Raghu: > This is true, but is it pricing an option really so much different > from pricing an asset? In the end, almost any financial asset can be > considered as an option because of bankruptcy laws.
Yes! All financial assets are derivative securities because their values depend some underlying non-financial assests/variables. For example, the equity (E) of a corporation may be viewed as a call option on its assets with an exercise price equal to the value of its debt. Since the debt (D) is equal to the assets (A) minus the equity, the debt of a corporation is a derivative security also: it is a portfolio that bought the assests and sold the equity, that is, a call option. The issue is this: the values of the equity and debt are determined by the market whereas the value of the assets are not because assets are not traded in the market. If we have faith in the market, then we can price the assets using A = E + D. But what if A is not equal to E + D ? For example, when there is a buble and the connection among A, E and D is broken, the knowledge of E and D does not give us any information about A. This is what Stiglitz is talking about, except that the assets he is talking about are themselves some derivatives. You may try to back out the asset values from the prices of the derivatives on them, but had the assest themselves been traded on the market, their values would have been different than the values implied by the values of the derivatives on them. It is a matter of degrees of separation, in other words. > Is this really a useful distinction to make? So, I would say, yes! > This is very poor reasoning. In this example, what happens if the true > value of the asset turns out to be $138? In that case, the investor > loses 100%, the taxpayer recovers all their investment. A great deal, > isn't it? If we are allowed to cherry pick scenarios, we can justify > any conclusion we want. But, this is a newspaper article, not an academic one, right? How is one supposed to communicate such things to an audience who knows almost nothing about the probability theory, if one does not oversimplify the picture. Even then most people will not get it, anyway. The issue is: who is taking bigger of the risks? The answer is obvious: the tax-payer. I can show that this is the case using heavy probability theory if I write an academic paper but I would not do that in a newspaper article. > Nonsense. Once again this is atrocious reasoning. There are two sides > to this argument too. Why would a PIMCO or a BlackRock participating > in the Geithner program willingly overpay for assets? This is exactly > the reason why it may not be such a bad idea to have savvy private > parties to partner with the government. I think you are wrong and Stiglitz is right here, again. It is not PIMCO or BlackRock who is overpaying, it is the government who is overpaying and PIMCO or BlackRock goes with that because their loses are limited to their initial investment, or to the "haircut," as they say in this business. So, the problem is not one of adverse selection (the Banks) only, there is also a moral hazard problem (PIMCO or BlackRock) associated with this because PIMCO or BlackRock would not have agreed to pay the inflated prices if they were buying all of the toxic assets with their own money. The government is allowing them to make highly leveraged bets and letting them move away from the deal when they lose their initial investment: they have limited downside risk but unlimited upside potential. We may be better off if the government buys the toxic assets directly or just not buys them and lets the banks fail or just nationalizes the banks. Of course, there may be better solutions. This public-private solution is not the second best as you suggested: it is the fourth, may be fifth best, if it is not worse. Best, Sabri _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
