Rewriting history
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Rewriting history

Systematic traders and risk managers rely on tons of historical data to help predict probable gains and losses. So how will they predict the behaviour of the euro during its first few trading days, weeks, months? By David Shirreff.

The new European currency, due to start trading on January 4 1999, will have no history. This trite observation has tremendous consequences for investors and traders, risk managers and regulators.

Why? Because all of them have come to rely, to a greater or lesser extent, on time-series data and historical volatility as a guide to pricing the risk they are taking and the likelihood of price movements in the future. Suddenly, history disappears.

For chartists, who like to follow trends, there will be no trend. For data providers, who like to supply their customers with nice graphs, the database has to start from scratch. For option traders, who like to check prices against historical volatility, there is none. For bond traders and investors, the performance parameters of many bonds will change. For risk managers who want to calculate maximum possible losses to a 90% confidence level, the confidence floor has temporarily disappeared. For regulators and supervisors there are no data against which to back-test value-at-risk numbers.

This is a potential nightmare not just in Euroland, but anywhere where institutions have big euro positions. The good news is that the nightmare will be temporary: the uncertainty will decay daily as tick data for the euro accumulate.

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