CHAPTER 24What Lurks Behind Your Trading Station

One of the most common words in the financial lingo is risking— the other is de-risking. The basic idea is that assets funded by being short dollars (borrowing dollars) generate returns that match the risk, but when funding and margin costs reduce the return, investors de-risk. Everyone sells at the same time, causing risk asset prices to crash. Since liquidity is most of what has driven up risk since early 2009, this risk-on, risk-off mentality works very much like a coin flip.

You can model a sequence of binary outcomes with a Bernoulli process that assigns a fixed probability to one of two possible outcomes and another probability to the other possible outcome. It is like modeling a coin flip. ...

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