Clapp_B_CaseStudyReport_v2 - Date: November 2, 2007 To:...

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Date: November 2, 2007 To: LTCM2 (M. Gallagher, C. Hawkins, H. Zhang) From: Brian Clapp Subject: Report on Case Study Sources Cc: Sharon Ahlers This report on Long Term Capital Management focuses on the communication aspect of the firm’s collapse rather than focusing heavily on finance and mathematical theory as most LTCM literature does. I hope that this report will provide useful information for the other members of LTCM2 to include in our presentation on November 12. I have made several changes since I sent you the first draft. I cut out several paragraphs and one entire sec- tion of the summary. This deleted content was not relevant to my thesis. The entire section originally focused on reinforcing one of the topics that I explore. I removed it because my thesis does not focus on reinforcing that topic. Instead, I use the topic as a step on the path to my conclusion. In addition to removing content, I also revised the structure of many of the sentences to avoid wordiness. Overall I hope that this report is seen as a useful contribution to the knowledge of anyone who reads it. Best wishes, Brian Clapp LTCM2 Team Member Enclosures
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Brian Clapp Report on Case Study Sources v.2 2 Report on Case Study Sources Prepared by: Brian Clapp Operations Research & Engineering Cornell University Prepared for: Marcus Gallagher Caitlin Hawkins Helen Zhang Sharon Ahlers November 2, 2007
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Brian Clapp Report on Case Study Sources v.2 3 Table of Contents Executive Summary 4 1. Introduction 5 2. Summary of Case Study Sources 5 2.1 Empiricism in the Face of Theory: Nassim Taleb 5 2.2 Low Risk and Rational 6 2.3 Stages of the Collapse 6 2.4 Economic Performativity 6 2.5 Five Narratives of Long Term Capital Management’s Collapse 7 3. Analysis of Case Study Sources 8 3.1 Markets not a Natural Phenomenon 8 3.2 Three Inadequate Narratives 9 3.3 The Reason for Collapse 9 References 11
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Brian Clapp Report on Case Study Sources v.2 4 Executive Summary Long Term Capital Management is often portrayed by the media and popular opinion to have collapsed for several reasons. Many of these reasons do not accurately describe the situation or take into account all of the forces that affected the firm. In this report, I examine Nassim Taleb’s theories on market behavior and their implications for financial models. Although Taleb is most likely correct, abandoning models leaves the world with no quantitative tools to use for investing. After exploring Taleb’s theory for why LTCM collapsed, I explore five other narratives that attempt to ex- plain the collapse. The first three narratives given are either wrong or too simple. I explore them even though they are incorrect because they are the most commonly encountered opinions. The fourth and fifth narra- tives, a flight to quality and a superportfolio, describe the situation accurately when considered together. I build on the analysis done by Donald MacKenzie and apply game theory to the situation to explain why the market acted as it did. LTCM’s collapse, and the chaos that would have resulted had it not been saved from bankruptcy, are directly
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This note was uploaded on 04/06/2008 for the course ENGRC 3350 taught by Professor Ahlers during the Fall '07 term at Cornell University (Engineering School).

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Clapp_B_CaseStudyReport_v2 - Date: November 2, 2007 To:...

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