Convexity Made Simple

Convexity is a concept that all traders and investors must understand. While it can be complex, it isn’t difficult to grasp; at its core, convexity is simply an expression of non-linearity. What makes it so important is that it applies outside of finance, to life itself – as a philosophy of making small sacrifices for large potential returns.

Focus On Convexity: Long Or Short, That Is The Question

Being short convexity is akin to picking pennies in front of a steamroller

Imagine that you just started trading the financial markets, and a more experienced investor offers you this choice: Would you prefer Death By A Thousand Cuts, or Getting Flattened By A Steamroller?

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Focus On Convexity: How It Applies To Banks

Banks are inherently short convexity due to their lending activities

Now that we have established a solid understanding of what convexity is and how it applies to markets as well as life in general, we can use it as a lens through which to view the financial system.  

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How Regulators Are Making Finance More Fragile 1

Concentrating risk into central clearinghouses sounds like a good idea, but only serves to create a gigantic short convexity position in the middle of the financial system

Where things get really interesting, and much scarier, is how the post ‘08 regulatory and legislative environment has failed to take convexity into account.

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How Regulators Are Making Finance More Fragile 2

Concentrating risk into central clearinghouses sounds like a good idea, but only serves to create a gigantic short convexity position in the middle of the financial system

Considering the severity of 2008 and how quickly the largest banks in the US became insolvent, it is quite clear that the financial system had too many mega-banks even then.

Which means that the American financial system at even greater risk today, considering how much the US banking industry has consolidated and shrunk in the decade plus since.

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Why Convexity Is Important In Choosing Your Career 1

Convexity also applies to our career choices

Considering that convexity and its effects show up in something as simple as flossing one’s teeth, it shouldn’t be surprising that they show up in our employment choices as well.

Needless to say, all jobs are different in this respect, with some being more short convexity than others.

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Get a different perspective on all things trading & investing every week!