Friday, January 8, 2010

Kelly builds a franchise

A great Bloomberg article on near term interest futures. Interest futures increasingly bet on a near term interest rate increase, then capitulated. Now the futures predict lower interest rates farther out. In a queuing view, what just happened is investors holding out for a return to competition became increasingly disappointed, and begin to buy Kelly trades retail. In other words, the Kelly trades are seeking economies of scale by production line. Relating this to Shannon Channel theory consider a Huffman coder that begin to see a pattern and adds a second layer of detector to recode that pattern.

Remember that increasing the stages of production mean expanding the operating points on the yield curve, an inflation, in this case an inflation of the Kelly trades. Longer term bets are made with smaller lot sizes. Some Kelly bets will be made for the next longest term, the five or seven year term. The jump is not linear, and only three terms seem to be independently operating at the moment. So, as the Fed gets moves toward a 50/50 gamble, then the Kelly system will suddenly deflate, with volatility at the long tem rate.

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