Close Mountain

Close Mountain Advisors LLC

Selected essays, publications, and working papers

Over the years Mr. Coleman has worked on a variety of problems, some of general interest. A variety of papers have been released on the Social Science Research Network:

Below we have also collected essays and publications covering various topics:




Risk Management

Quantitative Risk Management (Wiley) and A Practical Guide to Risk Management (RF of the CFA) are major new books covering modern risk management. These books deliver a synthesis of common-sense management together with the cutting-edge tools of modern theory. Most provocatively they challenge the conventional wisdom that "risk management" is or ever should be delegated to a separate department. Good managers have always known that managing risk is central to a financial firm and must be the responsibility of anyone who contributes to the profit of the firm. Quantitative Risk Management is published by Wiley, April 2012. A Practical Guide to Risk Management is published by the Research Foundation of the CFA Institute, July 2011

"A Guide to Duration, DV01, and Yield Curve Risk Transformations" (also on SSRN - may be older version) - March 2011. Yield curve risk and sensitivities (DV01s) can be measured with respect to different variables: forward rates, par rates, zero yields, or others. This paper describes a simple method for transforming sensitivities between alternate representations and provides examples. The benefit of this transformation method is that it only requires calculating the risk of a small set of alternate instrument and does not require re-calculating the original portfolio risk. The paper is also available in a digitally enhanced version in .cdf/.nbp format with dynamic interactivity enabled (requires free Wolfram Player).

Black Swans and Brown Turkeys The term "Black Swan" is at risk of being over-used, and most sightings of a Black Swan turn out to be nothing more than Brown Turkeys - events that are indeed unexpected but not exceptional probabilistically speaking.






Valuation and Modeling

"A Primer on Credit Default Swaps (CDS)" - 21 October 2008 (revised December 2009) - available at Social Science Research Network (SSRN) click here. What is a CDS? How does a CDS behave in response to changes in the markets? How does one value a CDS? What is the risk? This primer aims to answer these questions for plain-vanilla single-name CDS, showing that a CDS is equivalent to a leveraged floating-rate corporate bond (a floating rate note or FRN).

"Convexity Adjustment for Constant Maturity Swaps" Derivatives Quarterly, Winter 1995 (pdf, 60k).  Both CMS (Constant Maturity Swap) and LIBOR-in-arrears swaps have payments that are linear with respect to an index while the offsetting hedges are convex. The linearity of the payment (relative to the convex hedges) imposes a cost that requires a "convexity adjustment" applied to the linear payment.  This note lays out a practical method for calculating the value of the convexity adjustment.

"Adjusting Constant Maturity Swaps for Convexity" Derivatives Week, August 28, 1995 (pdf, 20k).  Outlines the "convexity adjustment" applied to constant maturity swaps.

"A Practical Guide To Bonds And Swaps" February 1998, updated 2005 (pdf, 52p., 180k), also available at Social Science Research Network (SSRN) click here.  This manual provides a practical introduction to the fixed income capital markets. It is intended to provide the practical, institutional aspects of the markets together with the fundamental concepts used in today's capital markets. In line with their ubiquity throughout the markets, derivatives (swaps and options) are introduced early.

"Fitting Forward Rates To Market Data" 1998 (pdf, 200k), available at Social Science Research Network (SSRN) click here.  This paper has two purposes. First, to outline a general framework or methodology for fitting the forward curve to market data. Second, to report on and compare results from fitting forward curves using three particular functional forms: piece-wise constant forward rates, piece-wise linear zero rates, and piece-wise linear forward rates. The third is particularly interesting because it retains much of the simplicity and ease of use from the first two while solving a problem (large jumps in the instantaneous forward rates) exhibited by them. Results are reported for US dollar swap curves for October 1994 and June 1997.

"Accurately Estimating and Building the Yield Curve" 1999 (34 slides, pdf, 90k) Presentation for Risk Magazine Yield Curve Course, October 1999. Using methodology from "Fitting Forward Rates to Market Data," discusses the general approach to fitting the yield curve, mathematics of yield and forward curves, a simple example, use of and criteria for curves, choice of input data, and various functional forms.

"Convexity And Correlation Effects in Swap Pricing; 1997 (30 slides, pdf, 100k) Presentation for Risk Magazine Swap Course, September 1997. Discusses some simple approaches to modeling products that incorporate correlation, such as yield curve spread options. Focus on using the simplest model which solves the problem and on hedging and managing risks.




Economic Research - Thoughts on the Current Situation

Thoughts on the macroeconmic environment 13 March 2009 (html) - The current macroeconomic environment is simplified by focusing on two issues: First, the recent speculative boom and bust and the consequences following there from; Second the increases in spending (fall in "savings rate") over recent years and the current readjustment to more normal historical levels.

