Tuesday, July 24, 2012
With all the chatter about Spain's credit curve inverting and the amount of associated press coverage going positively "Tabloid", we thought it would not be long before even the otherwise financially vacuous celebrity mags such as Grazia and Hello try to cover it. So in the spirit of open source journalism, Team Macro Man thought it would be an interesting challenge to provide comparisons and analogies that would make the complex subjects involved more understandable to their readership. So without wishing to offend anybody and humbly apologising in advance for anything that readers might consider "bad taste", TMM thought they'd have a bit of fun and look at the similarities between derivative pricing in the financial and celebrity worlds. God knows we are in need of a good distraction, so here is free copy for any celeb glossy to use at will:
So first things first, terminology: CDS - otherwise known as the
Credit Default Swap"Celebrity Death Swap". This is a fancy insurance policy (you know, like those ones Sheila's Wheels give you for your pink VW Beetle) only in this case it will pay you some money if your favourite celebrity dies.
So how do we work out how much they cost? Well, as you know in far more detail than TMM, celebrities - with their hard party filled lives - often tend to burn out in a blaze of glory, often in their late-twenties/early-thirties. But if they manage to make it to 35 without copping it, they've got a reasonable chance of living a lot longer - which means lots more photos of them on the beach flashing cellulite/being caught having an affair/having a hair transplant. TMM have studied lists of the ages of various celebrities at death and have produced the chart below which shows the probability of dying (on the vertical axis) by age (horizontal axis). For normal people, it looks like the red line, with most people dying in their late-80s. Celebrities are different, though, as you can see in the blue line which has a "hump" around the age of 30 and another one around the age of 50.
By using these probabilities, we can work out what the survival probabilities of our favourite celebrities are based upon their age [this is all a bit naive and simple, but it's just a bit of fun]. From that we can work out how much insurance we'd have to pay each year to cover the risk of them dying. Let's take one of our current favourite divas, Lindsay Lohan as an example. Her lifestyle and age put her right at the point of maximum risk. So that means that if you were to buy a CDS on her that matured in the next few years it would be more expensive in terms of premium each year than it would be for 30yrs (see chart below, dark blue line). Lindsay's CDS curve has inverted around the 5year point - just like Spain's has - and may well invert further. Ah! There it is! We mentioned Spain... We are sure you've seen something about this on the TV just as you were flicking the channel over to TOWIE or Jersey Shore.
So just like Lindsay's hard partying means that she has a hump in her CDS curve which is in the process of inverting, so does Spain, which has also done a bit of partying and is paying the consequences. Now if Spain can manage to get through the next couple of years, it's also going to probably be OK, so its credit curve also slopes downward beyond its "hump".
So what about Keith Richards & Justin Beiber, you ask? Let's start with young Justin, whose curve gently slopes up until the 15yr point and then gradually slopes down. Well that's because he will hit the "hump" around 30 in about 15years and there after he will still be quite young, so the chances of him copping it are reasonably low. Ageing rocker Keith Richards, on the other hand, doesn't look so hot. At the pensionable age of 69, the chances of him dying in any of the next few years is quite high. And that sort of thing exposes investors to "jump to default" risk - no, we're not taking about a song - we mean the payout that someone who had sold the CDS would have to make. That means that they have to charge more premium on shorter dated CDS to compensate. A bit of trivia for you - using TMM's back of the envelope calculations, a CDS on a normal person at age 18 would be around 1/7th as the cost as one on Justin Beiber. Perhaps there is the proof that Justin Beiber can never truly say "I'm just a normal person".
So let's go back to the European crisis and have a look at some real country CDS curves (talking Credit Default Swaps now).If Spain can be thought of as Lindsay Lohan, Greece is more like Keith Richards - ageing, having partied hard and had several health scares, but refuses to sink. France looks a bit like Kate Moss - good looking, but has had a few too many run ins with things they shouldn't (too much government spending). On to China, which surely must be Justin Beiber - young, good looking and growing, but with many people worrying about it adopting bad habits learned from its elder peer group. Oh yes, and the "Normal" Person must surely be Germany, for they would never do anything naughty... Ahem.