Category Archives: Financial Crisis

Hayek vs. Keynes Sequel "Sneak Peak"

‘Fear the Boom and Bust’ Hayek vs. Keynes rap video“, I reference and link to the very clever (and popular –  more than 2 million views on youtube.com) video production by filmmaker John Papola and economist Russ Roberts which compares and contrasts the ideas of two “famous” dead economists, John Maynard Keynes and Friedrich von Hayek.  Here’s a “sneak peak” of the “sequel” (hat tip to Russ Roberts): ]]>

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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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"Fat Tails" and implications for risk management

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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Duke/CFO Business Outlook Survey

I received an email invitation today from CFO (Chief Financial Officer) Magazine to register for an upcoming webcast on the “Recent Findings from the Duke/CFO Magazine Global Outlook Survey” (see below).  According to the Duke/CFO Business Outlook Survey website located at http://www.cfosurvey.org/, the survey is conducted quarterly, and it “…polls CFOs of both public and private companies around the globe”.

In view of all of the discussion in the media concerning how firms are flush with cash these days, it is interesting to read the summary below, which notes that according to the most recent survey, “CFOs … are concerned about the availability of credit” (italics added for emphasis). Furthermore, I can’t help but wonder whether these cash holdings also correspond to chief financial officers having deflationary expectations; in a world with falling prices, it actually does make quite a bit of sense to horde cash.  Anyway, I am looking forward to “tuning in” to this webcast to learn more!

Capture

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How the Great Recession Was Brought to an End?

A new working paper entitled “How the Great Recession Was Brought to an End“, by Princeton’s Alan Blinder and Mark Zandi of Moody’s Analytics, was released two days ago. In his blog posting entitled “The Impact of Another Kind of Stimulus“, New York Times reporter David Leonhardt characterizes it as “…the first serious attempt at analyzing the effect both of the stimulus programs passed by Congress and of the various financial-market policies put in place by the Fed, the Treasury and Congress” and summarizes some highlights of their analysis.  Yesterday, the New York Times published an article about the Blinder-Zandi paper entitled “In Study, 2 Economists Say Intervention Helped Avert a 2nd Depression” and also quotes Stanford professor John B. Taylor as saying that Blinder and Zandi’s empirical results were quite different from his own empirical work on the policy responses to the crisis.  Today, Professor Taylor provides a detailed critique of the Blinder-Zandi paper on his blog (see “More on the Blinder-Zandi Working Paper on the Crisis”).  Anyway, an interesting and very public academic debate is unfolding here which obviously has critically important policy implications; there’s a lot here to “chew” on!

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“What Wall Street Reform Means for You”

Hat tip to my former MBA student, Jason Gould, for pointing out a 3 minute video which was recently posted at http://www.whitehouse.gov/wallstreetreform entitled “What Wall Street Reform Means for You”.  Jason characterizes it as “Wall St. Reform for 1st Graders”, noting that “It is simply amazing that this is how they choose to speak to the American public. A 2300 page law explained in a 3 minute video by the White House. Obama and his staffers must be joking…it is embarrassing.” 

I completely agree with Jason; this video is simultaneously embarrassing, condescending, and grossly misleading. That’s because this is a political narrative designed to attribute blame to the private sector; as if the public sector was an “innocent” bystander, powerless to do anything other than bail out TBTF institutions. Thank God that we now have a 2,300 page reform bill that will empower the federal government to protect us from ourselves!

Anyway, here’s the video:

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Assorted Links (7/13/2010)

Eugene White: Dodd-Frank, Meet William Jennings Bryan – WSJ.com

online.wsj.com

“In the Wall Street Journal, Eugene White explains why a ‘Financial Crisis Fund,’ similar to current proposals, was rejected over a century ago during the financial crisis of 1893.”

Amity Shlaes: FDR, Obama and ‘Confidence’ – WSJ.com

online.wsj.com

“Amity Shlaes writes in The Wall Street Journal that demonizing business deepened the Great Depression. The Obama White House can learn from Roosevelt’s mistakes.”

William McGurn: Obama’s Immigration Fakery – WSJ.com

online.wsj.com

“In The Wall Street Journal, Main Street columnist William McGurn says that in 2007, Barack Obama helped derail immigration reform as a junior senator from Illinois. As president, he is not serious about a bipartisan bill today.”

Brian Riedl: The Bush Tax Cuts and the Deficit Myth – WSJ.com

online.wsj.com

“In The Wall Street Journal Heritage Foundation fellow Brian Riedl explains that runaway government spending, not declining tax revenues, is the reason the U.S. faces dramatic budget shortfalls for years to come.”

Two Thumbs Down on the Financial-Reform Bill – Freakonomics Blog – NYTimes.com

freakonomics.blogs.nytimes.com

Economics Nobel laureate Gary Becker’s take on the financial-reform bill; he particularly dislikes the facts that this bill 1) adds regulations and rules about many activities that had little or nothing to do with the (financial) crisis, and 2) essentially says nothing about Freddie Mac or Fannie Mae.

Bret Stephens: Dr. Berwick and That Fabulous Cuban Health Care – WSJ.com

online.wsj.com

“In The Wall Street Journal, Global View columnist Bret Stephens writes about the death march of progressive medicine.”

Op-Ed Columnist – An Economy of Grinds – NYTimes.com

www.nytimes.com

“The slow economic recovery is shutting out the small businesses that are vital to its success.”

Fund Track: Collar Fund Offers Low Risk, Low Reward – WSJ.com

online.wsj.com

“A cautiously bullish strategy is the mainstay of the $31 million Collar Fund, whose portfolio has low enough risk to inspire comparisons to a bond fund, but whose hedged exposure to stocks aim for stronger returns than bonds.” The Collar Fund represents an interesting application of some very simple financial engineering; this is the sort of stuff we study in my “Options, Futures and Other Derivatives” course at Baylor University…”

Correlation Soars on S&P 500 Shares – WSJ.com

online.wsj.com

“Stocks are trading in lock-step more than at any time since the 1987 crash, and the trend has some analysts concerned.”

2010 World Cup comes to a close – The Big Picture – Boston.com

www.boston.com

Who Pays for ObamaCare? – WSJ.com

online.wsj.com

“The Wall Street Journal on what Donald Berwick and Joe the Plumber both understand.”

Lessons From the Swedish Welfare State – WSJ.com

online.wsj.com

“In The Wall Street Journal, Swedish economists Andreas Bergh and Magnus Henrekson cite research that shows bigger government is associated with slower economic growth. Sweden is a prime example. It’s recent performance is due to market-oriented policies and a declining government share of GDP.

Pat Michaels: The Climategate Whitewash Continues: Don’t Believe the ‘Independent Reviews’

online.wsj.com

“In The Wall Street Journal, climate scientist Patrick J. Michaels criticizes the recent exoneration of charges that the Climatic Research Unit at the University of East Anglia. He says that the members of the committee had a conflict of interest and that the review work was shoddy.”

Fred Barnes: Obama’s Entitlement Opportunity – WSJ.com

online.wsj.com

“In The Wall Street Journal, Fred Barnes notes that the president’s deficit commission isn’t likely to agree on tax increases. But it might recommend Social Security reform.”

Book review: Getting It Wrong – WSJ.com

online.wsj.com

“Edward Kosner reviews W. Joseph Campbell’s Getting It Wrong: Ten of the Greatest Misreported Stories in American Journalism.”

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