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Richard Bookstaber  

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  • Banks' Risk Management [View article]
    One correction. You say "They are bright men, but they have never managed the risks of a financial institution." Rick Bookstaber was the first head of market risk at Morgan Stanley, oversaw firm-wide risk (both client and proprietary) at Salomon Brothers. Then was the risk manger at a number of the world's largest hedge funds, including Moore Capital and Bridgewater.
    Sep 12, 2009. 06:04 PM | Likes Like |Link to Comment
  • The Seven Habits of Highly Suspicious Hedge Funds [View article]
    As someone who by now would be regarded as an "old hand' in the financial markets, how can I not agree with you?

    But, while experience is valuable and reduces the problems with hubris, I don't know that one's performance in the past markets is as useful as some might think. The world changes, so that a strategy that worked well in the 1990's might not work today. For example, I remember when people would make money with the sort of things you read about in intermediate macro -- PPP on the one hand and trading against a currency under attack on the other.

    On Jun 22 10:44 AM Michael Young wrote:

    > Oustanding summary. I would add that the Madoff's are still few and
    > far between. Most investment managers do their best morally for
    > clients. I think the issue is less about the complexity of hedge
    > funds and the inability of the man-on-the-street to understand what
    > he is investing in, but the gap between the risk the investment manager
    > thinks he is taking (based on data-mining and past risk-adjusted
    > returns) and the actual risk embedded into the fund which is uncertain,
    > as the future and its impact on asset prices is unknown. If you pay
    > a 30 year old investment manager a small fortune a year, inevitably
    > he starts to think he is smarter than he actually is. It's just human
    > nature. Maybe you need to have worked through three recessions before
    > you should be allowed to be the final decision maker on a investment
    > fund? Taking into consideration the ongoing boom and bust monetary
    > policy, we shouldn't have long to wait to see three.
    Jun 22, 2009. 12:36 PM | 1 Like Like |Link to Comment
  • Citigroup: Extrapolating to 2015 [View article]
    I admit this is a 'loose' post...the advantages of doing a blog rather than having to answer to the editor of a real journalistic enterprise. But consider two of my points in the abstract:

    1. It is more exciting to work with an underdog where your actions can have an impact.
    2. An underdog, like a new entrant, has more ability to take risk and disrupt the industry.

    Now the question is if Pandit and crew can pushing in the right direction to take advantage of these tendencies.

    On Jun 13 08:57 AM Skipy wrote:

    > Why did you even bother writing this? You didn't include one single
    > fact to back up your bold prediction. It's like saying the Washington
    > Nationals will win the World Series in 2015. Yes it could happen
    > but tell me how.
    Jun 16, 2009. 10:47 AM | 1 Like Like |Link to Comment
  • The Mark-to-Market Myth [View article]
    I wrote about this in a post two years ago at and won't repeat it all here. But in brief, during a liquidity crisis, the mark to market is really a 'mark to liquidity' and may have no bearing on the longer term value. If a bank intends to hold longer term, they should not be forced to price as if they are going to participate in the fire sale. And in any case, marketing at the fire sale price is not reflective of the true current market value of the bank's positions. The price at which someone sells $100MM will have nothing to do with where the bank could run out and sell $20 billion.
    Apr 3, 2009. 08:48 AM | 5 Likes Like |Link to Comment
  • Current Popular Argument Against AIG Bonuses Takes the Wrong Viewpoint [View article]
    Viniar, the Goldman CFO, stated that if AIG failed, GS would have had little in the way of losses. According to him, Goldman had collateral on the one hand, and hedges on the other in sufficient size to cover the firm.
    Mar 23, 2009. 12:01 PM | Likes Like |Link to Comment
  • Risk Management Watch: The Fat-Tailed Straw Man [View article]
    I agree with these points. Here are two clarifications -- not to argue against what you are saying, but to add to it.

    First, the question for regulation is, given the way the world is going, given that we cannot turn the clock back too far, what should we do to improve regulation. I agree that we also should make securities less complex and curb the excessive use of leverage. But for any level of leverage and complexity, how should regulation work?

    Second, in terms of VaR, it might be less than helpful and it might be misleading, but if so, it is because of the way it is used and interpreted. But I think the risk managers by and large understand its failings. And if those failings are known, then it is better to have it than not to have it. By way of analogy, many areas of empirical science use models that have restrictive assumptions. But if those using the models understand the implications of these restrictions, the models still can provide insight.

