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Old 31.05.2011, 08:49
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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There are lots of products yet almost no one in Switzerland has any exposure to them. I cant figure out why this is? And this is why I ask.
Just out of interest, I don't know what breadth of survey or what kind of access or clout you have among the wealth managers here but how can you be so sure? My experience is very few private wealth managers open up to you and divulge what their portfolio protection strategies are.

Having said that, fat tail risk insurance isn't mainstream here. As you say, there are products out there for those that want them. Maybe like GenevaSculler says, many aren't convinced of the promised returns. Then there are issues around credit rating and transparency of pricing and liquidity of some of these products. In any case, from what I see, portfolio managers here still stick to the principle that the best way to protect wealth is through diversification of investments to spread the risk. Then if the going gets tough, the best way of capital protection is to get out of the markets altogether and into cash. That can work but only as long as all asset classes don't move in the same direction, which as we have seen, can happen in a crisis. In that event it depends on how quick you are to get into cash and how liquid markets are.

In the end it all comes down to what the portfolio mandate is. If a fat tail risk happens then you may miss out on making a few bucks, but as long as the capital is protected, that's an opportunity loss.

I'm a bit confused. Some of your posts sound like you're advocating wealth managers should trading risk/volatility just because it's cheap. That's a trading strategy, not a capital protection strategy though clearly it would pay off in a black swan event.
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Old 31.05.2011, 09:28
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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Just out of interest, I don't know what breadth of survey or what kind of access or clout you have among the wealth managers here but how can you be so sure? My experience is very few private wealth managers open up to you and divulge what their portfolio protection strategies are.

Having said that, fat tail risk insurance isn't mainstream here. As you say, there are products out there for those that want them. Maybe like GenevaSculler says, many aren't convinced of the promised returns. Then there are issues around credit rating and transparency of pricing and liquidity of some of these products. In any case, from what I see, portfolio managers here still stick to the principle that the best way to protect wealth is through diversification of investments to spread the risk. Then if the going gets tough, the best way of capital protection is to get out of the markets altogether and into cash. That can work but only as long as all asset classes don't move in the same direction, which as we have seen, can happen in a crisis. In that event it depends on how quick you are to get into cash and how liquid markets are.

In the end it all comes down to what the portfolio mandate is. If a fat tail risk happens then you may miss out on making a few bucks, but as long as the capital is protected, that's an opportunity loss.

I'm a bit confused. Some of your posts sound like you're advocating wealth managers should trading risk/volatility just because it's cheap. That's a trading strategy, not a capital protection strategy though clearly it would pay off in a black swan event.
Ive spoken openly with people I have known for years who run these shops in CH. Typically asset exposure (as apposed to specific investment names) isnt a secret amongst any of us. So its a topic of discussion. Also, after speaking with several fat-tail-risk fund managers I was amazed that they had almost no Swiss clients. One large family office was the only one. They sold a large Gold position and loaded up on two funds.

"credit rating and transparency of pricing and liquidity of some of these products" is only a problem if you want an internal hedge. But thats a great reason to outsource it. The chief macro pm over at SAC isnt allowed to own or trade cds's. Steve wont allow it because of the issues you mention. So he gives money to a small fund that specializes in it. SAC doesnt normally do that kind of stuff.

"Then if the going gets tough, the best way of capital protection is to get out of the markets altogether and into cash".... Yes, like after your portfolio is down 20%. I dont know too many who have mastered the timing issues implied with "rolling into cash". So in theory youre right. But in reality its never worked.

Advocating anyone to buy cheap protection isnt actually a trading strategy. Its a risk/reward strategy. And thats all any Family Offices talk about, how much and I risked and how much could I make. So yes, these hedges are cheap because the risk of 35 to70bps a year vs. a reward of 1000bps in one of the next 3 years. But CDS's arent the only way to go either. Its just the easiest example.

And I hate the term "black swan"..... A Tsunami that wipes out a nuclear reactor is a black-swan.... Yes. But a Japanese government bankruptcy is a white swan. They are 3x as leveraged as Greece and they now have a negative savings rate. 5yr CDS's are at 86bps and 10yr JGB's are at 1.16%. The black swan isnt in the event, its in the repricing of risk.

