Friday, July 31, 2009

Dertivatives and spot

Via the Finance Professor, here is a look at whether action in the futures market has an effect on the spot price. This is related to the metals market. However, there has been a lot of speculation about this in the oil market in recent year and a lot of discussion about the mechanism that can cause speculation in futures to feedback into spot.

Tuesday, July 21, 2009


Malcolm Gladwell assesses the role of over confidence in the financial crisis

The psychologist Ellen Langer once had subjects engage in a betting game against either a self-assured, well-dressed opponent or a shy and badly dressed opponent (in Langer’s delightful phrasing, the “dapper” or the “schnook” condition), and she found that her subjects bet far more aggressively when they played against the schnook. They looked at their awkward opponent and thought, I’m better than he is. Yet the game was pure chance: all the players did was draw cards at random from a deck, and see who had the high hand. This is called the “illusion of control”: confidence spills over from areas where it may be warranted (“I’m savvier than that schnook”) to areas where it isn’t warranted at all (“and that means I’m going to draw higher cards”).

This is what social scientists mean when they say that human overconfidence can be an adaptive trait. “In conflicts involving mutual assessment, an exaggerated assessment of the probability of winning increases the probability of winning,” Richard Wrangham, a biological anthropologist at Harvard, writes. “Selection therefore favors this form of overconfidence.” Winners know how to bluff. And who bluffs the best? The person who, instead of pretending to be stronger than he is, actually believes himself to be stronger than he is. According to Wrangham, self-deception reduces the chances of “behavioral leakage”; that is, of “inadvertently revealing the truth through an inappropriate behavior.” This much is in keeping with what some psychologists have been telling us for years—that it can be useful to be especially optimistic about how attractive our spouse is, or how marketable our new idea is. In the words of the social psychologist Roy Baumeister, humans have an “optimal margin of illusion.”

Saturday, July 11, 2009

Demand for liquidity

Pepys' diary 6th July 1666

Thence to Lumbard Streete, and received 2000l., and carried it home: whereof 1000l. in gold. The greatest quantity not only that I ever had of gold, but that ever I saw together, and is not much above half a 100 lb. bag full, but is much weightier. This I do for security sake, and convenience of carriage; though it costs me above 70l. the change of it, at 18 1/2d. per piece.There is a lot in the comments for this day and the next that show the need for liquidity when fears for government finances rise.

Friday, July 10, 2009

Fischer Black and the future

Rorty Bomb points us to Fischer Black and the development of derivatives.

“Thus a long term corporate bond could actually be sold to three separate persons. One would supply the money for the bond; one would bear the interest rate risk, and one would bear the risk of default. The last two would not have to put up any capital for the bond, though they might have to post some sort of collateral.”

- Fischer Black, “Fundamentals of Liquidity” (1970)

In case that doesn’t freak you out, let me explain why it should. That’s 1970 (!!!), and it predicts everything. It’s before the Black-Scholes Equation (same Black) is published and popularized, creating the derivative market, so it is during the first wave of thinking how derivatives would change everything.

Monday, July 06, 2009

Housing wealth effect

Charles W. Calomiris, Stanley D. Longhofer and William Miles take a closer look at the housing wealth effect and find that when consumption and house prices are looked at simultaneous effects of expected decline in future income, the influence is much lower than previously believed.

Other researchers have analysed data from Great Britain and have similarly found that, once one takes simultaneity problems into account, there is also little, if any, housing wealth effect in that country. Orazio Attanasio, Laura Blow, Robert Hamilton, and Robert Leicester (2009) express scepticism that a large housing wealth effect exists, and find, for instance, that (without correcting for simultaneity bias) the “wealth effect” appears to be the same for renters and homeowners. This would make no sense if household spending were really driven by housing wealth, because renters are actually hurt by rising home prices. They conclude, as we do, that housing wealth is acting mainly as an indicator of changes in perceived economic prospects, which apply to homeowners and non-homeowners alike.

Private equity buy-ins

A study by the Credit Management Research Centre at Leeds and the Centre for Management Buy-Out Research in Nottingham, suggests that buy-ins are much more risky that buy-outs.

The study also found that private equity deals are more likely to fail when outsiders are brought in to run a company (management buy-ins) than when done with the support of existing managers (management buy-outs).

“Buy-outs have a higher failure rate than non-buyouts, with MBIs having a higher failure rate than MBOs, which in turn have a higher failure rate than private equity-backed buyouts,” it said.

“However, MBOs and private equity-backed deals completed post-2003 are not riskier than the population of non-buy-outs if we control for other factors.”

Future of finance

E&Y report on the reaction of financial services companies to the downturn.

The unpredictable and uncertain market conditions have led to a dramatic increase in spending on controlling and reducing risk: 80 per cent of the banks surveyed had increased their investment in this area over the past six months, the report says.

Financial services companies are also bolstering their legal, audit and regulatory functions even as they make swingeing cuts in departments such as information technology and supply chain management.

“The end of the recession and a return to profitability is a tough one for any industry to call,” said Tom McGrath, managing partner of Ernst & Young’s Europe, Middle East, India and Africa financial services business.

“But financial services are naturally more cautious – and possibly more realistic – about when the return to profitability might happen.”

According to E&Y’s research, the financial services industry was taken aback by the ferocity and depth of the economic downturn, with 72 per cent of respondents saying they were surprised at the severity and another 70 per cent surprised by the speed of the crisis.

Saturday, July 04, 2009

Investment advice

Investment advice from the ever-reliable John Kay

So think probabilities and be detached. It’s hard advice to follow. That is why the financial services industry is better off than its customers.

Wednesday, July 01, 2009

The Winners' Curse

There is a good overview here from the FT of the winners curse (Wikipedia).

The East Coast line’s problems arise directly from the ludicrous £1.4bn National Express agreed to pay in August 2007 over the seven years it was due to operate the franchise. Two years later, the recession has laid bare the rosy assumptions it made about passenger growth, and losses have steadily mounted at the special purpose vehicle it created to operate the franchise. Once the £40m loan that National Express posted with the SPV, plus its £1m sliver of equity, are exhausted, the company has no obligation to provide more, other than a £32m bond it has already posted. The franchise will then return to the state. While the government might like to sound Churchillian about ensuring continued service, this has happened before.