Transferring Risk: Aversion and Inversion

Transferring risk is a mega industry. Not only are financial markets made to reduce perceived risk, but capital is invested to reduce fundamental, firm risk (the alpha risk).

Aversion to risk has developed into a highly technical means that results in an unexpected inversion of its indicators. The price of gold, for example, has been in an overbought condition despite the risk of inflation being low with a strong recessionary, if not a deflationary, trend.

Buying gold with the massive infusion of liquidity to resist deflation has supported both the recessionary trend and the price of gold into a market (beta-risk) bubble.

If a "market maker" wants to support the recessionary trend (unemployment) and gain capital at the same time, support commodities. The support suggests both a jobless recovery and a recovery indicated by rising commodities prices at the same time.

Rising commodity prices have been a false positive. Now, markets are worried about deflation. How can that be? The global economy is flush with anti-deflationary liquidity. The risk indicators are inverted.

If you are assessing the risk to do business, you will notice that the uncertainty (volatility of markets) does not stem from the public sector. It is doing what is fully expected--averting deflationary risk with inflation (currency devaluation). The source of uncertainty is from a consolidation of capital and risk in the hands of a few corporates in the private sector that far exceeds the monetary muscle of government spending.

According to the CFTC, the futures market is approximately a $34 trillion capital market. So, it is you versus trillions of dollars of market-making risk that can literally turn in a flash, likely determined by whatever position you have--if you are long, they are short...until you are trapped. Thus, for example, a government will protect its public policy position with the application of gamma-risk authority. Like Germany recently protecting (averting the risk to) devaluation of the Euro, by banning naked shorts on its largest financial corporates.

Germany is averse to the risk of infused capital (its devalued currency) being trapped in a speculative bubble rather than being trickled down. While the action is too late, it indicates the source of the uncertainty and instability.

Germany is also acting to invert the risk directed by the big demand for derivative-driven, risk-transfer products. In an effort to cause growth and economic stability, giving real support to the value of European debt, German authorities are doing what derivative markets purport to do.

The public and private sector are at odds (the risk aversion and inversion), struggling over who determines the distribution and timing of value (aversion), and the direction of the risk (inversion), causing a high level of uncertainty.

The aversion to, and inversion of risk (the uncertainty) has been transferred to gold, and will be transferred to other commodities with the assistance of highly technical, difficult to discern risk-transfer vehicles. The market for these aversion/inversion vehicles is made with the derivative/futures markets, which largely exist in the dark.

These denizens of the dark sneak up behind you and... surprise! The risk is suddenly reversed.

Black boxed, with the risk only apparent and available for manipulation to elite insiders who have the most credit-worthy access to the discount window, the market-risk makers command and control the distribution of the risk. Just as important is to control the narrative that explains the shifting patterns of risk, which controls both the direction of the risk and, even more important, mitigates what is otherwise a questionable free-market legitimacy.

The testable hypothesis of a free-market legitimacy is the only remaining liability of the averted (re-directed) alpha risk--the risk of accountability the averted alpha risk would otherwise provide without question, and without lengthy legal process. The more time spent applying accountability in public process, the more disconfirmed the free-market hypothesis.

To mitigate the probable risk of liability, market makers argue the use-value of making markets.

(Keep in mind that legitimacy is a critical function of power, and the exercise of power to a detriment without complaint or fear of reprisal is a measure of power. Use-value is an eristic for reconciling theory with practice; contending, for example, that reduction of alpha risk produces more useable value than the legitimacy of its full, theoretical value.)

Markets are made to hedge shifting patterns of alpha risk (that it averts) and beta risk (that it inverts). If markets are not made to absorb the risk, market makers contend, with trillions of dollars to manipulate the market, capital investment would be sub-optimal because there would be too much risk. They liquify markets by reducing the level of risk (by transferring the risk).

Pending financial reform will do well to redefine the problem by questioning the use-value of transferring risk.

Reform has been so far dominated with negotiating what the problem is, which indicates an aversion for inverting the current risk hypothesis to a more useful form of legitimate risk that distributes the austerity of the debt into a peaceful and prosperous pluralism.

