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Add to that fundamental limitations of both VAR pricing, and the BS model:
a) they assume a normal distribution
b) they don't take into account liquidity.
Push came to shove, and the traders and the mathematicians sat around the table and tried to figure which positions to drop to get their risk back under control, and more cash in their pocket to support their positions.
maths guys argued for the most illiquid positions (hardest to get out of)
traders argued for the least profitable positions (which also happened to be mostly the liquid ones).
traders won the argument. They dumped the unprofitable/liquid positions.. kept the profitable but illiquid positions.. market kept moving, eventually their cash ran out, they couldn't exit the positions because they were so illiquid = crunch.
turns out the traders were right, with their calls, at least - the positions would have come right eventually, and even been profitable.. it was just, as you point out below, too long coming, they couldn't handle the mid-trade margin requirements.
A lot of this was brought on by a move away from the initial concept of LTCM, heavily risk balanced (neutral) positions, which worked well the first few years they traded them, into more "take a punt" directional calls - without the same level of lack of directional bias.
Ultimately, all these things unwound them.
Si
At 09:43 1/04/2004, you wrote:
>From what I know about LTCM, they didn't go bust because of any shortcomings
>of BS equation. They simply didn't take into account 3 major things, other
>than thinking they could do no wrong.
>
>1) The markets can remain "irrational" far longer than they can remain
>solvent
>2) Sovereign nations do default on their debt (Russia)
>3) Too much (well, way too much) margin.
>
>The inputs to their models was based on faulty assumption. The Russian
>default totally killed their volatility assumption.
>
>BS is just fine.
>
>Abhijit
>
>
>----- Original Message -----
>From: "Gerald Marisch" <gerald388@xxxxxxxxxxx>
>To: "Omega Chat" <omega-list@xxxxxxxxxx>
>Sent: Wednesday, March 31, 2004 1:49 PM
>Subject: Black Schoales
>
>
>> Anyone recall the name of the video that detailed some NY firm going bust
>> for billions by using the Black Schoales (spl?)option pricing model?
>>
>> Inquiring minds want to know! Thanks in advance.
>>
>>
>>
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