You can sort of fix this in a free market system through reinsurance which spreads the risk out across multiple counterparties with deep capital reserves. But ultimately the only way to eliminate the risk is through insurance by a sovereign with the ability to levy taxes and print fiat currency.
Don't you just transfer the risk to some other party this way? So that other party will now have to either have the bigger buffer or transfer it to someone else. At the end there will be no net effect on the larger scale. The cycle probably continues until somebody stupid enough to dismiss the risk buys into it at loss.
Take on /less/ long term assets (sell them and buy t-bills) to remove the existential risk.
It's not going to be much different in cost. You see it? Derivatives aren't magic pixie-dust insurance. They will cost about the same as a rebalance on that scale or you hit them as hard as you can because they're mispriced and represent free money.
Insurance and derivatives are supposed to find prices for rare events. And if an organization can't insure or securitize a risk it should make them think real hard about mitigation.
There are S&P ETF’s that hedge out the dollar risk and pay out in euro’s. Not saying your concerns aren’t valid, just that modern financial instruments are varied and sophisticated enough to hedge most exposure concerns that an individual might have.
Not even most hedged investments at large scales. Hedging doesn't make risk disappear: It just shifts it somewhere else, either to someone even larger, or dispersed among many parties. When the risk is correlated with the risk from others, like the trillions in underperforming treasuries that the bing banks have in their balance sheets, who is the safe counterparty? Not the next bank, which also has a similar position. We saw this with the housing crisis and synthetic CDOs, and we see this on insurance against sufficiently large natural disasters.
So sure, small banks failing to hedge is irresponsible, but at a large enough scale, someone holds the bag.
Risk mitigation is usually done best by splitting your bet.
In other words, sell a part of your business to limit your exposure, keep the rest. If in the future it goes down the tubes completely you will not have lost all. If it continues to go up split your risk again. And so on.
Hedging doesn't eliminate risk, it moves it around. If you hedge away $100B of interest rate risk then your counterparty takes that hit when interest rates go up. Who's that counterparty supposed to be? Another bank? Pension funds?
Hedging via insurance, futures, put/call options, etc. The same way companies that deal in commodities like grains and metals handle this sort of risks. I'm sure people like the Winklevi are more than happy to offer this sort of service.
My understanding of the point in the video is that the volatility resulting from the systematic risk is a symptom of the market not having enough normal/baseline volatility to clear out the dead wood, so to speak. Quite analogous to forest management, where more smaller fires clear out the fuel on a regular basis so that a large scale fire cannot occur.
Now it is probably the case that the HFT traders make The Market far more intertwined than is sensible, and hence far too combustible as a whole. In the video Taleb points out that he favours many smaller organisations over fewer larger ones for the simple fact that within an ecosystem a few small systems can fail with little negative effects on the whole. Where as if a large system fails it is far more catastrophic.
So perhaps the solution here is to make some sort of upper limit in financial (HFT, Banks, etc) firms so that there would be more smaller ones, where failure would be more common and the destruction of smaller companies should not disasterously affect the system as a whole.
That said, the recent wiping of trillions of dollars in value, seemed to be an effect of the many years of apparent calm. With a lot of companies creating new derivatives with the appearance of safety but were anything but safe.
To bring it back to the parent article, I do agree that everyone on the exchange should be paying some sort of transaction fee, I have to pay one when trading shares, and so should other traders.
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