An Arbitrage Machine

Imagine you had a perpetual arbitrage machine, a machine that would create risk free profits for you, forever.  It would nearly be as cool as a perpetual motion machine.

Aint no thing like a perpetual motion machine

I’m with you Homer, those three rules…erm…rule

You there at the back, with your hand up.  Come hither and speak.  What is arbitrage?  Well, Wikipedia defines it as;

…an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state…

Ah….right.  Point being, arbitrage is risk-free profit, there is no probability of an overall negative cashflow to your good self.

Let’s say you had an opportunity to buy a goat for £50 and sell it to another willing party for £70 the next instant, £20 profit right there. That would only be an arbitrage opportunity if there was absolutely no possibility that the buyer would back out, change their offer to below your purchase price or of the goat perishing.  Not all that realistic, I mean who stands that close anyway.

Indeed, in a lot of the financial theory I learnt while studying relied on the assumption that the market was arbitrage free, especially as we ventured into the dark arts of pricing optionality.  Financial academics really do not like arbitrage being present, it complicates things and is actually their kryptonite.

Being able to simultaneously buy an asset for a low price and sell it for a higher price is the thing of dreams 😉 .  If these situations do appear I suspect they ‘correct’ themselves rather sharpish, to an aggregate exhale of the faculty of academics.  The arbitrage finder goes into a buying and selling frenzy until the prices converge and the opportunity no longer exists.  When arbitrage does it exist it does so in a very unstable state.  Brimming with untapped potential energy and like a short lived radioactive isotope it fritters away before long.

Theoretically though, if you did stumble across a stable perpetual arbitrage machine you would be able to pump money into it and continually generate guaranteed profits…instantly.  You could grow the tiniest amount into…well…infinity I guess.

Sounds a bit silly…or is it?  A French man called Max Herve George might well have his very own perpetual arbitrage machine.  This is news from earlier in the year that I have only just come across, because I barely watch the news.  Go have a 10 minute read, we’ll wait for you to catch up.

What it boils down to is “George has the right to invest in upwards movements in the markets after they have happened.”  That’s right, you read that correctly.  AFTER THE EVENT Mr George can choose what to invest in.

“Ahhh the FTSE has gone up 10% in last two days?  I’ll buy it at the price two days ago and sell at today’s please.”

It’s actually restricted to trading on Friday against the last Friday’s price, but you get the idea.

Pretty close to a perpetual arbitrage machine if you ask me.  There is a bit of a legal war going on surrounding these contracts (yes, plural, there is more than one of these contracts) as they quite clearly have the power to crush a company, even a giant company like Aviva.  Not surprisingly Aviva’s balance sheet can’t support a perpetual arbitrage machine, that would require an infinite well of money or their own perpetual arbitrage machine.  To quote the Independent;

Aviva has been ordered to credit George’s investment account with €1.4m (£1m) – and his family with a total of €9.6m – to cover the potential increased value of their funds between 1997 and 2007. Since the seven-years-old George’s contract was originally worth F50,000 or €8,000 in 1997, this amounts to an annual growth rate of 68.6 per cent a year.  If George’s fund continues to accumulate wealth at the same compound rate until 2020, he would be worth €1.2bn. By 2030, Aviva would owe him €230bn – more than the value of Aviva.

A growth rate of 68.6% a year would be outstanding.  But, come on now Mr George, you’d have to be an almighty prick to use the contract to generate billions at the detriment of others.  Perhaps it’s not really fair to draw conclusions on someone from one article, but I’m afraid Mr George you do have a little whiff of arseholeness about you.  Mr George, I think you are a man than needs to learn how much is enough.

We humans might be one of the few creatures that can think more than a few seconds into the future but we sure do suck at figuring out when enough is enough.  We seem to be programmed to chase the endless more, we find something we like and just want more of it.  Money, cream teas, cake or drugs.  We want more and more and more, until the effects are so diluted we need tonnes of the substance to get anywhere near the initial high we used to get.  Hedonic adaption is a bitch Mr George, it’s an endless treadmill of nothingness, get off while you still can.

