

From the above we need to have some way of monitoring debt levels as opposed to merely monitoring the cost of servicing the debt.

I briefly looked at single name CDS vs. share price,

http://www.noelwatson.com/blog/PermaLink,guid,27af9f1a-63b5-4e47-88a9-59d03ed7f90d.aspx

but today want to look at the credit and equity indices, and in particular, why the equity market has taken so long to price in the upcoming downturn. Way back in August 2007, the ITRAXX spiked from 20 to 60bps, and in March of this year was at 160bps, yet the FTSE was still over 6000 in April, compared to ~4000 today

One reason could be that equity analysts are a lagging indicator

http://ftalphaville.ft.com/blog/2008/10/22/17316/montier-analysts-are-rubbish/

yet people still take note of what they say. Earnings per share is still expected to rise according to the analysts

So on paper, the FTSE appears to good value relative to historic averages

with a yield of over 6% and P/E under 8. However, how much will earnings and yield be cut in the upcoming recession? Furthermore, while the market may be cheap, it can get a lot cheaper - FTSE All Share was yielding 10% in 1974.

http://www.thisislondon.co.uk/standard-business/article-23569535-details/It's+got+so+bad+that+even+the+bears+are+buying/article.do

I have commented on this in the past

http://www.noelwatson.com/blog/PermaLink,guid,2060fb25-5d11-4a30-93b1-9c257651b104.aspx

Stephen Bland no longer writes for the Motley Fool and instead writes a subscription newsletter for MoneyWeek

http://www.moneyweek.com/about-us/the-moneyweek-team/stephen-bland.aspx

Before he left Fool, he gave an example portfolio for troubled times

http://www.fool.co.uk/news/investing/high-yield/2007/11/20/high-yield-picks-in-a-troubled-market.aspx

Bland's belief was that the best time to invest is now, and you shouldn't think you know what the future holds. Furthermore, the portfolio should be held indefinitely, as you are unable to predict the future. The portfolio is now almost a year old, so I thought I would do a little analysis. The HYP has fallen slightly more than the FTSE (-39.76% vs -38.14%). Certain shares have fallen more than others. For example, Taylor Wimpey is worth 5% of purchase price.

Were there any warning signs that could have told us that maybe we should sell? I decided to look at the CDS spreads (credit markets are notoriously slow to react). Unfortunately, Taylor Wimpey doesn't have an active CDS market, so onto another big faller.

I didn't pick RBS as its spread has been influenced by the BOE bail out, so instead will pick DSGI. Downgraded by Moody to speculative grade in May, by this point the stock had almost halved. So what did the CDS market show us? Soon after Christmas, DSGI started to move out, from around 100bps to 450 in mid Feb.

compared with the ITRAXX Europe which jumpled from 50bps to 160bps in the same period

So the first question could be, "Should be have a ratio of single name spread change to index spread change, and if our entity breaches it, we sell?"

I'm not sure it is as simple as this, as Rexam's CDS spread has gone from 60bps to 380bps, yet its share price has outperformed the market

and even Glaxo's CDS spread (the best performer) has gone from 27 to 110. So maybe we could have a rule that says if spread > MIN (500, ITRAXX Europe*2.5) sell. Furthermore, we could exclude names for which there is no CDS spread. of course, we cannot get excess return without taking risk, but maybe we can mitigate some of the risk by applying mechanical rules.

Here are my initial suggestions

Purchase

• Entity must be BBB rated or above when purchased
• Entity must have liquid CDS spread (tricky in current market!), and this must be no greater than 1.5*ITRAXX Europe
• Entity must not be in ITRAXX XOver (DSGI is in this list)

Reasons to sell

• Entity gets downgraded below BBB (probably too late to save majority of the fall in share price)
• CDS spread is greater than 2.5 times ITRAXX, or spreads goes above 500bps.
• Entity gets included in XOver on index roll

Research has been done into the link between credit spreads and stock prices

http://thesis.haverford.edu/dspace/bitstream/10066/1447/1/2008HaferS.pdf

but no link was found between the two that could be used to make excess return.

Attcahed is spreadsheet with working

HYP.xls (26 KB)

Will update at a future date

http://www.hedgeweek.com/articles/detail.jsp?content_id=48740

Index was launched in 2007

"According to Merrill Lynch, simulated back testing of the Equity Volatility Arbitrage Index has outperformed most major global broad-based investible and non-investible hedge fund benchmark indices.

Moreover, the firm says, the strategy returns were negative in only three quarters over the past 18 years. The source of this strong performance is the high demand for S&P 500 index volatility relative to supply, a structural imbalance that has persisted for decades"

Looking at the price graph, it would appear that the index has indeed given strong performance

But if we look at the last few weeks...

The perils of backtesting.....

FT:

• Pensions have billions in toxic assets

http://us.ft.com/ftgateway/superpage.ft?news_id=fto101920081613587193

Looks like the U.K. funds may be O.K.

"However, the UK appears to have escaped relatively unscathed. David Norgrove, chairman of the Pensions Regulator, said a survey of the UK's 80 largest schemes found "relatively limited exposure" to toxic assets.

• UK pensions beat the crash

http://us.ft.com/ftgateway/superpage.ft?news_id=fto101920081613587192

        Good to see a surplus even in troubled times.

