Lecture 4: Crisis: LTCM

1
Lecture 4 Crisis LTCM

• Galina A Schwartz
• Department of Finance
• Business School
• University of Michigan

2
Plan of todays lecture

• Theoretical overview
• What do we call financial crisis?
• Why do crises occur?
• Trillion Dollar Bet a discussion
• LTCM a summary
• What went wrong?
• Was it a failure of mathematical models?
• Was FED intervention justified?
• Will you invest with LTCM II, if it happens?

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Theory behind crisis

• In one word dis-equilibrium
• Who is a guilty party?
• Central bank
• Government
• Financial industry
• International organizations
• Foreign government
• Who could serve as a rescue quad?
• Who should serve this role?

4
Trillion Dollar Bet

• Some citations
• Cannot measure the things like expectations of
  investors Zvi Bodie
• Dots on WSJ over performed the best traders.
  how to interpret? bias?
• Russia 98 suddenly and with no explanation
• Math does not drive the markets. Individuals do.

5
LTCM

• Feature narrower spreads between the interest
  paid on deposits and the interest earned on loans
  ?
• Advantages of Eurodollars (from narrow spread and
  no regulation)
• For borrowers better rates
• For depositors better returns

6
Summary

• I am biased I believe in LTCM approach
• I am sane you might disbelieve
• Do you trust Soros, LTCM, none? both failed
• Will future markets be more mathematics driven or
  less? compared with today?
• So, do your beliefs or disbeliefs matter?