An obvious question to ask is why the fuck would you EVER write a contract like it?  Who knows and it looks like it was written by some smaller firm that Aviva gobbled up, so much for due diligence.  As Tim Worstall put’s it;

It allows the policy holder to switch funds this Friday based upon the prices of those funds last Friday. And that isn’t just stupid that’s doolally.

Tim’s article goes some way in explaining why these types of contracts were written in the first place, there was a tiny bit of logic there closely followed by an incredible amount of short sightedness.

Here’s the kicker though, if you were in any doubt the Mr George isn’t at least a bit of a douche;

He’s made arrangements with a hedge fund or two (who wouldn’t like 70% per annum returns?) to inject perhaps a further €20 million….

Sorry Mr George, you have been certified a douche-bag by Mr Zombie.

youre-a-douche

Certified Douche Bag

The legal battle continues and who knows if he will win his case (and potentially ruin a company in the name of greed), if he will simply be offered a, substantial, settlement or end up with nothing.

Getting wound up that someone could be so potentially greedy aside, it does raise an interesting question.  If you had this perpetual arbitrage machine how much would you settle on?

The contract above isn’t a perpetual arbitrage machine really, it’s not generating you risk free profit from nothing.  In this case it’s straight from the balance sheet and shareholders (and policyholders) of Aviva.  You win, someone else loses.  Not as nice to think of it like that, is it?

£1million would spit out £30k a year with a 3% withdrawal rate, and that’s way more than I’m spending now.  Let’s say £2million, Mrs Z can have a million too.  That would probably be far far too much for us, but small enough that Aviva could swallow it without it hurting any one else and yet large enough to provide a substantial margin of safety.  In the grand scheme of Aviva’s balance sheet it would barely register, something small and seemingly insignificant at that scale, like a gnat defecating on your head.

Interesting though.  In terms of building a stash that I would feel comfortable calling myself financially independent, we are talking about £500-625kish to support £20-25k a year.  Yet I would want more out of the settlement referred to above.  Given the opportunity I would take a bit of prudence I guess, I just hope it’s not greed rearing it’s mishapen head.

Thing is, it would take the fun out of saving for Financial Independence.  One of the reasons that this route is so appealing to me is precisely because you have to work at it, it’s not just handed to you.  It’s a middle finger towards the consumer driven lifestyle that so many seem to favour, a concious choice to fight the corporate marketing behemoths.  There’s something a little honourable in that.  Essentially being gifted the money isn’t the same and I doubt it would provide the kind of closure from the corporate working world that many of us are seeking.

Over to you, dear reader.  If you had this perpetual arbitrage machine how much would you settle on?  And would that differ any savings target you currently have?

Mr Z

20 thoughts on “An Arbitrage Machine

  1. John B

    If you thought your charitable goals were more important than the fate of the company, why not destroy the company and give the money away to better causes.

    Reply
    1. Mr Zombie Post author

      It would impact shareholders and policy holders. Not to mention the ramifications to the markets in general! Not sure I could deal with that kind of power…or could I?

      Reply
  2. Neverland

    This rather reminds me of the story of the bonus promises to made to Commerzbank investment bankers in London whose “savvy” trading drove the bank into a German government bail-out

    Commerzbank refused to pay the bonuses and was dragged by the bankers through every court in the UK

    After defeat in the court of appeal Commerzbank paid out

    The world is full of rentiers exploiting their “legal rights” to skim money off people for doing little or nothing or pay no taxes because of exemptions

    Capitlalism is full of douche bags rentiers, often they come come out on top

    Why do think Trump and Sanders are currently doing so well in the US polls?

    Reply
    1. Mr Zombie Post author

      People love a bit of free money. Someone I know works for a company. The company hadn’t been paying utility bills for years, the fault of the provider. So they had a meeting to sort it out. The company, conservatively for them, worked out what they think they owed, say £10k. At the meeting they saw workings from the company suggesting £5k. So they went in at £3k. Settled at £4k. The person in question was patted on the back, and their great business acumen celebrated. That’s just being an arse in my eyes. Then again, maybe I’m too nice to be good at “business”.