But my argument is that these guys are uber long Private Equity and cash.... Thats almost everyone. As far as market environments it doesnt get much better than this. At this stage in the cycle why wouldnt you put some money into hedging your positions? You cant roll a PE fund share into cash if VIX is at 25+....
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Old 31.05.2011, 13:03
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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Ive spoken openly with people I have known for years who run these shops in CH. Typically asset exposure (as apposed to specific investment names) isnt a secret amongst any of us. So its a topic of discussion.
I'm not questioning the prudence of appropriate risk management, or saying that portfolio diversification is the be all and end all of risk management. I'm just observing from experience that, at least among the large and medium sized fund managers I talk to, the approach here is still focussed around portfolio diversification and vanilla hedging products to protect wealth.

What I don't get is, you have a relationship with the folks who run these shops in CH and can speak to them openly. So if you want to know why they don't use fat tail insurance, then why not simply pose the question? The only thing I can think of is that this kind of stuff isn't in their mandate.
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Old 31.05.2011, 13:28
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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I'm just observing from experience that, at least among the large and medium sized fund managers I talk to, the approach here is still focussed around portfolio diversification and vanilla hedging products to protect wealth.

What I don't get is, you have a relationship with the folks who run these shops in CH and can speak to them openly. So if you want to know why they don't use fat tail insurance, then why not simply pose the question? The only thing I can think of is that this kind of stuff isn't in their mandate.
right, but with vanilla hedging products the returns arent that great for the risk. i.e. if I go short an equity the most I can probably make, if I get my timing right, is 60%. Take a look at the VIX curve. Its pricing in a bear market already. How much am I really going to make on owning z1's? which are 37% above front month?

I have asked these guys. Everyone thinks I am nuts. They are all looking for Private Equity investments. They dont think that there are really any risks. They think the system is back to 2003. On top of that UBS and CS are both sellers of CDS, and buy almost nill to offset that. Our CDS broker tells us who the lop-sided guys are. Swiss and Italian banks. Why dont Swiss banks buy cds's? Typically you buy and sell cds's if youre a bank or insurance company.

As far a not being in their mandate? Family offices dont really have a 'mandate' in my experience. Only a fund manager who is running a fund has a mandate. One of these fat tail guys has an "African diamond arb" fund that all the family offices jumped at. I highly doubt thats in any mandate anywhere.

Do you believe there are risks Nev? Or are you also uber long, waiting to go into cash? Am guessing youre not a family office.
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Old 31.05.2011, 13:39
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

first 80bps for a family office return is quite a lot. Considering the small gross return and the fees they charge, there's only a thin margin left.
Then, if you buy an end of the world CDS, who would be your counterparty? Lehman? AIG? The past crisis showed that there's no riskless counterpart, even the USA have a credit spread...
Also, those funds are mainly in bonds, so the rise in bond prices in case of a crisis already plays for the portfolio return overall.
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Old 31.05.2011, 13:48
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

But how do you effectively hedge a fat-tail event? By its very nature it is out of the ordinary, otherwise it would have become a consensus trade and the outsized returns/protection would have gone. I see a series of rhetorical problems:

Long vol, has a huge time premium to it and is this worth paying? Strategies involving vol futures involving VIX futures suffer from crazy roll costs as you allude to.

How do CDS work? Many current tabled work out solutions in Europe would not trigger default clauses, purposely to avoid doing this. On the deliverable side of those long protection, post-2008 there were price spikes in the default bonds that needed to be delivered for those owning protection. Oh... and the whole area of the counter-party risk for who you are trading those contracts with. Given that the top tier banks are arguably the ones holding much of the toxic assets and sovereign debt still marked at par, do you want to face off to them in a trade, when any crisis of the same magnitude as the GFC sees them as being insolvent again.

Is Japan really going to go bust? Long CDS on Japan is an interesting example, but I have heard pitches from managers to be short Japan for more than a decade. Whether it be Japan, or the time honoured JMK quote, but the markets "can remain irrational for longer than you can stay solvent". There is clearly a huge chunk of luck with timing allocations to such strategies. Those short sub-prime suffered massively 2005-07, but those that came late to the party grabbed the headlines when they hit the jackpot in 2007-08.

From what I have seen, there is the scepticism of many of these strategies and GenevaSculler alludes too this. The trades will need to be perfectly structured if thet are indeed to protect. For many it is simply, that such strategies are beyond their core understanding and so they shun such complicated ideas. For others there are practical constraints that they don't have ISDA agreements in place, or have credit/collateral lines necessary to trade everything.

There are reasons for and against. If you are convinced that the end is nigh, then don't complain. You don't want tonnes of private capital flooding in and dilluting your returns!!!
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Old 31.05.2011, 13:52
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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first 80bps for a family office return is quite a lot. Considering the small gross return and the fees they charge, there's only a thin margin left.
Then, if you buy an end of the world CDS, who would be your counterparty? Lehman? AIG? The past crisis showed that there's no riskless counterpart, even the USA have a credit spread...
Also, those funds are mainly in bonds, so the rise in bond prices in case of a crisis already plays for the portfolio return overall.

