STOCK MARKET WATCH -- Monday, 19 January 2015

[Demeter]

23. No One Was Supposed to Lose This Much Money on Swiss Francs

WELL, TO BE FAIR, THEY LOST MONEY BY SELLING THE FRANC SHORT...

http://www.bloombergview.com/articles/2015-01-16/no-one-was-supposed-to-lose-this-much-money-on-swiss-francs

One does not normally see sharp right angles in financial charts, but you could pretty much cut yourself on this chart of the volatility of the Swiss franc against the euro:



One straightforward takeaway is: Whoa, that volatility is super high! But perhaps a more useful takeaway is: Whoa, it was super low for a really long time! This is of course because the Swiss National Bank capped the franc's value against the euro: The SNB wanted a price of no less than CHF 1.20 per euro, and the euro itself wanted a price of no higher than CHF 1.20 for reasons of its own, so the result was pretty much a peg at slightly above 1.20. In the 12 months ending on Wednesday, the euro traded in a range of 1.20095 to 1.23640 francs:



Those two days -- yesterday and today -- really put the previous year in perspective.

Goldman Sachs Chief Financial Officer Harvey Schwartz said on this morning's earnings call that this was something like a 20-standard-deviation event, and while the exact number of standard deviations is of course a subjective matter, that's the right ballpark. Over the 12 months ended on Wednesday, the annual volatility -- that is, the annualized standard deviation of daily returns -- of the euro/franc relationship was a bit over 1.7 percent; over the last three months of that period the volatility was less than 1 percent. That converts to a daily standard deviation of something like 0.1 percent. On Thursday, the euro ended down almost 19 percent, or call it 180 standard deviations, depending on what period you use.

An 180-standard-deviation daily move should happen once every ... hmmm let's see, Wikipedia gives up after seven standard deviations, but a 7-standard-deviation move should happen about once every 390 billion days, or about once in a billion years. So this should be much less frequent. Good news I guess, Switzerland won't be un-pegging its currency for at least another billion years, go ahead and set your Swatch by it...

This is obviously dumb. You can't predict the next billion years based on the last one year of data. A billion years ago, how much were your euros worth? The franc was not volatile for a reason, and then it became volatile for a reason, and those reasons were mostly related to the policy actions of the Swiss National Bank, and those actions were and are comprehensible by the human mind, as long as that human mind didn't just robotically consider one year of historical data price data and nothing else. Most forecasters, who have human minds, did not predict that the SNB would remove its cap this quarter, or even this year, but they thought it might happen in 2016. No one was waiting until 1000002015....



I HAVE SIMILAR OBJECTIONS TO THE ABUSE OF STATISTICAL TECHNIQUE WHEN IT COMES TO CLIMATE CHANGE, A SITUATION WHERE THE MODELS SUCK, THE DATA IS FULL OF HOLES, AND THE VARIABLES ARE TOO NUMEROUS TO INCORPORATE, IF IN FACT THEY HAVE ALL BEEN IDENTIFIED TO BEGIN WITH. AND THEN, THERE IS THE LIKELIHOOD OF HUMANITY BEING UNABLE TO DO ANYTHING ABOUT IT IN THE FIRST PLACE.

EARTH IS A DYNAMIC SYSTEM WITH INPUTS FROM THE SUN, SOLAR SYSTEM AND POINTS WEST. EARTH CHANGED BEFORE MAN APPEARED, IT WILL CONTINUE TO CHANGE EVEN IF MAN DISAPPEARS. IF MAN THINKS HE HAS ANY CONTROL OVER IT, HE'S AN EGOTISTICAL IDIOT. SHORT OF NUCLEAR ANNIHILATION, THAT IS. THAT COULD IN FACT DESTROY THE EARTH AS HABITAT FOR LIFE. BUT WHO KNOWS? WE WOULDN'T BE THERE TO SEE.