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Monthly Archives: August 2009

Well done Emanual Derman. At last someone is asking the right questions. I broke EMH, Portfolio Risk/Diversification and CAPM in my1995 University College Dublin 500-page Master’s thesis. I showed that,
1. Markets are only as efficient as the data reported.
2. Portfolios do not fully diversify away unsystematic risk.
3. CAPM is only valid within a 90-day range.

I published my thesis in 2002 as a 278-page book, titled “A Rational Approach to Unsystematic Risk, Re-Thinking Modern Finance” . You can still purchase it from http://www.quantumrisk.com/books.html while stocks lasts.

I too had a quick look at Andrew Lo’s AMH. It could be a good approach. However, being an engineer by training, I’m not keen to rush into more theory. In 1995 I had proposed how we could measure market efficiency (see table below). While I am not a whole hearted fan of EMH, I believe we should use metrics to measure market efficiency to monitor and improve markets. My 1995 results suggest that market volatility plays a part in market efficiency.

Stock Exchange Index Prob. of
Weak Form
Prob. of
Strong Form
Bangkok SET Index 100.00% 81.59%
Frankfurt DAX 87.29% 77.42%
Gold Gold Spot 100.00% 94.18%
Hong Kong Hang Seng 100.00% 90.49%
Kuala Lumpur Composite 83.40% 76.09%
Kuala Lumpur Emas 81.46% 66.15%
London FTSE 81.33% 71.33%
New York Dow Jones 84.13% 59.05%
New York S&P 500 84.20% 80.68%
Singapore All Share 76.26% 74.83%
Sydney All Share 100.00% 98.87%
Tokyo Nikkei 82.64% 76.79%

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Returns are almost always long tailed distributions. Depending on the circumstances, they can have negative long tail (the ‘famous’ lognormal fat tails in risk analysis), positive long tails or both.

If you don’t have the experience or the expertise, handling all these variations can be quite a challenge. For small samples I have observed many times people ignore the tails – i.e. the justification is that these outliers are ‘infrequent’ and due to some other unknown process (a nice way to say “I don’t want to trouble myself”) – and then fit a reasonable normal distribution.

Another problem I have observed with small samples  is that the distribution can change markedly from sample to sample. This can be a severe problem. The concern here is, if you don’t know the true population distribution, how do you model it correctly? I don’t know how others treat this if they do or if they just ignore the whole thing and assume normality.

Note: depending on the data even 100 data points can be considered small.

One important reason why normal can be used. If you are measuring the average of many small samples, than normal gives a good fit. You have to make the distinction that you are working with averages and not the return statistic itself but I find that when this happens many times people don’t. 

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Your Business Model in 1-Hour! In 1-hr you will definitely learn to quickly fix your strategy problems. Register here for Aug 17, 18 & 19 2009. This is critical  knowledge in a recession. 2 presentation slides are shown below.
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Feedback of previous related seminars:
1. Great, very informative (DM),
2. Very well thought out, effective and practical (RS)

Premium Webinar: Your Business Model in 1-Hour!

Benefit: You will immediately learn,
1. If your business model works.
2. How to recognize useful industry metrics.
3. Determine what strategies work for your company.
4. Take away some strategy maps / frameworks.   .   .   .   .   .   .    Register here.

This is a practical short course on how to recognize the real strategies your business needs and how to recognize the industry metrics for you to stay on track. It demystifies the role of financial statements and gets you back on track with real industry data to manage your strategy. This seminar concludes with a set of quick checks for your business model.

 

Who Should Attend: CxOs, Corporate Managers, Consultants & Investors.

About Benjamin T Solomon: Managing Principal of QuantumRisk LLC, he has 28+ years working in multinational, national and regional companies (Texas Instruments, West Port, Capmark, Coopers & Lybrand …) developing IT systems, streamlining business processes, designing and implementing strategies, and extensive econometric & economic capital modeling in the CMBS/RMBS industry.

Registration: This will be a 1 hour webinar limited to 20 participants per session. Register here.

Dates: August 17, 18 & 19, 2009.

Notes:
1. You will be emailed a meeting key to join, and webinar link.
2. You will be provided a pdf copy of the slides, 7 days after the seminar.
3. Last Refund Date: No refunds after Aug 14 2009.
4. Refund Policy, here.

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2 Presentation Slides:

Slide32

An Example of a Process Framework

 

Slide33

An Example of a Format Framework

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Your Business Model in 1-Hour! In 1-hr you will definitely learn to quickly fix your strategy problems. Register here for Aug 17, 18 & 19 2009. This is critical  knowledge in a recession.
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This blog is in response to a discussion on LinkedIn.

