The Man Who Invented Modern Probability - Issue 4: The Unlikely - Nautilus

The Man Who Invented Modern Probability - Issue 4: The Unlikely - Nautilus: "Kolmogorov drew analogies between probability and measure, resulting in five axioms, now usually formulated in six statements, that made probability a respectable part of mathematical analysis. The most basic notion of Kolmogorov’s theory was the “elementary event,” the outcome of a single experiment, like tossing a coin. All elementary events formed a “sample space,” the set of all possible outcomes. For lightning strikes in Massachusetts, for example, the sample space would consist of all the points in the state where lightning could hit. A random event was defined as a “measurable set” in a sample space, and the probability of a random event as the “measure” of this set. For example, the probability that lightning would hit Boston would depend only on the area (“measure”) of this city. Two events occurring simultaneously could be represented by the intersection of their measures; conditional probabilities by dividing measures; and the probability that one of two incompatible events would occur by adding measures (that is, the probability that either Boston or Cambridge would be hit by lightning equals the sum of their areas)."

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Knowledge, uncertainty and Bayesian priors

A fantastic journey from a discussion of job insecurity through the basis of knowledge and back to how to estimate the probability of being sacked.  Not Quite Noahpinion: Perceiving Job Insecurity:

"Keynes was one of many to critique this principle. His views on probability and uncertainty remain controversial, as does the Principle of Insufficient Reason. There is actually quite a large body of literature in statistics concerning "noninformative priors" that continues to study the fascinating and controversial issue of how to represent ignorance. There are also subfields of behavioral economics that study how people treat probability, particularly when it comes to low-probability events (like job loss, usually)."

Excellent links provided.

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Noahpinion: A healthy side effect of High Frequency Trading?

Lovely overview of HFT,

Noahpinion: A healthy side effect of High Frequency Trading?: "High Frequency Trading is nearly universally reviled. The Tournament Externality is just too obvious; it yields no social value to bring a piece of information to the market 1 millisecond before it would otherwise have arrived, but people are apparently spending lots of money in an effort to do so. It can't be efficient to commit our best and brightest minds to beating each other to the punch by 1 millisecond. Because of this, many have suggested a small Tobin Tax to curb HFT. Others have suggested"

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Luck

Interesting case. Does the demise of Nintendo suggest that the previous success was just luck.  They had two good products:  Nintendo DS and wii?   The alternative is changing clans.  It would add the gamecube and say that it had an era and some fundamental change allowed Microsoft to take over.

"Iwata expects sales of 3DS and Wii U hardware to increase, and promises return to "Nintendo-like profits"; lines up new Nintendo Direct web session to reveal fresh game details"

Link,

Calendar-based Sector Strategy | Systematic Investor

EMH in action.

Calendar-based Sector Strategy | Systematic Investor: "I recently came across the Kaeppel’s Sector Seasonality Strategy which is described in Kaeppel’s Corner: Sector Seasonality and updated in Kaeppel’s Corner: Get Me Back, Clarence."

It depends on the interpretation. This is how I interpret it.

Productivity and inequality

At some point the gap between inequality and productivity must make people move between the two spaces to reduce the gap.  How does that not happen?

There are barriers, such as the social capital of being from a different class, though these can be overcome after a certain point and return reach an extreme level; there is ignorance of the ability or requirements that are necessary to move; there are other barriers such as legal and educational constraints.

What determines this gap?  It is clearly larger in the US than in Germany or some Scandinavian countries.  Do these constraints have other effects?

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Michael Lewis: Did Goldman Sachs Overstep in Criminally Charging Its Ex-Programmer? | Vanity Fair

Michael Lewis: Did Goldman Sachs Overstep in Criminally Charging Its Ex-Programmer?
A month after ace programmer Sergey Aleynikov left Goldman Sachs, he was arrested. Exactly what he’d done neither the F.B.I., which interrogated him, nor the jury, which convicted him a year later, seemed to understand. But Goldman had accused him of stealing computer code, and the 41-year-old father of three was sentenced to eight years in federal prison. Investigating Aleynikov’s case, Michael Lewis holds a second trial."

