Trading and Speculation

Intro

Abuse

Risk

Activities

Policy

Chapter 9 Trading and Speculation
Jon Danielsson © 2009, 2010, 2011, 2012 LSE

Michaelmas Term 2012

Intro

Abuse

Risk

Activities

Policy

Introduction

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Risk

Activities

Policy

Speculation
Force for good and force for bad

• Speculators help farmers to plan production • And traders to threaten the financial system • There is no clear definition • But generally investment is long–term, speculation

short–term (buy and hold vs. buy and sell) • It is often impossible to distinguish between “ legitimate” and “illegitimate” speculation • It cannot be eliminated, even though many political leaders have expressed the desire to do so

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Terminology (Appendix)

• Party and counterparty • Orders, clearing (clearing house), settlement • Exchange vs. over–the–counter (OTC) • Market maker (quotes both sides) • Broker arranges transaction and charges commission • Netting • Central counterparty (CCP)

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scandals and abuse

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London whale and JP Morgan
• Chief investment office (CIO) at JP Morgan lost perhaps

$5.8 billion in London • Part of adjustment to Basel III, thought to lower risk–weighted assets • But became a speculative bet on the shape of the yield curve “flawed, complex, poorly reviewed, poorly executed, and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective as a hedge than we thought,”

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LIBOR scandal
• LIBOR/EURIBOR benchmark interest rate (average • • • •

reported rate) Very costly because many contracts (e.g. derivatives and mortgages) have the rates set by LIBOR ($ 800 billion) Some banks manipulated is (Barclays admitted to, but others are investigated and even prosecuted) Happened before/after crisis And also to