Gordon,
RE: LTCM
There were quite a few reasons why, in the end, that LTCM failed. As the partners of that firm said, they believed that they were a "vacuum cleaner" scooping up nickels on the ground. Of course, others believed that LTCM was, essentially, scooping up those nickels in front of a bulldozer. This was their convergence trade where they would essentially short the "on the run" 30 year treasury and go long the 29.5 yr treasury. Eventually, everyone entered that area of the market and the arbitrage opportunity, eventually, vanished.
Later, they entered the merger arbitrage (equity) and promptly lost a bundle on the failed Ciena merger.
When other brokerages learned that LTCM was "on the ropes", it is rumored that other brokerages took the "opposite" side of the LTCM trades causing them to lose even more money.
Basically, LTCM did not become insolvent b/c of Black Scholes.
Dave |