Employment and Unemployment Flows - July/August 2010. Unemployment in the U.S. has risen dramatically since the start of the recession in December 2007, going from about 6.8 million people in May 2007 to over 14.6 million in June 2010. This is often spoken of as "losing 7.8 million jobs," but the reality is that something 4-to-6 million jobs were lost each month, with a comparable (but just slightly lower) number found each month. Employment and unemployment are dynamic with large monthly flows, and to understand them we need to look at theses flows. The BLS recently started publishing flow data. This note examines those flows, with some interesting conclusions.
Complete discussion with detailed figures and tables (pdf)

Personal income and savings rate - 23 August 2011. A robust recovery will occur after households adjust spending downwards. The data show that such adjustment may be starting to occur. This is good news and bad news. The good news is that it will allow a robust recovery. The bad news is that it implies there will be a recession, potentially a bad recession, before that recovery can occur.
... more as html
... more as pdf

Household debt and spending - April 2010 (6pg, pdf, 40k) - My fear is that the current recovery is storing up problems for the future. Household debt continues to decline, and the savings rate has increased. This should be good news for the recovery of the economy: much of the recent recession was about households adjusting spending, debt, and savings to reduce debt and increase savings rates. The rise in the savings rate, however, has been entirely due to lower taxes - households have not substantially adjusted spending lower in response to the recent recession. Government taxes as percent of income will have to rise in the future, and households will have to adjust eventually.

Inflation background and current situation 28 October 2009 (14pg, pdf, 86k) - Discusses the causes of inflation and hyper-inflation, and the current reasons to worry or not worry about inflation.

Historical perspective on the liquidity crisis - 11 January 2009 (11pg, pdf, 160k) - We are in a liquidity crisis following the pattern of 19th century speculative booms and busts. Historically, the unwinding of a speculative episode has been marked by a severe slow-down in economic activity; a fall in general prices, and major banking or monetary disturbances. ... more

Past discussions of personal income and savings rate
Past discussions of household debt and spending

Slides for talk in Paris on the relevance of economic history to today's events - 14 January 2012






Miscellaneous

"Probability, Expected Utility, and the Ellsberg Paradox" on SSRN, updated May 2011 (pdf, 16p), or on this site. The Ellsberg paradox is often cited as evidence for unknowable "ambiguity" versus computable "risk", and a refutation of expected utility maximization and "subjective" or "belief-type" probabilities. I have concluded the paradox is not convincing. The results can be explained by differences in distributions that show up in repeated "games." The distributions behind Ellsberg's thought experiments are different and economic agents should be expected to respond to these differences.

"Managing a Sovereign Wealth Fund: A View from Practitioners", co-authored with D. Darcet and M. du Jeu, in Economics of Sovereign Wealth Funds: Issues for Policymakers, ed. U. S. Das, A. Mazarei, H. van der Hoorn, published by the IMF.

"Compensating Fund Managers for Risk-Adjusted Performance," Thomas S. Coleman and Laurence B. Siegel, Journal of Alternative Investments, volume 2, number 3, winter 1999 (pdf, 40k).  Explores a risk-adjusted performance fee structure for hedge funds that addresses incentive compatibility and helps reduce asymmetry, while at the same time being feasible and easy to implement.

"Estimating The Correlation Of Non-Contemporaneous Time-Series" on SSRN, December 2007 draft (pdf, 280k), or abridged version. Examines the problem of estimating the correlation of non-contemporaneous time-series observations such as daily returns for the FTSE and S&P500 stock indexes.

"Effective degrees of freedom during the radiation era," Thomas S. Coleman and Matts Roos, Physical Review D 68 027702 (2003), e-print at http://arxiv.org/abs/astro-ph/0304281.  This paper updates the curves of the effective degrees of freedom for the energy density g*(T) and for the entropy density g*S(T) during the era of radiation domination in the Universe. We find that a plain count of effective degrees of freedom sets an upper limit to the temperature of the quark-hadron transition at TQCD< 235 MeV for the energy density and TQCD< 245 MeV for the entropy density.

"A Dynamic Model of Labor Supply Under Uncertainty 1985", T. Coleman, Research Paper No. 272, State University of New York at Stony Brook, July 1985 (on SSRN, pdf, 190k). Lays out the model as in 1981 paper but also discusses estimation and identification in some detail. Simplifies to a stationary environment with a single wage and then fits gross flow data. Includes empirical results showing interesting differences across demographic groups in fitted parameters and resulting behavior. (Also available on this site)

"A Dynamic Model of Labor Supply Under Uncertainty 1981" T. Coleman and J. Heckman 1981 (pdf, 220k). Lays out the theory of a three-state model of labor supply (job, unemployed, and out of the labor force) in full detail - stationary and non-stationary, discrete and continuous time.  Proves existence and uniqueness of the value function.  Not much on estimation or identification.

Related to the two above - Employment and Unemployment Flows - July/August 2010.