I have not seen a model yet that shows how all this redistribution causes weakness in economic activity. Certainly the incentives are hurt. But I think a model similar to what Friedman uses to show how money should grow with 2 or 3 people on a desert island would show how hurtful this is.

Tyler Cowen writes:

Moral hazard escalates.

Keep in mind that since bank failure is deflationary, the Fed can address bank failure by printing up a lot of money without a net inflationary effect. On the inflation front we are simply holding even, more or less.

But we are substituting interest-bearing reserves for M2, or public sector assets for private sector dealings, a very bad long-term trend.

Plus higher moral hazard and now European banks are Too Big To Save and don't have a real central bank behind them.

Did you see that JP Morgan is now forecasting 9.5 unemployment for 2012?





Speak your mind

2 Comments so far

  1. douglas roberts dimick on August 23, 2011 7:06 pm

    I reprint here a conversation on exotic Fx derivatives at…

    I get the points on liquidity and “razor-thing spreads” for the demand of these options. However…

    What is the “omplex (exotic) payoff on top” as referenced at #1 of the final post?

    Is it if the currency exchange rate swings in favor of the option holder?

    Also, this poster asks…

    Why don’t we see more S&P 500 or US 10Y Treasury exotics?

    What is the answer?



    Ps. The Quant Fin thread…

    3 Answersactiveoldestvotes
    up vote
    down vote

    As I understand it, the currency derivatives are meant for customers to hedge actual exposure. A foreign distributor obviously has exchange-rate risk, but it’s hard to say who actually has risk exposure to the S&P 500. (There’s the effect of beta, of course, but it’s pretty rare for someone to have tangible—not just CAPM—exposure to the S&P. Someone who holds the S&P does so intentionally.)

    Fear not, though. There are a few OTC derivatives that are used in levered ETFs. Consider 3X Russell 2000 or Ultra NASDAQ 100, both of which list index swaps among their holdings.

    link|improve this answer
    answered Aug 12 at 16:11

    up vote
    down vote
    Since this is an asset class which is so tightly coupled with interest rates - it makes good products for clients inherently complex.
    It also makes good sense to make wider markets for more exotic products than the plain vanilla ones - in which razor-thin spreads rule (and trading huge notionals is not everyone’s cup of tea)
    link|improve this answer
    answered Aug 3 at 22:04

    up vote
    down vote
    Posting this question to a LinkedIn discussion group solicited the following additional answers:

    The underlying is relatively well understood and simple in a pricing sense. This allows you to put a complex (exotic) payoff on top.
    The vast majority of FX spot volumes are spread among a small group of G-7 currencies, unlike equities or other markets where you have a myriad of different tickers.
    No major barriers to the market / inside information / absence of manipulators (except for Central Banks who do not have speculative missions).
    Pension and insurance firms are taking deposits in one currency which they invest in a different currency for carry/performance. They only partially hedge their currency exposure using options, and sometimes exotic OTC options are designed in order to best fit their particular mix of assets and liabilities.
    I do have my own question on point #2, though. Aren’t there relatively few highly liquid equity indices and fixed income futures? Why don’t we see more S&P 500 or US 10Y Treasury exotics?

    Update: I actually like #4, which just came in from LinkedIn, best so far. Basically, the real-world exposure of unsophisticated firms is complicated, and so they offload the complex hedging to a sophisticated counterparty. This, combined with @chrisaycock’s answer, completely answers the question to my satisfaction.

  2. Andre Wallin on August 23, 2011 7:18 pm

    today was a switch


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