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Kickstarter

An idea for an assignment in finance.  Look for a project on Kickstarter.  Investigate the potential returns and risk.  Make an assessment of the sort of funding that you would be prepared to make and the additional information that you would like.  This can begin as a sort of Dragon's private equity financing but can be expanded to a discussion of different options and the relative merits of these options.

Smith and Speculation

In the middle of a debate about Smith, Brad DeLong quotes the Theory of Moral Sentiments:

"Let us suppose that the great empire of China, with all its myriads of inhabitants, was suddenly swallowed up by an earthquake, and let us consider how a man of humanity in Europe, who had no sort of connexion with that part of the world, would be affected upon receiving intelligence of this dreadful calamity. He would, I imagine, first of all, express very strongly his sorrow for the misfortune of that unhappy people, he would make many melancholy reflections upon the precariousness of human life, and the vanity of all the labours of man, which could thus be annihilated in a moment. He would too, perhaps, if he was a man of speculation, enter into many reasonings concerning the effects which this disaster might produce upon the commerce of Europe, and the trade and business of the world in general."

It seems to suggest speculation.  What is the effect of this on trade?  Buy spice and silk, sell whiskey and shortbread.

Gladwell on Taleb

Very Interesting.  Gladwell has a profile of Tlaeb. The hedge fund that buys out of the money options. There is a good link to Kahneman and Tversky.

 "Nonetheless, we have strong preferences among them. Why? Because we're more willing to gamble when it comes to losses, but are risk averse when it comes to our gains. That's why we like small daily winnings in the stock market, even if that requires that we risk losing everything in a crash."

The most interesting point is whether options are under-priced.  We know about the smile and the way that this allows fat-tails.  Is that sufficient?  I supposed they checked.

The Future of Computer Based Trading

Tim Johnson has a blog Magic, maths and money: Here is is looking at a government report on computer based trading.  He makes the distinction between broking and jobbing or market-making and speculating.

 "Modern criticism of high frequency trading  is a continuation of a long tradition of distinguishing the activities of Monied Men investing in the market and Traders speculating within the market.  As such it can get entangled in a web of social judgements, such as it is OK for the rich to gamble but not the poor.  To make decisions about HFT, therefore, requires some understanding of this mess."

This is the same issue that arises time after time through Thomas Mortimer, Keynes and into the assessment of HFT.  The role of speculation in the market is a major issue.  One interesting point that Tim makes is that Big Bang blurred the line between broking and speculation.

Life In The Slow Lane

Paul Krugman shows how traffic congestion encourages road rage.  Life In The Slow Lane (Trivial) - NYTimes.com.  Probably a good exercise to conduct all these calculations:

1. What is total journey time? 
2. How much time spent flashing past others? 
3. How much time watching others flash past? 
4. Time saved with a 50 mph train.  

Data analysis

The FT has an interesting article today looking at
the work of James Cheshire on spatial analysis. The link to the FT article is here.  James's website is here.  He also blogs at mappinglondon.co.uk.  Some of the work appears to have been done with R. 

Hungary struggles with foreign currency loan burden

Hungarian foreign currency loans. FT.com:

"But the financial crisis sent the forint tumbling. The capital value and servicing costs of the loans mushroomed in forint terms; consumer spending slumped. At the end of March, Hungary still had over Ft3.55tn ($15.8bn) of foreign currency mortgages outstanding, equivalent to 12 per cent of gross domestic product. More than 20 per cent of the loans by value had repayments more than 90 days overdue."

This is the resolution of the HUF carry trade, conducted by domestic households:  borrowing EUR and CHF to purchase higher yielding domestic assets.

