If I were a believer in QM Theory and I wanted to cheat the buyers of derivitives out of their money, this is how I would do it.
I would deliberately construct lot sizes that are not maximum entropy, and hence I secretly create opportunities for minimum variance trades and short the sold bundles. My side information is the disequilibriated entropy design of the bundles, my hedging system are minimum variance insurance trades.
The most similar cheat we all understand are the programmers who shave off the fraction of pennies in interest accounting by computer, then hold the saved penny fractions in secret accounts.
This is complimentary to cheating the Fed with Kelly trades when the Fed distorts the banking channel. In this case, the Fed creates channel distortion by deliberately enabling minimum variance trades, but entropy traders jump in and hog the channel.
With bundled derivatives, the sellers design in a round off error because the bundle lot sizes do not match the actual entropy of the mortgage aggregate. That round off error becomes the probability in a Kelly trade formula or the minimum variance insurance premium.
The seller can do this when the seller has advanced or more detailed knowledge of the original mortgage aggregates than the buyer. When this situation exists, then the buyer cannot take the bundles and reverse the coding process with any accuracy.
Anyway, by understanding which norm dominates a channel, the trader can find other opportunities, maybe, using the complementary norm. The norms are balanced when transaction costs of variance trades equal quantization noise of entropy trades. Hire me as an expert witness in the trial against Goldman Sachs.
Congress is performing a similar trick with Health Care. They are Requantizing, and key legislators know that the quantization is not entropy optimum. The variance trades in this case are the many free riders that result. Employers, insurers and medical professionals will be searching out empty spaces in the market where variance trades can shave of a percentage from the government.
1 comment:
Very interesting and good analysis on derivative and QM THEORY AND FRAUD, Watt. The presumption of your analysis. supposed that the seller has advance , or more detailed knowledge information....then the buyer....I understand this analysis conveys deals between two or may be among more traders from big corporations or dominant financial market makers that have experts to make trades based on this type of analysis where concepts such as standard deviation, variance,entropy, plus calculus are well understood; setting aside, the big majority of investors via mathematical schemes that only the experts know.
On the other hand, entropy can be applied not only to derivatives but to any security and now is done in politics and other studies categories, this is the continuous fight among the The Seven Big, nowadays, grown little bit, expanded with China India, Brazil etc.
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