I did run into an interesting paragraph though, a cautionary note from the author (who partly redeems himself with such reminders that complex risk management does not lead to risk eradication) that applies perfectly to our current predicament. He talks about what Martin Leibowitz dubbed "dragon risk, taken from ancient mythology when people believed the earth was flat and feared there be dragons in the spaces beyond or to put differently, beyond-model risk whose precise nature and structure are unknown". He goes on to list some of them: "underdeveloped financial markets, liquidity concerns, limited access to acceptable investment vehicles or first-class managers, problematic fee structures, regulatory or organizational strictures, peer-based standards, headline risk and insufficient or unreliable data". All these risks have some relevance to the ongoing financial crisis. But it is what follows that really resonates and is prescient in a way, the risk that "these assets will perform entirely differently from expectations or that the distribution of outcomes will include higher probabilities for extreme outcomes than allowed for in the original planning. Under these circumstances, the whole process could turn into a disastrous mess that would be far from easy to unwind."
And when would such a mess materialize? "The whole scheme could fall apart if the field becomes overcrowded. [...]the arrival of too many investors drives up asset prices and reduces prospective returns." Bernstein concludes with what was a footnote a year and a half ago and is a front-page truism now:
"When new and different players are entering asset markets they never even considered before, and when the whirlwind of new derivatives affects every corner of the financial markets, the pricing, volatility, and expected returns of asset classes are not stable."
(All emphasis mine)
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