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Review
"Mr. Bookstaber is one of Wall Street′s ′rocket scientists′––mathematicians lured from academia to help create both complex financial instruments and new computer models for making investing decisions. In the book, he makes a simple point: The turmoil in the financial markets today comes less from changes in the economy––economic growth, for example, is half as volatile as it was 50 years ago––and more from some of the financial instruments (derivatives) that were designed to control risk." (The New York Times)
"Bright sparks like Mr Bookstaber ushered in a revolution that fuelled the boom in financial derivatives and Byzantine ′structured products.′ The problem, he argues, is that this wizardry has made markets more crisis–prone, not less so. It has done this in two ways: by increasing complexity, and by forging tighter links between various markets and securities, making them dangerously interdependent." (The Economist)
"He understands the inner workings of financial markets...A liberal sparkling of juicy stories from the trading floor..." (The Economist)
"…smart book…Part memoir, part market forensics, the book gives an insider′s view…" (Bloomberg News)
"Like many pessimistic observers, Richard Bookstaber thinks financial derivatives, Wall Street innovation and hedge funds will lead to a financial meltdown. What sets Mr. Bookstaber apart is that he has spent his career designing derivatives, working on Wall Street and running a hedge fund." (The Wall Street Journal)
"Every so often [a book] pops out of the pile with something original to say, or an original way of saying it. Richard Bookstaber, in A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, accomplishes both of these rare feats." (Fortune)
"a must–read amidst the current market chaos" (BusinessWeek.com)
"Bookstaber is a former academic who went on to head risk management for Morgan Stanley and now runs a large hedge fund. He knows the subject and has written a lucid and readable book. To his aid he calls mathematics (from Bertrand Russell to Godel′s theorem); physics (particularly Heisenberg′s uncertainty principle); and even –– meteorology." (Financial Times)
"The book covers a lot about risk management that is relevant to capital markets conditions today and the liquidity crisis." (Financial Times, Saturday 25th August)
"...an insider′s guide to markets, hedge funds and the perils of financial innovation. We saw plenty of those in 2007." (The Sunday Telegraph, Sunday 25th November 2007)
"I cannot recommend this book too highly. It is a clear exposition of what the combination of derivatives, leverage and hedge funds can do to the markets.
In short, A Demon of our Own Design is a guide to the dangerous financial markets we have created for ourselves by the clever innovations of structured finance, derivatives, credit default swaps and other newfangled products that are a mystery to the ordinary investor and even plenty of the sophisticates in the investment business. To understand the demonic risks we′re taking, read this book."––Forbes.com
"He understands the inner workings of financial markets...A liberal sparkling of juicy stories from the trading floor... (The Economist, April 21st 2007)
“…smart book…Part memoir, part market forensics, the book gives an insider′s view…” (Bloomberg News, 30th April 2007)
"...shines a light on what the future holds for a world where capital and power have moved from Wall Street". (Actuary, June 2007)
"The book covers a lot about risk management that is relevant to capital markets conditions today and the liquidity crisis." (Financial Times, Saturday 25th August)
"...an insider′s guide to markets, hedge funds and the perils of financial innovation. We saw plenty of those in 2007." (The Sunday Telegraph, Sunday 25th November 2007)
“Richard Bookstaber’s fine book on modern financial innovation”. Financial Times Wednesday 17 June 2008
"...a unique perspective" (PEF, Volume 7/3, November 2008)
Actuary,June 2007
capital and power have moved from Wall Street".
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Customer Reviews
We generally think of risk managers as "Don't do that, Maud" types. In fact the reverse is true. Far from preventing the firm from betting the farm, the risk managers job is to help to bet the farm, but only on a sure thing. Hence the development of risk strategies which allow firms to profit from market imperfections.
Bookstaber gives a history of these strategies, enlivened often by amusing anecdotes and a dry wit. Some of them (statistical arbitrage, for example) appear to have been invented almost by accident. All of them lose their edge over time and become just another part of the market with very low returns for the risk. Most users of these risk strategies provide liquidity to the market, which Bookstaber shows is necessary and (less convincingly) under-rewarded.
By this analysis the financial markets were almost programmed to blow up. Recessions and depressions come always from the financial markets to the real economy, not the other way round as Galbraith alleged.
Now that the crisis is upon us, what does Bookstaber recommend? If he had a good plan I'd elect him world president right away, but this is unsurprisingly the weakest part of the book. But he's good on what won't help. More regulations? Useless, because they'll only control the obvious. Ban short trading / hedge funds? Likewise. Better risk management? Of limited use, because some risk is unpredictable and so unmeasurable. He recommends eschewing the more exotic derivatives. No doubt they are already untradeable (and so worthless) but if someone wants to buy one you can be sure that Wall St will find a way to sell it. Less leverage? Well, we've already got that with a vengeance, without any new legislation.
I repeat: this is a terrific book, buy it. The author should be congratulated for not mentioning Faust or Prometheus once in 260 pages.
The book does seem to focus very much on the author's time at Morgan Stanley and Salomon/Citi though, with only a small amount of information on his time at Moore or Ziff Brothers which I would have liked to have seen more information on.
Definitely worth reading but don't expect it to be another FIASCO or Liars Poker with lots of stories about greedy traders and salespeople.
The author describes how endogenous risk lead to the 1987 market crash and the Long-Term Capital Management failure in 1998. The 20% fall in the stock market one day in 1987 wasn't due to a sudden reappraisal of economic prospects, as rational theories of the stock market insist. Instead, it was due to a highly popular and destabilising strategy called portfolio insurance, which mandated the selling of stock exposure as the stock market fell. This created a feedback loop, as selling begat price falls which lead to further selling -- and panic amongst those who might ordinarily be expected to capitalise on cheaper prices.
The Long-Term Capital Management (LTCM) failure was, in the author's perspective, chiefly caused by the public unwinding of an incredibly similar portfolio of trades which was owned by the investment bank where the core of the LTCM team used to work. This lead to coordinated price movements with no real external economic justification. Even though the LTCM portfolio was diversified globally, this lead to no real protection as the strategies they'd been using to achieve such high returns were mimicked by many other market participants. Because the fund was highly leveraged, even small price movements could lead to large losses. Lenders would then demand more money, which could only be provided by selling some of the portfolio. This selling reduced prices further and a further deterioration in the portfolio.
The author asserts that these events are an unavoidable by-product of a highly complex and fast-moving financial system. Regulation may not necessarily be a cure-all, as it creates more complexity and will always be backward-looking. The author thinks that simplicity might be the answer, and finds a parallel in biology where the cockroach has lived for millions of years with a very crude survival mechanism, which out-performs more complex and more specialised optimisation as the environment changes.
For a more academic look at endogenous risk I'd suggest checking out Risk and Liquidity (Clarendon Lectures in Finance). The author's blog also goes into some of these topics in a bit more depth.
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