Who will Gazprom assasinate next?

After this cheeky bit of news:

“The head of a Russian fund that says it promotes the development of small oil
and gas producers was shot dead on Tuesday in southwest Moscow, the Reuters news agency reports. Zelimkhan Magomedov, 50, general director of the National Oil Institute Fund, was shot twice in the head.”

One simply has to wonder - who will be next? Will it be…

Arkady Ostorvsky for making the below comment in his article in the WSJ:
"Gazprom, the dominant gas supplier that frequently doubles as a Kremlin foreign policy arm, is not producing enough for an economy growing at more than 6 per cent a year. "

Vladimir Milov, head of the Institute for Energy Policy, for making the following comment to the media:
"Gazprom was given enormous privileges in exchange for providing the country with gas at regulated prices. If it wants to behave as a commercial company, it should not be a monopoly."

German Gref, minister for economic development and trade for implying Gazprom should be “independently regulated.”

Analysts at UBS Russia for questioning Gazprom’s strategy.

“Analysts say the problem is not the lack of gas - Russia has 16 per cent of the world's total reserves - but rather Gazprom's investment strategy. Over the past few years the company has spent vigorously on anything but developing its reserves. It has built a pipeline to Turkey, taken over an oil company, invested in UES and tried to gain a foothold in European distribution markets. All this was in the name of creating a national energy champion. But investment in Gazprom's core activity was inadequate.”

Why has Gazprom not been investing in developing fields? Because it’s going to take Sakhalin away from Shell (who has already done all the work).

The citizens of St. Petersburg as they re-experience the horrors of WWII when their city loses heat in the middle of winter.

The country of Turkmenistan for not supplying enough gas and quibbling with the Allmighty.

Chechnyan Warlords (or random Georgians who will be dressed up to look like Chechnyan warlords) who will then be blamed for the gas shortage as well as every other problem plaguing Russia at the moment.

Always seeking to profit from energy arbitrage, I am relocating some of my freelance monkey snipers (alluded to in the previous post) to Russia.

cliquer l'hypothèse efficace du marché

To continue in the vein of my previous post on EMH, here’s an excerpt from a book[1] I’m reading on volatility trading:
“Those sellers using local volatility models will certainly value a digital cliquet[2] at a lower price than sellers using stochastic volatility. Perversely then, those sellers using an inadequate model will almost certainly win the deal and end up short a portfolio of misvalued forward-starting digital options, or even worse - a dealer could have an appropriate valuation approach but be pushed internally by the salespeople to match (mistaken) competitors' lower prices."
Basically – when you’re trading really complex structured derivatives nobody knows what the real price is, because said price can only be derived by a model and the models are largely proprietary. It’s arbitrary arbitrage! Without set market prices there can be no market efficiency.
Oh, but these are OTC derivatives Fama would say. To which I will reply that 1. you, kind sir, have already implied that there should be no measurable difference in efficiency when liquidity is decreased and 2. said derivatives are based on a very liquid equity option that is itself a derivation of allegedly perfectly efficient securities like equities, bonds and even currencies. Moreover, the mere fact that you cannot price these instruments without making predictions (discrete or not) about their future value means that option markets cannot be played passively on assumption that they are efficient.
At this point Fama would rise from his armchair and, thrusting his cigar at me in a decidedly confrontational manner while swirling his brandy irately, exclaim: “So am I to understand then, that you have no faith at all? No belief in market efficiency? Then I put it to you, sir, that you are a heretic of the first degree!”
To this I shall reply, while serenely sipping my single malt, “No, my friend – I am a heretic of the second degree. A heretic derivative, if you will, which is to say a rebel against theory, fighting in the name of reality. Indeed, just as you don’t advocate strong-form efficiency I in no way support the weak-form hypothesis. Moreover, I believe that news is priced very quickly (though not instantaneously) and that many (though not all) markets are mean-reverting. Nevertheless, inefficiencies exist and increase proportionately with a decrease in liquidity and regulation or an increase in complexity. Both technical and fundamental analysis can yield superior returns in the hands of a gifted (and not just lucky) individual. Some of us aren’t monkeys throwing darts at a list of stocks as your friend Malkiel believes. Rather, we are monkeys with sniper rifles. And we’ve got efficient markets in our sights.”
I then tip my hat to the bewildered Fama and make my exit. As Fama takes a sip of his brandy he realizes that ashes from his cigar have inadvertently fallen into the snifter. The taste is almost as raw as the state of his prized theory.