    On Mar 12 09:02 PM mark weidmann wrote:

    > Mr. Bookstaber: I think you proposed the solution as to how to deal
    > with risk and uncertainty in your own book - that we should be more
    > like the lowly cockroach, a humble beast that is optimized for no
    > environment but has managed to survive in all.
    > The cockroach-like characteristics for the financial environment
    > were proposed as far back as 1933 by Graham and Dodd in Securities
    > Analysis. Some of these include: 1) criterion for conservative amounts
    > of debt (also known as leverage) so that one can survive downturns;
    > 2) investing with a margin of safety – only invest in circumstances
    > where you believe you are paying less for the asset than its intrinsic
    > worth, so as to minimize the downside; and 3) to the extent that
    > you are uncertain, or uncertainty exists in one investment – spread
    > the risk by diversifying into a number of opportunities.
    > Applying the second of these principles, it was difficult to find
    > hardly any opportunities before the recent crash that provided a
    > margin of safety. Furthermore, a variety of crude, gross general
    > measures indicated that, for example, stocks and real estate were
    > overpriced. Since 1980, the entire market price of publicly traded
    > stocks increased significantly more than the historical average,
    > their book value, their profits, GDP, and so on. Likewise, the price
    > of homes increased significantly more than did the home buyer’s income,
    > net worth, and so on. Some of these ratios were at historic highs,
    > indicating the possibility that they were overvalued. (Currently,
    > many of these ratios have switched the other way – indicating stocks
    > and homes may actually be undervalued now).
    > The purchase of stocks and houses with debt or leverage that was
    > given without adequate collateral clearly led to the run up of stock
    > and housing prices above historic norms. As the appeal of the profits
    > of leverage are too tempting to people (with 33 to 1 leverage, I
    > only need approximately a 3% increase to double my money), I agree
    > with the need for a market regulator (or market regulation) to oversee
    > leverage. I also agree that we should continue to discover and analyze
    > other dynamics that lead to fat tailed events.
    > I understood it as a point of your book that no matter how much you
    > discover and analyze about dynamics that lead to fat tailed events,
    > when you are dealing with the market, you are dealing with a complex,
    > adaptive system that will have Knightian uncertainty (described by
    > Frank Knight in his 1921 classic, Risk, Uncertainty, and Profit as
    > uncertainty that is unknown and cannot be measured). Thus, I believe
    > that, despite your frustration and despite your yearning to know
    > and quantify uncertainties, you are actually in agreement with the
    > point of the fat tail critics of VAR, that there will always be uncertainties
    > that you can’t know or quantify. Thus, your cockroach analogy.<br/>
    > What I find inconsistent with your views is that, while you admit
    > that VAR is based on flawed assumptions, you find it a helpful guide
    > to day-to-day market risk. I believe that VAR, since it is based
    > on flawed assumptions, it worse than not helpful, it is actually
    > harmful and misleading. I don’t have the space to detail why here,
    > and I also believe that, as an exercise, you could most likely present
    > my argument better than I could myself, even if you disagree with
    > it. If not, I would be happy to detail it, suffice it to say, it
    > would be based on well known, similar criticism of other theories
    > that it shares assumptions with, such as modern portfolio theory,
    > CAPM, etc.
    Mar 23, 2009. 10:03 AM | 1 Like Like |Link to Comment
  • Mapping the Market Genome [View article]
    A belated reply to these comments.

    Data will not take care of everything. But it is a logical first step. Logical because it can give us more information to understand what dynamics are important. And logical because, at least in my current view, it would not be costly or intrusive.

    If the data are not well analyzed, or if the analysis is good but there is no follow-through by the government to take action, then the efforts still might not be successful. I am arguing to take the first step, and see where things then sit. I take it as a given that even if this first step is well executed, regulation could fail.
    Mar 23, 2009. 09:57 AM | 1 Like Like |Link to Comment
  • Risk Management Watch: The Fat-Tailed Straw Man [View article]
    I think we must use other tools in addition to VaR. Use VaR for what is can be used for, but then add, for example, stress tests and scenario analysis. Most risk managers already try to do this. If we miss a particular scenario that has a reasonable chance of occurring, and we likely will miss some, then we are worst off for having done so. Which means we still will not be perfect, but the more we understand the market dynamics, the more likely we will be to include these.

    On Mar 11 01:32 PM cr0bar wrote:

    > I don't understand the risk managers job. Surely if the risk manager
    > knows that fat tails exist, and that a fat tail event will result
    > in a particular trade yielding and enormous and consequential loss
    > (perhaps larger than all the profits ever made), they would advise
    > that the bet not be taken and to look elsewhere for trading opportunities.
    > Also, why is VAR a useful measure of day-to-day risk on the days
    > the fat tail event does not occur, but not a useful measure on the
    > day it does occur? If you don't know in advance the day it is not
    > going to be a useful measure, and that day results in you losing
    > all the profits you've ever made and more, surely it was never a
    > useful measure on any day? I.e. didn't you just not yet know it wasn't
    > useful on the other days?
    > You also seem to suggest (although I may have misunderstood this)
    > that a thorough analysis of market dynamics could allow us to predict
    > future unlikely events. I find this rather optimistic for a great
    > many reasons. For a start, how will we know in advance that we've
    > analysed the right market dynamics to predict future shocks? We will
    > only know what happened in the past, any future shocks are unlikely
    > to be from the same source, not least because past shocks will result
    > in changes to the market dynamics!
    Mar 12, 2009. 05:37 PM | 1 Like Like |Link to Comment