Amazing market micro-structure

In the post, Zero Hedge says that the maximum possible level implied correlation can reach is 100%.  That is wrong.

Although a 100% maximum is true when talking about realized correlation, it is NOT TRUE when talking about implied correlation.  Implied correlation is basically a measure comparing the implied volatility of index options to the implied volatility of the options of the constituent securities.  If the implied volatility of the index options spikes to a sky-high reading while individual stock option volatilities don’t rise as fast, you could get a situation where the implied correlation rises above 100%.

In fact, it’s already happened once.  The 2009 index spiked above 100 a few times in November 2008.

Implied Correlation … How High is High?

This is fascinating, but I don’t see how they assign a number to this. Correlation is Cov(X,Y)/ SQRT(var(X)*Var(Y)). It can be shown mathematically that this is always between -1 and 1. I assume that there is some underlying pricing model, probably built on a Gaussian copula. But given that mathematically that this relationship cannot be greater than one, are they saying simply that the pricing model implies that the only way to reconcile the observed price is to see a correlation of greater than 1 which is impossible. But clearly the market is inefficient and / or the model is wrong. In either case, why would we care specific number is generated, because we know it is garbage in any case. I’d view any implied correlation higher than 1 as simple model and market breakdown and not a useful quantity beyond that.

Link roundup

Things I thought were interesting or provocative but with little comment

Conrad Black’s Decline, but Not Inevitable Decline

What is needed is a colossal reorientation of the country away from consumption and toward investment, the cleaning out of the morass of the plea-bargain justice system and attendant vacuum cleaners of the legal and prison industries (and the gigantic fraud of the War on Drugs), drastic education reform, genuine health-care reform, a redefinition of U.S. national interests in the world to what is essential and defensible, and then restructured alliances to reflect shared interests. Until those issues are addressed, all talk of the American superpower is rubbish. Obama’s is the fourth consecutive failed administration, and each succeeding one will make the festering problems more dangerous and difficult. As the problem is misdirection, not internal degeneracy or imperial overreach, it is a decline that will end in recovery, not a fall.

Why complex numbers are fundamental in physics

The shocking revelation came in 1572 when Rafael Bambelli was able to find real solutions using the complex numbers as tools in the intermediate calculations. This is an event that shows that the new tool was bringing you something useful: it wasn’t just a piece of unnecessary garbage for which the costs are equal the expenses and that should be cut away by Occam’s razor: it actually helps you to solve your old problems.

10 Rules for Radicals on how to win against government bureaucracies. Amazing and must see.

Why is the government trying to force me to divorce my wife? On the marriage penalty

How to tell when your boss is lying It’s not just that his lips are moving

David Larcker and Anastasia Zakolyukina of Stanford’s Graduate School of Business analysed the transcripts of nearly 30,000 conference calls by American chief executives and chief financial officers between 2003 and 2007. They noted each boss’s choice of words, and how he delivered them. They drew on psychological studies that show how people speak differently when they are fibbing, testing whether these “tells” were more common during calls to discuss profits that were later “materially restated”, as the euphemism goes. They published their findings in a paper called “Detecting Deceptive Discussions in Conference Calls”.

Deceptive bosses, it transpires, tend to make more references to general knowledge (“as you know…”), and refer less to shareholder value (perhaps to minimise the risk of a lawsuit, the authors hypothesise). They also use fewer “non-extreme positive emotion words”. That is, instead of describing something as “good”, they call it “fantastic”. The aim is to “sound more persuasive” while talking horsefeathers.

When they are lying, bosses avoid the word “I”, opting instead for the third person. They use fewer “hesitation words”, such as “um” and “er”, suggesting that they may have been coached in their deception. As with Mr Skilling’s “asshole”, more frequent use of swear words indicates deception. These results were significant, and arguably would have been even stronger had the authors been able to distinguish between executives who knowingly misled and those who did so unwittingly. They had to assume that every restatement was the result of deliberate deception; but the psychological traits they tested for would only appear in a person who knew he was lying.

The obscure spices quiz

Enhancing linux terminals with byobu, a better version of screen

Momentum in Employment: Why it Matters

The story I would tell is that there are clusters of firms that interact with one another. In an expanding cluster, growth of one firm leads to growth in others. In the 1920′s, as more people were employed in building automobiles, there were bound to be more people employed at gas stations. In a contracting cluster, declines in some firms lead to declines in others. As you get fewer horse-and-buggy drivers, you get fewer horse trainers, fewer horseshoe makers, and fewer manure sweepers.

A Time to Appease  by  Paul Kennedy