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U.S. Securities Regulator Proposes New Rules On Use Of Derivatives In Exchange Traded Funds
The proposal would apply not only to ETFs, but "to mutual funds (other than money market funds), exchange-traded funds (“ETFs”), registered closed-end funds, and companies that have elected to be treated as business development companies (“BDCs”) under the Investment Company Act."
It is based on limiting a fund's "value at risk" (VaR) relative to that of a benchmark, e.g. not more than 150% as much risk. I confess to not being familiar with the (apparently commonplace) term VaR. Briefly:
It is the probability that a portfolio will experience a mark-to-market loss that exceeds that of a specific predetermined threshold value.
Essentially this means that value at risk is measured in three variables:
Several of the limitations presented are discussed in the NYU paper. One that isn't is what Nocera presents as gaming:
That sounds good in principle, but managers began to manipulate the VaR by loading up on what Guldimann calls “asymmetric risk positions.” These are products or contracts that, in general, generate small gains and very rarely have losses. But when they do have losses, they are huge. These positions made a manager’s VaR look good because VaR ignored the slim likelihood of giant losses, which could only come about in the event of a true catastrophe. A good example was a credit-default swap, which is essentially insurance that a company won’t default. The gains made from selling credit-default swaps are small and steady — and the chance of ever having to pay off that insurance was assumed to be minuscule. It was outside the 99 percent probability, so it didn’t show up in the VaR number. People didn’t see the size of those hidden positions lurking in that 1 percent that VaR didn’t measure.
This is what I have in mind when I question portfolios that seem to do just a little bit better, until they don't. How are they levitating? They'll likely never have a problem, but if they do they may crash swiftly and steeply.
I wonder if this affects / will affect CAPE and DSEEX.
I remembered that Nocera piece only because one of my kids was in B-school at the time and commencing formal study of VaR, Taleb all the rage. Also I was making then losing money with Novastar. (French taught at that B-school, so also much ultrafine discussion of efficiency in markets.)
Comments
SEC proposed rule: https://www.sec.gov/rules/proposed/2019/34-87607.pdf
The proposal would apply not only to ETFs, but "to mutual funds (other than money market funds), exchange-traded funds (“ETFs”), registered closed-end funds, and companies that have elected to be treated as business development companies (“BDCs”) under the Investment Company Act."
It is based on limiting a fund's "value at risk" (VaR) relative to that of a benchmark, e.g. not more than 150% as much risk. I confess to not being familiar with the (apparently commonplace) term VaR. Briefly: https://marketbusinessnews.com/financial-glossary/what-is-value-at-risk-var/
A more extensive discussion, including VaR's uses and limitations, and various ways it may be calculated: http://people.stern.nyu.edu/adamodar/pdfiles/papers/VAR.pdf
https://www.nytimes.com/2009/01/04/magazine/04risk-t.html
Several of the limitations presented are discussed in the NYU paper. One that isn't is what Nocera presents as gaming:This is what I have in mind when I question portfolios that seem to do just a little bit better, until they don't. How are they levitating? They'll likely never have a problem, but if they do they may crash swiftly and steeply.
I remembered that Nocera piece only because one of my kids was in B-school at the time and commencing formal study of VaR, Taleb all the rage. Also I was making then losing money with Novastar. (French taught at that B-school, so also much ultrafine discussion of efficiency in markets.)