Friday, March 20, 2009

DE Shaw On The Basis Monster That Ate Wall Street

DE Shaw's quant Ph.D. geniuses are focusing on the topic de jour: the Basis Trade (to Boaz Weinstein's chagrin they are 6 months off). Always good to get one more perspective on the issue. Great bedtime reading for hardcores: enough new concepts here to find at least 5 brand spanking new ways to blow up the world. Particularly interesting section:

What's critical here is that the two risk factors most responsible for driving cash -synthetic basis-namely, the availability of financing and the positioning (long or short cash relative to synthetic) of levered players - inconveniently also two of the least desirable risk factors for a levered instrument vehicle like most hedge funds. Those factors' combined impact literally describes the terms of a classic common-investor liquidation crisis. By incurring heavy exposure to financing risk and the portfolio of other levered investors, a levered hedge fund is effectively selling a gigantic put option on its ability to finance its own positions. Moreover, this put option has characteristics that greatly increased the probability that the option will move in the money at the worst possible moment. If a levered investors suddenly finds itself facing heavy losses, it's not a stretch to suppose that, at the same time and for largely the same reasons, that investor's equity capital base is under pressure from redemptions, its financing position is weakening because of a credit crunch, and other similarly positioned investors are liquidating. Worse still, all of these phenomena lend to self-reinforce in pernicious ways. In such circumstances, it's imprudent to count on financing and trading counterparties to provide help because, as already noted, they're likely to be deleveraging at the same time.

Also, a great discussion on Berkshire abnormally positive basis. Hat tip purearb


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11 comments:

Anonymous said...

Sch├Ądelbasis

Anonymous said...

Wondering if a big wedge of some of the XO name basis is due to distressed exchange concerns not triggering CDS while bonds would suffer - so CDS protection buyers need some premium redux to accept that risk...as well as the stuff DE Shaw said LOL...

Anonymous said...

Tyler,

Geithner is planning to take garbage assets off the banks balance sheets without Congressional input by using the FDIC and the Fed; see link below. It looks as if Summers/Geithner are going to try to evade Congressional oversight, like they did by using the ESF when Citi and other wall street banks were insolvent due to bad loans to Mexico and lat am.

http://www.foxnews.com/politics/2009/03/20/geithner-reveal-plan-relieve-banks-toxic-assets/

Anonymous said...

Tyler,

What do you think the chances are that Geithner's plan is successful?

sw said...

they should call this common sense insights

James L. said...

Any research or published views that come out from hedge fund houses like DE Shaw etc be very very careful before you use it. I have been informed these top hedge funds NEVER EVER share their thoughts/views in the event it may compromise their trading positions/strategy current or future. If anything, its probably dis-information. Note also no author has attached his name to this piece.

Anonymous said...

James,

Bingo.

I worked for one for many years.

The secret recipe never gets out.


Tyler,

I would like to send you some information that you will find very eye opening from my days at the quant. Whats your email?

Anonymous said...

Tyler,
Be careful "Anonymous", asking for your email is a CIA operative and will use your email to track your ip address and ultimately "silence you".

After your FDIC article The Spooks are on to you......

Anonymous said...

everyone knows that DE shaw trades basis vol

Tyler Durden said...

tips at zerohedge dot com works just fine

Nooyawka said...

When will this dude appear on the Leno show? I can't wait for the zingers.