Tuesday, May 22, 2012

Financial Food for Thought

Here is some financial food for thought based on terms I've never heard before this week:

1) Syriza: Coalition of the Radical Left. A coalition of leftist political parties in Greece. They quadrupled their number of Parliamentary seats in the last election in May at the expense of the two central parties which had negotiated the Greek bailouts (which in a nutshell requires Greece to reign in out of control spending in exchange for money from the rest of the euro zone; i.e. Germany). But, because Syriza refuses to form a governing coalition with other parties, new elections are being held in June.

Their platform? Hold Europe hostage. That is, cancel planned reductions in spending while still demanding the bailout money. Why do so many Greeks think this is a real solution? The longer fundamental structural problems are ignored, the worse the outcome is at the end. And the outcome is already looking to be pretty bad.

2) Bank Jog: What a pundit calls a bank run that he hopes ends quickly and with minimum damage. (I think. A definition is hard to come by.)

I know bank runs are disastrous, but isn't it even worse to not admit one is happening? If one acknowledges it is happening, then isn't there a better chance of stopping it by solving the problems causing the bank run? By the way, how much money has to be withdrawn from banks (and how quickly does it have to be withdrawn?) in order to be considered a bank jog, sprint, or run? Are only "runs" bad?

3) Empty Voting: When agents with negative economic interests in a corporation have voting control. May lead to controlling agents voting against the interests of the company and other stock holders. 

Evidently, empty voting is becoming a big concern in some circles because voting rights and financial positions in the company have become increasingly decoupled leading to situations where incentives may be misaligned. How does this happen? An agent buys voting stock in a company then perfectly hedges. This has become easier to do with the plethora of new types of markets available. By perfectly hedging, the agent has voting power in the company, but is not impacted financially at all. Perfectly hedging is not quite as simple as it sounds, though. JPMorgan lost several billion dollars in the last few weeks due to a miscalculation in their attempt to hedge.

But, is empty voting necessarily bad? Is it possible for empty voting to be efficient? On Monday in the Applications Seminar, Scott Kominers argued empty voting may be efficient because it is possible for empty voting to be in the core. (He constructed an example to show this is the case.) The bigger picture seemed to be that the core and not competitive equilibrium is the correct solution concept for thinking about financial markets.


Friday, May 18, 2012

Food for Thought

The NATO meetings are in Chicago this weekend, so in that spirit, here is some foreign policy and political economy food for thought:

From the WSJ opinion pages today:
We do not get to choose if a freedom revolution should begin or end in the Middle East or elsewhere. We only get to choose what side we are on.... [I]f America does not support the advance of democratic institutions and values, who will? (George W. Bush)
This op-ed clearly shows that President Bush supports actively promoting American ideals (democracy and freedom) over stability through foreign policy (esp. in the Middle East). To me, this attitude shift was the biggest change in US foreign policy after 9/11 and the defining feature of the Bush Doctrine -- even more so than "preemptive strike."

From the NYT opinion pages today:
People used to believe that human depravity was self-evident and democratic self-government was fragile. Now they think depravity is nonexistent and they take self-government for granted. (David Brooks)
I liked this piece because he quotes Madison in Federalist 55:
As there is a degree of depravity in mankind, which requires a certain degree of circumspection and distrust, so there are other qualities in human nature, which justify a certain portion of esteem and confidence.
Also, Madison in Federalist 10 warned against the tyranny of the majority ("majority factions") and took the time to explain how he believed a republic with separation of powers, not a pure democracy, would better serve the "public good."

Sunday, May 6, 2012

The Biological Basis of Economic Preferences and Behavior

The Becker Friedman Institute sponsored an interdisciplinary conference Friday and Saturday titled "The Biological Basis of Economic Preferences and Behavior."

I went to all the talks and some were better than others. Here are some of the highlights and some things I learned (listed by presenter):

Saturday, May 5, 2012

Observational Studies

[O]bservational studies, researchers say, are especially prone to methodological and statistical biases that can render the results unreliable. Their findings are much less replicable than those drawn from controlled research. Worse, few of the flawed findings are spotted -- or corrected -- in the published literature.
That's from a WSJ front page article, "Analytical Trend Troubles Scientists," published Thursday, May 3rd, criticizing the increased use of observational studies (over true experiments) in the hard sciences over the last dozen years. The whole article is really good. I am glad the WSJ devoted a front page article to this issue.