[1] The Volatility Surface: A Practitioner's Guide (Gatheral, 2006)
[2] From AMEX Dictionary of Financial Terms: The French like the sound of “cliquet,” and seem prepared to apply the term to any remotely appropriate option structure. (1) Originally a periodic reset option with multiple payouts or a ratchet option (from vilbrequin à cliquet—ratchet brace). Also called Ratchet Option. See Multiperiod Strike Reset Option (MSRO), Stock Market Annual Reset Term (SMART) Note. See also Coupon-Indexed Note. (2) See Ladder Option or Note (diagram). Also called Lock-Step Option. See also Stock Upside Note Security (SUNS). (3) Less commonly, a rolling spread with strike price resets, usually at regular intervals. (4) An exploding or knockout option such as CAPS (from cliqueter—to knock)
Now that your are completely and utterly bewildered stare into this headlight young deer:

Ah, now it makes sense! It’s just a performance-linked digital option with resets! Duh.

Fama Keeps Preaching (but the choir ain't singing)

Fama, my old nemesis, is still preaching efficient markets. Check out the interview.
I especially love the interviewer’s interrogation regarding the 1987 crash, although I am disappointed she did not ask him about his own little fund, Dimensional, and its strategies. Namely how does Dimensional pick “risks that are worth taking and the risks that are not.”

Some parts I shall comment on:
(FEN - Financial Engineering News, EF - Eugene Fama, BSD - Arbitrageur's apropos pseudonym)

FEN: As an undergraduate at Tufts, you tried to beat the market.
EF: Yes. I was already working on stock market data. I tried to figure out ways to beat the market for Harry Ernst, who taught economics. I came up with mechanical kinds of strategies. He always made me have a hold-out sample to see if the strategy worked on new data – and it never did.
BSD: …and as a way of justifying your failure you dedicated the rest of the life to erroneously proving that you were playing a game one cannot win (although – of course – some consistently do).

FEN: If markets are efficient, a stock price reflects the intrinsic value of a company, but does that mean the price is always right?
EF: It means you can’t figure out whether it’s wrong. It’s not always right because there’s some uncertainty about what right is, but basically you just can’t beat it.
BSD: In another life you would have made a great spin doctor or lobbyist. You neither answered the question nor provided any evidence to the contrary of the point presented – you simply questioned the meaning of “right.”

FEN: What about [inefficiencies in] smaller, illiquid stocks?
EF: That’s what people claim – that smaller stocks are not priced as efficiently as bigger stocks, that emerging markets are not priced as efficiently as developed markets. But anyone who looks at it empirically can’t find any evidence to that effect.
BSD: Yeah, anyone but the investors who’ve been consistently raping those markets precisely on the basis of exploiting inefficiencies that result from a poorly regulated market.

FEN: I was just talking to a trader in Canada who’s at a fund that has beaten the broad Canadian market by investing mainly in financials for the last 20 years.
EF: Look across the spectrum of all funds – you’ll always find people in both tails. That can happen even if nobody has any special information. Some people are going to be lucky and some unlucky. The lucky ones get the attention, and then they think they’re smart.
BSD: So guys like Stevie Cohen who’ve been “lucky” for decades must have made some deal with the devil, because statistically such a streak of luck is near-impossible.

FEN: Have you moderated your views over the years that markets are efficient? Many academics and others say you have.
EF: Many people get confused. Many people don’t understand the difference between efficient markets and the risk-return story.
BSD: I think you don’t understand the difference, homey. Your original paper, understandably, does not account for the many ways to hedge risk that currently exist. The problem is that, like a caveman driving a car on square wheels you are unwilling to change.

FEN: There’s no need for active investors to go in search of information?
EF: There’s no need for active investors who don’t actually succeed in uncovering new information. People who act on bad information make prices worse.
BSD: Correct. So, since – according to you – most active managers act on bad information their very existence erodes efficiency.

FEN: Are traders following momentum strategies an example of people without information moving the market away from the most efficient price?
EF: I don’t know.
BSD: BS. You do know, you just can’t explain it with your theory. You said (in this very interview) that there is “evidence that there’s some short-term momentum in returns” – the very existence of observable and predictable momentum in liquid markets implies profit potential through an active strategy.

FEN: You’ve been a skeptic of the idea that people’s irrational behavior and decisions affect market prices in predictable ways, and you’ve been a critic of behavioral finance more generally. Do you think behavioral finance poses a threat to the idea of efficient markets?
EF: It poses interesting questions and legitimate questions for research. I haven’t seen researchers in that area come up with much that indicates that prices are bad. They’ve produced a lot that indicates that individual investors don’t always act completely rationally. Those are two different things. At the micro-micro level, they have done some really interesting stuff. At the level of price-setting, it’s not so clear.
BSD: Assuming a significant number of price-setters who do not act rationally how can markets be efficient? You cannot say that there is no direct relationship between price efficiency and the rationality of market participants. Furthermore, there has been research applying behavioral finance to prices – you just aren’t bringing it up, perhaps because you can’t outright disprove it.

