Monthly Archives: September 2010

The Definite Picture

Credit outperformed equity today in a cautious session. Protests against government austerity measures took place across Europe, including a general strike in Spain. But in a day light on economic news the markets were far more concerned with the fate of Anglo Irish Bank and a possible downgrade of Spain. Both issues should be resolved tomorrow, and investors and dealers seemed to spend most of today adjusting their positions, according to the daily alert frpm Markit.

“The Irish Times reported that the government will also release a “worst case” scenario that will show the cost rising well above EUR30 billion. We “will get the definite picture tomorrow” according to foreign minister Michael Martin, though it is likely to be after the close.”

Gavan Nolan

Further news on Anglo Irish emerged after the FT published a report stating that the government will announce an additional capital injection of EUR5 billion. This will bring the total cost of bailout to EUR30 billion, short of the EUR35 billion figure that so unnerved the markets.

“But the Irish Times reported that the government will also release a “worst case” scenario that will show the cost rising well above EUR30 billion. Ireland‘s spreads were only slightly wider on the news, and quickly recovered later in the day. We “will get the definite picture tomorrow” according to foreign minister Michael Martin, though it is likely to be after the close,” Gavan Nolan, vice president at Markit Credit Research writes in today’s daily alert.

Tomorrow will also see the expiration of EUR225 billion in ECB 3-, 6- and 12 month loans.

“The central bank allocated just 104 billion in 3-month loans today, well below the EUR150 billion consensus estimate. Tomorrow’s weekly auction will give a better idea of banks’ reliance on the ECB for funding,” Nolan points out.

Equity markets remained lacklustre throughout the day, unlike their sovereign and financial inspired credit counterparts. Even robust leading indicators from Asia couldn’t provide impetus.”

The Markit/HSBC China Manufacturing PMI came in stronger than expected, with the sector posting its highest reading for five months. Japan’s Tankan business sentiment survey also beat expectations, although signs that manufacturers are pessimistic about the months ahead tempered gains. Consumer finance firms Acom and Promise Co widened sharply following Takefuji’s bankruptcy.

S&P placed both firms on negative watch.

BP was one of the day’s strongest performers after it managed to sell $3.5 billion of senior unsecured notes ($2bn 2015, $1.5bn 2020). “The company’s spreads have tightened since it managed to stop the oil leak, though it remains significantly wider than its single A peers. The credit will struggle to shake off the litigation risk premium that has been attached to it since April,” Gavan Nolan adds.

  • Markit iTraxx Europe 112bp (-3), Markit iTraxx Crossover 514bp (-7)
  • Markit iTraxx SovX Western Europe 159bp (-5)
  • Markit iTraxx Senior Financials 144.5bp (-4.5)
  • Sovereigns – Greece 790bp (-17), Spain 230bp (-5), Portugal 440bp (-6), Italy 198bp (-4), Ireland 475bp (-8), Belgium 132bp (-4)
  • Anglo Irish Bank 935bp (-12)
  • BP 165bp (-19)


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Espen G. Haug: Algorithms Should Be Monitored On A Daily Basis

Leading derivative expert, author and regular contributor at the Econotwist’s, Espen Gaarder Haug, says algorithms have many weaknesses and should be monitored on a daily basis by people with extensive market knowledge and experience. The former Norwegian Wall Street trader  have a thing or two to say in relation to the ongoing circus at Oslo District Court – also known as the “robot case.”

“Should the major players be allowed to carry on trading algorithm with no monitoring, without people with broad market experience monitoring them?”

Espen Gaarder Haug

The day traders in the so-called “robot case”  – now appearing before the Oslo District Court accused of market manipulation – run their scheme undisturbed for nearly six months. First, when the Oslo Stock Exchange contacted the brokerage and investment firm that owned the shares that the robot was trading, the alarm was raised and  the possibility to manipulate the trading program was removed.

“A rational investor would have plugged these holes quickly,” Dr. Espen Gaarder Haug comments.

“If you choose to outsource market making to a computer and you lose money.. I mean, you just have to accept it,” he adds.

Espen Gaarder Haug holds a  Ph.D. from NTNU and is regarded as one of the worlds leading experts on derivatives and option pricing models.

His book “The Complete Guide To Option Pricing Formulas” is seen as “The Bible” by many fund managers and derivative traders.

He has worked almost 17 years as a trader on Wall Street, among others, at JP Morgan and Chase Manhattan Bank.

He has also worked as an active manager of multi-billion dollar hedge funds, like Amaranth and Paloma.

Dr. Haug underlines that he don’t know anything about robot manipulation other than what’s been written in media, but says he recognize similar issues from his experience in the international financial industry.

He believes that the trading algorithm requires good internal monitoring y individuals with broad market experience.

“I know many who run algorithm trading, and they’re always following the trades with several well-qualified employees – and often by the one who created the algorithm,” he says.

There’s Always A Risk

“Robot trading always involves a risk of weakness in the algorithm,” Haug points out.

