The Allais Paradox

The Allais Paradox | Wired Science | Wired.com:

There is some explanation of the Allais Paradox here in Wired.com.  The is a tendency to value certainty but once this is gone, there is a tendency to take risk. For speculation, this means that the positive skew to returns are very attractive but the negative skew does not have very much influence.

"But why was certainty so attractive? Kahneman and Tversky wanted to understand the psychology behind the paradox. Their breakthrough came by accident. Kahneman had been reading a textbook on economic utility functions, and was puzzled by the way economists explained a particular aspect of our behavior. When evaluating a gamble—like betting on a hand of poker, or investing in a specific stock—economists assumed that we made the decision by taking into account our wealth as a whole. (Being rational requires factoring in all the relevant information.) But Kahneman realized that this isn’t how we think. Gamblers in Las Vegas don’t sit around the card table contemplating their complete financial portfolio. Instead, they make quick decisions that depend entirely upon the immediate terms of the gamble. If there is a $100 wager, and you’re trying to decide whether or not to ante in with a pair of aces, you probably aren’t thinking about the recent performance of your mutual fund, or the value of your home."

This may mean that fat tails are attractive as the possibility of large gains draws attention while the possibility of large losses is given less weight than it should.  There is loss aversion.  If there are large potential losses, losses should be cut swiftly, but there is a tendency to hand on a hope - with potentially catastrophic results.

A guide to bootstrapping

Bootstrapping and Subsampling: Part I « Normal Deviate:

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Compartments and belief

The Mind’s Compartments Create Conflicting Beliefs: Scientific American: An overview of the idea that the mind contains compartments that may contain conflicting ideas.  The key thought that when there is conflict, there is more agitation and people are more likely to shout or try to assert their belief.

"Cognitive dissonance may also be at work in the compartmentalization of beliefs. In the 2010 article “When in Doubt, Shout!” in Psychological Science, Northwestern University researchers David Gal and Derek Rucker found that when subjects' closely held beliefs were shaken, they “engaged in more advocacy of their beliefs ... than did people whose confidence was not undermined.” Further, they concluded that enthusiastic evangelists of a belief may in fact be “boiling over with doubt,” and thus their persistent proselytizing may be a signal that the belief warrants skepticism."

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Rajiv Sethi: Risk and Reward in High Frequency Trading

Rajiv Sethi: Risk and Reward in High Frequency Trading: "These are interesting findings, but there is a serious problem with this interpretation of risk-adjusted performance. The authors are observing only a partial portfolio for each firm, and cannot therefore determine the firm's overall risk exposure. It is extremely likely that these firms are trading simultaneously in many markets, in which case their exposure to risk in one market may be amplified or offset by their exposures elsewhere. The Sharpe ratio is meaningful only when applied to a firm's entire portfolio, not to any of its individual components. For instance, it is possible to construct a low risk portfolio with a high Sharpe ratio that is composed of several high risk components, each of which has a low Sharpe ratio."

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Knight, Risk, Uncertainty, and Profit, Part III, Chapter X | Library of Economics and Liberty

Knight, Risk, Uncertainty, and Profit, Part III, Chapter X   Profit is the return for having belief in the ability to forecast the future.  Of course this is self-fulfilling if luck ensures success and increased profits increase confidence.

 "The receipt of profit in a particular case may be argued to be the result of superior judgment. But it is judgment of judgment, especially one's own judgment, and in an individual case there is no way of telling good judgment from good luck, and a succession of cases sufficient to evaluate the judgment or determine its probable value transforms the profit into a wage."

However, the build up of confidence, profits and positions that are based on luck rather than ability to forececast the future could increase risk, particularly if risk is identified as a risk of reversal or crash.

The New Physiocrats - NYTimes.com

The New Physiocrats - NYTimes.com: "What’s really going on here, as far as I can tell, is a modern version of the 18th century physiocratic notion that only agriculture is real, that everything else is fluff on top. And we really shouldn’t be seeing a rebirth of that sort of nonsense in the 21st century. If you believe that we should have fewer schoolteachers and firefighters — or that education should be privatized — make that case. Don’t try to hide your prejudices under a mystical doctrine in which important, productive jobs somehow don’t count if they come from a place with a .gov email address."