• Trustees should take asset allocation advice

John Redwood (I mentioned his blog a few posts back) makes the point that as it is almost impossible to pick shares that beat the index, instead they should be selecting the correct mix of assets to outperform. I'm not sure how it will be any easier to do the latter then the former

• Only the brave buying up junk

http://us.ft.com/ftgateway/superpage.ft?news_id=fto101920081613597200

It will be interesting to see how these funds perform with the level of corporate defaults expected to rocket

• How to save a column from Armageddon

http://www.ft.com/cms/s/0/822be2cc-9c6d-11dd-a42e-000077b07658.html

"I have just been listening to someone who worked on Wall Street in 1929, and it seems it isn’t. Irving Kahn, now 102, was last week interviewed on the BBC World Service and crisply said that today “things are a great deal better. People are spoiled”. The main villains, he said, were the journalists – “the reporters who want to get attention writing up headlines saying how bad it is"

• Lamppost in the dark mathematics:

http://www.ft.com/cms/s/0/eb87dcda-9e3e-11dd-bdde-000077b07658.html

The author of this letter proposes that normal distribution is hopeless. he then goes on to mention alternatives such as Mandelbrot's fractal work. The problem with this is that Mandelbrot does not propose a system that can be implemented - maybe this is not possible

http://www.amazon.co.uk/Mis-Behaviour-Markets-Benoit-Mandelbrot/dp/product-description/1861977654

• A long way down

http://us.ft.com/ftgateway/superpage.ft?news_id=fto101920081602167168&page=2

Bubbles are getting much easier to identify (admittedly in hindsight). Maybe this is because there has been some much money sloshing round the system due to central banks that we are getting more experienced at seeing the warning signs. We have seen housing pop, oil at $140 was (IMO) a bubble, and commodities are plummeting. Will Dubai be next?

• Nervous times for investors in loan markets

http://us.ft.com/ftgateway/superpage.ft?news_id=fto101920081750287216

It was my understanding that LCDS always traded tighter than CDS due to expected greater recovery rate

http://www.fitchratings.com/dtp/pdf1-08/ibas0110.pdf

"What then of the spread relationship between CDS and LCDS? Theoretically, players in
both structures generally face the same risk of a credit event being called, therefore,
besides market technicals (a very significant consideration), recovery expectations should
really be the primary driver of differences in trading levels. Making this assumption,
what is commonly done is to compare the ratio of the LCDS spread to the CDS spread, and
relate that to the ratio of their respective expected recovery rates"

Maybe the LevX/LCDX are suffering illiquidity in the indices, much like ABX a while back

• The view isn’t pretty as the banking crisis dust settles

http://www.ft.com/cms/s/0/30645a4e-9df5-11dd-bdde-000077b07658.html

"All this has not been lost on the equity markets. The yield on European non-financial stocks, according to Citigroup, is now higher than that on a basket of European sovereign bonds. This is unprecedented, at least in the 45 years Citi has looked at the data.

For the entire European market including financials, Merrill Lynch says, the yield is now the highest since 1975. Put those together, and the market plainly expects sweeping dividend cuts.

Merrill calculates that in the three last recessions dividends were only cut by 8 per cent on average, against falls in earnings of 35-40 per cent. And bank dividends only fell by 7 per cent."

Could now be the perfect time to buy into the indices? Buffett seems to think so.

http://www.guardian.co.uk/business/2008/oct/17/warren-buffett-shares-markets

 

Telegraph:

• House prices are close to affordable levels, reveals survey

"Diana Choyleva, director of Lombard Street Research, said prices were unlikely to fall much more than 20pc, and should stop falling by mid to late next year"

Not sure where they are getting their information from. If only these people would accept a small wager!

iI would appear that Gordon has done a good job convincing the public that the current crisis wasn't his fault

I disagree

http://www.noelwatson.com/blog/PermaLink,guid,bc024a3b-6d2a-4ea1-bd0e-052811080655.aspx

at current risk models being used, and people who think they can model events accurately

http://www.youtube.com/watch?v=ABXPICWjFIo

related article

http://online.wsj.com/article/SB122385689217827341.html

and this is the kind of person that Taleb talks about

"Nigel Marriott thinks it is a genuine Black Swan event, "a one-in billions" chance"

http://www.bloomberg.com/apps/news?pid=20601109&sid=acw1G8iS8oXc&refer=home

Note that their data only when back to 1992 (so missed the 1987 crash), and also note that these banking disasters tend to happen with regular frequency (admittedly not of this magnitude)

UPDATE:

Taleb's clients have benefitted from market turbulence

http://www.bloomberg.com/apps/news?pid=20601087&sid=aDVgqxiT9RSg&refer=home

Gordon Brown is angry with the bankers for causing the the current crisis.

http://www.thisislondon.co.uk/standard/article-23569789-details/Brown+at+war+with+the+City/article.do

His anger with the bankers is second only to his fury at the Americans for creating this mess. If it wasn't for these two groups the UK would allegedly be in fine fettle. The scary thing is, the UK population are starting to believe this.

Now Gordon Brown must be right, as he has the astonishing ability to eliminate the economic cycle

http://www.guardian.co.uk/politics/2000/sep/25/labourconference.labour6

"We will not put hard won economic stability at risk. No return to short-termism. No return to Tory boom and bust."