Prosperity comes through retransformation of systemic risk into an alpha risk ontology, giving risk a real and present value that is peacefully verifiable.

Rather than conserving a fractile, geometric progression that appears to be the ontological legitimacy of a random walk, financial reform must consider the deficiency of the use-value eristic that falsely characterizes consolidation of risk being analagous to the legitimacy of an alpha-risk ontology.

Risk Indicator Signals Support for Recovery and Resistance for Equity Values

The Obama administration's highly visible move into a nominally non-ideological policy space is manifestation of a gamma risk indicator dangerously overvalued.

The risk "bubble" (a measureable accumulation of otherwise diffused value) gives any third element outside the bivariate too much power to reduce the probability of the targeted outcome (the probable, predictable variation).

Gamma risk--the underlying risk that free-market mechanics will be modified, with the more modification yielding more accumulation of the value--is unavoidable. However, our binomial political system, instead of managing the risk to maintain a diffused value, will try to avoid it. The probability for continued accumulation is, then, still high, and this is where the investor finds reliable predictive utility--a technical indicator that cannot be manipulated into a false positive or negative. The risk is unavoidable--it is gamma.

For example, an analyst notices a popular trend for less government with the probable result (value) being an accumulation of popular sentiment for the Republican party. According to popular theory, that will reduce the gamma risk.

Rather than being reduced, however, the risk is increased, and because the risk value is unexpectedly inverted, it reaches a massive, crisis proportion.

The probability is then for realignment, but that will not reduce the gamma risk. At best, it will keep the risk from continued accumulation (like slowing job losses with a recovery package).

All along the way, the gamma risk is an easily measureable and predictable value largely ignored by the model of bivariate ideology, and it will continue to be ignored with highly predictable results.

While the popular sentiment for managing the gamma risk will retrace some of the accumulated equity value, it will be short-term because the value of the gamma risk has prior support. The value will be managed indirectly because managing it directly recognizes the risk and, especially, the source of the risk.

Indirect management means that the slope of a populist retrace will be long and slow (taking more time than a binomial party is likely to survive). Equity values will tend to dip in order to finance the recovery without inflation and reduce the excessive risk in the short term. The fundamental support the long slope provides will add volatility.

The accumulated, non-fundamental value will have to be shared, undergoing a short retrace with less funds available to push overvaluations. Consolidation of firms will occour in the dip to retrace the lost value longer term, and the gamma risk will have been conserved.

Having neither been abated or avoided, with the objective being, at this point, for government to spend less, but not too much less to avoid a double dip, the risk, and the manifest double dip, will be shifted to the future.

A current high level of excessive gamma risk bodes bad for equity valuations. A declining value is a buy signal. A rising value, sell.

Quants (whether left or right wing) fail on the accumulation of gamma-risk value because the variable must be hidden to prevent "the risk" being technically corrected into a distribution. The working hypothesis is: the more value accumulated and consolidated the less the gamma risk with an accumulation of power. The hypothsesis and the analytical models derived from it are entirely wrong and will fail a predictive utility.

Measuring the gamma risk is a measure of deviance from the free-market model of pluralism. As the risk accumulates the stability of a free-market ontology diminishes. The legitimacy of power--the means of rewards and deprivations--must be managed by an administrative elite that compounds the primary elements of power into a third analytical model: the bureaucratic model that adjusts the level of gamma risk.

For example, former treasury secretary, Paulson says there was no indication of a housing bubble. He told President Bush the risk was low when it was excessively high.

Whether prime or sub-prime, the alpha and beta risk to home equity and loan values was accumulating along with the benefit of an accumulating capital that resulted in a liquidity crisis. The gamma risk accumulated to a dangerously high level and presented as "the bailout" that avoided "the systemic risk" (the gamma risk).

The gamma risk was not avoided, it was shifted to the future where it is being politically bivariated to manage it into an alpha and beta economic measurement of risk. Market valuations will be determined by the allowable variation of the risk dependant on an easily predictable bivariation of variables punctuated by a crisis of ignorance, deliberately modeled to recurrently ignore an excessively accumulated gamma risk.