Friedman and Krugman

New Frontiers in Economic Barbarism - NYTimes.com: "Quite. What Matt may not know, however, is that this is a classic argument in international macro, and the person who made it best was …. drumroll … Milton Friedman. Here’s a snip from Friedman’s 1953 essay “The case for flexible exchange rates”:


Is it really possible that people at the University of Chicago have unlearned not only Keynes but Friedman? Alas, yes."

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Cross Validation

A number of related ideas about the cross validation of models:

Arlot paper on cross validation

Rob Hyndman

R code for comparison

Why Only Germany Can Fix the Euro | Foreign Affairs

At the heart of the Euro area crisis.

Why Only Germany Can Fix the Euro | Foreign Affairs:

" According to Eurostat, Germany's trade surplus with the rest of the EU grew from 46.4 billion euro in 2000 to 126.5 billion in 2007. The evolution of Germany's bilateral trade surpluses with the Mediterranean countries is especially revealing. Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany saw its final total consumption fall from 78.5 percent of GDP to 74.5 percent. Its gross savings rate increased from less than 19 percent of GDP to almost 26 percent over the same period."

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Unintended consequences

The unintended consequences of trying to reduce the Greek debt burden while preventing the triggering of CDS has the unintended consequence of making all bond positions look vulnerable (even when there was a previous CDS protection. The FT quotes Commerzbank chief a:

"Mr Blessing criticised the Greek agreement since investors that insured Greek bonds using CDS had not received a pay-out because the voluntary agreement was not deemed to be a so-called “credit event” and thus did not trigger CDS payments."

This can lead to other bond holders selling the bonds because they find that they are not protected from default.

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Michael Lewis on Prospect Theory

Prospect Theory and MoneyBall

"The moment the psychologists uncover some new kink in the human mind, they bestow a strange and forbidding name on it (“the availability heuristic”). In their most cited paper, cryptically titled “Prospect Theory,” they convinced a lot of people that human beings are best understood as being risk-averse when making a decision that offers hope of a gain but risk-seeking when making a decision that will lead to a certain loss. In a stroke they provided a framework to understand all sorts of human behavior that economists, athletic coaches, and other “experts” have trouble explaining: why people who play the lottery also buy insurance; why people are less likely to sell their houses and their stock portfolios in falling markets; why, most sensationally, professional golfers become better putters when they’re trying to save par (avoid losing a stroke) than when they’re trying to make a birdie (and gain a stroke)"

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Unintended consequences

Unintended consequences: "In the UK, the “Merton Rule” – it originated in the Borough of Merton and has been widely emulated – demands that substantial new developments include the capacity to generate 10 per cent of the building’s energy needs through renewable sources, on site.

Alas, such a rule is hopelessly slack for an out-of-town supermarket – an environmental disaster because of all the driving it encourages, yet with plenty of real estate for solar panels. Meanwhile it is too challenging for a city-centre skyscraper, which is naturally a low-energy building because of its compactness and proximity to public transport."

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The evolution of overconfidence

A paper in Nature makes the case for the positive aspect of over-confidence: it encourages action and decisive response; it is generally successful or adaptive; when it goes wrong, it goes very wrong.

The evolution of overconfidence : Nature : Nature Publishing Group:

This would be consistent with the behaviour that is mirrored in financial markets. The carry trade is such a confident trait. There is the belief that the exit can be achieved before the shock. This is generally successful, certainly more successful than the alternative strategy that would hold back and worry about the risk of a funding currency appreciation. Those who embark on the strategy make years of gains. Those who stay on the sidelines, lose out. When the hit happens, it is a shock that is explained away by specific circumstances. The over-confident are not blamed and the cautious and not proved 'right' in most cases.

The price of protection - FT.com

The price of protection - FT.com: "However, most banks expect the biggest impact to be felt by corporate customers, particularly mid-sized companies that rely heavily on bank debt. Analysts believe these businesses will sit outside the ringfence, alongside the investment bank activities – the part most at risk of a sharp rise in wholesale funding costs. Creditors generally give higher ratings to banks with retail and investment banking under one roof as they believe they are more stable. Remove that benefit and ratings are likely to fall, making it harder and more expensive to access funds."