Hedge Fund Poetry

Not sure if anyone gets/likes these, but here's another one:

Luring pension plans
With a clever snare
Of high yield

Eroding counterparties' assets
Like acid rain on unsuspecting
Salted flesh

Before you yell "villain"
Remember the law of
Zero Sum.

The Hedgie

Ok, so here is the much delayed scoop on my new job. It’s not that I haven’t had the time (I worked a blissful 55 hours last week), it’s just that I’ve been too busy enjoying my newfound free time.
There has been much inquiry into what it is exactly that I do every day. That is – what is my routine? The honest answer is that there isn’t a typical day. This is a phrase one hears very often, and a lot of bankers will say that because it sounds much better than “depends on who decided to rape me today” but the fact is in banking you’re working in either Excel or Powerpoint/Word making models and pitchbooks. The type of model and underlying company stops mattering after you’ve done them all twenty times over till 3AM. The key difference between working at the quant hedgie and investment banking is that whereas in the latter I could painfully see myself becoming ever more robotic and melancholy here I’m becoming smarter and every day. At this rate my brain will soon be sharper than a coke addict’s razor blade.
At the hedge fund my only routine is morning P&L when I mark-to-market our positions (which can take 30 minutes or 3 hours depending on how many new trades I have to account for, and whether or not our broker messed up) and execute new trades as dictated by my Portfolio Managers and our black box model. The P&L models themselves are about as complex as anything you’ll see at a bank – VLOOKUPs and VBA macros galore.
After that I may spend the rest of the day on a project that one of the PMs asked me to do (I’m rarely told what to do here, since everyone is extremely polite). The projects vary across all aspects of running a fund: so far I’ve been asked to write an optimization function for one of our models, research a way to trade global term structure volatility and come up with various investment hypotheses. The best part is that I never feel like a grunt here – all of my work is genuinely interesting to do and receives immediate feedback.
When I don’t have a project however, which is about half the time, I am free to learn about whatever I want. It’s free time to get smart on sexy topics in quant finance and think of ways to turn them into profit for the fund. Getting paid [extremely well] to learn about the things I am so passionate about is a great feeling, I believe it’s called joy – but I’ve forgotten after working in IB for 4 months.
I’m done with my day whenever I feel like it’s time to go, which tends to fall between 6 and 7. Since we don’t trade intraday the whole atmosphere is extremely relaxed – hourlong lunches away from the desk and leaving early to go out on Friday is not only accepted but outright encouraged. In short, I haven’t been this happy with a job since I worked for a fashion house where part of my duties involved interviewing models and attending open-bar fashion shows.

Go Big or Go Home

The two weeks of my vacation have been amazingly relaxing (I was at any given point either sleeping or drinking). In a world of compromises, sometimes excess is mandatory to break the routine.
Having thus rested up I started my new job, which is even better than I imagined. More on that in my next post. Meanwhile, I have some Brazilian swaps to execute.

Bye Bye Banking!

If I haven't made any posts in a while it is because I have been drunk with joy. And alcohol. Last Friday the 29th I resigned from my role as Investment Banking Analyst to pursue my dream of controlling the world's financial markets (the key to success is having modest, easily-achievable, goals). Here's how the Arbitrageur got a new job (and put some substance behind his name):

About a month ago I applied for a Portfolio Analyst role through craigslist to work for a "new quantitative hedge fund platform, a strategic growth initiative funded and seeded by []. This is a small company centered around quantitative fixed income strategies with an entrepreneurial work environment that is well suited for focused, energetic, self-motivated and flexible top investment talent." Although the job required 2-3 years of buy-side experience, in my desperation to get out of my shoddy sinking dinghy of a bank I applied anyways, hoping that my mix of derivatives and programming knowledge and the intellectual tenacity of an Oxford educated pit bull would carry me through.

A couple days later I got an email from the president of the fund, asking me to come in for an interview. Thus began a quest that would consist of 7 hours worth of interviews, masked as so many doctor's appointments that my MDs must have thought I have become either terminally ill, a hypochondriac, or both. The questions asked of me by the president and his elite team of quant Ph.Ds (I'm the only person employed by the fund without one) ranged from derivative modeling to programming to econometrics and math. Quite frankly, I'm surprised that I made it out alive. My black belt in bullshit isn't exactly applicable to questions such as "write an SQL program that calculates the aggregate return and risk of a portfolio." I guess you never know how far you can stretch yourself until put into the "seat of heat", and that's exactly why I can't wait to start my new job. My mind will be honed to have the all the speed and litheness of a gymnast on a racehorse.

Before I begin climbing the steep and shaky ladder to the top, however, I am taking two weeks off to shed my banker skin and come to work ready to be reborn. Expect a recap when I return from my world tour of debauchery. Till then, I remain your arrogant Aribtrageur.