tag:blogger.com,1999:blog-582368152716771238.post1893299157175785076..comments2024-03-28T05:14:02.071-05:00Comments on The Grumpy Economist: Duffie and Stein on LiborJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger6125tag:blogger.com,1999:blog-582368152716771238.post-67146329296126471912015-08-20T17:48:50.730-05:002015-08-20T17:48:50.730-05:00This article has been an interesting read, I hope ...This article has been an interesting read, I hope to see more like this in the future. Thank you John for keeping this awesome blog running!Williamhttp://www.autonationacuranorthorlando.com/noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-21229910610243147652015-03-20T01:59:38.472-05:002015-03-20T01:59:38.472-05:00Absolon,
You should think about the ratio of notio...Absolon,<br />You should think about the ratio of notional/actual debt the way you think about the transactions velocity of money. The difference is that because the bond derivative transaction has delayed settlement there is a record-keeping reason to “account for” the notional pool of transactions generated debt.<br />To what I think is your point, these large chains of time-shifted settlement transactions can become long and complex, and a credit failure by just one major counterparty can cause immense confusion and panic because the linkages (and offsets) in the counterparty credit chains are not transparent.<br />The essence of run-free banking is to hold these types of assets somewhere other than in the balance sheets of the commercial banks where they can potentially threaten the “settlement system”. <br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-69233384706498562282015-03-17T18:43:36.858-05:002015-03-17T18:43:36.858-05:00John - I understand what notional means. And I un...John - I understand what notional means. And I understand that banks write off-setting interest rate swaps that can be based on the same underlying bonds with the result that $100 in bonds can "support" $200 or $300 or maybe "$500" in notional values on swaps that are all outstanding at the same time. <br /><br />I'm a lawyer (and a fair mathematician). My training is to look for things that make no business sense as an indicator that something is "hinky". The global bond market is about $100 Trillion in total principal outstanding. Not every market participant is going to want to swap all of their interest rate exposure for something else - and the $100 Trillion is just the interest rate swaps tied to LIBOR. If I am reading the BIS statistics correctly there over $400 Trillion in outstanding notional on interest rate swaps. Global GDP is only about $75 Trillion per year. The total notional for all types of derivatives is about $700 Trillion which is about $100,000 for every man, woman and child on the face of the earth.<br /><br />Given the deficiencies in LIBOR is seems unlikely that anyone would actually trade billions or trillions of dollars using it as a reference rate.<br /><br />So I reach two working conclusions: (1) Even though we are only talking about interest on the notional, a tiny error (or unexpected rate move) could have huge impacts. One tenth of one percent of $400 Trillion would be $400 Billion. (2) The notional is so disproportionate to the underlying that there cannot be a legitimate business reason for the market so I expect that there is some other purpose being served. Cooking Greece's national accounts can only explain so much. I expect that a lot of derivatives are done to move income and expenses between jurisdictions, between income and capital gains, and between time periods. <br /><br /><br />Absalonhttps://www.blogger.com/profile/09131268683451462949noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-11928859373283314702015-03-17T17:09:09.098-05:002015-03-17T17:09:09.098-05:00"Notional" means notional. If I promise ..."Notional" means notional. If I promise to pay your fixed on $100 in return for you paying my floating, the notional is $100, but no money changes hands initially and only the difference of interest rates ever changes hands. Then if I hedge that by entering in to another identical swap at slightly different rate, profiting from the spread, we have $200 notional outstanding. Notional is an easy number to collect, but vastly overstated for many purposes. John H. Cochranehttps://www.blogger.com/profile/04842601651429471525noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-2655954196932370232015-03-17T16:42:47.124-05:002015-03-17T16:42:47.124-05:00"volume of gross notional outstanding in the ..."volume of gross notional outstanding in the swap market that references LIBOR at this tenor is on the order of $100 trillion"<br /><br />The global bond market is about 100 Trillion dollars. For the interest rate swap market to be as large as the underlying market would require that basically EVERYONE who issues or buys bonds is swapping interest rates on EVERYTHING and ties the swap to LIBOR. There would be other interest rate swaps. It confirms my belief that there is something profoundly wrong at the core of the derivatives markets. There can be no legitimate commercial reason for that level of nominal outstanding. One of these days those markets are going to blow up in spectacular fashion (or be exposed as one giant set of off-setting wash trades designed to evade taxes).Absalonhttps://www.blogger.com/profile/09131268683451462949noreply@blogger.comtag:blogger.com,1999:blog-582368152716771238.post-32814412398443251332015-03-17T10:17:07.463-05:002015-03-17T10:17:07.463-05:00Libor based derivatives are computed and calibrate...Libor based derivatives are computed and calibrated by bootstrapping libor futures with a multi curve framework. While libor funding may not be heavily used, the futures contracts are highly liquid and these discount rates are what really determines the valuation of interest rate derivatives. So determining a more robust reference rate sounds all fine and well but how then do your price interest rate derivatives? Price with one rate then settle on a different rate?Andrewnoreply@blogger.com