Lehman's collapse was ultimately due to the exposure of subprime mortgage products. At the same time, QDII collective diving occurred in China, and some structured bank wealth management products "zero income" events caused huge losses to investors. When a product continues to decline by 30%, 50% or even 70%, we have to think about the design structure of the product itself and the problems and defects in its risk control. This article is to reveal the mystery of risk model for you.
First of all, the mystery of the risk model used by Lehman.
(1) A large number of simulation technologies are used in the model.
Since 1980s, derivatives, as an effective hedging tool, have developed rapidly because of their great role in finance, investment, hedging and interest rate behavior. However, these derivatives to avoid market risks contain new credit risks. There are three methods to measure the credit risk of derivatives: one is the risk exposure equivalence method, which aims to estimate the credit risk exposure value, consider the intrinsic value and time value of derivatives, and establish a series of ree calculation models with special risk coefficients. The second is the simulation method. This computer-intensive statistical method uses Monte Carlo simulation process to simulate the possible paths of key random variables that affect the value of derivatives in the transaction process and the value of derivatives at each time point or maturity date, and finally gets an average value through repeated calculations. The third is sensitivity analysis, which uses these comparative values to estimate the value of derivatives through scheme analysis or application of risk coefficient.
In recent years, a basket of credit default swap instruments and portfolio credit derivatives such as collateralized debt obligations (CDO) have grown rapidly, and their risk analysis and pricing mainly depend on model analysis. Turning to Lehman Brothers' Guide to Credit Derivatives, we can find that nearly half of the pages are devoted to the risk pricing and forecasting models used in credit derivatives transactions. The recommended modeling techniques of portfolio credit derivatives include default time simulation and semi-analytical model, which are widely used, especially Monte Carlo simulation. Monte Carlo simulation is named after the famous casino in Morocco. It can help people express some very complex interactions in physics, chemistry, engineering, economy and environmental dynamics mathematically. Mathematicians call this expression "mode". When a mode is accurate enough, it can produce the same reaction to the same conditions in actual operation. But Monte Carlo simulation has a dangerous defect: if a random number in a pattern must be input, but it constitutes some subtle non-random patterns, then the whole simulation (and its prediction results) may be wrong. Therefore, Dr. Reid of Bell Laboratories once warned people to remember Neumann's great advice: "Anyone who believes that computers can generate real random numbers is crazy."
(2) The model pays too much attention to the frequency of extreme events.
It is usually assumed that the probability distribution of market risk is normal distribution, because the fluctuation of market price is centered on its expected value, mainly concentrated on both sides, and the situation far from the expected value is less likely to occur, which is roughly bell-shaped. Although strictly speaking, there is a certain phenomenon of heavy tail in market risk, the assumption of normal distribution reflects the basic characteristics of market risk in most cases. In contrast, the distribution of credit risk is not symmetrical, but biased. One end of the income distribution curve leans to the left, and fat Le Tai appears on the left, which is caused by the small probability event of enterprise default and the asymmetry of loan income and loss.
In some recent new credit derivatives models, the hypothesis of heavy tail correlation is used more. That is, by giving a higher probability of extreme events and analyzing the impact on the expected loss discount of portfolio, the rating of credit derivatives and the appropriate compensation for credit exposure can be measured. After comparing the estimation results of the model, the research department of Lehman Company thinks that the model based on heavy-tailed correlation hypothesis can estimate the risk probability and value of credit portfolio more accurately.
Second, the lack of risk model.
(A) the model assumption is seriously divorced from reality.
The advantage of credit risk model of derivatives is rigor. The model tries to identify credit risk with quantitative and rigorous logic. From the shortcomings and deficiencies, the strict premise assumption of derivative credit risk model (when a variable changes, it needs to overturn the original conclusion and re-demonstrate) limits its application scope. Moreover, from a large number of empirical research results, the credit risk model of derivatives has not been fully supported. Like Tamiflu? Duffie Singleton (1999) found that the simplified model could not explain the term structure of credit differences between different credit ratings. Although the credit risk model of derivatives is the latest scientific method, it must be combined with the concept of financial risk management and subjective judgment to play its role.
In the subprime mortgage crisis, although financial institutions such as Lehman Brothers set up a well-designed pricing and rating model for credit derivatives, in the face of the systemic risk of sudden price reversal in the US real estate market, the premise of the model seriously deviated from the market reality. For example, the risk of Fannie Mae and Freddie Mac being taken over by the US government is not included in the risk events assumed in the CDS contract at all, let alone its probability distribution, so it is impossible to price this risk event reasonably. However, after Fannie Mae and Freddie Mac were nationalized, financial institutions and enterprises holding a large number of shares of Fannie Mae and Freddie Mac suffered heavy losses, and the default rate rose sharply, resulting in a substantial increase in CDS default compensation. It shows that if the credit derivative model is input with unrealistic assumptions, it can only get unrealistic results.
