Sunday, May 27, 2007

Derivatives 101

The Epicurean Dealmaker has a fantastic, albeit long, essay that explains the deriviatives market in terms that even a monkey can understand. Genius lies in being able to make the complicated seem simple, and Epicurean Dealmaker prove themselves yet again. The fact that I laughed out loud a couple of times is a bonus.

The Epicurean Dealmaker: Nobody Expects the Spanish Inquisition
Furthermore, just where is all this securitized risk going? Is it spreading out nice and smooth across hundreds of diversified hedge fund portfolios, so that no one risk event or connected series of risk events (e.g., Amaranth) could cause a pile-up on the Global Market Highway? Or is it collecting stealthily into large, concentrated, correlated pools of which their owners may or may not be aware (e.g., LTCM)? The former condition would indeed be a big improvement over the historical concentration of risk in a few large, highly levered commercial banks and broker dealers. The latter would be no improvement at all, and might be worse.

Just read the whole damn thing!

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