Understanding leverage, volatility, and the crash

One can critique Nobel laureate Robert C. Merton’s work on a number of fronts, from the CAPM model to his involvement with the 1998 failure of Long Term Capital Management. And he still doesn’t get to the true source of the current crisis — monetary policy and an erratic U.S. dollar. But I found this MIT lecture useful in explaining how changes in asset prices can drive both instability and volatility in a highly non-linear, pro-cyclical way and confound all the risk and economic models. Merton also offers a simple method to swap risk and improve returns using right-way contracts. (Hat tip: Gordon Crovitz.)