Saturday, April 2, 2011

When Goldman Sachs was Really, Really Unlucky (GS)

In March 2009's post, "David Viniar, CFO of Goldman Sachs Blows Smoke at Journalists on AIG" I mentioned, tangentially [what else is new? -ed]:
...Reading Mr. Viniar's words, I am reminded of his statement on market moves in August, 2007:

“We were seeing things that were 25-standard deviation moves, several days in a row”
Several folks, when they finally quit laughing, pointed out how blatently Mr. V was spinning.
Most however underestimated how infrequent 25SD events are, the most common guess being once in 100,000 years. Tee hee.
In a snappy little eight page paper "How Unlucky is 25 Sigma" we see that at 7 Sigma the odds are....

....The authors go on to describe the problems involved in computing numbers on the cosmological scales required for 25 standard deviations. A good read, both for the statistically challenged and for pros like Viniar, a very highly paid PR guy, in addition to his CFO duties.
Today MIT's Physics arXive has
which includes:
How Unlucky is 25-Sigma?

The introduction is still wonderful and proves that academics can, at times, be funny:
Dowd and Woods: Centre for Risk and Insurance Studies, Nottingham University Business School, Jubilee Campus, Nottingham NG8 1BB, UK. Cotter: Centre for Financial Markets, School of Business, University College Dublin, Carysfort Avenue, Blackrock, Co. Dublin, Ireland. Humphrey: School of Accounting and Finance, University of Manchester, Crawford House, Oxford Road, Manchester M13 9PL, UK. Corresponding author:

One of the more memorable moments of last summer’s credit crunch came when the CFO of Goldman Sachs, David Viniar, announced in August that Goldman’s flagship GEO hedge fund had lost 27% of its value since the start of the year. As Mr. Viniar explained, “We were seeing things that were 25-standard deviation moves, several days in a row.” One commentator wryly noted:
That Viniar. What a comic. According to Goldman’s mathematical models, August, Year of Our Lord 2007, was a very special month. Things were happening that were only supposed to happen once in every 100,000 years. Either that … or Goldman’s models were wrong (Bonner, 2007b).
But sadly Goldman were not alone. In 2007 alone, massive losses were announced by Bear Stearns, UBS, Merrill Lynch and Citigroup, and then there were the earlier financial disasters – 1987, Daiwa, Barings, Long-Term Capital, the dotcoms, Russia, East Asia, and so on – and afterwards Société Générale and Bear Stearns again in early 2008, with rumours of more yet to come. Citi’s case was particularly interesting.
To quote from the same commentator:
Gary Crittenden, Citi’s chief financial officer, claimed … that the firm was simply a victim of unforeseen events. … No mention was made of the previous five years, when Citi was busily consolidating mortgage debt from people who weren’t going to repay … pronouncing it ‘investment grade’ … mongering it to its clients … and stuffing it into its own portfolio … while paying itself billions in fees and bonuses. No, according to the masters of the universe, downgrades by Moody’s and Fitch’s were completely unexpected … like the eruption of Vesuvius; even the gods were caught off guard. Apparently, as of September 30th, Citigroup’s subprime portfolio was worth every penny of the $55 billion that Citi’s models said it was worth. Then, whoa, in came one of those 25-sigma events. Citi was whacked by a once-ina-blue-moon fat tail.
Who could have seen that coming? (Bonner, 2007c).
Be all this as it may, one thing is for sure: there are certainly a lot of very unlucky financial institutions around....MORE