Category Archives: Finance

Michael Mauboussin rocks!

From Knowledge@Wharton: “How do we know which of our successes and failures can be attributed to either skill or luck? That is the question that investment strategist Michael J. Mauboussin explores in his book “The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing“. Wharton management professor Adam M. Grant recently sat down with Mauboussin to talk about the paradox of skill, the conditions for luck and how to mitigate against overconfidence.”

I also recommend Mauboussin’s book entitled “Think Twice: Harnessing the Power of Counterintuition“. Mauboussin does a wonderful job explaining how to use modern social science findings (particularly behavioral finance) to become a better decision-maker when facing risk and uncertainty.

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Debt Maturity

The Grumpy Economist: Debt Maturity.  Excellent financial advice for the US Treasury Department concerning the importance of taking advantage of (historically) low long term interest rates by lengthening the maturity structure of the federal government’s massive debt.  As University of Chicago finance professor John Cochrane notes, “Our Government has taken the opposite tack. When you include the Fed (The Fed has bought up most of the recent long-term Treasury issues, in a deliberate move to shorten the maturity structure) the US rolls over about half its debt every two years.”

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Foreign holdings of US debt hit $5.46 trillion

See today’s Houston Chronicle article entitled Foreign holdings of US debt hit $5.46 trillion”. Putting this number into perspective, this represents an increase over the past two years of roughly $1.26 trillion.   As I document in my November 5, 2010 blog posting entitled “Political economy and the (inflationary) future“, foreign holdings of US debt two years ago stood at around $4.2 trillion.

For my friends out there who are data geeks, the US Treasury Department regularly updates information concerning foreign holdings of treasury securities (by country) at http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt.

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Cracking Down on Oil Market Manipulation

This coming Saturday will mark the one year anniversary of the creation by the Obama administration of the “Financial Fraud Enforcement Working Group” (see the MSNBC article from 4/21/2011 entitled “Obama says new task force will examine gas prices”, available on the web at http://on.msnbc.com/JdlbDx). The article referenced below (entitled “Cracking Down on Oil Market Manipulation”) is from the White House blog and is dated 4/17/2012.

While the notion that “high” gas prices result from “price gouging” by a cadre of unsavory and greedy oil companies, energy traders, and speculators makes for a provocative political narrative, it’s really bad economics. As canards go, this one is particularly favored by politicians; indeed (as you can see from the time-date stamps of the April 2011 MSNBC and April 2012 White House blog articles), you can almost set your watch on these kinds of things.

I wrote a blog posting about the economics of “high” gas prices on April 23, 2011 (source: http://blog.garven.com/2011/04/23/is-gas-price-gouging-to-blame-for-high-gas-prices), and many, if not most of the points I raised in that article are as applicable today as they were then (now the geopolitical risk du jour is Iran; back then it was Libya)…

 
Cracking Down on Oil Market Manipulation | The White House
www.whitehouse.gov

“President Obama announces a new series of steps to strengthen oversight over the energy markets.”

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Is gas “price-gouging” to blame for high gas prices?

President Obama raised this question a couple of days ago during a “town hall” meeting in California. The MSNBC article entitled “Obama says new task force will examine gas prices” quotes him as saying, “”We are going to make sure that no one is taking advantage of the American people for their own short-term gain.” This article also quotes the President as saying that “The task force will focus some of its investigation on “the role of traders and speculators” in the oil-price surge”.

An article which appeared in the The Globe and Mail entitled “U.S. launches probe into energy prices”, notes that “U.S. Attorney-General Eric Holder made no allegation of wrongdoing against companies or speculators on Thursday. But the multi-agency Financial Fraud Enforcement Working Group will play a key role in identifying fraud in the energy market, he said” (italics added for emphasis).

While the notion that “high” gas prices result from “price gouging” by a cadre of unsavory and greedy oil companies, energy traders, and speculators makes for a provocative political narrative, it’s really bad economics. As canards go, this one is particularly favored by the political elites; indeed, as Tim Evans, energy analyst with Citi Futures Perspectives, told Reuters news service, “You can almost set your watch on these kinds of things.”

I can think of several reasons why gas prices are high compared with historical norms and likely to remain so for some time:

  1. Rising demand from emerging markets (particularly China and India)
  2. Risks of supply chain disruptions due to the ongoing political upheavals in Libya and the Middle East
  3. Domestic supply constraints due to the ongoing deepwater drilling moratorium in the Gulf of Mexico
  4. The ongoing depreciation of the value of the US dollar vis-a-vis foreign currencies. The Federal Reserve’s major currencies index (which measures the foreign exchange value of the U.S. dollar against a subset of currencies in the broad index that circulate widely outside the country of issue) currently stands at 20–year lows. Since this past January, the value of the US dollar compared with other major foreign currencies has fallen by nearly 5%. Since trading in the global oil markets is dollar denominated, some of the rise in gas prices can be attributed to this factor alone.