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The Social Responsibility of Business is to Increase its Profits, by Milton Friedman

The Social Responsibility of Business is to Increase its Profits, by Milton Friedman: "The New York Times Magazine, September 13, 1970. Copyright @ 1970 by The New York Times Company.

When I hear businessmen speak eloquently about the "social responsibilities of business in a free-enterprise system," I am reminded of the wonderful line about the Frenchman who discovered at the age of 70 that he had been speaking prose all his life. The businessmen believe that they are defending free en­terprise when they declaim that business is not concerned "merely" with profit but also with promoting desirable "social" ends; that business has a "social conscience" and takes seriously its responsibilities for providing em­ployment, eliminating discrimination, avoid­ing pollution and whatever else may be the catchwords of the contemporary crop of re­formers. In fact they are–or would be if they or anyone else took them seriously–preach­ing pure and unadulterated socialism. Busi­nessmen who talk this way are unwitting pup­pets of the intellectual forces that have been undermining the basis of a free society these past decades."

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Technology Can't Save Us From Math Mishaps - WSJ.com

Nice

Technology Can't Save Us From Math Mishaps - WSJ.com: Mr. Clarke, the economist, suggests that we go easy on statisticians. "Everyone makes spreadsheet mistakes," he says. He repeats advice he received from his best man at his wedding: "The best way to remember your wedding anniversary is to forget it once."

Profits from ETF

FT.com: "Why are ETFs so profitable when they appear to be so cheap? Annual management fees have been driven down by price wars, which have been particularly fierce in the US. Synthetic ETFs obviously offer scope for profitable derivative trading and collateral management, but the opportunity to extract revenue is less obvious with physical ETFs, being mainly confined to securities lending. Perhaps running an ETF business is at least in part a means of running a securities lending operation, in which case providers should reveal what proportion of stocks in a portfolio are lent, as the associated counterparty risks are material to investors."

2011 World’s Most Ethical Companies | Ethisphere™ Institute

Useful for the selection of 'ethical companies'.

2011 World’s Most Ethical Companies | Ethisphere™ Institute: "The World’s Most Ethical Companies designation recognizes companies that truly go beyond making statements about doing business “ethically” and translate those words into action. WME honorees demonstrate real and sustained ethical leadership within their industries, putting into real business practice the Institute’s credo of “Good. Smart. Business. Profit.”"

Bond market liquidity

The reduction in bond market liquidity due to the decline in bank risk appetite and increased capital requirement.

Lack of liquidity bad for big bond funds - FT.com: "In 2007 bond fund managers were able to trade bonds at bid/offer spreads of 0.25 per cent. That widened to 2-3 per cent at the height of the crisis from September 2008 to March 2009. Trading spreads subsequently fell back to 0.4-0.5 per cent but have since crept up again to about 1 per cent on fears of the European sovereign debt crisis. Mr Davidson says: “It’s clear the banks don’t want any credit instruments on their books, especially given everything that’s going on in peripheral Europe.”

As a result, he adds, anyone managing a bond fund with assets of £1bn ($1.6bn) or more – with individual holdings of £10m plus – has their hands pretty much tied, “unless they resort to the euro market for greater cash liquidity or the CDS [credit default swap] market for greater active liquidity – but they’d be giving away yield in both cases. It is taking people a long time to trade out of an accumulated position of over £100m in a single, not very liquid bond.”"

Pension fund exposure

Two interesting aspects of this FT report: The decline in equity share and the increase in alternative assets.

Reductions in equity exposure to continue - FT.com: "UK pension funds have been gradually reducing their allocation to equities in the past decade from 74 per cent in 2000 to 55 per cent in 2010, according to Towers Watson. The equity exposure of UK funds remains the highest of all the large markets; compared with 49 per cent in the US, 37 per cent in Japan, 33 per cent in the Netherlands and 28 per cent in Switzerland. But a decline in equity allocations is common, with the net overall allocation across the largest pension fund

markets down by 13 per cent in the past five years, as pension funds diversify into alternative asset classes, which now account for 19 per cent of all portfolios."