Measuring Recession

Jeffrey Frankel compares US and European methods of assessing recessions and comes down firmly on the side of the US version: not two quarters of negative growth but a more holistic assessment of the economy and its potential.

"These measurement issues may sound like minor technical details; but they can have significant real-world implications. So, what are the differences between European and US criteria for judging recessions?"

The US measurement removes the constant twitter about double or triple dips.

Bandwaggons and herding

The Economist assess why missing out on one job application is bad news for your chances in the next.

"The existence of bandwagon behaviour can be hard to prove. A product or an asset usually becomes popular (or unpopular) in the first place because it is genuinely superior (or inferior). But some have tried to isolate the self-fulfilling effects of popularity. One 2004 study* by Alan Sorensen, now of the University of Wisconsin, examined accidental omissions from the New York Times bestseller list"

As with the carry trade, there is some underlying effect but it is magnified by the attempt to deal with asymmetric information. This magnification causes a distortion that can eventually be significant.

Two decades ago Abhijit Banerjee, now at the Massachusetts Institute of Technology, devised a model of “rational herding” in which market participants base their decision on a combination of their own information and the actions of others. Over successive rounds of transactions, participants responded less to their own information and more to the herd.

Expectations and learning

Learning from Inflation Experiences assess the way that expectations are formed and finds that personal experience has an impact.

: "How do individuals form expectations about future inflation? We propose that personal experiences play an important role. Individuals adapt their forecasts to new data but overweight inflation realized during their lifetimes."

There is scope here to use some of these ideas in understanding how expectations about the probability of success with the carry trade can affect the trade itself. What is the recent experience?  How have traders experienced the carry?

Frequency of words over time

The ngramr – an R package for Google Ngrams can create charts of the frequency with which words are used over time.  The package uses the Google Books diagnostics to scan Google Books to look for names.  The chart needs to be turned into data.

 "The Ngram Viewer will display an n-gram chart, but does not provide the underlying data for your own analysis. But all is not lost. The chart is produced using JavaScript and so the n-gram data is buried in the source of the web page in the code. It looks something like this:"

This can be used to see how economic words change over time and use this as a proxy for sentiment or thinking and then look for how this sentiment or general thinking affects things like the work of the central bank or the structural budge deficit, the PE ratio or more.

Budget iPhone: ugly on purpose | BGR

Analysis by BGR suggests that the Budget iPhone is ugly on purpose

"Pictures of candy-colored entry-level iPhones with rounded corners have started circulating. Many have branded them hideous, crude atrocities. They need to be. Apple is facing a unique dilemma: Because of the stellar success of the iOS app universe, the entry-level iPhone has to have nearly the same specs as the flagship iPhone. The display has to be large. The processing power has to be substantial. Apple cannot afford to fragment the iPhone device base, particularly since it has spent years mocking Android vendors mercilessly for doing just that. Still, the budget iPhones have to be something that affluent and aspirational consumers despise."

Is this price discrimination?  Some textbooks provide the example of French third class train carriages that, they say, used to have the roof taken off to make sure that they were inferior to the second class.

Global factors in capital flows and credit growth | vox

Consistent with the idea that loose monetary policy can be translated across borders and that the Japanese half-hearted attempt at quantitative easing was at least partially responsible for the global financial crisis by spreading Japanese money across the globe (through the carry trade).

"In a recent paper (Bruno and Shin 2012a) we examine the theoretical and empirical basis for global liquidity. Schematically, global liquidity propagates as shown in Figure 1. When global banks apply more lenient conditions on local banks in supplying wholesale funding, the local banks transmit the more lenient conditions to their borrowers through greater availability of local credit. In this way, global liquidity is transmitted through the interactions of global and local banks through the waxing and waning of bank risk-taking."

Valenina Bruno and Hyun Song Shin take a look in Global factors in capital flows and credit growth | vox.  Is there a link between the global carry trade and the transmission of liquidity.  Can the waxing and waning  of the carry identify increased global financial risk?