Merton really gets it. Merton covers a lot of ground in this video.
This video is worth the 1.5 hours. It contains explanations of:
- Convex function of a convex function leading to extreme non-linear outcomes
- Infrastructure problems
- Why it is not necessarily all about "bad" people
- Pension plan risks are looming
- Hints of the nature of asymmetric outcomes and behavioral responses
One of the concepts Merton hints at in his talk is the trade off in an economy, having to operate a less "efficient" economy for a safer one. Classic case of a locally sub-optimal solution being globally optimal in this case stable.
Merton covers a lot of ground in very easy to understand language. Ideally this video would be a book and expanded with more examples and visuals.
I wish he would use the language of normal accidents and asymmetry in behavioral responses to "put" like incentives and the need for CDS regulation, but he gets it by and large.
His conjecture at the end is that govt. may not want the "complex" derivatives to be valued. I would tend to agree, the convexity of the functions inherent in a lot of CDS and correlation type products is almost too scary to consider, but considering and acknowledging these things is something we must do. He also re-iterates Andrew Lo's correct calls for an NTSB equivelant for financial markets.
