An Analysis of the Volatility of the British Pound to Guide Arbitration

Alicia Carriquiry (Iowa State University)

In the mid 1990s, an individual (we will call him Claimant) established
a trading account with a financial corporation (that we shall call
Respondent).  Account was established with a very low margin requirement
and high limits, terms very favorable to Claimant but that could
potentially increase Respondent's exposure. By February of 1994,
Claimant held positions (futures, options, spot contracts) in that
account valued at about two and a half billion British Pounds (BP).
During the weekend of February 25 and 26 of 1995, Barings Bank in Asia
collapsed.  Respondent began liquidating Claimant's positions on March
1, and by the afternoon of March 2, the amount left in the account was
less than four million BP.

Claimant sued Respondent. He argued that Respondent had panicked with
the news of Barings' collapse and that the forced liquidation of account
positions caused him a huge and avoidable loss.  The liquidation of
positions was unnecessary, Claimant argued, because by March 1 and in
spite of Barings, the volatility of the BP had not increased.
Respondent's answer was that by March 2 and 3 the BP volatility had
increased significantly and had Claimant held on to his positions, his
losses would have been even greater.  Claimant responded that the
volatility increase was in fact caused by Respondent through the sudden
liquidation of extensive positions.

We describe a statistical modeling and analysis approach used to try and
shed some light on these arguments.  We provided expert advice to
Claimant's lawyers during the arbitration case, and considered the
following questions: When did the volatility of the BP increase?  Could
the increase have been predicted shortly after the collapse of Barings?
What caused the sudden increase in volatility of the BP on March 2 and 3?