Risk Latte - The “Zero-Space ” in interest rates, financial assets, and our lives! – Part I

The “Zero-Space ” in interest rates, financial assets, and our lives! – Part I

Team latte
December 17, 2008

The US short term interest rates are, for all practical purposes, zero. This is the first time such a thing has happened

Our interest in the zero hour, or the "zero-space" as we would like to call, however, is more to do with the math behind it. Let’s first look at the “zero-space” in general, as in our daily lives.

Zero is the boundary on a number line. On one side lies the positive axis with positive real num-bers, such as 1, 2, 3, ….. up to infinity and on the other side the negative numbers, such as -1, -2, -3….. up to negative infinity. But in reality what is the significance of negative numbers? We can have 5 (five) apples but can we have minus five, i.e. -5 (negative five) apples? No. We can drive for 45 miles and reach a destination, but there is no such thing as negative (minus) 45 miles or minus 30 miles (unless of course, you think of retracing your steps backwards as a negative move). You can serve someone a cup of tea but you cannot serve anyone a minus (negative) cup of tea. No matter how hard you look or search you cannot find any quantity in nature, or any at-tribute of life, that can have a mathematically (arithmetically, if you will) negative value.

A small exception is temperature where we do indeed have negative temperatures. The tempera-ture of New York in winter dips below zero and becomes negative. You have minus 10 degrees Celsius or minus 6 degrees Celsius. However, here it is more to do with a relative measure and benchmarking. We define zero degrees as a point when water freezes up and hence anything be-yond that point – in terms of the temperature in degrees Celsius – falls in the negative territory. A more apt example would be the "absolute zero" (in Physics), which is defined as minus 273 degrees Celsius and beyond which, on the negative side, the arrow of temperature cannot go. So the absolute zero temperature is like the mathematical zero that we have in our every day life.

The negative space is very un-real, or rather surreal. Reality, as we perceive it around us in the three dimensional space is very much a "positive" experience. Our world, mathematically speak-ing, is on the positive side of the number line.

Around the zero some very interesting things happen. The water from a glass, at the zero-space, disappears and the glass full of water becomes empty; one moves from something to nothing, from "A" to "not A". But even if a drop of water is left in the glass, it cannot be said to be empty.

It is about to change its state, but just not yet. As you drive back home from office the distance diminishes and finally it becomes zero, you reach home. One moment you are away from your home, removed from your loved ones – doesn’t matter even if you are one hundredth of a kilo-meter away, even a fraction of that – and the next instant your car goes into your garage. The dis-tance has become zero. At zero, or extremely close to it (in a "zero-space") our state changes, the state of the reality around us changes.

And just as in our lives, so is it in the financial markets. The reality around the zero value can become quite convoluted.

To be continued in the next article………………………......

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