Saturday, December 31, 2011

buy-side vs sell-side trader -- real diff

buy-side (asset manager incl HF) vs sell-side trader -- real diff

Both bet "house money" and keep Positions. See my acid test in http://bigblog.tanbin.com/2009/09/adp1-acid-test-for-brokerdealerpropflow.html. What's the real difference between both? Many friends gave me similar answers -- strict hedging (though how strict is questionable -- See Barings).

Sell-side trader must delta-hedge her positions. When market moves against her, her bank must be protected by the hedges. Sell-side is part of the "infrastructure" and the financial "services" (buy-side being the service-consumer). Therefore it needs more stability and less risk-taking.

In a volatile environment, a bank is supposed to /survive/ longer than a buy-side. A bank failure triggers deeper /repercussions/ and leads to larger /domino-effects/.

The best-known measure to enforce stability (and reduce risk-taking) on a sell-side trader is a strict policy of hedging. Upper management and regulators want to see VaR numbers and stress test results, periodically.

Effect of hedging should be obvious -- risk should be much lower and profit also lower.

Barings didn't hedge as market makers should. Nick Leeson hated to cut losses when market moved against him. He was acting like a buy-side and his firm failed like a buy-side.

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