Category Archives: Risk and Uncertainty
Today’s required reading: The Day Coronavirus Nearly Broke the Financial Markets
“The March 16 stock crash was part of a broader liquidity crisis that pummeled even seemingly safe bonds, threatening the viability of companies and municipalities across America. Only action from the Federal Reserve brought things back from the brink.”
Bank of Japan Introduces Negative Interest Rates
The Bank of Japan’s (somewhat counterintuitive) stated goal for implementing it’s new (negative interest rate) policy is “…to push down borrowing costs to stimulate inflation”. While I certainly do not claim or pretend to be a monetary economist, a policy that punishes savers and rewards borrowers doesn’t seem like a particularly good script for long-term economic success. I think it’s a tacit acknowledgment that the Japanese economy is struggling with deflation. See https://www.boj.or.jp/en/announcements/release_2016/k160129a.pdf for the official policy statement issued by BOJ…
Are Shareholders Obsolete?
In his January 2, 2015 Wall Street Journal essay, columnist Holman Jenkins makes a compelling case for the principle of shareholder value maximization by noting that owners seeking to maximize the value of their businesses end up doing a pretty decent job of satisfying customer and employees along the way. Think of this essay as a 2015 sequel to Milton Friedman’s famous New York Times Magazine essay (published September 13, 1970) entitled “The Social Responsibility of Business is to Increase its Profits” (see http://bit.ly/Social_Responsibility_of_Business for Friedman’s essay; Thomas Coleman provides important context in his recent (2013) essay about Friedman entitled “Corporate Social Responsibility: Friedman’s View @ http://bfi.uchicago.edu/feature-story/corporate-social-responsibilty-friedmans-view)…
Terrorism risk insurance
Clearly insurance is an enabling technology; without insurance many if not most large-scale commercial activities would grind to a halt. In a Business Week article entitled “The Unexpected Threat to Super Bowl XLIX“, Wharton professors Howard Kunreuther and Erwann Michel-Kerjan point out that that if Congress decides not to renew the Terrorism Risk Insurance Act (TRIA) (set to expire on Dec. 31), there is a chance that the Super Bowl might not be played. Will Warren Buffet step in as an insurer of last resort if TRIA is not reauthorized? Also, Gordon Woo raises some excellent points about possible private sector alternatives to TRIA in his blog posting entitled “RMS and the FIFA World Cup: Insuring Against Terrorism“.
Suggested books and readings on finance and risk management
In my opinion, the following 3 books are particularly worthwhile for students who are interested in learning more about finance and risk management:
- Against the Gods: The Remarkable Story of Risk, by Peter L. Bernstein.
- A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, by Burton G. Malkiel.
- Stocks for the Long Run : The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies, by Jeremy J. Siegel.
Philosophically, these books present what I would consider to be an “orthodox” perspective; i.e., they fit well with the so-called rational choice, efficient markets view of the world which is prevalent in most departments of finance and economics. For some “heterodox” alternatives, I like (but am nevertheless highly critical of) both of Nicholas Taleb’s books:
- Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (read this first).
- The Black Swan: The Impact of the Highly Improbable (the sequel to “Fooled by Randomness”).
Finally, I would be remiss to not also include two other favorites which are not books on finance or economics; rather they deal with the history and philosophy of applied mathematics. These books include:
- Innumeracy: Mathematical Illiteracy and Its Consequences, by John Allen Paulos.
- A Brief History of Infinity, by Brian Clegg.
House of Debt
House of Debt – http://bit.ly/1rulBgN
This 1 hour long video (@ http://bit.ly/1rulBgN) featuring Amir Sufi (who is the Chicago Board of Trade Professor of Finance at the University of Chicago Booth School of Business) was recorded last Monday evening as part of the Myron Scholes Global Markets Forum at Chicago Booth. Here’s a description of his talk:
“The Great American Recession resulted in the loss of eight million jobs between 2007 and 2009. More than four million homes were lost to foreclosures. Is it a coincidence that the United States witnessed a dramatic rise in household debt in the years before the recession—that the total amount of debt for American households doubled between 2000 and 2007 to $14 trillion? Definitely not. Armed with clear and powerful evidence, Professor Sufi will discuss his forthcoming book, House of Debt, and how it reveals the Great Recession and Great Depression, as well as the current economic malaise in Europe, were caused by a large run-up in household debt followed by a significantly large drop in household spending.”
The Economist: Essay on the history of finance in five crises
From The Economist:
“This week we publish an essay on the history of finance in five crises. They have a common theme: in each case the state increased the subsidies and guarantees it gave to finance—and helped set up the next crisis. Our cover leader points out that this is happening again. An American can now blindly put $250,000 in a bank, knowing his deposit is insured by the state. Finance, we say, should be treated more like other industries.”
Options Away: Insurance Against Airfare Price Hikes
The underlying idea behind “Options Away” is quite interesting. I can’t help but wonder why the airlines and/or the various intermediaries such as Expedia and Orbitz haven’t already implemented similar arrangements.
The “insurance” described in the article referenced below is different from traditional travel insurance which requires purchasing a ticket prior to buying the insurance. Here, one can purchase a call option that locks in a favorable fare today without obligating the consumer to actually purchase the ticket.
Options Away: Insurance Against Airfare Hikes
“Options Away… will sell you the right to buy a plane ticket within a certain timeframe at a certain price. If the airfare goes up within your option’s time frame, good for you—you can buy the ticket, paying your optioned fare, and Options Away pays the difference. If the airfare goes down within your option’s timeframe, you simply ignore your option and buy your ticket at its now lower fare. Either way, you’re out the option fee, but you are not obligated to buy the ticket.”
The Affordable Care Act, adverse selection, and the “insurance death spiral”
The so-called Affordable Care Act provides a superb “real world” study of the consequences of adverse selection. This is further analyzed and illustrated in a Forbes article which was published today on the forbes.com website. The author of the article is Dr. Scott Gottlieb, who holds a research appointment with the American Enterprise Institute in Washington, DC. Also see “Adverse Selection – a definition, some examples, and some solutions” and the Wikipedia article about adverse selection (@ http://en.wikipedia.org/wiki/Adverse_selection).
Obamacare Faces A ‘Death Spiral’ — But It Turns On The Declining Participation Of Health Plans, Not Just Rising Premiums
“Given the failed launch of Obamacare, there’s a real chance that the entire scheme falls into an “insurance death spiral” — but not as visibly (or rapidly) as the way these sorts of unsuccessful insurance pools usually unravel. A death spiral happens when only the sickest beneficiaries get into an insurance pool, causing the cost of medical claims to rise, and in turn raising future premiums. These higher premiums, in turn, dissuade healthier beneficiaries from buying coverage. This exacerbates the strains and makes sure the pool continues to attract only the sickest consumers who are most in need of the medical coverage, and willing to pay the rising premiums. This is how the downward spiral ensues.”