When a politician makes these claims, it is always good to look at facts to see how much they are lying. Did the bankers cause these problems? Did America cause this, and if so, why are they different from the UK?

First the U.S.

• In 1999, the Clinton Administration encouraged low and moderate income people to buy housing

http://query.nytimes.com/gst/fullpage.html?res=9C0DE7DB153EF933A0575AC0A96F958260&sec=&spon=&partner=permalink&exprod=permalink

• Alan Greenspan famously said he couldn't identify a bubble until it had burst

http://en.wikiquote.org/wiki/Alan_Greenspan#Quotes_on_the_Housing_Bubble

Look at the graph below, why would interest rates be cut to 1% when housing was looking increasingly overvalued.

So, Brown may have been right about America causing this mess, but could it be just bad luck that the US bubble burst before the UK one?

In 1997, the Bank of England were granted operational independence over monetary policy

http://en.wikipedia.org/wiki/Bank_of_England

this sounds all well and good, but depends on what inflation target the BOE is given.

http://en.wikipedia.org/wiki/Consumer_price_index_by_country#United_Kingdom

In my opinion, the CPI is flawed - look at the Halifax house prices below - why were house prices going up at such a rate when inflation was at or near target?

Furthermore, in 1997, the Government gave responsibility for managing debt to the FSA

"Concurrent with assuming control of the interest rate in 1997, the bank transferred the duty of managing the government's debt to the Treasury Department and its regulatory functions were assumed by the Financial Services Authority ("FSA"). "

http://www.gocurrency.com/articles/england-bank.htm

Appointments to the MPC committee seem somewhat dubious (article below is admittedly not the most impartial!!)

http://www.johnredwoodsdiary.com/2008/05/17/why-has-the-government-and-the-bank-of-england-failed-us-on-inflation/

So where does this now leave us?

• We have unprecedented levels of personal debt

http://www.independent.co.uk/money/loans-credit/for-the-first-time-britons-personal-debt-exceeds-britains-gdp-462825.html

• Negative savings rate

http://business.timesonline.co.uk/tol/business/economics/article4854282.ece

and negative real interest rates meaning that people are unlikely to start saving anytime soon

http://www.telegraph.co.uk/finance/personalfinance/savings/3166408/Financial-crisis-UK-savers-lose-out-with-negative-real-interest-for-first-time-in-27-years.html

(I mentioned this previously)

http://www.noelwatson.com/blog/PermaLink,guid,ac794dad-98e0-4bde-b5b0-d05409bea9fa.aspx

• The less said about public sector debt the better (Private Eye are good for this)
• Housing is now more overvalued than the U.S.

http://www.reuters.com/article/ousiv/idUSTRE49767320081008

Jeff Randall sums it up well

http://www.telegraph.co.uk/finance/comment/jeffrandall/3168301/Debris-from-the-City-and-Wall-Street-will-destroy-innocent-lives.html

To conclude, the bankers must share the blame, but I believe the central banks (partly through constraints placed upon them) should take most of the blame. If you look at the economic problems in the last century, the central banks, in hindsight, have made the problem worse. Take the Great Depression

http://en.wikipedia.org/wiki/Great_depression

"Monetarists, including Milton Friedman and current Federal Reserve System chairman Ben Bernanke, argue that the Great Depression was caused by monetary contraction, the consequence of poor policymaking by the American Federal Reserve System and continuous crisis in the banking system"

Brown may gloat at the current U.S problems, but I am certain that the UK are only 12-18 months behind in the slide into recession.

It is all well and good to criticise without offering a better solution - here is mine.

• An inflation measure must be chosen that has asset prices as an input. Using the CPI measure is flawed (it is flawed even for the EU - one size does not fit all - see Ireland and Spain).
• House prices must form a large part of this measure. We should take the long term trend (e.g. 2% pa over wage increases). Whenever it deviates +/-2% from this target, the input into the overall inflation target will change
• Money supply needs to be targeted. Mervyn King said that inflation and money supply are strongly correlated - yet we ignore M4 numbers.
• Members of the MPC must be selected by an independent committee.
• The Government debt controls should be placed back under control of the BOE
• The rating agencies need to be improved. They, along with the FSA need to recruit the best people that would otherwise go into banking. For this, they must pay top rates.
• The banks may need to be better regulated - this is a tricky one

UPDATE 1:

• Brown says no return to boom and bust

         http://www.youtube.com/watch?v=E5UILQzJgCA

http://www.youtube.com/watch?v=aCQREoAmsu0

 

• Greenspan talk about subprime in 2005

http://www.federalreserve.gov/BoardDocs/speeches/2005/20050408/default.htm

"With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. The widespread adoption of these models has reduced the costs of evaluating the creditworthiness of borrowers, and in competitive markets cost reductions tend to be passed through to borrowers. Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s."

There have been a lot of people on various forums expressing surprise about the events unfolding in Iceland. Some are saying that there was no warning.

(I discussed this on another forum back in April)

http://www.pistonheads.co.uk/gassing/topic.asp?h=0&t=518561

People are upset at Martin Lewis on MoneySavingExpert

http://blog.moneysavingexpert.com/2008/04/01/icesave-how-safe-are-your-savings-facts-and-myths/

"Icesave has high interest rate accounts, and is a best buy in certain categories. That makes it an attractive account. The risk of it going bust, doesn’t seem to be very substantively more than any other top savings account bank and this is unlikely to happen (though nothing’s impossible)".

