Tail Events and Financial Engineering

I was always amazed how quickly new financial models get absorbed and used in production. If you consider the long development cycle in the pharmaceutical industry it becomes obvious that products who are the results of financial engineering are not sufficiently tested and are just sold somehow careless to the market. No wonder that the side effects have never been tested.

If you consider the set-up in a lab and the daily use in production there is certainly a massive difference and a product which might have worked brilliant under lab conditions might be a real disappoitment once deployed in production.
Usually Financial Products are also developed under lab conditions. Just consider the back-testing issue providing the illussion of a long and sound track-record. Why is it even possible to include a Historic NAV development based on a simulated time series as part of a Factsheet.

Now how are we testing the product to check ex-ante the risks involved.

If we  consider the massive devastating impact of the MBS Desaster in the US and the spillover - effects to other asset classes it becomes obvious that we should control the number of securities issued. If we have 1 house, we should have a 1 by 1 coverage of mortgage and CDS and Insurance in case the borrower defaults.
If we allow 1 house to be protected by 100 insurance policies we simply pay in 99 cases money to people with no interest in the underlying security. 

If we find it appropriate that we investigate if Microsoft is controlling a market why are we not investigating this market worth trillions of Dollars. To the best of my knowledge not much happend ex-post melt down. 

I never thought I'm gonna propose this but we need to pay more attention to the stakeholder and if a market of let's say 1 billion dollars has pending securities of 100 billion dollars we need to ask - WHY.

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