How to avoid Black Swan excrement

Sep 30th, 2009 | Filed under: Hedge Fund Operations and Risk Management, Today's Post | By:
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swanwarningThere is no certainly shortage of circumspect navel-gazers looking to determine what went wrong last year in terms of miscalculating risk. And fair to say that the entire investment industry, hedge funds included, could benefit from a little circumspection in the wake of the worst financial crisis in more than 70 years.

The reality, however, is that post financial market meltdown and Great Recession, looking at what could work going forward in terms of having the bells, whistles and flashing lights go off rather than figuring out what didn’t work is, at this stage, a much more effective and enticing proposition.

Part of which explains why Dr. William Shadwick’s presentation to AIMA Canada and PRMIA Toronto members on “Going to Extremes to Control Risk” a few weeks back pulled in such a strong crowd.

“It’s not that the risk management and valuation practices being used by the banks and others weren’t any good,” Shadwick told roughly 100 intent listeners gathered at the University of Toronto’s Fields Institute, “it’s that they didn’t work.”

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  1. ES or CVaR are already used in the industry. I agree that ES is much better measure of risk than VaR. But they don’t solve the black swan problem in asset classes like ABS, CDO and the like. The problem with such asset classes remains that in quiet periods you cannot afford being out (you get the sack because your peers do better than you) and in turbulent periods you cannot afford being invested (your investment gets killed, and you get the sack anyway). Timing the exit before the black sawn strikes cannot be achieved with either ES or CVaR. The problem lies with skewness and kurtosis of returns of such investments and with how fund managers and traders are assessed on their job by investors and their bosses.

  2. [...] then the black swan poop hit the [...]

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