Never buy anything you don’t understand

Once upon a time, I almost went to grad school to study Theoretical Computer Science. So when Alea and Freedom to Tinker mentioned this paper, I had to read it for myself. The paper is titled “Computational Complexity and Information Asymmetry in Financial Products”.

Traditional economics argues that fi nancial derivatives, like CDOs and CDSs, […]

Bond crash/course: Swap spreads

When we abruptly stopped last time, we had just finished figuring out the Present Value of the variable side of the swap I offered you:

PV of variable side = 1 – P(tN)

…where tN is the time of the final payment at the swap’s maturity, and P(t) is the discount factor derived from […]

Bond crash/course: Swap pricing

Once again, I need to talk about something else before I discuss swap spreads. I could skip over this, but the details are actually somewhat interesting. And the math below is not as bad as it looks. Really.

To understand swap spreads, we need to understand a little bit about swap pricing. So here we […]

Bond crash/course: Price, Yield, Duration

As mentioned in the intro post, if you have a zero-coupon bond with face value F maturing in N years and trading today at price P, to determine the yield you have to solve this equation for y:

F = P*(1+y)^N

But remember that bond traders always think in terms of yield, not price. They would […]

Fun with uniform distributions

(Update: If there are too many numbers and equations below, Mike at Rortybomb has created a fantastic post illustrating the principles graphically. And he even uses lognormal distributions like a real financial engineer.)

In my earlier post on the “Geithner Put”, some people objected to my model as unrealistic. Which is true. So, using ideas […]

Put that in your Bayes’s Theorem and smoke it

One of my favorite pastimes is calculating implied conditional probabilities from Intrade contracts. (I lead an exciting life.) But try this one on for size.

As I write, the contract for Hillary winning the Democratic nomination has a bid of 4.6 and an ask of 4.8.

The contract for Hillary winning the Presidency has a […]

More fun with conditional probabilities

This post will be even more dull than the other one, but please skim that first anyway since I want to use the same notation.

Let A represent the event “Barack Obama becomes the Democratic nominee”. Let B represent the event “Barack Obama becomes our next President”. As I write, Intrade prices P(A) at 0.911 […]

Fun with conditional probabilities

On Intrade right now, Barack Obama is trading at 75% to be the Democratic Presidential candidate.

Hillary Clinton is trading at 15% to be the Vice-Presidential candidate.

Let’s assume that one of them will be the Democratic Presidential candidate, but not necessarily the Vice-Presidential candidate.

Quick summary of handy standard notation: P(x) is shorthand for […]