I don't agree with the above. I used to look at the CDS spreads in our flow desk blotters and the Icelandic banks (Glitnir, Kaupthing, Landsbanki) were always in the top 10 highest CDS spreads over the last year or so.

(note that I haven't included the last month's data as it compressed the y axis too much)

Compare this (Landsbanki) with Abbey (part of Santander, so they trade approximately the same CDS levels). Now I'm not sure what rate Abbey were offering at the time, but seeing a CDS spike above 800bps sets alarm bells ringing.

There has been lots of debating as to whether these spreads have been justified - they are illiquid in the CDS market (typically 850/950 bps), so hedge funds were rumoured to be pushing them wide

http://www.efinancialnews.com/assetmanagement/index/content/2450194340

http://www.moneysupermarket.com/community/forums/t/turnaround-in-icelandic-cds-levels-signals-end-of-20926.aspx

I have also read research pieces saying that there were forced protection buyers at the short end of the curve pushing the curve wider.

I am a believer that certain markets (maybe not credit) are reasonably efficient, so while the market may not be right all the time, it would be foolish to ignore them.

The same goes for the betting exchanges (Spreadfair etc) that were showing falls before the general population cottoned on.

Lots of people in the city are getting annoyed with Peston - as one trader to me said, "If I was doing that I would be in serious trouble. He is mentioned on the Guido blog

http://www.order-order.com/2008/10/pesto-wire-causes-more-misery.html

and has a fan club

http://robertpestonmustdie.blogspot.com/

EDIT:

Michael Howard has asked the FSA to investigate

http://www.order-order.com/2008/10/exclusive-michael-howard-complains-to.html

I wonder what the outcome will be (can't be hard to guess)

Peston is saying the HBOS deal will go through

http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/10/insane_markets_and_hbos.html

The credit markets show

LLOY 185/200

HBOS 315/345

Which will be right?

Last time this happened was around 25 years ago

http://www.telegraph.co.uk/money/main.jhtml?view=DETAILS&grid=&xml=/money/2008/03/14/bcnbear414.xml

As discussed in the counterparty example a couple of days ago

http://www.noelwatson.com/blog/PermaLink,guid,98491b4a-d1ef-40a0-b115-3252e87ae62a.aspx

Firstly Ben proposed that lenders allow borrowers off some of the principal

http://www.federalreserve.gov/newsevents/speech/bernanke20080304a.htm

as this will be cheaper than allow the borrower to foreclose

Then we have Darling saying that we should have a gold standard of mortgage to get the MBS market moving again

http://www.ft.com/cms/s/0/cfb0b2ca-ea2f-11dc-b3c9-0000779fd2ac.html

No doubt this will make the same flawed assumptions that the other rating agencies made - using historically low levels of defaults and not taking into account fat tails in their calculations.

I think these two should stop trying to influence the market and let it run its course - even if there is some pain along the way

On a related note, Darling is planning to exclude Northern Rock from the budget

http://business.timesonline.co.uk/tol/business/economics/article3486125.ece

thereby keeping the net debt below the 40% GDP rule (something that Gordon has manipulated in the past). I wonder if PFI will make an appearance

http://www.guardian.co.uk/business/2008/feb/19/northernrock.banking3

Until recently, Xenomorph has been using a proprietary model to store data. However, reading in the latest Wilmott magazine (January 2008 - "Spreading Wings"),

(article should appear here at some point)

http://www.xenomorph.com/news/

CEO Brian Sentance talks about how Xenomorph are working with Microsoft to store the data on SQL Server. It will be interesting to see what performance can be achieved in the relational world (assuming that is how it is implemented).

On a related note, SQL Server is falling down the rankings on the TPC-C league

http://www.tpc.org/tpcc/results/tpcc_perf_results.asp?resulttype=noncluster

if SQL 2008 offered any tangible performance improvements I would have expected to see an entry by now

There are new records in other areas

http://blogs.msdn.com/sqlperf/archive/2008/02/27/sql-server-2008-launched-today-with-great-performance-amp-scalability.aspx

http://www.tpc.org/tpce/tpce_perf_results.asp

but could this be down to hardware improvements? Furthermore, the absence of competing databases implies that other vendors don't take this as seriously

First SocGen and Risk Magazine's award of Equity Derivatives House of the Year

http://www.risk.co.uk/public/showPage.html?page=685494

now Peleton and EuroHedge awarding credit prize

http://www.hedgefundintelligence.com/Event.aspx?ProductID=7122

I was looking at MoneySupermarket and comparing mortgage rates. A mortgage from Cheltenham and Gloucester came up as having the best rate of 4.99%, but further investigation showed that it came with a 2.5% initial fee

I therefore wrote a very simple calculator to work out how much the total cost of an interest only mortgage is for a given set of criteria taking the initial fee into account

In the example shown above, for a 2 year £100000 mortgage with an interest rate of 5.49% and fee of £899, the total cost is £11273.

http://www.bankofengland.co.uk/monetarypolicy/pdf/cpiletter070417.pdf

http://www.hm-treasury.gov.uk/media/FEE/3D/chxresponse_170407.pdf

I am confident that inflation will not return to 2% unless rates are raised significantly

Not entirely unexpected - to me it seems that the Bank were trying to keep CPI as close to 3% as possible without breaching it rather than aim for their official 2% target. RPI is now at 4.8%.

http://www.statistics.gov.uk/pdfdir/cpinr0407.pdf

http://www.statistics.gov.uk/pdfdir/cpi0407.pdf

http://www.bloomberg.com/apps/news?pid=20601087&sid=ahFq3UK672s8&refer=home

The minutes of the April meeting will be out tomorrow - I would be surprised if people are now not losing faith with the ability of the MPC to make the tough decisions when necessary.