Smell like team spirit

When it comes to taking most of the profits, the top investment banks do not compare with football clubs. The money flows to the talent.

Sports franchises: smell like team spirit - FT.com:

"Ditto Stateside. The headline grabbing $400m Platinum Equity supposedly paid for the Detroit Pistons this month is equivalent in size to Stein Mart, 468th in the S&P 600 small cap index. (And the retailer makes 10 times the revenues.) Sports profitability is worse. Why? Wages. Incredibly, the market cap of Juventus FC is only 30 times the annual salary of its best paid player. Goldman Sachs’s market cap is 5,000 times its boss’s last pay packet."

Pencil full of lead

BBC - Scotland - Sunday at RockNess 2011

Beware the tottering Greek domino

Good overview of market sentiment and its measurement.

FT.com / Markets - Beware the tottering Greek domino

FT video.

How I Failed, Failed, and Finally Succeeded at Learning How to Code - James Somers - Technology - The Atlantic

How I Failed, Failed, and Finally Succeeded at Learning How to Code - James Somers - Technology - The Atlantic

‘National mania’ blamed for Irish crisis

The FT.com on the report about Irish banks. The national speculation seems to be a feature of all such financial crises. It is obvious in retrospect. At the time, everyone is part of it and after none will take responsibility.

"Mr Nyberg said the attendant risks went undetected or were seriously misjudged by regulatory authorities “whose actions and warnings were modest and insufficient”.

A “happy go lucky” attitude prevailed during the period, including among the bondholders that lent to Irish banks.

“When it all ended, suddenly and inexplicably, participants had difficulty accepting their appropriate share of the blame for something in which so many others were also involved and that seemed reasonable at the time,” the report states"

Economist's View: Empirical and Historical Validation of Macroeconomic Models

Economist's View looks at the failure of the Bernanke type economic accelerator model to explain much of the deviation in output. However, this is rather the same as the failure of the short period of housing data to show the possibility of a simultaneous fall in house prices across the country.

"That was a mistake, but what is the lesson? One is that we should not necessarily ignore something just because it cannot be found in the data. Much of the empirical work prior to the crisis involved data from the early 1980s to the present (due to an assumption of structural change around that time), sometimes the data goes back to 1959 (when standard series on money end), and occasionally empirical work will use data starting in 1947. So important, infrequent events like the great Depression are rarely even in the data we use to test our models. Things that help to explain this episode may not seem important in limited data sets, but we ignore these possibilities at our own peril."

Spanish rates and the ECB

FT.com / "Almost all Spanish mortgages are based on the one-year Euribor money market rate, which is now close to 2 per cent, and rising"

What will people do for money?

What will people do for money?: "In the hypothetical scenario, 64 percent of participants said they would never administer a shock to someone else for money. However, in the real world that number changed, and in a big way. When faced with real money, 96 percent chose to shock the person in the other room for money."

Fixed income hedge funds

The FT looks at fixed income and some of the key players and strategies in the market:

"The resources and infrastructure required means that yield curve hedge funds tend to exist inside banks and the largest asset management firms. In Europe, well-known credit exponents include Trafalgar Asset Managers and BlueBay Asset Management, while yield curve funds include Brevan Howard, Moore Capital, Comac Capital and Prologue Capital."

ESM and seniority

FT.com / Capital Markets - Eurozone bonds face boycott by investors: "Standard & Poor’s, the US credit ratings agency, warned earlier this month that any country borrowing from the ESM could face further ratings downgrades because of the seniority issue."

Global credit gaUge

The FT.com reports on international measures to increase required capital ratios if credit growth breaches a threashold.

"The agreement drew strong support from around the world despite predictions that regulators would be unable to come up with a common definition for bubbles. The deal uses the ratio of credit-to-GDP as its basic measure. But regulators can use other metrics, provided they make their reasoning public"