The unfortunate answer is no, we have not yet bottomed out. But there is a second unasked question, when will the housing market and the residential mortgage industry recover?

Regarding the first question. Agree with you in that the economy is so bad that the media and the economist are putting on a bright face.

If you look at the Composite-10 CSXR Home Price Index as a guide there appears to be some more downside to home prices.

HP(1)

But if you look at the 1-yr moving average in the growth or change in this index we see that growth peaked in June 2004, and was in decline but positive until August 2007 when it turned negative. (The 1-yr MA is a lagged index.)

HP(2)

The important point to note is that the negative growth bottomed out in May 2009, however, it still remains in negative territory. The extrapolation would suggest that growth would turn positive around February – April 2010 time frame. That is residential home prices will bottom out in 1Q 2010.

To answer the 2nd unasked question, when will the residential mortgage industry recover? This is more complex. The FRED data would suggest that between April 1993 to October 2004, Nonrevolving Credit was a driver of home price appreciation, with an average lag of about 2.5 years (>2.5 yrs in the earlier years and<2.5 yrs in the later years).

It is interesting to note that this was also about the time securitization of mortages was introduced.

But from October 2004, the relationship is inverted, with Home Prices driving Nonrevolving Credit, and the lag appears to be arounf 2.5 years. So add that lag to the 1Q 2010 forecast bottom we get a residential mortgage industry that at the very earliest, recovers in 3Q 2012. Sorry, the bad news is no residential mortgages no real estate jobs.

Given a 2.5 year lag it is a good thing that the Obama Administration is “pushing heavily” otherwise the lag could be much longer and we will definitely be looking at a 1930s type depression. This is not a political statement (my opinions have always be apolitical) but a need to face the gravity of the situation.

Regarding 53% modified loans go back to foreclosure. The number used to be much higher, and the very simple reason for this was the so called “modification” actually led to a higher monthly payments! Add to that a substantial unemployment situation.

Sometimes I just don’t understand the banks, which would they prefer (1) lose a few % in interest for a few years or (2) take a 50% cut in principal value today? This problem is not going to go away anytime soon, and everyone needs to be patient. Given these two options, foreclosure moratorium is the only viable solution for the banks if their customer doesn’t walk away. The banks need to try very much harder to keep homeowners in their homes if they are to forestall writting down their asset values, which will in turn depresses home prices further.

The more distressed properties you have the less likely people will buy because they can wait for further distress. There are properties (in Illinois?) where banks are giving the “vacant & disgruntal owner” properties away for free because it is more expensive to bring them up to code to sell them.

So what do we do between now and 3Q 2012? Reduce our risk. Contact me, Ben Solomon, benjamin.t.solomon@QuantumRisk.com, for a free phone review on what QuantumRisk can do for your company.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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The Opportunity:
What would you pay to know the Black Swan of your CMBS deal risk?

Reverse that question!

What would a deal manager pay you to know the Black Swan of his CMBS deal?

The Need:
Inspite the bad publicity surrounding CDOs and structured finance the tranche strucutre is one of the most efficient methods of creating differentiated classes of assets, as The Committee on the Global Financial System explains:

A key goal of the tranching process is to create at least one class of securities whose rating is higher than the average rating of the underlying collateral pool or to create rated securities from a pool of unrated assets. This is accomplished through the use of credit support (enhancement), such as prioritisation of payments to the different tranches.

However, what really caused the market to substatially undervalue these assets was that the default rate and the severity of the loss was much greater than even the complex rating processes had estimated them to be.  Have you noticed that some (many?) of the AAA tranches had losses?

The Solution:
The answer is an econometric assessment of the default and loss distributions of CMBS assets. Note, not a single point value but the whole distribution. This distribution will provide the CMBS Deal’s 95% or 98% VaR and CVaR loss estimates.

From this distribution we can then recalculate the loss estimates for each tranche, and be pretty certain what the loss characteristics of these tranches are independently of the ratings assigned to the tranches. A backup second opinion, if you would.

Why would this provide better answers?
1. We know the assigned ratings did not cut it.
2. We know the vintage or triangular matrix method provided incorrect default and loss curves. I was the first & only person to correctly identify that a major tool, vinatges/triangular matrix method, used in the mortgage idustry was providing incorrect results. The link provides access to an Excel worksheet that allows you to confirm this for yourself. To understand the magnitude of this finding one only need to look at the vast array of mortgage analyses, from the Esaki-Snyder reports to the Wachovia 2008 CMBS Loss Study, that use this tool.
3. The DSCR loss model used in the CMBS industry does not match the historical data. I discovered this weakness in the method through extensive testing against the historical data. Do you know of anyone who has personally tested these tool against the historical data?

