A Practical Example of Classification

Of herding 1 million hissing cats onto a carousel somewhere a few blocks north of Bryant Park in New York. It must be said though that the music on this particular carousel had stopped (and Edith Piaf had most definitely left the building).

As part of the unwind of Lehman Brothers’ derivatives portfolio for the post-bankruptcy Estate (a portfolio of over 1 million derivatives trades); the team conducted a classification exercise of the products in the portfolio (with underlying covering all major asset classes; and instruments running the gamut of complexity from vanilla single factor single asset class flow products to highly exotic structured multi-factor hybrid products).

The context and objective was valuing them in the shortest possible time, in the most efficient manner possible (given limited to no infrastructure), in the most defensible manner possible (given their eventual day in Bankruptcy court) over the days in September/October 2008 when they were unwound.

This classification exercise was essential to developing and driving the valuation strategy for the portfolio, covering:

• Team selection;
• Valuation platform, model and method selection;
• Computational resource provisioning;
• Market data requirements definition;
• Developing the netting and hedging assumptions needed to take a view on reasonable bid/offer and transaction costs;
• And conducting self-consistency checks of the valuations.

A complex and gargantuan valuation exercise that could only be accomplished by intelligent abstraction of product commonality through classification.