What can go wrong with interpreting data from observational studies? Lots. For example, when running an experiment, the scientist gets to control all the variables of interest, and by varying one of them can get a clear picture of how that variable interacts with the outcome of interest (usually the biggest analytical issues with experimental data is measurement error). In an observational study, many things change at once which makes it much harder to construct correct correlations (is A correlated with B because A causes B, B causes A, or C causes A and B?). 

In addition, yesterday at the Becker Freedman Institute Conference on the Biological Basis of Economic Preferences and Behavior, David Cesarini, one of the presenters, spent some time talking about this issue as it relates to the molecular genetics literature (a literature that in large part tries to determine which genes do what). This another sub-field where there are concerns about the veracity of much of the research. Basically his argument boiled down to another common concern with observational studies: data mining. Even with small p-values, when running hundreds of thousands of regressions of an outcome on a SNP (single nucleotide polymorphism), one is bound to find spurious correlation, especially since the regressions have such low power (he cited an average R-squared of .004). So, what was his advice to economists and other scientists who want to use genetic data in their work? "Stop recapitulating the mistakes of medical genetics and set high standards."

Economists really do have a comparative advantage here over other hard scientists. Economists have had to deal with the lack of experiments since the invention of the field. As a result, we are trained to always be on the look out for what could go wrong when interpreting survey and observational data (or even when we don't have the data we need at all), and we learn a lot of statistical techniques and econometric methods to deal with the problems that creep up all the time in observational studies. Most medical researchers and other hard scientists haven't had this training because all their data work has come from experiments where all the manipulated and controlled variables are known. Because of this, they are bound to make lots of mistakes.

Tuesday, May 1, 2012

Dream Sequence

Last night I had a dream. I don't usually remember my dreams, but this one I did. It went something like this:

[Setting: I was in a house organizing a knickknack drawer. I was very pleased to see two staplers and four rolls of Scotch tape in the drawer. As I was organizing, Barack Obama walks in with a set of tools and two window screens (no secret service). He begins installing a screen in one of the windows.]

ME: What are you doing?

BO: Installing energy-saving uv-protecting window screens which will lower your electrical bill saving you money.

ME: But I don't want to pay for them. I don't think the benefits outweigh the costs.

BO: Don't worry -- I'm paying for them.

ME: Okay. If it makes you happy...

[Barack begins installing the second screen.]

BO: You don't understand -- if enough people have them, others will see how much money they save and will buy them themselves without me paying for them. It's like Microsoft Windows, only green -- a tipping point will be reached.

ME: But there's an important difference: Users will not adopt some software unless enough other people use it because their utility depends on the number of other people using the software. Microsoft Windows has maintained so much market share not because alternatives are expensive, but because of network effects: it reached a tipping point, gained market share, and won't lose it because not enough people use the alternative. Window screens are not like that.

BO: Oh, I did not realize that.

[Barack thinks, then gathers his tools and leaves. I think that it's a little disappointing how much light the new screens seem to be blocking. Then I wake up.] 

Dreams are supposed to be crazy mash-ups of reality and things one is thinking about at the time you go to sleep ("what's on your mind"), but when light bulb bans* are reality, misplaced charity based on a mistaken parallel between types of windows seems positively sane.

* Evidently, the effective ban on traditional incandescent 100-watt bulbs is currently in place, but the enforcement of the law was de-funded by Congress at the last minute last year. I say effective ban because, as the NYT so gently put it last year, the law "simply requires that companies make some of their incandescent bulbs work a bit better, meeting a series of rolling deadlines between 2012 and 2014." That is, the law did not single out a certain product, but was phrased so that only the 100-watt incandescent qualifies. (The "work a little bit better" is referring to those more expensive (but cheaper than CFLs) blue incandescent bulbs you may see in the store that are 100-watt equivalents, but are not standard bulbs). Incidentally, by 2014, some lower wattage incandescent bulbs won't be legal, either.