Of course, real inflation is much greater than 3.1%, but we are stuck with this measure for the time being. I calculated my inflation and it was substantially more than the headline rate.

http://www.telegraph.co.uk/money/graphics/2007/03/31/YourInflationMar07.xls

The pound is very close to 2 dollars

and Betfair are showing an almost guaranteed interest rate rise next month

CVC's attempt to buy J Sainsbury appears to be over

http://news.independent.co.uk/business/news/article2442076.ece

with the 5Y CDS spread trading at  ~45 bps, down from its peak of ~130 bps, but still above the spread of ~25bps 6 months ago.

However, as can be seen from the chart below, the share price hasn't decreased by as much. If it mirrored the CDS spread, i would expect it to return to below £5.00.

Two things to note:

• Usually share prices and CDS spreads move in opposite directions - if a company is in trouble the shares go down as the perception is that the company is worth less and the CDS spreads increase because there is more likelihood of default. A leveraged buyout is different. The CDS spreads increase because the buyout will be financed using debt, making the company more risky, and the share price usually increase because the potential bidder tends to offer more than the market value to tempt people to buy into the offer
• In common with several other entities (Nokia being one that springs to mind), Sainsbury does not have any unsecured debt outstanding

http://ftalphaville.ft.com/blog/2007/04/11/3757/cds-report-market-awaits-cvcs-next-move-on-sainsbury/

I used to hold SBRY when it paid a good yield (around 6%) but sold it when the dividend cut was announced. If I were to attempt to make money from my above beliefs, I would either

• Go short on SBRY stock
• If I was worried about a buyout still happening (and assuming I could trade CDS as a private investor), I would buy CDS protection as a hedge.

http://www.finextra.com/fullstory.asp?id=16606

http://www.finextra.com/fullstory.asp?id=16254

The FTSE dipped below 6000 yesterday

As soon as 6000 was breached it quickly fell another 10 points before recovering later in the day

Even after the last week, FTSE volatility is still historically low (EWMA 5 day window)

Below shows the volatility of the ITRAXX Xover vs. FTSE 100 over the last few months

I haven't plotted the volatility of the main ITRAXX Europe index, but if it remains high, it will be interesting when the CPDO's come to roll on the 20th of this month.

The article below discusses the markets over the last week

http://www.ft.com/cms/s/7be783ec-cb51-11db-b436-000b5df10621.html

http://www.theserverside.com/news/thread.tss?thread_id=42563

Very biased towards Java (banks do write real time trading applications in .NET - my client is one of them), but worth listening to as it gives a good idea of what tools are being used in banks i.e. Tibco Rendezvous, and what the Java equivalent is for the .NET stuff we do.

Also worth reading the comments in the thread afterwards. One of the things discussed is "in memory" databases -

http://www.oracle.com/timesten/index.html

Oracle have TimesTen, but I can't find anything being developed over at Microsoft.

After the failure of LTCM

http://www.amazon.co.uk/gp/product/1841155047/026-8787779-9446068?v=glance&n=266239

it appears that Robert Merton's latest hedge fund related venture, IFL continuum, hasn't been too sucessful either

http://www.bloomberg.com/apps/news?pid=20601087&sid=api7F5j8W_nY&refer=home

http://www.amazon.co.uk/gp/product/1861977905/026-8787779-9446068?v=glance&n=266239&s=gateway&v=glance

An interesting book, and worth reading after Taleb to compare the two

http://www.noelwatson.com/blog/PermaLink,guid,f783a888-3239-433a-a850-db28dcc1994e.aspx

Mandelbrot differs from Taleb in that he thinks share prices are not random. Where they both agree is that share returns are not normally distributed.

As one of the reviewers on Amazon points out, a lot of talking is done about multifractals and how they can be used to generate accurate share price histories, but using fractals to assist with modelling is not really covered.

Now that I no longer pay for a service (Hemscott), I have found it difficult to get detailed information on shares - this site is one of the best I have found

http://fool.digitallook.com/?action=financials&ticker=BT.A&sub_action=fundamentals&page_view=financials

(Link shows BT Group's fundamentals)

I was reading this blog yesterday. The author talks about how some fund managers outperform the market, and a list of names are given. This is interesting to me after having just finished reading "Fooled by Randomness".

http://bigpicture.typepad.com/comments/2006/07/outperforming_f.html

Taleb believes that with a big enough pool of fund managers, probability dictates that some will outperform the benchmark, even over a long period of time.

