IPO less the iBank = Epic Fail

By nearly every media account, Spring Street Brewing Co.'s direct public offering in 1996 was a whopping success. That the little brewery fell short of its $5-million fund-raising goal mattered little. To have raised nearly $2 million over the Internet was itself worthy of the record books--especially to the cash-strapped entrepreneurs who ate up the story.

Andy Klein, a former securities lawyer and founder of the brewery, details how Spring Street's historic Internet offering ultimately failed on several counts...

"

Of 500,000 people who came and saw the prospectus on our site, only 3,500 invested. Yeah, we raised nearly $2 million, but the conversion rate was very, very small.

People aren't that stupid. And I say that sort of tongue-in-cheek. I mean, our beer company was a very decent offering, a perfectly legitimate effort to raise capital. But the average investor is smart enough to know that if there's not an intermediary who's in the business of evaluating the company, doing due diligence, and putting its reputation on the line with the company's reputation, that investors should beware.

The experience of the beer company proved to me that there was an enormous capability to raise capital through the Internet, but that what was missing was value that comes from having an intermediary.

"

http://www.inc.com/magazine/19990901/13720.html

Extreme Value Stats & Financial Risk

In the 18th century, statisticians sometimes worked as consultants to gamblers. In order to answer questions like "If a fair coin is °ipped 100 times, what is the probability of getting 60 or more heads?", Abraham de Moivre discovered the so-called "normal curve". Independently, Pierre-Simon Laplace derived the central limit theorem, where the normal distribution acts as the limit for the distribution of the sample mean.

Nowadays, statisticians sometimes work as consultants for economists, to whom the normal distribution is far from a satisfactory model. For example, one may need to model large-impact ¯nancial events in order to to answer questions like "What is the probability of getting into a crisis period similar to the credit squeeze in 2007 in the coming 10 years?". At ¯rst glance, estimating the chances of events that rarely happen or even have never happened before sounds like a "mission impossible". The development of Extreme Value Theory (EVT) shows that it is in fact possible to achieve this goal.

On Extreme Value Statistics Chen Zhou (http://publishing.eur.nl/ir/repub/asset/14290/ThesisDef.pdf)

(http://research.stlouisfed.org/wp/1989/1989-006.pdf)

(http://creditlab.stanford.edu/Research.htm)

(http://soe.stanford.edu/research/layoutMSnE.php?sunetid=giesecke)

(http://www.gsb.stanford.edu/facseminars/pdfs/credit_20.pdf)

(http://www.stanford.edu/dept/MSandE/cgi-bin/people/faculty/giesecke/pdfs/glss.pdf)

(http://www-m4.ma.tum.de/Papers/Klueppelberg/EVTFinance061207.pdf)

"In practice, an efficient way of creating information on [a company's] risk is to use risk markets and to transfer risk. [...]
Hayek (1945) has defended the efficiency of markets compared to scientific ‘plan’ in his role of ‘communicating information’."

-- Guillaume Gorge, Wiley Handbook of ILS

Pensions, like Mortgages: Bundle & Chop

"With the recent events in the U.S. credit markets, some are wondering whether traded longevity is another ticking time bomb."

Synthetic life settlements are financial contracts tied to someone’s’ actual life expectancy, or in another variation, on a group of lives. The contract issuer collects premiums from the contract holder and pays a benefit upon the individual’s death.

With these products, the investors rely on the credit rating of the bank, because what one is buying is not an actual policy with underlying assets, he notes.

“What happens if you buy from an AA [credit rating] bank that in 10 years becomes a BB bank?” he asks. “If I own an actual policy, I can see everything that’s going on, I can watch the credit rating of the carrier, and then I can sell the asset if I want.”

Simon predicts that for that reason, synthetic products will not be as marketable as life settlements. “The negatives far outweigh the positive, in my opinion,” he says.

“I don’t want a derivative product,” he concludes. “In today’s market, I want to touch and feel the asset.”

http://www.lifeandhealthinsurancenews.com/Exclusives/2009/02/Pages/Settlement-executives-size-up-new-product-competition.aspx

http://www.calbrokermag.com/Magazine/story/Dec08/weiss.htm



Nowadays, pretty much any time you bundle and chop, red flags will be raised. Add to that difficult-to-quantify risk and you've got something that smells a bit like mortgage backed securities.

http://www.efinancialblog.com/bundling-life-insurance-banking-oldfashioned/

It's been done....