80bps is a lot? hmmm... Have you ever traded CDS or physical govi spreads? um? So on a bread and butter $30mn notional CDS it costs me only $240,000.... So if the entity goes bust, and the bonds trade at 50c on the dollar, I will get back $15mn, on my 240,000..... But even if there is a scare they go to 1000bps, or $3mn.

As far as counter-party goes most of these guys trade through several entities and also buy CDS's on their counter-parties thourgh JPM (who is the largest share holder of the Federal Reserve Bank). When AIG counldnt cover its Iceland CDS payouts the Fed paid them, just incase you didnt know.

As far as being in bonds, yes they, Like our office, play spreads, So we are long bunds and short Spain and Italy govis. Its more liquid than CDS and if they ban CDS the spread will double.
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Old 31.05.2011, 14:05
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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But how do you effectively hedge a fat-tail event? By its very nature it is out of the ordinary, otherwise it would have become a consensus trade and the outsized returns/protection would have gone. I see a series of rhetorical problems:

Long vol, has a huge time premium to it and is this worth paying? Strategies involving vol futures involving VIX futures suffer from crazy roll costs as you allude to.

How do CDS work? Many current tabled work out solutions in Europe would not trigger default clauses, purposely to avoid doing this. On the deliverable side of those long protection, post-2008 there were price spikes in the default bonds that needed to be delivered for those owning protection. Oh... and the whole area of the counter-party risk for who you are trading those contracts with. Given that the top tier banks are arguably the ones holding much of the toxic assets and sovereign debt still marked at par, do you want to face off to them in a trade, when any crisis of the same magnitude as the GFC sees them as being insolvent again.

Is Japan really going to go bust? Long CDS on Japan is an interesting example, but I have heard pitches from managers to be short Japan for more than a decade. Whether it be Japan, or the time honoured JMK quote, but the markets "can remain irrational for longer than you can stay solvent". There is clearly a huge chunk of luck with timing allocations to such strategies. Those short sub-prime suffered massively 2005-07, but those that came late to the party grabbed the headlines when they hit the jackpot in 2007-08.

From what I have seen, there is the scepticism of many of these strategies and GenevaSculler alludes too this. The trades will need to be perfectly structured if thet are indeed to protect. For many it is simply, that such strategies are beyond their core understanding and so they shun such complicated ideas. For others there are practical constraints that they don't have ISDA agreements in place, or have credit/collateral lines necessary to trade everything.

There are reasons for and against. If you are convinced that the end is nigh, then don't complain. You don't want tonnes of private capital flooding in and dilluting your returns!!!

See previous posts... Should all be covered. As far as ISDA goes, thats only for non-single lines (i.e. Generic SOVR's). Also, you dont have to make money an an actual bankruptcy. Youre starting to sound like one of these Eastern European guys who like to argue for the sake of debate. Its the journey of repricing risk, not the destination of bankruptcy.

Until the CDS market destroys the system why not make money off of it? When they make it illegal all the banks will be bust. Oh and the airline companies who are borrowing at 5%? They will have to pay 20% on their debt. Its a crappy system. But its going to kill itself one way or the other. Why not try to make money before hand?
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Old 31.05.2011, 14:10
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

Do you believe there are risks Nev? Or are you also uber long, waiting to go into cash? Am guessing youre not a family office. [/QUOTE]

Nope, definitely not a family office and I only talk to clients who are institutional in size so I can only offer a perspective on medium to large banks.
Of course I think there are tail risks. But I don't see a systematic way of playing it in a tried and tested way. Extreme events are by nature unpredictable and might not play out like you think in terms of correlation - in which case your strategy will fail and you've wasted your money. And I think credit and liquidity risk remains a huge problem, especially in a crisis.

Anyhow, sounds like you have your answer.

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I have asked these guys. Everyone thinks I am nuts. They are all looking for Private Equity investments. They dont think that there are really any risks.
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Old 31.05.2011, 14:19
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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Of course I think there are tail risks. But I don't see a systematic way of playing it in a tried and tested way. Extreme events are by nature unpredictable and might not play out like you think in terms of correlation - in which case your strategy will fail and you've wasted your money. And I think credit and liquidity risk remains a huge problem, especially in a crisis.
I would agree with this. Most of our clients are independent asset managers/private bankers rather than family offices, but I certainly wouldn't say that they think everything is back to 2003. Still lots of people sitting on lots of cash and remaining very cautious when redeploying capital.

