Sigma is also called “standard deviation”. The number of sigmas is the confidence interval that something will (or will not) happen.
One sigma event has 32% chance to happen, two sigma is already 5% and three sigma event is rare enough to have only 0.3% chance to happen. Of course it makes sense only if the collected statistics is huge, so the case I’ll describe below is not strictly described by sigma as the history (number of data points) is limited.
Anyway, if someone will offer you $100 for accepting to be hit by the lightning with seven sigma chance you should take the money, as you have a bigger chance to be eaten by the lion escaped from zoo.
This is how twenty three sigma event looks like:
It’s CMBX-NA-AAA 3, the “AAA” rated credit default swap for commercial real estate.
You better stay home as the lion is waiting straight in front of your house
July 23, 2007 at 5:47 pm
These charts do look scary, but doesn’t this just mean that the spread went from about 0.075% to about 0.21% ? 0.21% doesn’t seem so bad… am I missing something?
July 23, 2007 at 6:18 pm
I guess the odds would be similar to hitting the lottery, twice in a row. LOL!
Seriously though, for us credit newbies is .21% a bad thing? I mean, I’ve seen the ABX’s do similar things and it always meant that some (or many) companies were getting ready for a NEW meltdown. Obviously this means more expensive insurance for commercial deals and more credit contraction, I’m just tryiong to figure out more specifically what this means, thanks.
July 23, 2007 at 6:22 pm
i’m confused also… I thought we got $100 for the lightning strike risk, and your your talking about the lion in front of the house.
Did I buy the wrong swap?
July 23, 2007 at 7:08 pm
bofiz: what this means is that any hedge funds that need to hedge losses on CMBS are cooked already, because the cost of protection is more than the already suffered losses. They cannot take more losses, they cannot hedge, and they cannot sell. They can only ride it down.
This is exactly what happened in February a week before the subprime mortgage lenders lost 50% in one day.
July 23, 2007 at 8:00 pm
[...] Twenty three sigma event Sigma is also called “standard deviation”. The number of sigmas is the confidence interval that something […] [...]
July 24, 2007 at 3:29 am
If you read page 390 of the book by Thomas Friedman,” The World Is Flat” it goes on to say …But the Indians and Chinese are increasingly adding one more thing to low-cost labour and hi-powered technology: unfettered imagination-that is high, innovative and creative capacities. They focus on solving their problems with cheap labour, high technology, and high creativity – re-imagining their own futures. Then they will focus on ours. We must have people, lots of people, who can do the same. So, for the last time, you have been warned. This is not a test.
Sir. When I read the failures of globalization articles in the Financial Times of UK and the rich countries that will have to participate in the more payment of tax to keep the poor sustainable or simply living, I was not just shocked but I though this is not the test, it is past the test. We are already fighting the poverty with nothing except the promises.
Let me go a little further. The bank of Tanzania is a holes case of theft and giving loans without any back up or the co-lateral values or simply being friend with the Director.
The budget by The Finance Minster Mrs. Zakia Meghji is simply trying to figure out what has happened. Do we increase the price of bus fare that the public do not want do re look ay the financial institutions that The World Bank’s request to give a depth report of the Bank of Tanzanian’s working?
Sir, not just a failure of the economy but a brutal force of poverty still in Tanzania and as FP names the failing states ion Africa. Well no need to further.
I have one here in front of you.
DOG EAT DOG WORLD. THE POOR ARE DYING LET THEM DIE.
I mean they are from the Tarzan land, are they not, so why worry. Aborigine in Australia are gone, Red Indians are gone now the cockroaches pest like poor countries have to go. Am I saying this? No. Your graph says this.
I thank you.
Firozali A.Mulla MBA PhD
P.O.Box 6044
Dar-Es-Salaam
Tanzania
July 24, 2007 at 3:41 am
Sir; When I read the BOOK on the Six Sigma, first I though I was reading the scientific way of doing my work. Then I looked back to the barter system we had. Popped another word, Spinsters. Who are they? They were the once in the world Wars set under the tunnel of the trains gave foods and kept on weaving the fabrics. Most of them were not married and hence called the spinsters. Like the farm- farmer.
Charles Babbage got the idea of the punching holes from them and not Alexander the Great sir!! ! So the six sigma has not done any new structure in my work except the added load of human checking so I do not get caught by SEC.
Say the small word like spinsters gives the huge re-engineering, out sourcing, innovation way does have to look for any re structuring or the economy curves. Or now the innovations curve that jumps upward daily and I cannot catch with this.
I thank you.
Firozali A.Mulla MBA PhD
P.O.Box 6044
Dar-Es-Salaam
Tanzania
July 24, 2007 at 8:04 am
>>> These charts do look scary, but doesn’t this just mean that the spread went from about 0.075% to about 0.21% ? 0.21% doesn’t seem so bad… am I missing something?
The coupon on those CDS is 8bp, so 13bp loss is about two years on income. Hedge funds hold those by huge bunches.
Remember, those are not bonds, you don’t need to invest any capital to sell protection, you just sign the papers.