... thank you Jivamukti, NYC.

Sylvain on Moody's Madness

I Am Love

Special Chars

... tragically hilarious

A Name Change can be your best Business Strategy

What characterises real speculators like Soros from the rest is that their activities are devoid of path dependence. They are totally free from their past actions. Every day is a clean slate.

Epiphanies rarely occur in familiar surroundings.

The slower we move the faster we die. Make no mistake, moving is living.

Marry Me?

"I don’t know how many people sit at Manic Coffee like this! Jonny always drinks his espresso with one leg behind his head. He says it tastes better."

More Here: http://jennifer-ballard.com/blog/2010/01/05/portrait-of-a-yogi-toronto-yoga/

ILS: Motivation & Structure

From RMS+[Goldman, Sachs & Co.]

A motivation for Injsurance Linked Securities (ILS)

Insurance companies are in the business of assuming risks from individuals or companies. They manage those risks by diversifying over a large number of policies, perils and geographic regions. A particularly difficult problem is the management of risk from high severity, low probability events (catastrophe risk, or “CAT” risk), such as that posed by major earthquakes or hurricanes. The risk from low severity, high probability events (for example, auto collision or medical insurance) can be diversified by writing a large number of similar policies. Suppose that the insurer charges a premium equal to the expected average annual loss and has a very large number of policies. By the law of large numbers, it can expect to pay out approximately this amount in claims in each year. It then can earn a stable profit on the investment income from the premiums. But the law of large numbers breaks down when confronted by infrequent and severe catastrophe risks — losses can occur across an entire pool of policies simultaneously.

An important tool to manage catastrophe risk is reinsurance. Reinsurance is the means by which insurance companies transfer their own portfolio risk to other reinsurance companies. In the late 1980s and early 1990s, several large losses from U.S. catastrophes (Hurricanes Hugo and Andrew, and the Northridge earthquake) put large strains on the capacities of the reinsurance markets (estimated to total $50–100 billion). Although the situation has eased in the last few years, prices in the reinsurance market remain very volatile and could potentially increase again, perhaps significantly, after one or more major future catastrophes.

Innovative mechanisms have been developed in recent years to stabilize pricing and coverage
by transferring risk, in security or derivative form, into the much larger pools of investment capital available in global capital markets. Since catastrophe risk is inherently uncorrelated with financial markets, such instruments are potentially attractive to many types of investors. Thus, an integration of the reinsurance and the capital marketscan be mutually beneficial for both insurers and investors,providing insurers with reinsurance coverage at reasonable and stable prices, and offering attractive securities to investors.

ILS Structure

1. A special purpose vehicle (SPV) is created
- provides reinsurance to a ceding insurance (or reinsurance) company
- issues securities to investors

2. SPV collects funding for the interest payments the investors receive via:
2. a) SPV collects funds from the investors, which are deposited in a trust.
2. b) Cedant (the insured) pays a premium to the SPV in exchange for the reinsurance that the SPV underwrites.

3. Payout
3. a) Loss doesn't occur or doesn't exceed pre-defined trigger => investors receive back their principal at maturity. Cedant gets nothing.
3. b) Loss above the attachment point (trigger) of the reinsurance contract occurs => funds are used first to make payments to the ceding company under the agreement, leading to a partial or total lossof principal to the investors.

Contract Structure:

1. index-based - loss 'trigger' based on an index (for example, of industry loss experience). Easier for investors to analyze the risk (no need to understand the details of the cedant’s business/underwriting quality). However, index-based introduces basis risk exposure for cedant (occuring if cedant exposure differs from that of the index used to determine the payoff of the contract; in which case, payoff may not fully cover loss).

2. indemnity-based - loss 'trigger' based on the actual loss experience of the
cedant’s own book of business, closely resembles a traditional reinsurance program.

3. parametric structure - loss 'trigger' based on the physical parameters of the natural hazard, such as the magnitude and location of an earthquake.

http://property-casualty.com/News/2010/7/Pages/Ala-Uses-Parametric-Cover-For-SIF-Hurricane-Exposure.aspx

Assessing Cat Risk

The underlying peril risk must be quantified in order to price an ILS. Various cat modeling firms employ an approach combining the use of historical data with certain parametric assumptions. We can estimate potential modern-day effects of historical storms, given today’s buildings and insurance policies. This leaves us with various problems related to the limited size of the sample of historical events (“tail problem”). This problem can be attenuated by making parametric assumptions about the probability distribution of the characteristics of the cat event, creating "stochastic storms".

