Michael Cohen mike at
Mon Sep 28 08:16:23 PDT 1998

Doug Henwood wrote:

> JayHecht at wrote:
> >Scholes & Co. averaged aboit a 50% return since 1995.
> You could have done that with the S&P on 50% margin, no? These guys were
> leveraged 80 to 1. Oh, yeah, but they were hedged!
> Doug

Everybody knows that all // most econometric models predict reasonably well ifthe real--world environment is statistically quasi stationary. Since this is almost never the case in the real work they predict very poorly indeed especially if the time scale is measured in years. The probably had enough capital not to simply lose money at the rate they did at the end because of bad luck but that they were simply wrong in detail. These guys were so arrogant as to believe the validity of their models. What they forgot to do is to statistically test their models on line. In Stat 100 or 200 people are taught what a goodness of fit test was. This is used in Physics and Chemistry all the time to validiate models in economics no doubt this is promptly forgotten because none of the models meet stringent statistical tests of validity. When they detected on line sufficient anomalies from their theory as how the hedge was supposed to work, they could have unwound their position at a loss and constructed the next revision. Of course then their rate of return would not have been so high. As likely as not Meriwether, Scholes, and Merton were is sales mode and the PHD's actually running the shop no doubt didn't think of doing this. Its not suprising, no doubt the bosses also forgot.

It would really be fascinating the have the data as what actually happened and who the players were on both sides of this . I think there could potentially be a hugh amount learned about how finance including fixing the markets work. One possiblity as to why the Fed strong armed the lenders to fix this amongst themselves rather than publicly is the details would become public. Unlike politics finance is still understandably reticent to give public lectures on the equivalent of being caught with ones pants down engaging in "inappropriate behavior". This is very unforutnate.

--mike -- Michael Cohen mike at Work: 677 Beacon, Street, Rm313 Boston, Mass 02115 Home: 25 Stearns Rd, #3 Brookline, Mass 02146 Tel-Work: 617-353-9484 Tel-Home:617-734-8828 Tel-FAX:617-353-7755

More information about the lbo-talk mailing list