As Amaranth Advisors reels from its losses, Edhec, the French business school, has issued a paper by commodities expert Hilary Til on the early lessons of the debacle. Til says that while the Connecticut-based firm’s natural-gas spread strategy was economically defensible under a number of different weather-shock scenarios, the scale of their position-sizing relative to the capital base clearly was not. Til suggests that Amaranth’s energy portfolio likely suffered an adverse 9-standard deviation event on Sept. 15 before the impending disaster made news. The half-dozen lessons include:
- Even without position-level transparency, investors would have known based on a monthly sector-level analyses of profits and losses that losing 24% would not have been unusual.
- Even with such a level of transparency, investors would have been able to tell that Amaranth’s over-the-counter natural-gas positions were massive compared with prevailing open interest in exchange traded futures markets.
- Risk metrics using recent historical data would have vastly underestimated the magnitude of moves as a result of an extreme liquidation-pressure event.
- Risk managers could have determined how risky the bets were based on scenario analyses of recent natural-gas spread relationships.
- The firm may have avoided losses had its traders better understood what flow or catalysts will allow a trader out of a position.
- While Amaranth was likely to provide an economic service for those trading in natural gas by providing liquidity for market participants who would lock in the value of forward production or the future value of storage, its spreading activities was much too large for its capital base.