I am currently reading Mandelbrot - the two authors have some contrasting opinions - review to follow

http://www.amazon.co.uk/gp/product/1861977905/026-8787779-9446068?v=glance&n=266239

UPDATE: After the comment from Barry, I thought I would give my opinion on outperformance. For a number of years I have invested my money using various mechanical strategies including:

• Stephen Bland's High Yield strategy

http://www.fool.co.uk/valueinvesting/2006/vi060630.htm?source=EDSP

• Validea

http://www.validea.com/home/home.asp

As can be seen from the links, these have outperformed their respective benchmarks over a timeframe of several years. If the market were truly efficient this shouldn't happen, unless we are at a particular point in the economic cycle that flatters these strategies. If I didn't believe outperformance were possible I would invest in a low cost tracker.

Other strategies that I've investigated but not yet invested are:

• Joseph Piotroski

http://www.alphaseeker.com/val03.htm

I wrote an application that downloaded all FTSE constituents (around 2200 at the time) from Hemscott and crunched the data to provide me with passing companies. I believe this strategy may be more suited to the U.S. as it requires quarterly reporting.

• Joel Greenblatt

http://www.amazon.co.uk/gp/product/0471733067/202-3803663-2591064?v=glance&n=266239

I was using Excel yesterday for some simple probability work, and what I was calculating as the standard deviation wasn't the same as what STDEV() was giving me. What I was doing was calculating STDEVP().

Difference shown below

Taleb has a blog on Wilmott

http://www.wilmott.com/blogs/kurtosis/index.cfm

and delivers a lot of lectures through 7city/Wilmott.

To summarise, Taleb proposes that success can be attributed to luck rather than skill. In theory, given enough investors, it is possible to produce another George Soros or Warren Buffett. When people fail, they put it down to bad luck, when people do well, they put it down to skill.

Futhermore, because the human mind tends to focus on the short term, people underestimate the risk of the "fat tail" event (one of LTCM's founders used this as an excuse for why the fund had failed). Taleb has a company, Empirica LLC, that takes advantage of this by buying options - on a typical day he will lose a small amount of money, but when a big market movement occurs (people selling the options underestimate this risk), he will make more than the amount he has lost, in theory.

http://www.amazon.co.uk/gp/product/0812975219/026-8787779-9446068?v=glance&n=266239

Free Office developer event in London

http://msevents.microsoft.com/CUI/EventDetail.aspx?culture=en-GB&eventid=1032301774

http://uk.finance.yahoo.com/q/hp?s=GM

This is useful for analysing characteristics of U.S. stocks (volatility, drift etc.) but is more limited for U.K. companies

http://help.yahoo.com/help/us/fin/quote/quote-12.html

http://www.wilmott.com/blogs.cfm

There are some impressive people blogging on Wilmott including authors of books I've read

• Satyajit Das
• Emanuel Derman
• Nicholas Nassim Taleb
• Paul Wilmott

http://www.amazon.co.uk/exec/obidos/ASIN/0273704745/qid=1150275471/sr=8-1/ref=sr_8_xs_ap_i1_xgl/026-8787779-9446068

This book has been discussed on Wilmott, with a few people moaning that it puts their profession in a bad light despite having not read the book.

http://www.wilmott.com/messageview.cfm?catid=11&threadid=38376

Das claims to have been in the industry for 25 years and has published a number of books

http://www.amazon.co.uk/gp/search/026-8787779-9446068?search-alias=stripbooks&field-author=Das,%20Satyajit

After reading Liar's Poker a while ago

http://www.amazon.co.uk/exec/obidos/ASIN/0340839961/sr=1-2/qid=1150275862/ref=sr_1_2/026-8787779-9446068?%5Fencoding=UTF8&s=books&v=glance

I hoped we'd get another similar book to carry on where that one left off. I personally feel that Traders Guns and money has almost pulled it off. The material in this book is very up to date, even discussing the GM downgrade in May 2005.

http://www.financialpolicy.org/fpfspb26.htm

There are a few good quotes in the book, including

"Selling options is like eating like chickens and sh*tting like elephants"

I felt that the book was maybe slightly too long and it drifted a bit after in the second half, but certainly worth reading

I spent some time looking around other parts of Bloomberg on Friday (I normally spend most time on AXCD). Looking at FTSE, I was comparing the index level with BBC and Yahoo, and discovered that Yahoo leads both BBC, and surprisingly Bloomberg.

• Yahoo

• BBC

• Bloomberg

http://www.amazon.co.uk/exec/obidos/ASIN/0471770574/qid=1148567945/sr=8-1/ref=pd_ka_1/203-6138512-1161516

Aaron Brown posts on Wilmott regularly

http://www.wilmott.com/tombstone.cfm?ProfileID=18

and the book was discussed on here

http://www.wilmott.com/messageview.cfm?catid=11&threadid=34004

This hasn't been reviewed on Amazon.co.uk yet, but has several reviews on the U.S. site

http://www.amazon.com/gp/product/0471770574/qid=1148567945/sr=8-1/ref=pd_ka_1/103-6532838-8605402?n=283155

Definitely a book worth reading - but it would be good to have a bit more written about his trading experiences rather than poker

MiFID requires that you are giving your client best execution.

http://www.fsa.gov.uk/Pages/About/What/International/EU/fsap/mifid/index.shtml

http://www.exchange-handbook.co.uk/articles_story.cfm?id=54127

Section 4.29 states that CDS (single name and tranches) come under the requirement

http://www.fsa.gov.uk/pubs/discussion/dp06_03.pdf

although section 4.39 indicates that equities will require the most transparency.

