Curriculum·Senior·R403
Risk Management as the Actual Product
Long-Term Capital Management, September 1998. Founded by John Meriwether, a former vice chairman of Salomon Brothers, and led by a team that included two Nobel laureates, the fund traded temporary price differences between similar securities using sophisticated mathematical models.
Lesson 1 opens on
Barings Bank and account 88888, February 1995
Nick Leeson traded futures in Singapore for Barings and recorded losses in account 88888, an error account intended for logging trainee mistakes and clearing daily. Rather than closing losing positions he added to them, betting that the Nikkei would recover, and after the Kobe earthquake of 17 January 1995 the index fell instead. By mid-February 1995 he held roughly half the open interest in the Nikkei future and about 85 percent of the open interest in the Japanese Government Bond future.
The lessons
- R403-01Risk per tradeDefine risk per trade as a number decided before entry rather than discovered afterwardsabout 42 min · opens on Barings Bank and account 88888, February 1995
- R403-02The position sizing formulaApply the sizing formula and state which three inputs it needsabout 42 min · opens on Amaranth Advisors, September 2006
- R403-03Drawdown, streaks, and ruinCompute the gain required to recover any drawdown, and why it is not symmetricabout 42 min · opens on Melvin Capital, January 2021 to May 2022
- R403-04Expectancy and R-multiplesExpress every outcome as a multiple of the risk taken, and explain why that unit is the right oneabout 43 min · opens on OptionSellers.com, November 2018
- R403-05Portfolio-level riskExplain why portfolio risk is not the sum of position risks, and what the difference is calledabout 33 min · opens on Three Arrows Capital, June 2022
- R403-06Circuit breakersDefine a circuit breaker as a rule that acts without requiring a judgmentabout 33 min · opens on Knight Capital, 1 August 2012
Labs
R403-L
Monte Carlo your own parameters
10,000 runs on the learner's own stated parameters. Output: expected drawdown distribution, ruin probability, and the leverage level at which the system fails regardless of edge.