Phorgy Phynance

Archive for the ‘Currencies’ Category

Quantitative Easing Explained

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Written by Eric

November 13, 2010 at 1:12 pm

Modeling Currencies

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I hope to begin some research into currencies. Before I come out with any result though, I thought I’d ask an open question and hope someone comes by with a response.

First of all, as a former scientist, thinking about currencies is very fun. See, for example, my previous article

This morning, I happened across a recent article that appeared on the arxiv:

The second paragraph really stood out:

One of the problems in foreign exchange research is that currencies are priced against each other so no independent numeraire exists. Any currency chosen as a numeraire will be excluded from the results, yet its intrinsic patterns can indirectly affect overall patterns. There is no standard solution to this issue or a standard numeraire candidate. Gold was considered, but rejected due to its high volatility. This is an important problem as different numeraires will give different results if strong multidimensional cross-correlations are present. Different bases can also generate different tree structures. The inclusion or exclusion of currencies from the sample can also give different results.

This is interesting because financial modeling is often about prices of securities or changes in prices. Currencies are about the relationship between prices. In graph theoretic (or category theoretic) terms, it is tempting to say that currency models should be about directed edges (or morphisms).

Is the best way to model currencies to choose some numeraire as is done in this paper? Or is there a way to study the relationships (morphisms) directly?

Written by Eric

October 28, 2010 at 6:01 pm

The new corporate trend: “onshoring”

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Ha! What did I tell you? It is wayyy past my bedtime and I should be sleeping (especially since I’m sick and feel like I’ve been run over by a truck), but just stumbled on an interesting article from one of my favorite economic development blogs: Design Nine. He points to an article in the

Recall that in the midst of all the market doom and gloom, I recently said:

I’m actually ironically optimistic about the outlook for suburban and rural economic development. A weaker dollar will make outsourcing less attractive. That will bring manufacturing jobs back home. I can imagine a boon in suburban and rural development. Just imagine if communities developed decent broadband via fiber-to-the-home/business. Suddenly, there will be attractive jobs and living standards in affordable places.

I admit that the quote is a bit misleading because Andrew Cohill has influenced the way I think about things, but still timely I think. Here is an excerpt from the article:

Small-town America: The new Bangalore?


Onshoring, in fact, is becoming trendy.

Some U.S. companies recently have pulled back from India to set up shop in rural areas where access to high-speed broadband connections isn’t the problem it was just a few years ago and where lower real-estate prices and wages are attractive.

Note that the key to onshoring is an investment in telecommunications infrastructure. In particular, fiber-to-the-home. It is quite sad to see so many municipalities rest their hopes on wireless broadband. That will only end in tears as the reality of wireless broadband becomes apparent. Any community that is not investing now in fiber will lose out on an important opportunity that is now beginning to present itself: onshoring. As Andrew will tell you more eloquently than I could, an intelligent investment in a communities future MUST involve a combination of both fiber and wireless and I would put wireless as a distant second. I can explain in gory detail why wireless will fail if you like (I did my PhD in the subject), but for now need to hit the sack.

Go onshoring! Go USA!

Written by Eric

December 4, 2007 at 12:50 am

Another proponent of economic Darwinism

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Just a quick note from MarketWatch before I hit the sack…

17 reasons America needs a recession

Here are some of my thoughts on the subject.

Good night and have a Happy Thanksgiving!

Written by Eric

November 21, 2007 at 10:28 pm

Another word for hedged… leveraged

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Market turmoil is still quite fascinating to me and I still believe the current environment will be one for the history books and I’m still trying to take as much as I can from this learning experience.

My professional work experience is in fixed income. For two years, I was very “plugged in” to the markets and was meeting regularly with some of the greatest thinkers out there, but now I’m more of a pure “quant” and most of my news comes from blogs, web news, etc. Unfortunately, I’m not yet spending as much time with the traders as I’d like (but that should change soon I hope). Most of the major news sources, e.g. Bloomberg, seem to concentrate more on equity markets than credit and fixed income. I pay more attention to the Dow now than ever before. That is why I am so perplexed by the stock market. I thought stocks were supposed to be easier than bonds, i.e all the smart guys are in fixed income, right?

