1 / 16

LTCM’s Analysis of Risk Management

LTCM’s Analysis of Risk Management. February 28, 2002 Frank Burke Larry Kissko Gurkan Salk Heather King. Agenda. LTCM Background Swap Spread Trading Strategy Project Analysis Comparison/measurement of LTCM’s Risk Assessment

gypsy
Download Presentation

LTCM’s Analysis of Risk Management

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. LTCM’s Analysis of Risk Management February 28, 2002 Frank Burke Larry Kissko Gurkan Salk Heather King

  2. Agenda • LTCM Background • Swap Spread Trading Strategy • Project Analysis • Comparison/measurement of LTCM’s Risk Assessment • Discussion on return and spread distribution, calculated implied std deviation • Estimate of LTCM’s Value-At-Risk • Proxy Tests • Take-aways

  3. LTCM Background • August 21, 1998, fund lost $550m mostly from swaps spreads and equity volatility bets. • LTCM believed this event would occur 1 in every 800 trillion years (or an 8.3 std dev move). • Swap spreads shot up from 60 bps to 80 bps intraday vs. an average daily move of 2 bps • LTCM’s swap position represented 2.4% of global swap market in December 1997 • Leverage ratios varied from 28:1 to a high of 55:1 in late 1998

  4. LTCM Trading Strategy We focused on of one of LTCM’s biggest trades: • Swap Spread Relative Value Trade • Swap spread – difference between the fixed rate on a fixed-for-floating swap and the yield on a coupon-bearing Treasury bond of comparable maturity • Speculative strategy that spread would converge to its historical mean • Long swap/short the treasuries (in 1998) • Crisis: Aug 21, spreads spiked 21 bps intra-day

  5. Swap Spread Frequency: “the bet”

  6. Project Analysis • Parametric VAR – assumes normal distribution • Historical VAR – based on actual data distribution • Proxy search – difficult to find a strong correlation • BAA- 10 year treasury • AAA- 10 year treasury • MBS - 10 year treasury • Forecasted daily variance Value At Risk – defined as the expected maximum loss over a target horizon within a given confidence interval

  7. Swap Returns Distribution (thru 7/98)

  8. Analytic Results

  9. Value at Risk (VAR) • Principal measure of risk at LTCM • LTCM parametric VAR measure • Capital (assume $1b) x daily std dev of returns (.02) x std dev of required confidence interval (3 = 99.85% 1-tail) • $1.0b x 2% x 3 = $60,000,000 • Our historical VAR measure • $ 1.0b x 9.5238% = $95,238,000

  10. Take-Away Thoughts • VAR not necessarily suspect – correct inputs are critical • Cannot blindly apply normal distribution • Dig into your data • If data is not complete consider: • Developing a risk proxy • Assuming fatter tails in distribution (Student’s T curve)

  11. Appendix - charts August 21, 2002

  12. Appendix - charts

  13. Appendix - charts

  14. Appendix - charts

  15. Appendix - charts

  16. References • Jorion, P., 2000 Risk Management Lessons from LTCM • Kolman, Joe, 1999, “LTCM Speaks”, Derivatives Strategy (April) p.12-17 • Lewis, Michael, 1999, “How the Egg-Heads Cracked” New York Times Magazine, January 24, p 24-77 • Anonymous, 1998, “Too Clever By Half”, The Economist Magazine, November 14 • Whaley, Robert, 2001, “Derivatives” Class Presentation • Scholes, Myron, 2000, “Crisis and Risk Management- The Near Crash of 1998”, AEA Papers and Proceedings Vol 90 No. 2, May. • Bloomberg – Swap spread data

More Related