Goldman deviates back to bad old standard: Fat Tailed Statements

Fat-Tailed: Fat-tailed distribution, phenomenon of approximately normal probability distributions that emerge in practice By Antony Currie

Goldman Sachs reported fourth-quarter net income of $2.17 billion on Jan. 16. On a call with analysts and investors, finance chief Harvey Schwartz was asked about the fallout in the currency markets from the Swiss National Bank’s decision on Jan. 15 to stop pegging the franc to the U.S. dollar.

He responded, “I haven’t confirmed any of these stats, but just going through with some of the folks, the single largest move in a day of any developed country. I think it was something like a 20-plus standard deviation move. And I think it was after three-plus years of 2 percent volatility. So, you’re right to call it extraordinary, but again, no issues here.”

His words echoed those of his predecessor, David Viniar, who in 2007 said of the financial crisis, “We were seeing things that were 25 standard deviation events, several days in a row.”

CFO Harvey Schwartz says the Swiss currency mess was “a 20-plus standard deviation move.” That’s a daft assessment. Predecessor David Viniar was similarly soft-headed in 2007. A bit of rhetorical flourish is fine, but not if execs look as if they don’t understand risk.

Goldman Sachs is deviating back to a bad old standard. On Jan. 16 Finance Chief Harvey Schwartz described the Swiss currency mess as “something like a 20-plus standard deviation move.” That’s a daft assessment devoid of any practical use. He’s not the first Wall Street executive to trip up on such a statement. In fact, his own predecessor, David Viniar, was similarly soft-headed when describing the storm in the markets in 2007.

Viniar talked of “25 standard deviation events, several days in a row.” Let’s put that in context. A seven standard deviation event is only supposed to occur once every 3.1 billion years, according to the 2008 research paper “How Unlucky is 25-Sigma?” written by several British and Irish academics.

A 20 standard deviation event, meanwhile, explain academics Kevin Dowd, John Cotter, Chris Humphrey and Margaret Woods, “corresponds to an expected occurrence period measured in years that is 10 times larger than the higher of the estimates of the number of particles in the Universe.” As for Viniar’s assertion, it would require that the “decimal point moved 52 places to the left!”

Using such terms to describe market movements might sound clever. But it actually exposes wrong-headed thinking on risk management. Schwartz, for example, was basing his 20-plus standard deviation estimate on the overall volatility of the Swiss franc being around 2 percent during the three-plus year life of the peg. Last Thursday’s 30 percent shift in the value of the franc against the euro may well fit that.

But the franc was far more volatile before the peg was introduced. Granted, the Swiss National Bank had called the peg a cornerstone of its policy days before ditching it. Risk managers, though, should be looking beyond three years of supine stats: the chance of the peg ending may have been low, but the pre-2011 numbers showed that the event risk was high.

Supine: 1. Lying on the back or having the face upward. displaying no interest or animation; lethargic 2. Having the palm upward. Used of the hand. 3. Marked by or showing lethargy, passivity, or blameworthy indifference: "No other colony showed such supine, selfish helplessness in allowing her own border citizens to be mercilessly harried" (Theodore Roosevelt).

It’s a similar story with other measures like value-at-risk. This relies on data either from the past one, three or five years, depending on the whim of the firm. In any event, it means that the more stable the environment becomes over time, the less the model is going to expect a problem. That path can lead to taking excessive risks –an impression Schwartz and other executives would be wise to avoid giving.

Germany's Schaeuble: Swiss franc move won't have lasting impact on euro Tue, Jan 20 05:58 AM EST NEW DELHI (Reuters) - German Finance Minister Wolfgang Schaeuble said on Tuesday that the Swiss National Bank's surprise decision last week to remove its cap on the Swiss franc was a "special case" that should not have a long-term effect on the single European currency. "Switzerland is a special case," he said during a visit to India. "It is not something that will have a long-term impact, especially on the euro. It shows that you cannot act against the markets in the long term." The removal of a three-year-old cap on the franc sent the Swiss currency soaring against the euro, which is under further pressure ahead of an expected move by the European Central Bank this week to buy government debt to boost the euro zone economy. (Reporting by Gernot Heller; Writing by Stephen Brown in Berlin; Editing by Madeline Chambers) BRIEF-EFG International comments on market developments relating to Swiss franc Tue, Jan 20 01:26 AM EST Jan 20 (Reuters) - EFG International AG : * Comments on market developments relating to the Swiss franc * Euro-Denominated assets under management (AUM) and revenues represent approximately 20 percent of total EFG International AUM and revenues Zurich, 20 January 2015. Following the market developments triggered by the SNB decision on 15 January 2015 to discontinue the minimum exchange rate of CHF 1.20 per euro, EFG International would like to clarify the following points: * Assuming that 2015 average exchange rate were to remain at current levels following the SNB decision, this would translate into a single digit percentage impact on EFG International's profit before tax Swiss franc-denominated AUM and revenues represent approximately 4% of total EFG International AUM and revenues, while Swiss franc-denominated operating expenses represent approximately 30% of the total cost base (down from over 40% in December 2011, as a result of the strategic and cost-efficiency measures undertaken as part of the Business Review, initiated in the second half of 2011). Swiss franc-denominated AUM and revenues represent approximately 4% of total EFG International AUM and revenues, while Swiss franc-denominated operating expenses represent approximately 30% of the total cost base (down from over 40% in December 2011, as a result of the strategic and cost-efficiency measures undertaken as part of the Business Review, initiated in the second half of 2011). * Impact due to the changes of the CHF/GBP exchange rate are not significant, as costs and revenues are broadly in balance. Source text - http://bit.ly/1Eke0HR Further company coverage: (Gdynia Newsroom) The impact on capital ratios is immaterial. EFG International will report its 2014 full-year results on 25th February 2015. Contacts – EFG International Media Relations Investor Relations +41 44 226 1217 +41 44 212 7377 mediarelations@efginternational.com investorrelations@efginternational.com About EFG International EFG International is a global private banking group offering private banking and asset management services, headquartered in Zurich. EFG International's group of private banking businesses operates in around 30 locations worldwide, with circa 2,000 employees. EFG International's registered shares (EFGN) are listed on the SIX Swiss Exchange. =========