From Peril Model to Financial Loss

Practice heroically.
T as in Torture... with Smiling Happy Face.
Learn to fail with pride — and do so fast and cleanly.
Everything is delightful and the air is clear.
I'm just having dessert and liquor.

Modeling Terrorism

From: GuyCarpenter

Modeling methodologies have been continually refined and updated relative to the peril of terrorism. However, quantifying the economic and human losses from an act of terrorism continues to pose major challenges for insurers and reinsurers. A variety of approaches exist for insurers to model terrorism risk. Most models involve three techniques:

1. Producing probabilistic loss estimates.
2. Conducting exposure-concentration analysis.
3. Generating deterministic loss estimates.

• Probabilistic modeling, also known as CAT modeling, estimates losses based on a large number of events. A key factor is the estimated frequency a modeler applies to all the possible events that could occur. The industry and rating agencies continue to question the credibility of probabilistic terrorism modeling as it requires predictions of human behavior. As a result, unlike hurricane and earthquake CAT modeling, little consideration is placed on probabilistic terrorism modeling.

• Exposure-concentration analysis, also known as accumulation assessment, identifies and quantifies concentrations of exposures around potential terrorist targets as defined by the modeler. Target-based accumulation assessment locates potential targets-typically with high economic, human, and/or symbolic value-and aggregates an insurer’s exposures in and around various distances from these targets.

An important variation of this analysis looks at an insurer’s largest exposure concentrations, independent of what any particular source defines as a target. Therefore, the scanning of clusters of multi-line exposure exceeding an economic threshold within a portfolio-irrespective of these perceived and defined targets-is essential. According to A.M. Best’s “terror charge” methodology, it is these largest of insured locations (differentiated by city) that can be potentially stress tested against published BCAR, regardless of their proximity to landmarks.

• Deterministic modeling represents a compromise between the lack of accuracy in accumulation analysis and the vast uncertainty surrounding probabilistic models. By imposing an actual event’s damage “footprint” at a specified target, a specific-yet hypothetical-scenario can be analyzed with some certainty. Major modeling firms offer an array of deterministic-analysis tools for conventional and NCBR attacks at defined target and non-target locations. This approach can be effective where coarse screening studies show that exposures for an area or event could be high, and a detailed assessment may reduce uncertainties and help decision making.

Relative to natural perils such as hurricane or earthquake, terrorism modeling is still young and untested. Insurers, reinsurers, and modeling companies are constantly learning, assessing and refining their models and the assumptions that underlay those models, thereby increasing their ability to manage terrorism risk in an educated and more quantitative fashion. Currently, deterministic, scenario-based testing is the most common tool used by insurers to assess their vulnerability to terrorism. Given the human and societal nature of the risk, it cannot be expected that the probability of terror events can be determined with the certainty needed to make critical risk management decisions.

Dr. Gordon Woo, Catastrophist at RMS' Emerging Risks Solutions dept. countered this point beautifully by stressing that in modeling terrorism risk, we are not modeling human behavior but social networks... which are more or less quantifiable. More on this here. Using network theory, Woo was able to incorporate the fact that "too many terrorists spoil the plot" into RMS' probabilistic terrorism model. Woo also authored a beutiful paper on game theory & terrorism found here.

Diageo, U.K. spirits company is pledging up to 2.5 million barrels of its maturing whiskey to its U.K. pension fund.

The transfer is part of a 10-year funding plan addressing a pension-fund deficit totaling £862 million ($1.29 billion)

Ian Warman, pensions partner at advisory firm KPMG said almost any form of asset could be used either as a contingent security or to generate an income stream for a pension fund..

The liquid held by Diageo's pension scheme will be a maximum of three years old and will therefore not be old enough to be bottled as whisky. Once the liquid reaches three years old and becomes usable, Diageo will take back the stock and replace it with fresh liquid, thereby ensuring that the value of the stock held remains constant at £430 million.

After 15 years, the pension trustee will sell its share of the partnership back to Diageo for an amount equal to the remaining deficit and no more than £430 million.

The deal provides the pension fund with an immediate and significant reduction in its deficit, a spokesman for Diageo said, while having no impact on the drinks giant's free cashflow. It also ensures Diageo retains complete control over its ability to use the liquid, he said.

