Michael Panzner at Financial Armageddon read this article too and on 3 November noted, "One failing of at least some of those who inhabit the academic world is a relentlessly popular and hopelessly arrogant delusion that human behavior can be reduced to formulas that others can or should rely on. Economists and finance experts seem especially guilty in this respect, having dreamed up models that regularly fail to predict anything that might be of value to those who must make decisions about what the future holds", well said Mike. Here's a link: http://www.financialarmageddon.com/2008/11/poisoned-math.html?cid=137572728.
Professor Siegel, apparently Gorton was once one of your "boys". Could you take him aside and in an avuncular way tell him about technical stock market analysis? Please. How do I see CDSs? First, they violate Uncle Miltie's TANSTAAFL principle. In the capital markets you pay. As I've written before, these products, unlike life insurance, can't be effectively modeled. GSG got paid before Uncle Sam stepped in. Did GSG benefit from a preference payment? Is the push to end mark-to-market accounting to conceal AIG's insolvency which may have predated GSG's payments? Will Dudley Do-right save Nell Fenwick from the oncoming train? Models "to forecast losses on pools of assets"? You're kidding? The ghost of Wassily Leontief haunts Wall Street. Gold, or fool's gold?
Let's return to "Fama-Miller" finance. Initial conditions:
Company A: market cap of stock, $10, of debt $8, total = $18.
Company B: market cap of stock, $20, of debt $10, total = $30.Total combined value = $48.
Company A's debt has an "A" S&P credit rating, Company B, "AAA".
Right on Derman! The physicists who dream these things up might talk to their scientific brothers, the chemists and borrow the concept of "equilibrium".