(2) Excessive packaging of vehicle models leads to serious information asymmetry.
Wall Street investment banks used the packaging of financial engineering to develop large-scale derivative financial products, such as debt guarantee certificate (CDO) and credit default swap contract (CDS), which were ostensibly sufficient to guarantee risks and protect investors' rights and interests, and these products became the chief culprit of this financial storm. In recent years, there are more and more levels of credit derivatives, each level adopts complex risk analysis model and pricing model, and the model analysis of the next level is based on the analysis results of the previous level. Therefore, as the trading chain becomes longer and wider, it becomes an impossible task for the ultimate investors to understand the ultimate risks they face through different levels of models. In addition, risks are constantly traded and transmitted in the complex chain, so it is difficult for participants in credit derivatives transactions (especially the initial lending institutions) to have the initiative to fully monitor the relevant loan risks. Therefore, the first layer of the credit analysis model may have defects, and the whole model analysis process actually becomes a complex black box. For example, after an investment bank bought a subprime loan portfolio sold by a mortgage bank, it upgraded its asset rating through CDO packaging. Investment banks generally sell seven grades of CDOs. The seventh level CDO is responsible for the first 3% of asset losses, while the first level is responsible for more than 30% of asset losses. Through the evaluation of financial engineering, the investment bank shows that the probability that the default loss of this group of subprime assets exceeds 30% is very small, so it convinces investors that the first-level CDO has the capital preservation function close to 100%, but it can obtain high returns. Coupled with the guarantee of large financial institutions, the original BB assets have been turned into AAA assets, and the tricks of turning garbage into gold have been announced and sold to the world through Wall Street. Under the complicated design, the transparency of the model analysis process is further reduced, and it is difficult for not only investors and regulators, but also investment banks themselves to fully understand the whole risk.
(C) the model ignores the expected effect of risk amplification consequences
In the credit derivatives model introduced by Lehman Brothers, although the dynamic nature of risk analysis is considered in a simplified model, and the risk of extreme events is estimated with heavy-tailed correlation and other assumptions, it can only answer the maximum loss under a certain probability (for example, 99.9%), but can not answer the degree of losses caused by extreme events, and traders' expectations will change. Due to the wide coverage and long trading chain, once the expected change occurs, the loss will be amplified to dozens or even hundreds of times.
For example, Lehman's "mini bond" is actually a structured debt product, including CDO, credit default swap and interest rate swap. Because the debt service of "mini-bonds" mainly depends on the CDO purchased by Pacific International Finance Corporation, it can be said that interest rate swaps, credit default swaps and other derivatives are all carried out around the packaging of CDO, and accordingly "mini-bonds" are also linked to the credit of internationally renowned companies. Because "mini-bonds" involve the credit of internationally renowned companies such as Pacific International Finance Corporation, Lehman Special Finance Corporation and HSBC, as well as a series of complex operations such as CDO, credit default swap and interest rate swap, any problem in these links will make Pacific International Finance Corporation unable to repay the principal and interest on schedule, leading to investors' default. Since the interest rate swap between Pacific International Finance Corporation and Lehman Special Finance Corporation was guaranteed by Lehman Brothers, the interest rate swap contract was automatically terminated after Lehman Brothers filed for bankruptcy. Pacific International Finance Corporation will redeem the "mini-bonds" in advance as agreed, and sell CDO as collateral, which will be paid to investors after deducting relevant costs and expenses. On the surface, with CDO as a guarantee, the investor's principal loss will not be too great, but in fact, what CDO assets are purchased and held by Pacific International Finance Corporation have not been disclosed in advance, and investors are not clear. Judging from the current international CDO market, affected by the subprime mortgage crisis, CDO's credit rating has dropped sharply and its market value has shrunk dramatically. Selling CDO will inevitably cause serious losses to investors' principal.
Before September 2008, most credit rating agencies gave Lehman at least Singal A (rating A), and many of them were double A (rating AA). However, on the afternoon of Friday, September 12, the credit rating company issued a warning that if Lehman Brothers did not raise new funds, they would downgrade its debt rating on September 15. This has greatly alarmed investors. In the subprime crisis, the three major rating agencies downgraded a large number of subprime products in a short period of time, which worsened investors' expectations and contributed to the vicious circle of the market. Within Lehman Brothers and among its investors, the panic is intensifying. Countless clients called to ask for divestment. Lehman Brothers' new york business department was unable to transfer money to its London account normally, resulting in its main European branch in London being basically paralyzed before September 15. So this old Wall Street store with a history of 158 closed down.
Third, some enlightenment.
(A) financial risk control can not rely too much on mathematics and physical analysis technology.
