If you’d like some non-real-time insight into the London Whale, may I highly recommend this oral history, by Edinburgh sociologists Donald MacKenzie and Taylor Spears, of how investment banks came to price and trade and hedge things like the index CDS that the Whale dabbled in? It made me tear up a little. It is let’s say somewhat technical but it’s not really about math or derivatives, it’s about how people experience their lives in derivatives departments of investment banks.
The main discussion is about the relationship between certain derivative pricing formulas and the credit crisis, and in particular about why ratings agencies did a bad job of rating asset-backed CDOs. The authors attribute these mis-ratings to a cultural problem, in which the people building and rather ABS CDOs were credit-analyst banker type rather than quant types who derive their views from market prices and efficient market assumptions: Read more »