Selena helps Justin about CDO

Dear Justin,

I hope that you and Hailey are doing great. We do not know each other but I’m a close friend of Selena. She told me that both of you are planning to make a huge investment in a synthetic CDO. I know a lot of things happened between you and Selena, it might be why you do not want to believe her but she’s genuinely concerned about you and she is right it is a very risky thing to do. I’m writing to you in order to explain you why.

Selena had a discussion with Dr Thaler a famous economist he explained to her what it is exactly about. To simplify: the system works like a clutch; you make an initial bet which is the mortgage bond and if you win the state market will rise. Because you won people believe that you will win in the future too so they’ll be making side bet on you. This is a synthetic CDO. The more people are confident that you will win the more side bets there will be. Which means many more synthetic CDO. Then it puts more and more people at risk of losing money this is a classic error.

Let me illustrate this with an example: a tennis player does not lose a match for two consecutive years so when sports betting takes place people will bet on him, the more games he win the more people will want to bet. But suddenly one day he loses. So all the people who bet on him will lose their money and are the only responsible for their losses. This is what we call a hot hand fallacy.

You never know what will happen in future so I hope that I’ve been able to convince you about the risks of making such an investment and that you’ll think about it again.

Take care,

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