What would the solution look like?

The graph below is a simulated long term VaR & CVaR loss outcome for a simulated CMBS deal.

CMBSPartnership

This graph is based on a set of CMBS loss & default distributions, and provides a second method to evaluating bond pricing. After all at the end of the day, isn’t cashflow analysis and DSCR’s about bond pricing? Notice how VaR (green dash) consistently underestimates CVaR (purple dash). We can add in Black Swans into this report. Note that my initial assessement was that CMBS Black Swans are on the order of 20% to 80%.

Partnership:
I am seeking partnerships with banks/investment funds/ratings companies to fund the development of this econometric CMBS business, which I expect to be transferrable to the RMBS sub-industry.

Call me 303-618-2800 or email me at benjamin . t . solomon AT QuantumRisk . com if you are interested in this business.

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Disclosure: I’m a capitalist too, and my musings & opinions on this blog are for informational/educational purposes and part of my efforts to learn from the mistakes of other people. Hope you do, too. These musings are not to be taken as financial advise, and are based on data that is assumed to be correct. Therefore, my opinions are subject to change without notice. This blog is not intended to either negate or advocate any persons, entity, product, services or political position.
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Is Your Business Model Sustainable? In 1-hr you will definitely learn to quickly fix your strategy problems. Register at Events.
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I had a very successful webinar series Strategy In A Recession? in July. 

Feedback for this webinar:
1. Great, very informative (DM),
2. Very well thought out, effective and practical (RS), &
3. Interesting ideas about strategy (JH)

August Premium Webinar:
I will be conducting another premium webinar Is Your Business Model Sustainable?

Benefit: 
You will learn,
1. How to determine if your business model is sustainable.
2. How to determine useful industry metrics.
3. Determine what business forces / strategies work for your company.
4. Take away some strategy maps / frameworks.

This is a practical short course on how to recognize the real strategies your business needs and how to determine the industry metrics required to keep on track. It demystifies the role of financial statements and gets you back on track with real industry data that should be used to manage strategy. This seminar concludes with a set of easy checks that enable you to determine if you should need to change your business model.

Who Should Attend:
CxOs, Corporate Managers, Consultants & Investors.

About Benjamin T Solomon: Managing Principal of QuantumRisk LLC, he has 28+ years working in multinational, national and regional companies (Texas Instruments, West Port, Capmark, Coopers & Lybrand …) developing IT systems, streamlining business processes, designing and implementing strategies, and extensive econometric & economic capital modeling in the CMBS/RMBS industry.

 Schedule & Payments:
This will be a 1+ hour (>30 slides) $97 fee based webinar limited to 20+ participants per session. Schedule and payments here.

Dates:
August 17, 18 & 19, 2009. 

Notes:
1.You will be emailed a meeting key to join, and webinar link.
2. You will be provided a pdf copy of the slides, Aug 18.
3. Last Refund Date: No refunds after Aug 14 2009.
5. Refund Policy, here.

 

Ben Solomon

P.S. I changed the title of the webinar from Determining the Status of Your Company to Is Your Business Model Sustainable? after I received feedback that the subject was a lot more interesting than the previous title had implied.

QuantumRisk is developing a community of Referral Partners. The objective is to mutually benefit the lead generators – the Referral Partners, and the Consultants working for QuantumRisk.

If you would like to participate please sign up here.

Initail Guidelines:

1. Commission for successful client engagement of up to 10% depending on their involvement, as follows:

a. Lead generation & referral only: 2%          (cum 2%)
       Note: Cold calls not accepted.

b. Supporting role in closing the deal: 5%    (cum 7%)

c. Instrumental in closing the deal: 3%         (cum 10%)

2. Commission payments are paid over the life of the engagement on a pro rata basis from payments received.

3. At some point in the future QuantumRisk will require that Referral Partners generate $x,000,000 per annum to remain a Referral Partner. The specifics are still being worked out.

 

If you have any questions or would like to provide inputs/advice please do contact me at benjamin . t . solomon at QuantumRisk . com.

I’m trying out twitter, probably 140 character opinions on the day’s news. My twitter address is @QuantumRisk.

Best,
Ben
Twitter: QuantumRisk