Skip to main content

Credit Default Swaps

Until reading James Rickards' FT article (need to be a registered FT user to view) about the financial crises in Greece I had a feeling there is something fundamentally wrong with CDS trade, but I didn't understand exactly what.

Other columnists say that derivative trading increased risk because: 1. they gave institutes the false sense of security in risk handling - relaying pseudo science mathematical models, as if they were the absolute truth. 2. They increased interconnection between financial institutes strengthening the domino effect 3. They made the investments more complex, harder to understand and thus less transparent.

While all the above-mentioned reasons are true Rickards introduces a simpler flaw with CDS. A regular insurance has a insurable interest. An insurance company giving a person life insurance has an interest in keeping the person alive since that way they will not have to pay the insurance. CDS traders, on the other hand, have an interest to exacerbate any crises since they are not liable for the insurance. As mediator between the two sides of the swap, they earn their income on margins on transactions and the more transactions (like in a volatile situation) the better.

Labels:

Comments

Post a Comment

Popular posts from this blog

AA Problem

AA stands for Attention Allocation not Alcoholic Anonymous. Sorry for the deceiving eye catcher. PTT presentation is work I did in 2005 in the purely abstract edges of Operation Research. I uploaded a PPT presentation. The presentation is lighter and more colorful than the actual article. Warning you have to be a bit of a geek to press the link above. For the super geeks I put a link to the full article. It’s called “Attention Allocation to Partially Observable Heterogeneous Customers – with Imperfect Treatment”, Catchy? Full AA Problem article
Post a Comment
Read more

Digital Life - Art of Display

TNS, a market research firm, conducted an extensive research on the use of mobile, internet applications and social media around the world. What's really cool about it, more than the findings themselves, is the way the findings are presented. Sometimes, visualization is what matters most. http://discoverdigitallife.com/
1 comment
Read more

SDM from up on the bridge

I am taking the first spring semester as a long distance student in MIT's System Design and Managment (SDM) program. The long distance option, which I am grateful for, poses some challenges. A month into the semester, I am still trying to improve the interaction with the classroom, faculty and fellow students and maintain a balance between school and work. Setting up a work station I am using my home office (/living room /dining room/ guest sofa) from which I connect to the ‘bridge’. I find it useful to work with two screens. One displays the class, the mike controls and my video (I want to see how I appear to people looking at me from the classroom). The other displays the presentation slides and notebook (OneNote). The webcam is positioned above the main screen and when I look at the other screen, I am not facing the webcam. Class participation The video and sound quality are good. Material is always available before hand on the web. So keeping up with the studies is eas...
3 comments
Read more