The problem for us is that trading CDS is probably too expensive as a long term strategy and not something we are expert in. We have seen a number of tail-protection funds, almost all of which have been launched post-2008 in order to respond to a replay of 2008. The question we keep wondering is what if the next crisis plays out like 2001/02 for example. Would these funds work? As I mentioned previously, so far we have not been convinced.
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Old 31.05.2011, 14:25
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Nope, definitely not a family office and I only talk to clients who are institutional in size so I can only offer a perspective on medium to large banks.
Of course I think there are tail risks. But I don't see a systematic way of playing it in a tried and tested way. Extreme events are by nature unpredictable and might not play out like you think in terms of correlation - in which case your strategy will fail and you've wasted your money. And I think credit and liquidity risk remains a huge problem, especially in a crisis.
.
OK, so in other words because no one in this thread has ever traded CDS's, or doesnt understand them (outside of a cool youtube video they watched so they could comment on this post) they arent good investments?

And since the people on this post dont understand the systematic nature of this trade then no one else can understand it either?????

I dont want this to sound rude so dont take it this way, but it sounds like your firm simply doesnt have a mandate for this kind of thing (as you alluded to earlier) so you wish to not waste time on it personally because for you its not an option.
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Old 31.05.2011, 14:29
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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OK, so in other words because no one in this thread has ever traded CDS's, or doesnt understand them (outside of a cool youtube video they watched so they could comment on this post) they arent good investments?

And since the people on this post dont understand the systematic nature of this trade then no one else can understand it either?????

I dont want this to sound rude so dont take it this way, but it sounds like your firm simply doesnt have a mandate for this kind of thing (as you alluded to earlier) so you wish to not waste time on it personally because for you its not an option.
Actually it does sound rude and somewhat aggressive. I really wouldn't go second-guessing the motivations and backgrounds of the posters on here...
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Old 31.05.2011, 14:32
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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Still lots of people sitting on lots of cash and remaining very cautious when redeploying capital.
We have seen a number of tail-protection funds, almost all of which have been launched post-2008 in order to respond to a replay of 2008.
I agree 100%.... We have the same issue. But we have found guys who have delivered repeatedly. So we are happy to take exposure with them. And what they dont offer specifically (as far as timing is concerned) we do inhouse.

But there seems to be a lack of effort in the Swiss community to even try and protect themselves. As stated earlier vol makes everything bread and butter expensive to hedge with. No one in Switzerland knows that Hungary is our biggest debtor. People dont ever see any risks it seems.
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Old 31.05.2011, 14:52
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

yes 80bps is a lot, obviously you have no idea how the credit market works, you must have discouvered CDS on TV last week end on fantasized about buying at 80 selling at 800...
The main credit index is at 100bps and that's the benchmark for the credit market.
If your managed portfolio returns 6%, and that's very good, less fees and inflation, you're left with less than 1% above the risk free rate. Go ahead and by CDS for 80bps (on your 30M...) for an unlikely event that certainly eats up your returns.
I think the teams of managers would have figured out if it was the Graal to protection for systemic risk.
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Old 31.05.2011, 15:04
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yes 80bps is a lot, obviously you have no idea how the credit market works, you must have discouvered CDS on TV last week end on fantasized about buying at 80 selling at 800...
The main credit index is at 100bps and that's the benchmark for the credit market.
If your managed portfolio returns 6%, and that's very good, less fees and inflation, you're left with less than 1% above the risk free rate. Go ahead and by CDS for 80bps (on your 30M...) for an unlikely event that certainly eats up your returns.
I think the teams of managers would have figured out if it was the Graal to protection for systemic risk.
Been trading CDS and spreads (without training wheels) for about 6 years.... I agree that CDS's are 4x as expensive as they were 5 years ago. But if you think that the UK should be priced at 59bps your nuts. Were the economy to cool at any point in the next 3 years the UK would be in trouble. Will they default? Nope.... Would CDS's be trading like Belgium's? Yup....

In your case I think youre referring to a fixed income fund/manager. 6% is great in that case, especially for CH. Im talking about fat tail risk events though.