      Reply
  3. The Rhino

    that is a great story – I love the French, reminds me of that story of the grain of rice, the king and the chessboard

    100 mill and I would settle – nice round figure, job done. All sounds a bit stressful for the young chap at the moment, poor fella.

    In the meantime – I think I’m going to try and lend him some money.. need to hedge my position as an aviva life assurance policy holder

    Reply
    1. Neverland

      If you actually read the links these contract were just sold to rich private banking clients and his fathers identical contract was bought out by Aviva, presumably for a tidy sum

      Some time ago this rich French family appear to have moved out of France and be living in Switzerland

      I am sure it is just totally coincidental that France has an annual % wealth tax

      So basically it seems this bunch want the French courts to uphold one aspect of French law while avoiding paying taxes in France themselves

      Double douche bags

      Reply
  4. The Rhino

    It would be very exciting to hold that contract though.

    It wouldn’t really make any difference if you had to pay a %tax on it, you would be guaranteed super-wealthy regardless

    seems to me that contracts must be upheld – you can’t just renege on the deal because one side was foolish or didn’t perform due dilligence. at the same time you don’t want to hurt lots of innocent people. So the sensible outcome is a settlement that hurts aviva in some way, i.e. a few people get sacked and they lose a substantial sum. That way everyone wins, and moral hazard is avoided in as much as aviva and others will be careful not to repeat the feat. But the world is not sensible so who knows what will happen.

    one other thing, can anyone who is not american refrain from using the term ‘douche-bag’

    Reply
    1. Neverland

      @Rhino

      The money that Aviva might lose on this will be their shareholders not the managements and the people who did the work on the acquisition will have long retired on final salary pensions

      Plus ca change plus la meme chose – am I allowed to say that despite not being french?

      Reply
          1. The Rhino

            c’est vraiment magnifique! particularement parce que je parle le francais comme une sac-a-douche..

  5. Mortimer

    You hit the nail on the head: how much is enough. Before definitely answering that question there’s basically no point in asking how to use the arbitrage machine, because it would just be like easy credit: a bottomless pit coextensive with unaddressed desire. In other words, infinite.

    Reply
    1. Mr Zombie Post author

      I think you are right, it is just Aviva France.

      Interesting link – not quite risk free, but near enough. I wonder if there was a limit on the number of tickets sold?

      Reply
    1. Mr Zombie Post author

      I was just reading something similar in ‘Chance’, one of the New Scientist books. Soton uni? Nice, that’s where I studied. Aaaahhh sweet memories of drinking in the Hobbit.

      Reply
  6. theFIREstarter

    What an interesting story!

    A few random thoughts:

    Is there such a thing as a “no lose” PAM (Perpetual Arbing Machine)? Surely on any given Arb at least one of the prices is going to be wrong so someone is losing. Your profit is not magically created out of thin air.

    Having just gotten into Matched betting, I think this is as close to a PAM the average Joe will ever get, but it requires a fair bit of work and does not scale very well so you ain’t gonna get Max Herve George stinky rich.

    Enough – I would definitely settle for a cool million! There is no way I would turn that down if handed to me on a plate but I do agree that the best things in life are sometimes worth working hard towards… no doubt about it. However if you got the 1 mill in the bank then you could just move on to other hard things to work towards… more charitable goals as another commenter pointed out, for example.

    Really great post, it has in part captured my imagination about what crazy things are possible in this world and in part made me crazy mad at what kind of horrendous douchebags (one of my fave words by the way… I don’t care if I’m not American I’m going to use it liberally!) there are out there… !

    Cheers 🙂

    Reply
    1. Mr Zombie Post author

      Yeah – someone has to be losing out! Can’t create money out of nowhere….*Cough* QE *Cough*. I do sometimes think people view companies and bottom pits, ones where they are allowed to let their ethics slide if it means a quick claim for them.

      A million would be nice, and I guess not too much that you’d lose touch. At the very least it could mean a career change into something more interesting, that pays less?

      Reply

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