Ancient or New Sophism?

“Twenty years ago, investors relied on what they considered to be sophisticated strategies to try to avoid big stock-market losses. On ‘Black Monday,’ as the stock market plunged 22.6%, they found their safety nets had huge holes.

“Today, investors can much more easily and effectively hedge their exposure to the market. ‘With each successive crisis, the industry gets better and better; it's significantly better prepared than before 1987,’ says Pavandeep Sethi, global head of volatility trading at Chicago's Citadel Investment Group… ‘Risk management is more sophisticated, and good managers have a game plan’ to prepare for deep jolts to the market.

“But some worry that today's improved and sophisticated hedging techniques have created a false sense of security among investors, and that a dramatic market collapse is still possible if issues arise in areas where there is little transparency, such as the world of derivatives.

“Although there is a ‘richer menu’ of tools for investors to hedge their portfolios, there remains the possibility of ‘the same cascading effect as the sellers of the hedge have to move to protect themselves from a falling market, and everyone runs for the door at the same time,’ says Robert Glauber, a former U.S. Treasury undersecretary for finance…

“In many ways, risk management and hedging techniques have improved since 1987, and larger investors have many more-sophisticated tools available, analysts and academics say. For example, credit-default swaps, which essentially are insurance policies that pay off if a company looks more likely to default, give investors a way to hedge their exposure to specific companies and sectors.

“But many of the hedging products are new and relatively opaque, raising questions about how they will hold up in a market crisis…

“Recent losses also demonstrate that even large investors continue to be caught off guard by market moves, raising questions about their ability to hedge their risks…

“‘People have been lulled,’ says Nassim Nicholas Taleb, a former trader who made big money in 1987 and is the author of ‘The Black Swan’."

(“The More Hedges the Better, Right?; Blind Spots, Bottlenecks Lurk Among New Ways Of Preventing a Crash.” Gregory Zuckerman. Wall Street Journal: October 17, 2007. pg. C.1)

ANCIENT GREEKS saw Sophists as Wisdom's elite. Today we generally equate sophistry with trickery and deceit. When I dine from a "rich menu" of sophisticated delights, I normally walk away with a bad case of indigestion and regret. (Are we reminded of Enron's market magicians -- "The Smartest Guys in the Room"?)

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