Long Term Capital Management (LTCM) was a hedge fund that lost billions of dollars because its founders, including nobel prize winners, assumed 1) things that have been uncorrelated for a while will remain uncorrelated, and 2) ridiculously low probabilities of failure calculated from assumptions that events are distributed normally actually apply to analyzing the likelihood of various disastrous investment strategies failing. That is, LTCM reported results as if something which is seen from data to be normal between +/- 2*sigma will be reliably normal out to 3, 4, 5, and 6 sigma.
Yes, there WERE people who knew LTCM were morons. But there were plenty who didn’t, including nobel prize winners with PhDs. It really happened and it still really happens.
I am familiar with LTCM and how it crashed and burned. I don’t think that people who ran it were morons or that they assumed returns will be normally distributed. LTCM’s blowup is a prime example of “Markets can stay irrational longer than you can stay solvent” (which should be an interesting lesson for LW people who are convinced markets are efficient).
LTCM failed when its convergence trades (which did NOT assume things will be uncorrelated or that returns will be Gaussian) diverged instead and LTCM could not meet margin calls.
Hindsight vision makes everything easy. Perhaps you’d like to point out today some obvious to you morons who didn’t blow up yet but certainly will?
“…only one year in fifty should it lose at least 20% of its portfolio.”
And of course, it proceeded to lose essentially all of its portfolio after operating for just a handful of years. Now if in fact you are correct and the LTCM’ers did understand things might be correlated and that tail probabilities would not be gaussian, how do you imagine they even made a calculation like that?
Can we get a bit more specific than waving around marketing materials?
Precisely which things turned out to be correlated that LTCM people assumed to be uncorrelated and precisely the returns on which positions the LTCM people assumed to be Gaussian when in fact they were not?
Or are you critiquing the VAR approach to risk management in general? There is a lot to critique, certainly, but would you care to suggest some adequate replacements?
Long Term Capital Management (LTCM) was a hedge fund that lost billions of dollars because its founders, including nobel prize winners, assumed 1) things that have been uncorrelated for a while will remain uncorrelated, and 2) ridiculously low probabilities of failure calculated from assumptions that events are distributed normally actually apply to analyzing the likelihood of various disastrous investment strategies failing. That is, LTCM reported results as if something which is seen from data to be normal between +/- 2*sigma will be reliably normal out to 3, 4, 5, and 6 sigma.
Yes, there WERE people who knew LTCM were morons. But there were plenty who didn’t, including nobel prize winners with PhDs. It really happened and it still really happens.
I am familiar with LTCM and how it crashed and burned. I don’t think that people who ran it were morons or that they assumed returns will be normally distributed. LTCM’s blowup is a prime example of “Markets can stay irrational longer than you can stay solvent” (which should be an interesting lesson for LW people who are convinced markets are efficient).
LTCM failed when its convergence trades (which did NOT assume things will be uncorrelated or that returns will be Gaussian) diverged instead and LTCM could not meet margin calls.
Hindsight vision makes everything easy. Perhaps you’d like to point out today some obvious to you morons who didn’t blow up yet but certainly will?
An LTCM investor letter, quoted here, says
And of course, it proceeded to lose essentially all of its portfolio after operating for just a handful of years. Now if in fact you are correct and the LTCM’ers did understand things might be correlated and that tail probabilities would not be gaussian, how do you imagine they even made a calculation like that?
Can we get a bit more specific than waving around marketing materials?
Precisely which things turned out to be correlated that LTCM people assumed to be uncorrelated and precisely the returns on which positions the LTCM people assumed to be Gaussian when in fact they were not?
Or are you critiquing the VAR approach to risk management in general? There is a lot to critique, certainly, but would you care to suggest some adequate replacements?