Therefore, in order for gas prices to become cheaper for Americans, this will require some combination of 1) a slowdown in the global economy, 2) a favorable resolution of political risks in the Middle East, 3) a credible commitment on the part of the US government to rescind its deepwater drilling moratorium, and/or 4) a recovery in the value of the US dollar vis-a-vis other currencies.

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Fibonacci numbers in nature and in finance

My favorite econ blogger, George Mason University’s Russ Roberts, posted the following (short, less than 4 minutes) video called “nature by numbers” yesterday on Cafe Hayek.  This video provides a remarkable and beautiful presentation concerning how Fibonacci numbers appear in nature. 

For more information concerning the math used in this video, go here.  Peter Bernstein (author of the worldwide best seller “Against the Gods: The Remarkable Story of Risk”) traces the origins of risk theory and finance back to a 13th century Italian mathematician by the name of Leonardo Pisano, who was known for most of his life as Fibonacci (see pages 23–26 from Bernstein’s book for historical context on the Fibonacci number series).  For some examples of applications of Fibonacci numbers in finance, go here.

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“Fat Tails” and implications for risk management

Yale mathematician and emeritus professor Benoît Mandelbrot passed away last week at the ripe old age of 85. Mandelbrot was most famous for his seminal work in the field of fractal geometry, but is also considered by many (e.g., Nassim Nicholas Taleb, the author of Fooled by Randomness and The Black Swan) as the “intellectual father” behind critiques of efficient markets models. Mandelbrot’s critique of efficient market theory was centered on the notion that actual return distributions are more “fat tailed” than would be implied by the normal distribution. Taleb provocatively argues in chapter 15 of his book The Black Swan that the bell curve (normal distribution), when applied to financial markets, is a “great intellectual fraud”. Taleb has also recently argued that “… the Nobel Prize for Economics (specifically, the 1990 awards to Harry Markowitz, Merton Miller and William Sharpe for their work on portfolio theory and asset-pricing models and the 1997 awards to Myron Scholes and Robert Merton for their work on option pricing theory) has conferred legitimacy on risk models that caused investors’ losses and taxpayer-funded bailouts…”, and that “investors who lost money in the financial crisis should sue the Swedish Central Bank for awarding the Nobel Prize to economists whose theories he said brought down the global economy” (see “`Black Swan’ Author Says Investors Should Sue Nobel for Crisis“).

While there is no question that Dr. Taleb’s narrative is brash and provocative, I am not convinced. Of course, he would argue that people like me who received their graduate training in finance during the past 2-3 decades have a vested interest in defending orthodoxy for its own sake. However, it’s only fair to also recognize that Dr. Taleb has a vested interested in defending heterodoxy for its own sake. It seems that Taleb seeks to discredit pretty much anyone who happens to disagree with him, not on the strength of the arguments that they marshall on behalf of “orthodoxy”, but rather on the basis of ad hominem arguments about how they can’t be taken seriously because they are intellectually biased a priori in favor of efficient markets orthodoxy.

I couldn’t have explained the implications of Benoit Mandelbrot’s research for financial markets any better than Dr. Ewan Kirk, who is Chief Executive for Cantab Capital Partners in Cambridge, UK, so I quote directly from Dr. Kirk’s letter to the Financial Times entitled “How Mandelbrot Caused Confusion“: “It is true that markets are very difficult to model precisely. Indeed, even after this simple transformation, there continue to be significant non normal features to markets and of course there are always “unknown unknowns” and “black swan” events. However, these issues are considerably more subtle than just presenting the 100-year unscaled daily returns of the stock market and implying that foolish theoreticians and practitioners are modeling the returns as a stationary Gaussian or normal distribution.” Also, the essay by Bob Gillespie entitled “Black Swans and Absurdistan” is worth reading.

In closing, I would like to point out two interesting videos from FT.com. The first video, “Inefficient markets and Mandelbrot“, features a debate concerning whether the impact of Mandelbrot’s legacy has been overstated. The other video, “Why ‘efficient markets’ collapse” is an interview with Mandelbrot recorded last year in which Mandelbrot explains his more than 40-year old critique of the “efficient markets” hypothesis and why new (i.e., Mandelbrotian) theories on price movement discontinuities are needed in light of the financial crisis of 2007-????.”

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