Tuesday, July 24, 2012

Celebrity Death Swaps

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.

Readers might be interested to know that for a 5yr CDS, Lindsay Lohan is about as risky as Iceland, and Keith Richards is only slightly more risky than Ireland.

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Footnote - We are of course expecting our new CDS to banned before it is even launched. It's illegal in most countries to take out life insurance on any person unless you have provable financial "insurable interest" and that doesn't just mean the cost of the most garish wreath with white carnations spelling "Our Justin" on it. But hey, why don't you stick an ad in the back of your mag with a premium rate phone number on it and see how much you make...

20 comments:

Anonymous said...

Ol' Dirty Bastard says...

ROTFL !! Great stuff as usual !

Anonymous said...

http://celebritydeathpool.org/

Anonymous said...

Extremely bad taste!!! Hahahaha

There was a dead peasant insurance scandal sometime ago. Wasn't it deemed unethical rather than illegal?

abee crombie said...

K Richards's liver is like Japan's debt problem... something that should have blown up a long time ago but continues to go on

great post

Why again cant the ECB buy spanish bonds but it can buy covered bonds held by spanish banks? I understand they dont want to get involved politically but at some point numnut draghi will have to, at least to give spain some breathing room. Pretty soon Spanish bills will be >5% (and germany keeps going negative)

WellRed said...

That was fantastic.

I can remember reading an article whereby traders would buy out people´s existing life insurance policies in the US (when premiums became unaffordable for the original owner). Bizarre case, but not as universally bad as it sounds, because they would pay considerably more than the life insurance firms would offer to buy out the contracts..

amplitudeinthehouse said...

Sorry, TMM,Amps is going to duck this one.

Dee Dee Humberside said...

TEF throwing the towel
Hmmm...

Anonymous said...

C says'
So much for my TAT,but I hold true to the concept that this week down severely does not 'feel' right and I still don't expect it to end that way.

Leftback said...

Polemic and cpmppi have been out at the Playboy Club for lunch again... silly season in full swing.

Who Dropped the 224 year old Cognac?

Anonymous said...

Ol' Dirty Bastard says...

WellRed @ 3:47

That's basically right. Insurance Cos also offer you to buy back the policy but at a shitty rate. If a trader offers two or three times that price he can still make a profit on average. But the whole business took a hit in 2008 when the life expectancies were remodelled (until then there was an error... ehem... missunderstanding in the community it seems). The market is pretty much dead since then.

abee crombie said...

thanks draghi for telling em... now if you dont deliver next week...uh oh

Corey said...

Bravo. But I think TC CDS is a little rich...did you include a telekinesis factor?

Anonymous said...

C Says'
CDS for slightly burnt and shaken, not dead, would be our 007 cry for todays market logo. And such is our perrenial market problem for getting traction in any direction.

My Monti signoff for today is "don't mess with my yield, punk"
a la Eastwood !

Super Mario Brothers said...

"Go ahead, Mr Shorty. Make my day!"

Leftback said...

The Scene: An Alpine meadow in the far North of Italy. MANGLER is on vacation and has gone out in secret to meet SUPER MARIO, in spite of dire warnings from the BuBa.

MANGLER: Mario, it is Angela. I have come to Südtirol, a part of our glorious former Empire, to our secret place in Bozen, or Bolzano as you call it.

SUPER MARIO: I knew that you would come.

MANGLER: Is that a bazooka in your pocket or are you just pleased to see me?

SUPER MARIO: It is a bazooka and it is more than big enough to do the job. Do you want to see it?

MANGLER: I shouldn't. It is against my upbringing, and Jens and Wolfgang warned me about Italian men with higher inflation targets.

SUPER MARIO: As you wish. (Pause)

MANGLER: Is it really big enough? Do you have protection? What about the risk of excess liquidity spilling out?

SUPER MARIO: Angela, I am Italian, and a central banker. I can easily withdraw in time.

MANGLER: OK, whip it out then.

SUPER MARIO reveals the bazooka.

MANGLER: Gott in Himmel! Was für eine Wunderwaffe ! I have never seen anything like it. Except in back issues of the Economist that Helmut kept in his desk drawer....

SUPER MARIO: You must embrace the bazooka, Angela. Accept the inevitable. We must reflate.

MANGLER: Oh, Mario! I never knew monetary stimulus could be so......

(FADE TO BLACK)

Anonymous said...

C says'
Very funny LB and a nice way to sign off a week.
My final thoughts this week are I see are I have seen lot of prepositioning to rerun 2011 which is one reason why I remain interested in being selectively long because I could make the case for this being a rerun of 2010 where the need for collective easing has never been stronger.
Moreover 2011 was to a large extent trapping people who had become bullishly complacent and yet I see no way we can make the same claim this year as I say prepositioning is all over the place to be seen and I want no part of that.

CV said...

Bravo LB, bravo ...

Draghi got a little bit cocky though didn't he ? I mean, he did actually say ... "trust me, it will be enough". I would just love to see the war room of the Death Star on that comment. Eject, eject!

Claus

Anonymous said...

Dee Dee says

C' I am not sure I get the difference you make between the 2010 and the 2011 runs.

Leftback said...

LB thinks we have entered a New World Order where we have a slowdown/crisis almost every summer. Then every nation will wheel out our little Gods of QE and we will pray to them until it rains liquidity. Actually, I like it, it is very natural, after all, life is cyclical, maybe we should take summer off or work shorter hours and create more jobs in the process.

Trust me, if you work in the US, you can clearly see the economy slowing, every June, even though people keep on going to work in July and August instead of having 8 weeks vacation which is what we should do. The Philly Fed monitors an area where there is a lot of small manufacturing, and the summer temps are often in the 90s-100s. Not surprising to me that activity slows in May in anticipation. It's too darn hot.....

Leftback said...

The transmission function between Spanish 10y yields, Mr Shorty's rear end and LB's Spanish bank longs seems to be working very well today.

The leverage in play in these instruments is even larger than I had anticipated. Despite the shorting bans, there are still probably a shed-load of synthetic short positions in play today through EWP puts, various SPA-GER spread trades and the like, wonder how many peeps REALLY want to hold their Spanish CDS over the weekend? A few punters might also be wondering when the Schatz will hit the fan?

LB always enjoys a good compression trade. It's going to be a lovely drink up tonight after the close. Cheers, TMM!