The following link appeared on ContractorUK today

http://www.contractoruk.com/news/002671.html

The Sensex was extremely volatile on Monday

with the market having to be suspended for an hour after it plunged 10%. The police have been told to watch for suicide attempts at likely spots such as lakes and canals.

http://inhome.rediff.com/money/2006/may/23mkt1.htm

http://www.hindustantimes.com/news/5922_1703947,0015002500000000.htm

http://www.iol.co.za/index.php?set_id=1&click_id=126&art_id=qw1148291100209B253

Looking at the performance over the past five years, there may still be a long way to fall

I have commented on this previously

http://www.noelwatson.com/blog/PermaLink,guid,35888a0f-c06a-4e6c-a818-5d4871ed35b3.aspx

but came across a similar problem in Excel today. A trader is using the INT() function to remove decimal places. A number such as 23.59 will become 23. However, our solution (correctly I believe) interprets this as 24. It may be that the trader should've used ROUND().

http://support.microsoft.com/kb/q196652/

• Calculating simple and compounded spot rate with Act/Act in a stored procedure

DECLARE @DaysInYear DECIMAL (4,1)

SELECT @DaysInYear = CASE YEAR(GETDATE())%4
 WHEN 0 THEN
   CASE YEAR(GETDATE()) % 100
    WHEN 0 THEN 365.0
    ELSE  366.0
   END
 ELSE 365.0
END

SELECT CAST(((1/DiscountRate)-1)/(DATEDIFF(dd, GETDATE(), DATEADD(mm, Term*12, GETDATE()))/@DaysInYear)*100 AS DECIMAL (4,2)) As SimpleCompoundingSpotRate,
CAST(-LOG(DiscountRate)/(DATEDIFF(dd, GETDATE(), DATEADD(mm, Term*12, GETDATE()))/@DaysInYear)*100 AS DECIMAL (4,2)) AS ContinouslyCompoundingSpotRate,
DiscountRate, Term FROM Term

• Same as above but with 30/360

SELECT CAST(((1/DiscountRate)-1)/Term*100 AS DECIMAL (4,2)) As SimpleCompoundingSpotRate,
CAST(-LOG(DiscountRate)/Term*100 AS DECIMAL (4,2)) AS ContinouslyCompoundingSpotRate,
DiscountRate, Term FROM Term

• Calculating discount curve from sport rate and vice versa in a spread sheet (no day count convention)

Attachment

SpotRate.xls (18.5 KB)

References

http://www.moneychimp.com/articles/finworks/continuous_compounding.htm

http://www.riskglossary.com/link/fixed_income_term_structure.htm

http://www.euribor.org/html/download/euribor_2006.txt

http://www.riskglossary.com/link/compounding.htm

Active Credit Portfolio Management - Page 153

http://www.forbes.com/markets/feeds/afx/2006/03/05/afx2571014.html

I was discussing this is in the context of GM last week

http://www.noelwatson.com/blog/PermaLink,guid,7f056791-b34d-4d40-9554-ad772079878f.aspx

I'm not sure there are any companies with a higher spread than GM that haven't subsequently defaulted. I will be watching the GM spread with interest today.

http://www.topix.net/content/krd/14496815494907807422

I firmly believe in the mechanical investing approach and believe that taking the human element out of the decision making enhances returns. Modern computers offer the ability to crunch massive amounts of data, and although past performance doesn't predict future returns, I think this is the future for simple asset types such as equities.

 I use Validea to tell me which shares I should be holding.

http://www.validea.com/home/home.asp

I always knew this to be true, but didn't realise until after I'd read the Fischer Black book that it had a name

http://mathworld.wolfram.com/SiegelsParadox.html

Following on from my discussion on active vs. Mechanical trading, I found the following on Wilmott

http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID881105_code191081.pdf?abstractid=881105&mirid=1

Note that this is taking into account fees.

This book detailed Black's advanced thinking and how his ideas were rejected by the economic community at the time. Of particular interest to me was his discovery that a typical active fund doesn't beat a passive tracker, and that value (low beta) shares outperform growth shares over the long run. This was back in the 70's, yet active funds are still very popular today.

http://www.amazon.co.uk/exec/obidos/ASIN/0471457329/qid=1139387144/sr=8-1/ref=sr_8_xs_ap_i1_xgl/026-0058056-7028455

http://www.math.uic.edu/~hanson/Finance/M_Page_QF.pdf

I've just finished Emanuel Derman's autobiography

http://www.amazon.co.uk/exec/obidos/ASIN/0471394203/026-8223383-2541264

I bought this book as I was interested to read about someone that was actually working with financial theory in the 80's and 90's on Wall Street. After discussion of his life as a physicist, the remaining half of the book talks about his time on Wall Street. Of particular interest is his discussion on the Black-Scholes model, and the problem with constant volatility and "the smile"

http://en.wikipedia.org/wiki/Black-Scholes

http://en.wikipedia.org/wiki/Volatility_smile

A recommended read - his site is good too.

http://www.ederman.com/new/index.html

Other non technical finance books that I recommend are

Liar's poker - discusses life in Salamon in the 80's - home of BSD's

http://www.amazon.co.uk/exec/obidos/ASIN/0340767006/qid=1138106679/sr=1-1/ref=sr_1_2_1/026-8223383-2541264

When Genius Failed - discusses the downfall of LTCM

http://www.amazon.co.uk/exec/obidos/ASIN/1841155047/026-8223383-2541264

Both books feature John Meriwether.

http://news.bbc.co.uk/1/hi/business/4623076.stm

Allegations of fraud from internet firm Livedoor caused the Nikkei to drop almost 3% - so far this week it has lost 6.8%.

