Perspective on Risk - Dec. 22, 2022
Recession Probability; Housing - The Difference Between 2008 & Today; Another REIT Anecdote; Non-centrally Cleared Bilateral Repo; Timeline of Crypto Collapse; Reading; Music
Recession Probability
The NY Fed recession model in now in the 2001 and 2008 range.
Did you know that the originator of this gauge has a Twitter account? I didn’t; how could I miss this.1 Here’s the link to Arturo Estrella’s @intheyield. He published the below graph at the end of November.
One thing he notes; the yield curve does not seem to predict the depth or length of a recession.
Housing - The Difference Between 2008 & Today
Cramer gets a lot of hate, but Carl is actually quite good.
Another REIT Anecdote
Non-centrally Cleared Bilateral Repo
Most of the energy when I was at the Fed was focused on issues with Triparty repo. Since then, the powers-that-be have sought to better understand the full repo market to make sure that there were not other sources of risk.
OFR’s Pilot Provides Unique Window Into the Non-centrally Cleared Bilateral Repo Market2
The OFR collected NCCBR (Non-centrally cleared bilateral repo) transaction-level data from these dealers for three days in June 2022.
Low haircuts in Treasury repo markets have been noted as a concern in the past, with the Group of Thirty report on the U.S. Treasury market observing “competitive pressures [in recent years] driving haircuts down (sometimes to zero).
Haircuts in NCCBR differ dramatically from what is possible through other segments: for Treasury repo in NCCBR, 74% of pilot volume was transacted with zero haircut. This differs markedly from common practices in non-centrally cleared triparty repo, where the median haircut on Treasury collateral has held consistently at 2% for over a decade, and from cleared repo, where minimum margins are typically assessed on a portfolio basis.
Our preliminary findings, as well as outreach with market participants, suggest this may be due to the prevalence of netted packages, where a dealer will conduct both a repo and a reverse repo with the same counterparty and same tenor (usually short-term or overnight), but different pieces of Treasury collateral. In effect, these netted packages facilitate trades of one cash Treasury against another, a strategy popular with relative-value hedge funds.
Timeline of Crypto Collapse
Reading
Kindness Can Have Unexpectedly Positive Consequences (Scientific American)
Scientists who study happiness know that being kind to others can improve well-being. Acts as simple as buying a cup of coffee for someone can boost a person’s mood, for example. Everyday life affords many opportunities for such actions, yet people do not always take advantage of them.
In a set of studies published online in the Journal of Experimental Psychology: General, Nick Epley, a behavioral scientist at the University of Chicago Booth School of Business, and I examined a possible explanation. We found that people who perform random acts of kindness do not always realize how much of an impact they are having on another individual. People consistently and systematically underestimate how others value these acts.
Given that these warm gestures can enhance our own mood and brighten the day of another person, why not choose kindness when we can?
Capital Allocation - Results, Analysis, and Assessment (Morgan Stanley
Michael Mauboussin’s original Measuring the Moat came out about 20 years ago and is still a seminal work. He just put out the latest update to that work. Always worth reading.
Even though capital allocation is the most important responsibility of the chief executive officer (CEO), not all know how to do it well.
A Stylized History of Volatility
Not many people know more about financial asset volatility than Emanuel Derman.
The evolution of a quantitative approach to finance has proceeded through many small but significant steps and occasional large epiphanies concerning the management of volatility.
This article outlines how philosophers, physicists, and financial modelers have quantified the notion of derivatives, diffusion, risk, volatility, the riskless rate, diversification, hedging, replication, and the principle of no riskless arbitrage. Volatility, once a qualitative term, has become an asset that can be traded via models. But the models are always necessarily inadequate, and it is their very failure that opens up the possibility of trading the parameters they introduce.
Understanding Uncertainty Shocks and the Role of Black Swans3 (BOGFRS)
Moderately interesting paper by some Board economists. The difference between (measurable) risk and (unmeasurable) uncertainty has always interested me, and is important to understand as a risk manager, This paper hypothesizes that uncertainty in economic forecasts belief formation in the presence of the inability to know the true distribution of macroeconomic outcomes leads Bayesian updating of priors to result in more uncertainty.
Our main contribution is to explain why real-time estimation of distributions with non-normal tails are prone to large uncertainty fluctuations. We use theory and data to show how small changes in estimated skewness whip around probabilities of unobserved tail events (black swans). Our estimates, based on real-time GDP data, reveal that revisions in the estimates of black swan risk explain most of the fluctuations in uncertainty.
Meetings Are Miserable (Arthur Brooks; The Atlantic)
One of the most straightforward paths to happiness at work is to fight against the scourge of time-consuming, unproductive meetings at every opportunity.
One survey of 76 companies found that productivity was 71 percent higher when meetings were reduced by 40 percent.
But the real problem with meetings is not lack of productivity—it’s unhappiness. When meetings are a waste of time, job satisfaction declines. And when job satisfaction declines, happiness in general falls. Thus, for a huge portion of the population, eliminating meetings—or at least minimizing them—is one of the most straightforward ways to increase well-being.
Ruthlessly avoid and cancel meetings.
Create meeting-free days
Keep meetings to half an hour or less
Don’t invite everybody
If there is one rule to remember about work meetings, it might be that they are a necessary evil. They are necessary insofar as organizations need them for proper communication, but they are evil in that they are almost never inherently desirable, and should thus be used as sparingly as possible for the sake of productivity and happiness.
Santa Claus Is Comin’ To Town, 1978
This is the earliest, and best, version of this classic.
Merry Christmas Baby
See y’all next year.
One of my favorite memories at the NY Fed was when Arturo agreed with me in a discussion, and not the other economists in the room. I’ve remembered that to this day.
Hempel, Kahn, Mann, and Paddrik, OFR’s Pilot Provides Unique Window Into the Non-centrally Cleared Bilateral Repo Market, Office of Financial Research
Orlik and Veldkamp, Understanding Uncertainty Shocks and the Role of Black Swans, Board of Governors of the Federal Reserve System