So while the credit markets seem to be imploding, stocks are doing just dandy. Maybe people are taking cues from the market cheat sheet?

Anyway, I’ve blabbered quite a bit on this blog (and at my former employer) expressing my opinion of CDOs. I even managed to upset quite a few people while expressing my opinions as well. No regrets though. I’m happy to have this hugely public diary, both here and on NP, to later look back and see how I did in regards to thinking events through. Occasionally, I still like to poke my nose in over at NP and I see kr is still giving out the occasional nugget. Here is one of his latest:

A few thoughts:
– If you took all the writedowns at a single med-to-large bank rather than seeing them across the street, you could have reduced that entity’s equity to ZERO. For instance, MER has only something like USD54bn of mkt cap and USD39bn of book equity.
– If the view is that there will be another round of writedowns in the same amount as Q3 then you will have banks desperate to raise equity (i.e. it is not just the monolines). Who would buy that equity right now? Prince Alwaleed for example has floated his own holdings so I see him more as seller than buyer for example. I don’t see guys like JC Flowers or Cerberus well positioned for this job – in retrospect, even Barclays/RBS have not been with respect to ABN, as can be seen by the action in their share price and cost of jr capital.
– Another possibility would be the downgrade to BBB like the Japanese banks, with all the implications that brings with it. I.e. serious change in business model. That has contagion and macro effects. One example is that flow trading of financials has cost people a lot.
– I think investors will call foul on the FAS157 Level-3 assets, and it will hit guys like GS seriously as their L3 reporteds are a big multiple of their mkt cap.
– There was a funny comment in this month’s BBG mag about “nobody really knows how desks are hedging the CDO assets.” That is bull – the answer is that most people were NOT HEDGING AT ALL, BECAUSE THEY COULDN’T. Stuff was originated to sell, and the exit has vanished, or, it was originated to live forever on a trading book even though people tried to avoid saying that, and there is no decent MTM approach so instead banks are showing huge volatility, mostly to the downside.
– Implications of SIV / CDO / CP demise are pretty vast. There seem to be an increasing amount of trade receivables on the market, b/c there are no conduits to fund them… means corp cost of cap is going up in unexpected areas.

My hunch is that the fed cuts on the 11th b/c liquidity is dropping again, especially with year-end. It is out of control – specifically Ben’s control. It looks like political support for the various subprime fixes has stalled. What I think is that liquidity of all things financial (i.e. non-corporate) is going to get weaker and cause a full-on crisis for a market-traded institution. The talk about Citi cutting their div is one tremor, trading activity in Barclays is another, and the fact that even AFTER all the reported loss numbers, people still don’t feel comfortable, is yet another.

I think vols are still cheap, maybe looking to buy some.

All the while I was complaining about CDOs, I was coming at it from the angle of a “quant”, i.e. thinking about how to model CDOs and how those models are used in risk management, asset allocation, etc. Too bad I didn’t understand more about the legal/accounting aspects of CDOs. The term everyone has now heard of is SIV. I was blabbering about off balance sheet leverage and fair value accounting, but didn’t realize that the entire CDO market was (to a jaded eye) a big play on accounting in addition to the obvious play on ratings agencies. If I had known about SIVs, I might have been able to do more to help some who may have now lost a lot of money. Maybe not. That’s all in hindsight. But what am I missing now? Where is the next weakest link? How are corporations hiding off balance sheet debt? Has anyone looked at “Level 3” assets in corporate, i.e. non-financial, balance sheets? Are they as scary as the big banks?

I’ll say it again… this is not a subprime issue. Subprime contagion does not explain the current environment. Subprime was just the first to blow. We are experiencing the blowup of a global fixed income bubble. In fact, some would say we’re experiencing a general global asset bubble.

Who’s going to get hurt? Financial institutions for sure. Anyone who depends directly on the value of paper assets.

Who’s going to win? People whose wealth depends on physical assets.

