Today I read a very technical article on credit derivatives as used by banks (and other institutions), and in the end I came away thinking "this is madness." There are so many hairy problems involved here in attempting to price these things and no one knows the answers. I think answers are unobtainable. The assumptions being made about measuring risks are untenable. In an "Austrian" world, no one can predict them and past distributions do not suffice. Banks doing large amounts of trading in derivatives do not know what their risks are. However, astoundingly, huge sums of money are recorded as gains and losses on accounting statements based on estimates of risk parameters that no one actually is sure of. I kept thinking that these banks are doing all this trading while having their deposits insured and the FED as a backup. This is a huge moral hazard problem...Derivatives Risk – A Brief Rant
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