We could also point to the idea that manufacturing is all powerful and useful while services are to be avoided.
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Another side of the credit crunch

Gillian Tett assesses the fall in credit card debt and use of plastic. It should not be a great surprise given the increase in the savings rate.

"Yes, you read that right. Although Americans are (in)famous for their addiction to credit card debt, that love affair is cooling, or being forcibly cooled. By the middle of this year, the number of credit card accounts in circulation had tumbled to 383m, 23 per cent below its 2008 peak, and fresh applications for credit were declining too. Put another way, while cards are still being flogged to consumers (and even sometimes marketed, via direct mail, to pets), not all Americans are saying “yes”."

Another way to look at this is from the supply side.  As part of the 'credit crunch' and cut back in advances to risky credits.

Skin in the game - indeed

Finance is in need of a technological revolution - FT.com: "Less than two months before the Facebook fiasco, another IPO suffered an even more shocking fate. BATS Global Markets, which operates the third-largest stock exchange in the US, went public on its own exchange. If ever an organisation had sufficient “skin in the game” to get it right, it was BATS and if ever there was a time when getting it right really mattered, it was on the day of BATS’s own IPO. So when BATS debuted at an opening price of $15.25, no one expected it to plunge to less than a tenth of a penny in a second and a half due to a software error affecting stocks whose ticker symbols began with the letter A or B. The ensuing confusion was so great that BATS suspended trading in its own stock and ultimately cancelled its IPO."

BBC News - Olympic counties: Does it matter where medal-winners come from?

Wiggins Belgium and the South African cricketer

Andy Murray's gold postbox is in Dunblane, where the tennis gold medallist grew up - although he was, in fact, born in Glasgow, moved to Barcelona to train at 15 and now lives near Wimbledon in south-west London."

Rajiv Sethi: Belief Heterogeneity

Rajiv Sethi: Belief Heterogeneity the paper described here analyses competing views.  This can be used in the model of speculation and the carry trade in particular.  The simple carry trade is successful for some time and the more successful it is, the more traders are drawn to the trade, increasing its success.  It requires a shock to burst the bubble.

"Not surprisingly, then, the presentation I found most appealing was that of Blake LeBaron. Blake is a pioneer in the development of agent-based computational models of financial markets, and the paper he presented belonged to this class. A large number of different forecasting strategies, some based on fundamental information and others on technical data analysis, compete with each other and with a traditional buy-and-hold strategy in his model. The resulting trading dynamics give rise to asset price returns that exhibit both moderate levels of short-run momentum as well as mean reversion over longer horizons. Moreover, the long run population of forecasting rules is ecologically diverse, with both passive and active strategies well represented. "

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Crowds and networds

Tim Harford highlights the work of Mark Granovetter on networks and crowds.

: "Consider the following simple model of a potential riot, based on an idea published in 1978 by the sociologist Mark Granovetter. There are 1,000 people in a crowd of protesters, and all of them have some underlying tendency to embark on a looting spree. We might reckon that an outbreak of rioting might be triggered by insensitive policing, or by the poverty of the crowd, or the opportunities for theft or for violent protest. But for simplicity let’s assume that the only thing everyone in the crowd cares about is what everyone else in the crowd is doing. Some people will start looting without much company. Others will hang back until the riot is well under way."

This can also be used, I think, to look at the way that speculation can build.  Given the information cascade that builds when valuation is difficult and that activity of others can imply some understanding that may not exist.  

Finance must escape the shadows - FT.com

Excellent.

John Kay - The parable of the ox

Interesting - though I am not sure that the Chicago model (Black-Scholes?) manages to generate a price from thin air - it needs important elements (such as the current price and the estimate of volatility).  It is also important to remember that there are people like Buffett making guesses and if the crowd is very wrong, he will be the closest.  John Kay - The parable of the ox:

"One difficulty was that sometimes there were few, or even no, guesses of the oxen’s weight. But that problem was soon overcome. Mathematicians from the University of Chicago developed models from which it was possible to estimate what, if there had actually been many guesses as to the weight of the animal, the average of these guesses would have been. No knowledge of animal husbandry was required, only a powerful computer."