I’ve already lost all hope in Bernanke. He is not going to let his monicker “Helicopter Ben” go by the wayside in a “time of need”. Bernanke is going to lower rates and weaken the USD until oil exporters are forced to break the peg to the USD and inflation skyrockets. I predict that all these gloom mongers about home prices dropping by 30% will turn out to be wrong in nominal terms even if they are correct in real terms. In other words, home owners are going to be saved by the dropping value of the USD. All those on Wall Street who were so gleeful every time rates dropped are suddenly going to feel the pain when the value of their paper securities go up in smoke.

Watch out for the “happy stage of inflation”, i.e. wage increases. It will be interesting to see what the world will look like when oil is priced in EUR and the USD is no longer the world currency. Fortunately, I still have faith that we’ll come out of the current mess stronger as a country, but there will certainly be pain felt at the higher end of the wealth spectrum.

I’m actually ironically optimistic about the outlook for suburban and rural economic development. A weaker dollar will make outsourcing less attractive. That will bring manufacturing jobs back home. I can imagine a boon in suburban and rural development. Just imagine if communities developed decent broadband via fiber-to-the-home/business. Suddenly, there will be attractive jobs and living standards in affordable places.

Maybe a weak dollar is what this country needs, i.e. a good kick in the pants. Pain is the best teacher, right?

[Edit: PS, the title of the post was inspired by a great article on Financial Armageddon, but I never got around to explaining why, but have a look and it might be obvious.]

Bye bye dollar

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Needless to say, after my comment on August 28

PS: I’ve been ignorantly harsh on both Greenspan and Bernanke, but I have to say that I am quite impressed with Bernanke’s recent performance maneuvering through the current credit crisis. I expect him to hold the target rate at 5.25% on September 18. If he does, I’ll gladly apologize for anything less-than-flattering I’ve ever said about him. If he lowers rates, I’ll lose respect and throw him back in the Greenspan “save my Wall Street buddies” bucket.

I wasn’t particularly excited about the surprise 50 bps cut in both target and discount rates for the general long-term prospects of the US economy, although on a selfish level it was certainly good for my career stability. As far as I’m concerned, it is open season for Bernanke bashing. Greenspan bashing has been accelerating as well. Besides, if things really get bad with the USD, we’ll just move to Hong Kong or something 🙂

One of the things that I learned from Al Wojnilower was that the US economy could certainly keep chugging along for as long as the USD was the world currency. As he liked to repeat often, having the USD as the dominant world currency is like having an “American Express card with no limit”. One of the things that keeps the USD as the world’s currency is its position in sovereign reserves as well as the fact that oil is priced in USD. As far as I can see, both of these factors are beginning a worrisome decline.

With sovereign reserves continuing to diversify away from USD and Saudi Arabia refusing to cut rates in lock step with the US marks a real turn in the outlook for the USD dollar, and consequently the ability of the US economy to continue chugging along.

Written by Eric

September 22, 2007 at 7:28 am

More questions on “safe haven” status of USD

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[Note: Here I am joining the flocks of bloggers pointing to their prior words of wisdom. My apologies!]

On Saturday, I wrote

Flight to non-USD quality

Over the last few weeks, being on “garden leave” has given me a great opportunity to watch recent events unfolding from the sidelines. In that time, I’ve made a lot of comments. Some of them I hope make some sense. Some of them have probably been fairly ludicrous. I’m an admitted amateur and even the pros are struggling these days. One of the most ludicrous things I’ve said was on July 25 over on NP:

I also suspect that a “sovereign” flight to quality will not be a flight to US treasuries and in fact may be a flight away from US treasuries into EUR denominated government bonds. So as the credit market turns, the typical safe haven will not be available as even treasuries get whacked from sovereign sellers.

Even worse! I’m pointing to previous things I’ve said that reference even more previous things I’ve said. How long can this continue?! (Ad absurdum? 🙂 )

Anyway, since I am knee deep already I might as well trudge along. Along this theme of non-safe USD, Econocator points out some research from Barclay’s that I found interesting:

Is the USD a safe-haven currency?

Could there be something to the idea? I think so, but what do I know?

Written by Eric

August 14, 2007 at 10:15 pm