On the rare occasions when I boarded the 6:42 train to New York I observed with amazement the hordes of depressed business commuters (who seemed to prefer to be elsewhere) studiously buried in The Wall Street Journal, apprised of the minutia of companies that, at the time o f the writing now, are probably out of business. [...] I am happy to see such mass-scale idiotic decision making, prone to overreaction in their postperusal investment orders--in other words I currently see in the fact that people read such material an insurance for me continuing in the entertaining business of option trading again the fools of randomness.

-- Taleb "Fooled by Randomness"

provided a much needed cubicle stifled laugh this morning

Media Magnate + Head of Nat'l Security = A Mess

TVi and Channel 5 are two Ukrainian channels which recently had their broadcasting frequencies pulled. The journalists blame Valery Khoroskhovsky, the media magnate who owns Inter Media Group, the country’s largest television holding, and who doubles up as the head of Ukraine’s security service. Mr Khoroskhovsky, they say, exerted influence on the regulator that allocates frequencies, acting in a clear conflict of interest, an allegation Mr Khoroskhovsky strongly denies.

Ukrainian media was pluralistic even if it was not independent. Losing it would be a serious step back for democracy. The government’s assertion of control over television cannot be justified by the failures of journalists. But those failures make pressure easier to apply.

http://www.economist.com/blogs/easternapproaches/2010/06/ukrainian_television

American ambassador to Ukraine, John Tefft, has publicly criticised both the authorities for putting pressure on the media, and journalists for practising self-censorship:
http://ukraine.usembassy.gov/amb-iwp.html

Died & Went to Heaven

... when I saw this
I have a strange obsession with menswear (PBS' Are You Being Served). I've got the GQ subscription to prove it. HowEver (deathproof), I'm not one to usually go all gaga for any specific 'collection'. But Bottega Veneta Sp2011, pointed out by sartorialist.com, is absolutely amazing.






Whoever (and I personally know tons of kids who fall into this category) thinks dudes should not wear sandals is retarded. Sorry!

Sandals are mad sexy. Even when paired with socks. I guess it's Berkeley still seeping through my pores.

A sip of the stuff is ridiculously smooth, and despite the slight hints of citrus and vanilla, the taste is medium-bodied and less complex than some of its sippin'-whiskey brethren—in a good way. At 80 proof, it's not an overpowering spirit, however heroic it may be, and the lightly peated barley lends a gentle smokiness to the whiskey.

This is next in line to try after Lagavulin. Perhaps to be enjoyed next month in NJ?

"People don't want to hear this. We're in the second phase of this credit crisis," he told the paper. "Our debt burden has shifted from the individual to the government. It will work temporarily as you live on Miracle Gro and a sugar high, but when it runs out, then the economy will be in trouble again."

http://www.snl.com/InteractiveX/article.aspx?id=11352231&KPLT=4&Printable=1

Risk: from Reinsurance to Cat Bonds

Kenneth Froot (professor of business administration at the Harvard Business School & author of The Financing of Catastrophe Risk) said his research shows that capital for traditional reinsurers is slowly being drained by large “catastrophe risk shocks” like Hurricane Katrina and the September 11 terrorist attacks.

Each time the reinsurance industry has its capital base “depleted” by a catastrophic event, Froot argues it costs the industry significantly more to replace that capital. The resulting pressure and the inability to raise prices quickly is pressuring reinsurance balance sheets.

“Every dollar in reduction of capital adds up to more than a dollar in market capitalization,” Froot said. “Every dollar of surplus adds to market value, but every time you lose a dollar in surplus you lose more because your market value has begun to fall and you become distressed.”

Additionally, the financial crisis that started in 2008 will likely push regulators to tax large conglomerates like reinsurance companies.

Froot cautioned that although traditional reinsurance may play a smaller role in risk transfer over the next several years, ILS structures like catastrophe bonds and collateralized reinsurance need to continue to evolve. He cited individual transaction costs, structural problems and transparency issues that need to be worked out for the industry to thrive.

On determinants of success: "The most important factor is perseverance in your beliefs, assuming you have some. Most people don’t. Instead, they have fears that can only be alleviated with pats on the back and large bonuses. Belonging to a club or a “Society” is how the average man makes peace with himself. Otherwise, that fear is unbearable. Someone once called it “the unbearable light[ness] of being”. He was right."

On mandating lower microfinance interest rates: "This is not the time to scream “charity” or “social responsibility” when logic and self-consistency will do a far better job on a continuous and sustainable basis."

Sylvain Raynes

Soviet Propaganda: "Where are my royalties?"