Interesting, non-the-less. '

How Do You Choke Away the British Open? The Science of the Tight Collar | Wired Science | Wired.com

The explanation for why English Premier League players can be good for their club and poor for their country (outside ability of the rest of the team).

Sport psychology: "“You can’t dictate your genes,” says Stone. “But among the many identities you have, you can choose which to operate from.” Tiger Woods, for instance, has clearly forged an identity that transcends the potential vulnerabilities of his multiracial makeup. You can wallow in your most negative identity — the slow one, the overthinker, the one who doesn’t care — or you can foreground another identity, the one who is ready, the one who knows what’s coming, the one who calmly attacks the problem."

With a solution

The shocking story of how a council pursued Peter Williams

It raises the question of how different are the private and public institutions.

The shocking story of how a council pursued Peter Williams | Liberal Conspiracy: "On the 8th of February a man took his own life. Peter Williams was a gifted engineer, whose invention, still manufactured today, landed him in the Guinness World Records, but he was driven to bankruptcy and suicide by an unthinking and inhumane bureaucratic system"

Models

Krugman explains that models are tools or simplifications that are used to solve a problem.  However, the assumptions of the model cannot be used to explain the implications of the model.  That would be circular.  Gadgets Versus Fundamentals (Wonkish) - NYTimes.com:

"The point is that all this work USES Dixit-Stiglitz, but it’s not ABOUT Dixit-Stiglitz; D-S is a gadget, a tool that helps you work with the fundamental issues, but you don’t ever want to forget that it is no more than that."

George Monbiot – False Summit

George Monbiot – False Summit: "We were wrong about peak oil: there’s enough in the ground to deep-fry the plane"

It is always dangerous to make forecasts.  There is always some unsuspecting element that can crop up.

and then!

Monbiot peak oil u-turn based on bad science, worse maths

http://www.davidstrahan.com/blog/?p=1576

Oil glut forecaster Maugeri admits duff maths
http://www.davidstrahan.com/blog/?p=1570

David Strahan

Energy writer

Easter Island - people or rats?

Easter Island 

"Jared Diamond drew heavily on Flenley’s work for his assertion in Collapse, his influential 2005 book, that ancient Easter Islanders committed unintentional ecocide."
When the wood was gone and civil war began, the islanders began toppling the moai. By the 19th century none were standing. Easter Island’s landscape acquired the aura of tragedy that, in the eyes of Diamond and many others, it retains today.

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Andrew Gelman on political statistics

Andrew Gelman on How Americans Vote | FiveBooks | The Browser: "The idea is that these people know enough about us so that they can manipulate our vote. Realistically, political consultants nowadays know a lot about us, and they do try to convince us. There are two kinds of people they follow. One is people where they know who they’re going to vote for, but they’re not sure that they’re going to vote. The other is people who are very likely to vote, but you don’t know which way they’re going to vote. The first type of person they try to mobilise just to turn out and vote, and the second kind of person they try to persuade. They’re pretty good at knowing who people are. In fact, at this point, a lot of this is just a question of resources. To the extent they have resources they will go out to people and call you on the phone. If they think you’re already likely to vote for a certain candidate, they’ll try to find somebody to knock on your door and convince you that it’s an important election and it’s worth voting for. In some sense it’s not as mysterious or conspiratorial as it’s made out to be in that book."

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Greece’s ailing economy grinds to a halt - FT.com

The FT.com looks at the effect that a lack of credit is having on the Greek economy.

"But after thinking it over, Yannis Stamos, the company’s co-founder, turned the customer away. Filling the order would have meant reaching into Medical Service’s own pockets to cover the €35,000 cost of such a machine, since Greek banks have stopped lending and the company’s German suppliers now demand pre-payment in cash."