July 24, 2007 at 11:21 am
Anyone who models the distribution of (changes to) credit spreads with the normal (or bell-shaped) distribution is a fool. Such funds deserve to go under. Sigma does not apply – the probability distribution has a big fat peak on the left hand side.
July 24, 2007 at 1:38 pm
Anyone who models the distribution of (changes to) credit spreads with the normal (or bell-shaped) distribution is a fool. Such funds deserve to go under. Sigma does not apply – the probability distribution has a big fat peak on the left hand side.
DISCLAIMER. I totally agree, this price has nothing to do with normal distribution, it is probably closer to the Markoff Chain.
So my analysis was not scientific, in fact the probability of such event that just happened was quite realistic, this is why it happened.
But just looking at the chart you would agree that something exceptional happened.
July 26, 2007 at 11:31 am
Sorry theroxy my comment wasn’t really aimed at you, I hope I didn’t appear rude, but more at banks / hfs who do use such models for pricing this kind of risk. This works ok in normal times but blows up spectacularly (eg ltcm)
July 27, 2007 at 12:34 am
23 sigma meme is now spreading. To me this looks like a heart attack/seizure of the entire credit market:
http://market-ticker.denninger.net/
“AAA PAPER LOSING 5% OF ITS MARKED VALUE IN A WEEK IS NOT A THREE SIGMA EVENT. IT IS NOT A FOUR, OR EVEN FIVE SIGMA EVENT.
IT IS ROUGHLY EQUIVALENT TO YOUR ODDS OF BEING HIT BY LIGHTNING AT 3:02 PM TOMORROW WHILE YOU ARE SITTING IN YOUR OFFICE CHAIR ON THE 43 FLOOR OF AN OFFICE BUILDING – THROUGH THE GLASS!
IF this percolates through the debt markets, and there is absolutely no reason to believe it will not, then it is going to absolutely DESTROY the credit markets for ABX securities. Gone. Finito. End. Done. Period.
This means the total and complete end of all securitized mortgages that do not go through Fannie, Freddie or FHA, and it may even hit Fannie and Freddie paper!
It is also at least somewhat likely to totally slam the door closed on ALL leveraged paper for quite some time until the market figures out exactly how this event occurred and exactly how to prevent it from happening again. This means the immediate end of LBO deals, that many if not most currently in the pipeline will either be eaten by the banks involved or they will blow up, and the LBO premium will come out of the equities market – and rather quickly.
The severity of this event simply cannot be overstated, nor its potential impact. The seizure of the credit markets, if it actually happens, will make what we saw today look like a Girl Scout picnic!”
July 27, 2007 at 8:16 am
Dear T, your post was totally correct. I also want to stress that the formula to estimate the probability of what had happened must not be based on normal (Gaussian) distribution.
The correct approach to calculate the risk in that case is unknown to me. I was using “sigma” mostly for fun.
About the future of credit markets:
The problem with credit default swaps (CDS) is that apparently banks did not properly estimate the margin requirements. Remember, you need not to deposit any money when you sell CDS protection.
It’s very similar to insurance company. When you stop buy and insure you car they do not invest any money from their side. They just start collecting the fees, from the day one. Imagine if major earthquake destroys all the moving cars in the whole country and insurance companies are suddenly exposed to the insurance claims that far exceed their capitals? That’s what happened on those CDS markets…
I think the market will restore but the origination volumes will get back to 2003 levels. I don’t think the economy will survive this credit crunch without recession. I am posting my “credit cunch” series of posts
http://theroxylandr.wordpress.com/?s=credit+crunch
Since January. My “recession call” post:
http://theroxylandr.wordpress.com/2007/01/24/the-recession-call/
Is dated January 24th
January 23, 2008 at 2:28 pm
Six Sigma or the English Language does not help when the starvation sets in. I mean this Today 23rd January the stocks are so low that even the papers do not know how to set op the typos.
Davos,
The state of economy, politics or gossips no one can tell. Why too much hype in the language with many hiccups.
US politics trumping economics, or vice versa?
Weak data force bank to take bold approach
Sir:
If there is policy it belongs to the US. If the DAVOS turns into quagmire of politic issue and monetary issue of the felled markets of the world, the primary cause is US. How can you state otherwise? There is no vice versa. It is US and all know of this.
I thank you
Firozali A Mulla MBA PhD
P.O.Box 6044
Dar-Es-Salaam
Tanzania
East Africa
January 23, 2008 at 3:19 pm
Firozali, the real estate bubble in U.S., Spain, England and few other places is the reason for what you see. Everybody will suffer now.
February 8, 2008 at 12:53 pm
[...] February 8, 2008 Nostalgia Posted by theroxylandr under Economics, Finance, Money I had this chart back in July: [...]
May 17, 2008 at 9:32 pm
I’m also confused…
R
October 27, 2008 at 4:58 pm
Hi, Give something to help those hungry people in Africa or India,
I made this blog about this subject:
at http://tinyurl.com/6bz6t7