“It is therefore important to monitor whether such risks pops up, so that these algorithms can be adjusted, or turn off. If you choose to let the robot run without supervision, you take an unnecessary, additional risk,” says Haug.

The ongoing court case in Oslo have revealed that the two charged day traders was able to exploit the same weakness over and over again.

Timber Hill (who is a part of the Interactive Broker Group) was not aware of this before the Oslo Stock Exchange contacted them on March 14th this year.

Testifying before the court on Tuesday, Thomas Borchgrevink, manager of market surveillance at the Oslo Stock Exchange, said:  “I felt that they were not aware of this. They were not on the ball.”

Timber Hill closed down, temporarily,  the robot in question when the Oslo Stock Exchange made them aware of the error, and has since modified the algorithms.

Chill, Timber Hill

Espen Gaarder Haug assumes that the Timber Hills algorithm was not only used to make trading in stock (so-called market making) in the  Hafslund (B shares), Wilh. Wilhelmsen and Odfjell (B shares), which is relevant for this trial.

“In a way, Timber Hill, should be glad that someone intervened in these low liquidity stocks, and that no other big caps suffered even greater losses,” Haug points out.

There may be several reasons why a brokerage firm choose to let a robot trade without supervision, he says.

“They can, for example, have too much faith in their algorithm, so they do not fear failure. It may also be that they trade many shares in as many markets as possible, so that each share has little importance. And they choose to take a risk that in some cases leads to losses”.

“Around-the-clock monitoring is costly, but the algorithms have many weaknesses and should be monitored on a daily basis by people with extensive market knowledge and experience,” he notes.

Mandatory Monitoring?

Haug believes it is reason to ask whether monitoring should be mandatory:


“Should the major players be allowed to carry on trading algorithm with no monitoring, without people with broad market experience monitoring them?” Dr. Haug asks.

He believes naive algorithm trading, could not only harm itself, but at worst, damage the entire economy by reinforce large price movements.

Espen Gaarder Haug predicted in detail the financial crisis by the end of 2006, beginning of 2007, in a series of interviews and articles published by the Norwegian-The-Economist-peer – Økonomisk Rapport in 2007 and 2008.


“Although it is difficult to prove, there are good indications that the US stock market crash in 1987 was reinforced by the naive algorithm trading. The algorithms were based on a number of imaginative assumptions that broke completely with the crash. Some major players followed their naive algorithms slavic and sold more and more the more as the market dropped based on signals from the algorithms they slavishly followed,” Dr. Haug says.


Related by the Econotwist’s:

In Defence Of A Robot

Update: Day Traders Crack The Timber Hill Trading System

Oslo Stock Exchange Comments On Market Manipulation

Illegal To Outsmart A Trading Robot, Expert Says



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Confusion Reigns

Risky assets experienced a volatile session today, perhaps a reflection of market participants’ confusion over US monetary policy. The two major US economic releases of the day – the Richmond Fed manufacturing and the Conference Board consumer confidence surveys – were both well below expectations.

“Recovery locks are currently indicating a recovery of 18-20.”

Gavan Nolan

This had the typical effect of causing spreads to widen and stock prices to fall. But the markets quickly recovered in the afternoon, and European spreads were only slightly wider at the close.

“It is quite possible that investors see the slew of disappointing data as making the next stage of QE an inevitably, maybe as soon as November,” Gavan Nolan, vice president of Markit Credit Research writes in his daily alert.

Adding: “They will remember that the first stage of QE was positive for financial markets, if not the real economy.”

Earlier in the session, sovereigns were performing their usual role as the source of volatility.

Ireland briefly hit another record wide level after S&P weighed in with their latest assessment of Anglo Irish Bank.

In a radio interview an analyst from the rating agency reiterated the cost of the bailout at EUR35 billion. But he also raised the possibility of the rescue fund exceeding this amount, and that was enough to spook the markets.

Ireland’s spreads widened beyond 500bp and Portugal’s spreads also approached their record wides of 460bp.

A downgrade rumor on Spain also didn’t help.

The Irish government on Thursday is expected to provide some clarity on the Anglo Irish bailout and its intentions regarding subordinated debt.

“This could proved to be an important catalyst for future spread direction,” Nolan points out.

In Japan Takefuji Corp filed for bankruptcy protection today.

This wasn’t a great surprise given its was heavily trailed in the media yesterday.

Indeed, a glance at its spread history over the last two years suggests that it was something of a formality.

A credit event auction – only the third in Japan – will no doubt be announced in the coming weeks.

“Recovery locks are currently indicating a recovery of 18-20,” Gavan Nolan writes.

  • Markit iTraxx Europe 114.5bp (+1.25), Markit iTraxx Crossover 520.5bp (+4.5)
  • Markit iTraxx SovX Western Europe 162.5bp (+4)
  • Markit iTraxx Senior Financials 148.5bp (+4.5)
  • Sovereigns – Greece 800bp (+3), Spain 233bp (+6), Portugal 445bp (+20), Italy 202bp (+6), Ireland 485bp (+13), Belgium 136bp (+1)
  • Anglo Irish Bank 965bp (+17)

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