The collapse of Lehman Brothers once again shows that the financial market is ever-changing, and it is difficult to cover all the risk characteristics, no matter how exquisite and huge the mathematical and physical modeling techniques are. In particular, the pricing of credit derivatives has always been a frontier issue in finance. If the mathematical model is excessively worshipped to replace the complex and reasonable risk control mechanism, it will inevitably lead to the simplification and homogenization of investment behavior and lead to financial crisis. Therefore, while developing quantitative risk analysis technology, financial institutions must also rely on many comprehensive risk control means such as internal control system and risk management culture.
(2) Corporate bond products and their corresponding credit derivatives should not be geared to individual investors. Individual investors usually lack professional risk analysis and identification ability, and it is difficult to accurately identify risks in the face of corporate bonds and their complex credit derivatives. Although Lehman's "mini-bond" product bidding and sales plan has introduced the product operation mode in detail, many individual investors still regard "mini-bond" as a high-yield and low-risk product to buy in large quantities. In addition, the risk tolerance of individual investors is weak, and once the risk becomes actual loss, it will often cause serious consequences and even affect social stability. Therefore, the development of corporate bonds and credit derivatives in China should fully follow the market rules, be based on the OTC market and face institutional investors. Institutional investors have relatively strong risk identification and tolerance, can choose products with matching risks and returns for rational investment, disperse and dissolve risks through trading and circulation, and then promote the survival of the fittest of financial products and the benign development of financial markets.
(3) Improve and standardize the operation of intermediary organizations. First of all, relevant policies and regulations should be improved in project evaluation, asset pricing, process supervision and information disclosure. Lehman took advantage of the irregular trading of CDS and the opaque price, and turned the greed of unlimited capital appreciation into the reality of the expanding financial bubble. Secondly, we should cultivate and improve the credit rating system. The credit rating of securitized assets is an indispensable guarantee for investors to make correct choices.
(4) Improve market supervision and strengthen information disclosure. For a long time, the supervision of over-the-counter market in developed countries and regions is relatively loose, and the regulatory authorities pay more attention to the compliance supervision of institutions, while the supervision of products designed by them and their transactions with customers is relatively loose, which has buried hidden risks. In fact, both financial product issuers and sales organizations have the characteristics of profit-seeking, and they will deliberately avoid the information disclosure of product risks when designing and selling products. Therefore, regulators should perform their supervisory duties more comprehensively, strengthen information disclosure and safeguard the legitimate rights and interests of investors.
To sum up, the risk model used by Lehman Company relies too much on mathematical analysis technology, and excessive packaging leads to serious information asymmetry, ignoring the consequences of expected effects on risk amplification, divorced from reality, brewing risks, and eventually leading to Lehman bankruptcy.
The collapse of Lehman has had a certain impact on China's economic development, and it also gives us some enlightenment: for China financial enterprises in transition, there are generally structural defects such as insufficient professional segmentation, centralized asset allocation, and heavy dependence on the government path. We should learn from them, strengthen risk management and control, establish a sense of crisis, and improve market supervision. As the saying goes, "flies don't bite seamless eggs." If there were no subprime products (crisis), whether Lehman could still stand today would be a big question mark.
follow-up action
Matters needing attention in selecting structured products
For ordinary investors, structured products are both unfamiliar and familiar, and structured wealth management products are a special fixed income tool. It combines fixed-income products (usually fixed-income bonds) with financial derivative transactions (such as forwards, options and swaps). ) to improve product returns or productize investors' expectations of future market trends.
Due to the "fixed+derivative" characteristics of structured wealth management products, that is, by investing most of the funds in fixed-income products and a small amount of funds in derivative products, the possible high returns can be realized under the goal of capital preservation. This just meets the needs of some investors, who are eager for high returns in the capital market and unwilling to bear the risk of principal loss. When purchasing structured products, please pay attention to the following:
First, don't focus on the highest expected return;
The so-called highest expected return often appears in an ideal state, and the probability of realization is very small. Investment needs to consider risks, and for structured products, ask more about the possibility of the lowest return. If we understand the possibility and conditions of zero income, no one will regret it.
Second, don't be overly superstitious about historical materials;
Many banks will review the historical data of linked indicators in their product introductions. Based on these data, investors should not be optimistic about future earnings. History can only explain the past, and there will be many new uncertainties in reality, such as the subprime mortgage crisis. Therefore, historical materials can only be used as a reference, not as a basis.
Third, we can't simply be attracted by the concept of linked varieties;
The sales of structured products are becoming more and more commercialized, and some still use attractive trade names in their sales. However, investors should realize that concept packaging, like the theme speculation in the stock market, also has certain risks.
Fourth, "Don't put eggs in one basket".
By investing in different varieties, we will combine low risk with high risk, fixed income with floating income, short-term with medium-and long-term products, and structural with FOF products to avoid the risk of single variety investment.