"Posters depicting a coupon-clipping capitalist in a top hat, often with a cigar, looking, in Kipling's words, most excruciatingly idle, adorned many a classroom wall in Soviet secondary schools as an illustration of the inequities of capitalism." - Kuznetsov, Capital Markets for Quantitative Professionals

In trying to find such a poster, I asked my mom who pointed me to a different source of propaganda:



"Yelberton Abraham Tittle, from the Piney Woods of East Texas, played pro football from 1948 until 1964, retiring at 38 after starring for the Baltimore Colts, San Francisco 49ers and New York Giants. Although he was the quarterback in the 49ers' so-called Million Dollar Backfield, he is best remembered for his three years in New York, when his passing took the team to three NFL championship games, none of which they won, and for his willingness to take the field when badly hurt."

Back in the USSR, the photo's caption condemned US professional sports by comparing the sportsmen to ancient gladiators -- sentenced to die just to amuse and entertain the crowd.

Ironically, my mom had a chance to meet Y.A. and even talk to him regarding this famous photo. He replied something along the lines of: "Oh crap, they had no idea how much $$ I made during that game. I didn’t know that picture was used as a part of Soviet propaganda. Where are my royalties?"

Alas,

we are so gung-ho at appearing to be "tough on drugs" that we have left our capitalist brains behind...



WEST AFRICA has become an attractive trade route for Latin America’s cocaine smugglers in recent years. On June 8th two tonnes (2000kg) of the stuff (with an estimated street value of over $1 billion) were seized in the Gambia.

The street value of 1kg of cocaine is $500,000 (from the above text). If the cost to manufacturer (if legal) were say $500, it means that a smuggler can spend more that $400,000 per kg of cocaine in technology, bribes and other such costs and still generate a HUGE profit. That is what ultimately drives the cocaine business. If the profit margins are so huge, it behooves us to come up with better (smarter) techniques to combat cocaine usage (there can be no smuggling without usage).

CDS

How Credit Default Swaps Became a Timebomb

(a great primer on que pasa-ed)

In Modeling Risk, the Human Factor Was Left Out

(& another)

Credit default swaps:
a sort of insurance policy: a third party would assume the risk of the debt going sour, and in exchange would receive regular payments from the bank, similar to insurance premiums. JPMorgan would then get to remove the risk from its books and free up the reserves. It built up a "swaps" desk in the mid-'90s and hired young math and science grads from schools like MIT and Cambridge to create a market for the complex instruments. Within a few years, the credit default swap (CDS) became the hot financial instrument, the safest way to parse out risk while maintaining a steady return.

"financial weapons of mass destruction" --Buffett:
credit default swaps are privately negotiated contracts between two parties and aren't regulated by the government. There's no central reporting mechanism to determine their value. That has clouded up the markets with billions of dollars' worth of opaque "dark matter," as some economists like to say.

“Complexity, transparency, liquidity and leverage have all played a huge role in this crisis,” said Leslie Rahl, president of Capital Market Risk Advisors, a risk-management consulting firm. “And these are things that are not generally modeled as a quantifiable risk.”

AIG:
Today, the economy is teetering and Wall Street is in ruins, thanks in no small part to the beast they unleashed 14 years ago. The country's biggest insurance company, AIG, had to be bailed out by American taxpayers after it defaulted on $14 billion worth of credit default swaps it had made to investment banks, insurance companies and scores of other entities. AIG's fatal flaw appears to have been applying traditional insurance methods to the CDS market. There is no correlation between traditional insurance events; if your neighbor gets into a car wreck, it doesn't necessarily increase your risk of getting into one. But with bonds, it's a different story: when one defaults, it starts a chain reaction that increases the risk of others going bust. Investors get skittish, worrying that the issues plaguing one big player will affect another. So they start to bail, the markets freak out and lenders pull back credit.

Gov't Regulation:
Given the CDSs' role in this mess, it's likely that the federal government will start regulating them. "It made it a lot easier for some people to get into trouble," says Darrell Duffie, an economist at Stanford. Although he believes credit default swaps have been "dramatically misused," Duffie says he still believes they're a very effective tool and shouldn't be done away with entirely. Besides, he says, "if you outlaw them, then the financial engineers will just come up with something else that gets around the regulation."

"We’ve learned the hard way that the consequences can be catastrophic, even if statistically improbable" -- Mr. Lo, director of M.I.T. Laboratory for Financial Engineering