Olivier jacque morgan stanley

Second Edition

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GLOBAL DERIVATIVE DEBACLES

From Theory to Malpractice

Second Edition

Laurent L Jacque Tufts University, USA & HEC School of Management, France

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Published by

World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

Library of Congress Cataloging-in-Publication Data Jacque, Laurent L.

Global derivative debacles : from theory to malpractice / by Laurent L. Jacque. -- Second Edition.

pages cm Includes bibliographical references and index. ISBN 978-9814663243 (alk. paper) -- ISBN 978-9814663267 (alk. paper)

1. Derivative securities. 2. Finance. I. Title. HG6024.A3J335 2015 332.64’57--dc23

2015005685

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

Copyright © 2015 by World Scientific Publishing Co. Pte. Ltd.

All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the publisher.

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A la mémoire de ma mère.

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PREFACE

At a time when the global financial system is engulfed into the mother of all financial crises, it is indeed tempting and opportune to charge derivatives for creating mayhem. Are derivatives indeed “the financial weapons of mass destruction” as vilified by Warren Buffet? This book is not another treatise on financial derivatives. The purpose of this project instead is to unlock the secrets of mystifying derivatives by telling the stories of institutions, which played in the derivative market and lost big. For some of them, it was honest but flawed financial engineering which brought them havoc. For others, it was unbridled speculation perpetrated by rogue traders, whose unchecked fraud brought their house down.

Each story is unique reflecting in part the idiosyncratic circumstances of derivative use and/or misuse but, as the reader will discover, a number of key themes keep reappearing under various guises: flawed financial engineering, poor auditing, ill-designed risk management and control systems, weak governance, old-fashioned fraud … Each chapter addresses one major derivative debacle by first narrating the story before deconstructing the financial architecture behind the debacle. In the process, the reader will become acquainted with institutions encompassing universal banks, hedge funds, industrial firms, trading companies and municipalities, and their lead character or villain. Like many I find myself mesmerized by the ingenuity of these infamous derivatives and the saga of powerful institutions in the hands of which they misfired: This book is their story.

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ACKNOWLEDGEMENTS

Over the years, research projects, consulting assignments and discussions with many savvy executives and academics have helped me challenge received wisdom in the area of financial engineering, risk management and derivatives: for their insight this book is a better one. Most notably I wish to thank Daniel Ades (Kawa Fund), Y.D. Ahn (Daewoo), Blaise Allaz (HEC), Bruce Benson (Barings), Alex Bongrain (Bongrain S.A.), Charles Bravler (Oliver Wyman), James Breech (Cougar Investments), Eric Bryis (Cyberlibris), Gaylen Byker (Inter-Oil Corporation), Brian Casabianca (International Finance Corporation), Asavin Chintakananda (Stock Exchange of Thailand), Georg Ehrensperger (Garantia), Myron Glucksman (Citicorp), Anthony Gribe (J.P. Hottinguer & Cie), Charamporn Jotishkatira (Thai Airways International), Minsoo Jung (Chatham Financial), Margaret Loebl (ADM), Robert Kiernan (Advanced Portfolio Management), Oliver Kratz (Global Thematic Partners), Rodney McLauchlan (Bankers Trust), Avinash Persaud (State Street), Gabriel Hawawini (INSEAD), Jacques Olivier (HEC), Craig Owen (Campbell Soup), Guadalupe Philips (Televisa), Christoph Schmid (Bio-Oils), Jorge Ramirez (Aon Risk Solutions), John Schwarz (Citicorp), Manoj Shahi, Pat Schena (Tufts University), Sung Cheng Shih (GIC, Singapore), Roland Portait (ESSEC), Rishad Sadikot (Cambridge Associates), Charles Tapiero (NYU Polytechnic School of Engineering), Adrian Tschoegl (Wharton School), Georgi Tsekov (Standard Chartered Bank), Philip Uhlmann (Bentley College), Seck Wai Kwong (State Street), Ibrahim Warde (Tufts University) and Lawrence Weiss (Tufts University).