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Non-Tech : Derivatives: Darth Vader's Revenge -- Ignore unavailable to you. Want to Upgrade?

To: Worswick who wrote (658)	12/1/1998 4:21:00 PM
From: Michael Friesen	Read Replies (1) \| Respond to of 2794

I wonder if some long-term technical analysis would help Fleck not be too "early"?

To: Worswick who wrote (658)	12/3/1998 11:14:00 PM
From: Thomas M.	Read Replies (1) \| Respond to of 2794

"Long-Term Capital notwithstanding, hedge funds are here to stay. One reason: They create lots of business for Wall Street." forbes.com Tom

To: Worswick who wrote (658)	12/4/1998 12:06:00 AM
From: Thomas M.	Respond to of 2794

forbes.com Nobel Laureates With Black Boxes By David Dreman THE LONG-TERM CAPITAL MANAGEMENT debacle came within a hair's breadth of creating a financial panic. Can it happen again? Yes, and next time we may not be so lucky. Two Nobel Prize winners were shareholders in Long-Term Capital. Myron Scholes was one of the originators of the Black Scholes option pricing model. Robert Merton developed the theory further. Both model and theory are rooted in the Efficient Market Hypothesis, which I have so frequently criticized. This theory holds that markets always react rationally to developments. This year was not the first time that these gentlemen and their theories have cost us all dearly: Variations of their formula were the prime cause of the Oct. 19, 1987 crash and the near-meltdown of the domestic financial system the following day. In 1987 a variation of the Black Scholes model caused two trading strategies—portfolio insurance and index arbitrage—to combine into a doomsday machine that cascaded tens of billions of dollars' worth of stock onto a collapsing market. The more it fell, the more the model ordered the computers to sell. It was only after the plug was pulled on these interactive computer-driven strategies that the decline was finally halted. The Brady Commission investigating the 1987 crash put part of the blame, but only part of it, on the trading strategies derived from the preachings of Merton and Scholes. By coincidence, perhaps, another Long-Term Capital partner, David Mullins, later a Federal Reserve vice chairman, was associate director of the Brady Commission and, along with the executive director, Robert Glauber, played a key role in selecting the senior investigative staff. Note this: Nearly the entire Brady staff either believed in the unrestricted use of financial derivatives or made megabucks using them. Nobody who was vocal about the potential dangers was appointed to the staff. Had there been a genuine diversity of opinion represented on the panel, I do not think that this variation of the model would have gotten off so lightly. And thus variations of the Black Scholes model continue to play the crucial role in pricing hedging and arbitrage strategies. It assumes that any panic, any unreasonable movement in the market, will be stopped by rational buyers or sellers moving in and stopping it. This idea, which runs counter to real world experience, seems to have mesmerized Wall Street at its highest levels. It's almost as though The Street were mesmerized into thinking that these academicians and the traders who followed them possessed magic black boxes. But investors are not as emotionless as the computers they program. If enormous selling pressures develop, or fear sweeps a marketplace, buyers simply evaporate. They do not act rationally; they do not even stop to think. Thus the 41.5% drop in the S&P 500 futures in the 1987 crash, or the near-collapse of credit markets in 1998. In a thoroughly rational world, the market could not have been worth 2500 on the Dow one day in 1987 and only 1800 a few days later. Nor would the "flight to quality" have gone as far as it did in October of this year. It is sad that one of the staunchest defenders of this gobbledygook science is the Financial Analysts Journal, whose first editor was Benjamin Graham. Its editorial board has for years been a club made up primarily of efficient market believers. Thus, almost immediately after the 1987 crash, the Journal published an article by Mark Rubinstein, an inventor of portfolio insurance and one of its leading practitioners. Guess what? His article defended portfolio insurance and blamed everything else but it for the crash. The Financial Analysts Journal is not alone in being a captive of the efficient market crowd. The academic journals have become a tight elite that allow only the approved academic theorists of the day or other believers to publish. They don't burn the work of dissenters. They don't have to. They just don't publish it. The prevalence of the Efficient Market Hypothesis does not initiate panics, but it permits and encourages practices that make them worse. As long as this discredited theory holds Wall Street in thrall, we will have other 1987s, other 1998s.