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Spot Prices Fact or Fiction? Risk or Return? Adil Abdulali, Eric Weinstein - AdKap, LLC

Valuation Risk. Translucent Assets. Spot Prices Fact or Fiction? Risk or Return? Adil Abdulali, Eric Weinstein - AdKap, LLC Mortgage Backed Opportunity, LP 575 Lexington Avenue, 7 th Floor New York, NY 10014 212-350-4344 Adil.Abdulali@AdKap.com Weinstein@Post.Harvard.edu. Phantom

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Spot Prices Fact or Fiction? Risk or Return? Adil Abdulali, Eric Weinstein - AdKap, LLC

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  1. Valuation Risk Translucent Assets Spot Prices Fact or Fiction? Risk or Return? Adil Abdulali, Eric Weinstein - AdKap, LLC Mortgage Backed Opportunity, LP 575 Lexington Avenue, 7th Floor New York, NY 10014 212-350-4344 Adil.Abdulali@AdKap.com Weinstein@Post.Harvard.edu Phantom Prices

  2. Liquidity Pricing High Transparent: Common Stocks Medium Translucent: Junk Bonds, MBS Low Opaque: Real Estate, Art

  3. Translucent PricingMBO – 2000 Year End Dealer Quotes

  4. Trading by Appointment Feb-21, 2001 9:00 am: Ask 5 brokers- “Please Bid 15 Million FHR-2064-G” (Principal Only “PO” Class of a Collateralized Mortgage Obligations.) 10:30 am: Broker 1: 77 12:00 pm: Broker 2: 85.25 - Indication only - no firm bid 1:00 pm: Broker 3: 86.25 2:30 pm: Bonds sold

  5. NAV/Fair Value Survey • Overall 13% of respondents made adjustments of some kind to the “market prices” they receive from their valuation sources. • Most respondents indicated that adjustments represented less than 2% of NAV. • Some indicated that the adjustment in aggregate represented up to 30% of NAV. • 0% made adjustments on U.S. Government bonds. • 38.7% on warrants. • 35.1% on private equity.

  6. NAV/Fair Value Survey Reliance on a Single Quote

  7. NAV/Fair Value Survey • There is no consistent market practice regarding how dealer quotes are incorporated into valuations. Of the participants who use dealer quotes: • 44% use an average • 27% make a subjective judgement • 18% use the median • 9% drop the high and low and average the rest

  8. Chanuka Wish List for Phantom Price Framework • Reveals risk. • Conceals position level detail. • Provides analogs of all standard measures such as the Sharpe Ratio which collapse to the usual measures in the absence of Translucent Assets. • Allows measurement of a Hedge Fund Managers valuation bias.

  9. “Towards Hedge Fund Transparency: Quantifying Valuation Bias for Illiquid Assets” Dr. Eric R. Weinstein & Adil Abdulali Weinstein@post.harvard.edu Adil.Abdulali@AdKap.com Research sponsored jointly by Capital Market Risk Advisors (CMRA) And AdKap, LLC To Appear in Risk Magazine: January 2002. More details at: WWW.TransparentRisk.com after publication.

  10. 99.00 91.15 99.50 90.80 100.00 89.8 89.95 100.50 88.80 50.00 88.30 Price Quotes forming Market Beliefs Given these two sets of Quotes, Which set would induce you to sell the bond if you got a bid of 92.00? A B

  11. Phantom Prices Beliefs Preferences Vector of indicative prices at time t. Utility function representing an investors risk preferences. Probability distribution that the investor believes generated the sample .

  12. Gamma Distributions and Constant Relative Risk Aversion Gamma PDF

  13. Generic Phantom Prices

  14. Phantom Price as a Function of Sample Variance

  15. Phantom Price as a Function of Level of Risk Aversion

  16. Phantom Price as a Function of Both Variance and Risk Aversion

  17. Manager Sharpe Ratio: 2.34 Phantom Price Sharpe Ratio: 0.45

  18. Conclusion Translucent Assets Spot Prices are in fact a fiction for Translucent Assets. Phantom Prices can be used for any calculation or performance statistic that works for Transparent assets (including NAV.) Phantom Prices allow measurement of Valuation Risk by revealing managers valuation biases. Phantom Prices Valuation Risk

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