LTCM’s arbitrage required causal explanations, not just statistical patterns

Evidence

LTCM would not enter into a trade such as a swap-spread arbitrage without an understanding of why an apparently attractive opportunity had opened up. In early 1997, LTCM believed that there were identifiable, temporary reasons why the swap spread had become unusually narrow (See Perold 1999, p. A5.) Accordingly, it gradually built its position, using repo to buy bonds (and also buying bond futures), while entering into swap contracts in which it paid fixed interest and received dollar Libor. By July 1997, the predicted increase in the swap spread had indeed taken place, and the fund was able over the summer to liquidate its position, with a total net gain of about $35 million. — Donald MacKenzie, An Engine, Not a Camera, 1302

Categorization

• XREF: The arbitrageur-needs-a-story point connects to MacKenzie’s core argument in earlier chapters about how traders justify trades with models and narratives. — connects to: LTCM’s collapse was read as vindication of the efficient-market hypothesis — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1120; Arbitrage enforces a real link that anchors derivatives to underlying assets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 781

Broader Connections

• Arbitrage enforces a real link that anchors derivatives to underlying assets #expands (0.80) — Donald MacKenzie, An Engine, Not a Camera, 781