Risk has already come off - I am seeing it in private equity. If you run a startup and burn cash, have your plan B ready to go when the shit hits the fan.
I remember when this was originally posted 10 years ago.
I've got mixed feelings about this. It's not 2008, and there's no reason to expect another 75-year economic event again. On the other hand, tech and VC investment has more than tripped since 2008.
How do we know it's a 75 year event? Because it happened once 75 years before? How often should it happen?
We can't honestly answer how often it's going to or should happen. We can't honestly assess these sort of risk patterns because we don't have models that take enough of the variables into account (or even could?)
Check out Taleb's Black Swan. His big thing is understanding what risks are measurable (very few), which have a bounded/estimable impact (still very few), and which are both unbounded and immeasurable or most of them.
Interesting. The gist seems to be that we model market events with normal distributions, which is consistent with what I've seen in other "natural" and/or emergent processes, and this underestimates risk, because the true distribution is fat tailed.
The 1987 market crash (October 19, 1987, single-day loss of 23% in the S&P 500 index) was a 25 standard-deviation event. Mind you, an 8 standard-deviation event is an event that should occur once every 3 trillion years. And 25 standard-deviation events are unfathomable given the age of the Universe.
The conclusion is: due to faulty mathematics, far out of the money options are underpriced. Or, who Mandelbrot concluded, "investing on the stock market may be riskier than you think".
But if you have a few bucks to spare and want to gamble you could buy far out of the money options for a downturn. VIX gets priced in, don't know how it looks currently.
Or you can gamble with "paper money" at Thinkorswim.
If you see a 25 standard deviation you are either
1. Incredibly lucky
2. Incredibly unlucky
3. Or don't have a standard distribution (but a fat tail distribution or Levi flight or whatever)
In principle yes. If far out of the money options are systemically underpriced then just buying a bunch and holding them should make money on average, by definition.
In practice there are a bunch of concerns. You have the gambler's ruin problem: even if your bets are positive expected value, it's very easy to go bankrupt. Since your fund makes all of its money from crises you have a bunch of counterparty risk along a risk of regulatory intervention etc.. Your fund will lose money in most years and it's very difficult for potential investors to know whether you're actually positioned to make money from a crisis or just wasting all their investment. See Keynes' line about sound bankers.
Taleb endorses and advises a fund that tries to bet on "black swans"; it's explicitly advertised as a fund that will lose 5% of its value every year in "normal years", but hopefully pay off in exceptional years. You can invest in it if you want. In theory it should work, but no-one will really know until after we have one of those exceptional years.
The trouble with this is that you need to have enough of a black swan to trigger the options but not enough that it prevents them paying out, e.g. due to counterparty risk or some kind of systemic collapse.
And "the market can stay irrational longer than you can stay solvent" - by definition this produces few, rare payouts.
The trick is to do that with other people's money, on which you initially get huge returns. You can then collect large managment fees. The collapse takes out the fund, but it's an LLC so the staff get to keep their bonuses from previous years.
Generally not, because the price of the option is going to rise commensurate with the uncertainty of it being in the money.
It gets more and more difficult to accurately forecast that as uncertainty increases, which is why they're not priced as efficiently farther in the future. But since this is somewhat well known, you need to have some kind of edge to make it work - buying options haphazardly won't.
What is the "75-year economic event" timeframe based on?
We now have "1000-year floods" five times in a year [1], is there good reason to think the economic predictions are more accurate than the climate ones?
"500 year flood" just means that in any given year there's a 1/500 chance of it happening. In theory history has nothing to do with it.
In practice it's calculated with models that are tuned with historical data (among other things), so if you fail to notice some important changes and update your models you might be wildly off.
He's saying that they were 1/500 events previously, when the frequency was determined to be 1/500, but conditions have changed (climate, development, etc.) and they are no longer 1/500 events.
There are reasons to expect another such event again. First, those kind of shocks are not necessarily isolated, can happen in clusters. Second, the fundamental problems of 2008 were never fully solved, just transferred to govt/Fed balance sheets and pushed forward in time. It’s worth stress testing your current endeavors against a repeat.
>there's no reason to expect another 75-year economic event again
Because that so called 75-year economic event never really happened, or at least its full consequences, has been delayed by doctors injecting lots of adrenaline keeping it alive.
Japan, China, EU, and US has since printed unprecedented amount of money. A lot of people think there wont be another 2008, I would be happy if it was only 2008 recessions. I am worry it will end up like 1930 with Great Depression.
The post-08 tech boom is almost perfectly correlated to the rise of smartphones, which built a market for products like Facebook ads, Uber rides and the like. That too is a one-off event; we're at smartphone saturation these days.
I read The Road to Ruin last year. I don't know if it's viewed very credibly or not but the guy purports to have had a ringside seat to the 2008 GFC. That book reckons it's all about complexity theory and it's just becoming more and more complex and the next time it happens the complexity will be unparalleled and hence it is going to get hectic.
Now maybe that is just a way to sell books and it was a fun read, but I don't know.
I get the feeling we all know something is coming because it always has and it always will. Some suspect it's going to be catastrophic like never before. It's at least assumed it's going to hurt. We don't know when but it seems people are in agreement it's edging closer and closer and things are about to get really unfun for a while.
I just hope all the pain and misery happens to other people and I get through it unscathed. Totally going to take my share of the hurt most likely and that's OK I suppose. It's sort of fingers crossed at this point.
Financialization follows a cycle much like the hype cycle: something gets securitized, immense profits are made, people overextend and there's a crash, then it's reined in and becomes boring, and the next crash happens in something further out. If you read Liar's Poker, even in the '80s corporate equities were boring and all the action was in bonds. After the S&L crash, bonds were made boring (at least in the US for established companies) and the action moved to "emerging markets" and hot new IPOs. Asian crash of '97, dotcom crash of '99, these things get made boring and the action moves to mortgage securitization.
2008 crisis, mortgages get made boring, and the action now is in... well, if you can figure that out then there's a lot of money to be made. Car loans? Corporate loans? Foreign exchange? Commodities? I've seen all of those bandied about.
Angels pulling out last minute because they are worried about their stock portfolio. Investors withdrawing from a levered strategy because of the same concern.
Perhaps, but when it's industry-wide it's often a good leading indicator. My previous employer's only layoffs ever were in 2008, when one of their investors (I believe A16Z?) sat down the founders of their portfolio companies and told them to cut down, because the crunch was coming. These are companies whose management is in very close personal contact with the capital markets, and so often make decisions very quickly in response to what's going on there.
> Perhaps, but when it's industry-wide it's often a good leading indicator.
As far as I'm aware, employment data is considered a lagging indicator [0], as labor tends to be reasonably sticky.
> These are companies whose management is in very close personal contact with the capital markets, and so often make decisions very quickly in response to what's going on there.
I was fishing for other data, in part, because current data does not support the assertion that layoffs have accelerated [1][2]. In fact, initial claims data appears to be at -- or close to -- historical lows.
One indicator is the number of large venture IPOs. I see Dell going public again, for instance, as an indicator of Michael Dell not wanting to carry the private concentration of assets as a risk any further.
https://www.slideshare.net/eldon/sequoia-capital-on-startups...