"for an unlikely event that certainly eats up your returns"
Its not the fact its an unlikely event. Its the repricing of risk on the path to that event. That happens when there are economic slow downs. That is why spreads widen.
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Old 31.05.2011, 15:14
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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yes 80bps is a lot, obviously you have no idea how the credit market works, you must have discouvered CDS on TV last week end on fantasized about buying at 80 selling at 800...
The main credit index is at 100bps and that's the benchmark for the credit market.
If your managed portfolio returns 6%, and that's very good, less fees and inflation, you're left with less than 1% above the risk free rate. Go ahead and by CDS for 80bps (on your 30M...) for an unlikely event that certainly eats up your returns.
I think the teams of managers would have figured out if it was the Graal to protection for systemic risk.
FYI, when we buy the single line we dont own the underlying. If there is a requirement of ownership (as in some RMBS tranches which are frowned on these days) then you buy the bonds first and then sell them once you have the CDS.

But I think thats where we missed each other mate. I dont own the underlying.
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Old 31.05.2011, 15:54
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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OK, so in other words because no one in this thread has ever traded CDS's, or doesnt understand them.
I don't really care what you think about me sunshine. None of the products you're talking about are hard to understand, especially CDSs. It sounds to me you're ticked off because so far nobody - either the family offices you talk to, or anybody on this forum - is as gung ho about them as you want them to be. That doesn't mean nobody gets it but you. In fact I think you've had some pretty polite and measured responses here. It’s just folks don’t share your "passion".

Now why could that be? Perhaps what you're missing in all your comments of about fat tail risk is the concept of probability. The risk might be there, the protection might even come cheap, and the potential upside might seem astronomical. But if people think the probability of the risk is v. low then they might have better things to do with their money. Seems to me that's what the people you're talking to are telling you. It just isn’t sinking in. Or is it a case of a CDS trader talking his own book?

Once last point. In one of your posts, you make talk about what a certain person at a certain bank does. Very unprofessional.
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Old 31.05.2011, 16:09
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I don't really care what you think about me sunshine. None of the products you're talking about are hard to understand, especially CDSs. It sounds to me you're ticked off because so far nobody - either the family offices you talk to, or anybody on this forum - is as gung ho about them as you want them to be. That doesn't mean nobody gets it but you. In fact I think you've had some pretty polite and measured responses here. Itís just folks donít share your "passion".

Now why could that be? Perhaps what you're missing in all your comments of about fat tail risk is the concept of probability. The risk might be there, the protection might even come cheap, and the potential upside might seem astronomical. But if people think the probability of the risk is v. low then they might have better things to do with their money. Seems to me that's what the people you're talking to are telling you. It just isnít sinking in. Or is it a case of a CDS trader talking his own book?

Once last point. In one of your posts, you make talk about what a certain person at a certain bank does. Very unprofessional.
No Mate, the part that I was referring to you on was: "it sounds like your firm simply doesnt have a mandate for this kind of thing (as you alluded to earlier) so you wish to not waste time on it personally because for you its not an option."

Incase you didnt read the entire thread have a read and then you will see what the comment you quoted refers to "sunshine".....

CDS's arent that big of a part of our overall book. We use everything. Its just CDS's are a good example of mispriced risk. Thats why I use them as an example. Also, its an easy way for PE guys to hedge because the spreads on their debt are what determine their ability to sell that stuff off.

Last year the "probability of risk was low" for Ireland and Portugal as well.
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Old 31.05.2011, 16:26
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Re: Do Family Offices And Banks Have Fat-Tail Risk Protection?

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No Mate, the part that I was referring to you on was: "it sounds like your firm simply doesnt have a mandate for this kind of thing (as you alluded to earlier) so you wish to not waste time on it personally because for you its not an option."

Incase you didnt read the entire thread have a read and then you will see what the comment you quoted refers to "sunshine".....

CDS's arent that big of a part of our overall book. We use everything. Its just CDS's are a good example of mispriced risk. Thats why I use them as an example. Also, its an easy way for PE guys to hedge because the spreads on their debt are what determine their ability to sell that stuff off.

Last year the "probability of risk was low" for Ireland and Portugal as well.
if it is really mis-priced, why don't you just trade CDS only with massive leverage and become a multi-billionaire?

you can also insure against a particular set of euro-millions numbers being picked for less than 5chf. doesn't mean the potential upside and low cost to insure gives rise to a positive expectation.
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Old 31.05.2011, 16:37
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if it is really mis-priced, why don't you just trade CDS only with massive leverage and become a multi-billionaire?

you can also insure against a particular set of euro-millions numbers being picked for less than 5chf. doesn't mean the potential upside and low cost to insure gives rise to a positive expectation.

Its called volatility and risk adjusted returns.

But there are plenty of examples of people who have done the CDS trade and made billions. The pricing isnt as advantageous anymore, but sure you can make decent money when everyone else is down. Its all based on the economic cycle. So my probabilities are much better than gambling with lotteries.
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