What is surprising is that the market shut not because of the index dropping too much, but because volumes were too high - systems should be designed to cope with this.

There aren't that many books discussing both .NET and Finance

http://www.apress.com/book/bookDisplay.html?bID=10033

http://www.amazon.co.uk/exec/obidos/ASIN/1590595645/qid%3D1137504778/026-8223383-2541264

Published March 2006

Article in the Sunday Times yesterday

http://www.timesonline.co.uk/article/0,,2095-1985641,00.html

This isn't a new development - they were the most shorted back in November

http://www.timesonline.co.uk/newspaper/0,,2769-1879544,00.html

Data Explorers, the company that provides the data, has a graph showing the shorting

http://www.dataexplorers.co.uk/dxl/popups/mfi.html

Sells core brokerage business to private equity group for $768 million and Refco Inc. files for bankruptcy. None of the regulated subsiduaries have filed for Chapter 11.

According to The Guardian, hedge funds face crisis after a subsiduary of Refco suspended customer accounts

http://www.guardian.co.uk/usa/story/0,12271,1592054,00.html

Not sure how much of a crisis this will be - surely not as bad as the Ford/GM downgrades earlier in the year?

Listed below are some of the work related books I have read, newest to oldest, over the last couple of years.

.NET

• Effective C#

http://www.amazon.co.uk/exec/obidos/ASIN/0321245660/qid=1122547865/sr=8-1/ref=sr_8_xs_ap_i1_xgl/202-1389977-0403848

I bought this one from after a recommendation from a colleague. Managed to read within a day and learnt a few things, such as CLSCompliant attribute

http://msdn.microsoft.com/library/default.asp?url=/library/en-us/cpref/html/frlrfSystemCLSCompliantAttributeClassTopic.asp

• Customising the Microsoft .NET framework

http://www.amazon.co.uk/exec/obidos/ASIN/0735619883/qid=1122548063/sr=1-1/ref=sr_1_18_1/202-1389977-0403848

Not managed to read yet as other books have seemed more tempting

• Patterns of Enterprise Application Architecture

http://www.amazon.co.uk/exec/obidos/ASIN/0321127420/qid=1122548175/sr=1-1/ref=sr_1_3_1/202-1389977-0403848

A good read - helps you focus on reuse of code through identifying common problems and implmementing patterns.

• .NET Remoting

http://www.amazon.co.uk/exec/obidos/ASIN/0735617783/qid=1122549105/sr=2-3/ref=sr_2_3_3/202-1389977-0403848

Not that impressed. Maybe the book came out too early, but doesn't seem to follow best practice and isn't a patch on Rammer.

• Advanced .NET Remoting

http://www.amazon.co.uk/exec/obidos/ASIN/1590594177/qid=1122549105/sr=2-1/ref=sr_2_3_1/202-1389977-0403848

The remoting bible. Contains the vast majority of information you need on remoting. I have used code (encryption) from here in a production system. Supported by an excellent website.

http://www.thinktecture.com/

• .NET Components

http://www.amazon.co.uk/exec/obidos/ASIN/0596003471/qid=1122549335/sr=1-8/ref=sr_1_3_8/202-1389977-0403848

Read in conjunction with another O'Reilly C# book, Programming C#. Has been updated with 2.0 info

http://www.amazon.co.uk/exec/obidos/ASIN/0596007620/qid=1122549335/sr=2-1/ref=sr_2_3_1/202-1389977-0403848

• Programming C#

http://www.amazon.co.uk/exec/obidos/ASIN/0596006993/qid=1122549565/sr=2-3/ref=sr_2_3_3/202-1389977-0403848

A good introduction to C# and if you are a complete beginner, it may be worth reading the introduction book first

http://www.amazon.co.uk/exec/obidos/ASIN/0596003765/ref=pd_sim_b_dp_3/202-1389977-0403848

• Applied Microsoft .NET Framework Programming

http://www.amazon.co.uk/exec/obidos/ASIN/0735614229/qid=1122549739/sr=2-1/ref=sr_2_3_1/202-1389977-0403848

The .NET bible. This should be on every .NET developers bookshelf.

Finance

• Fixed Income Mathematics

http://www.amazon.co.uk/exec/obidos/ASIN/0786311215/qid=1122550071/sr=1-1/ref=sr_1_2_1/202-1389977-0403848

This book helps understand bond pricing calculations because it contains lots of examples with numbers. It is then easy to use the examples in code to arrive at the same result

• Paul Wilmott Introduces Quantitive Finance

http://www.amazon.co.uk/exec/obidos/ASIN/0471498629/qid=1122549959/sr=8-2/ref=sr_8_xs_ap_i2_xgl/202-1389977-0403848

Really easy to read - good introduction. Recommends the Fabozzi book in Chapter 14.