Economics & Finance

EMH Vs. “Irrational Exuberance”

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WSJ ran an article today (subscription required) on the continuing debate between efficient market theorists and the so-called behaviorists who have set up shop at Friedman’s old office. I don’t know about the “boyz” but I continue to split my funds three ways in both my personal account and in 401K: International Index, Russell 2000 Index, and SP 500 Index. As the “behaviorists” concede, I find it hard to beat the market over the long-run. And in my case, long-run is when I die most probably in about 40 years or so.

Addressing the Social Security problem will be one of the most important domestic issues in the next four years regardless of who wins the November election. I suspect we will be hearing more of this topic in forthcoming years.

-Sulaiman

More on Manipulated Markets

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In a previous post I speculated about politically driven manipulation of online political futures markets. As I noted then, other bloggers also thought something was amiss.

Today’s Intrade press release acknowledges attempts at manipulation:

A wave of heavy selling hit the George Bush re-election contract on
Intrade Friday driving the market down to all time lows before recovering.

“Our exchange operations staff continuously monitors our markets and
reported that a very large sell order hit the Bush Presidential contract at
approximately 1:30 pm EST on Friday October 15th”, said Chief Executive
Officer John Delaney.

“The sell order caused the market to trade at new lows before
recovering to earlier levels. The exchange has more than 40,000 members,
after assessing there was no news to cause the decline, traders quickly
started buying and within 3 minutes the market fully recovered to price
levels seen prior to the sell order being executed” says Delaney.

Some question if the market can be manipulated with such heavy selling
or buying.

“All emerging markets will experience volatility, we are gratified
that the market recovered so quickly and without any intervention on our
part. This demonstrates the market’s resiliency, that the Intrade exchange
is the destination for serious traders in political contracts and that the
utility of the market as a price discovery mechanism is firmly intact” says
Delaney.

Post-debate sell off hits Bush contract

The Intrade Bush contract has become the battle ground of wills between
a cadre of large, well financed rogue traders seemingly bent on driving down
the Bush re-election contract and a growing list of financial traders who
think they can predict the outcome of this election.

Some question if George Soros is behind these market moves.

[. . .]

And Don Luskin further develops his argument.

I have an increasingly strong feeling that Bush will win overwhelmingly.

(Related posts: Here, Here and Here)

Economics Nobel

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The University of Chicago is nearly as dominant in October as the New York Yankees, but this was not the year (Go Sox!). This year’s prize went to Finn Kydland of Norway (Carnegie Mellon University and the University of California) and Edward Prescott of the United States (Arizona State University and the Federal Reserve Bank of Minneapolis).

Their breakthrough publication was “Time to Build and Aggregate Fluctuations,” Econometrica 50 (November 1982): 1345-70. Econometrica’s archives are available only to paid subscribers, but there is a copy at the Minneapolis Fed’s website, which also has many other articles by Prescott, some with Kydland. Central banking policy, not surprisingly, was another area of study for them, and “Rules Rather Than Discretion: The Inconsistency of Optimal Plans” (Journal of Political Economy 85 (June 1977): 473-91) extended and quantified viagragen Friedman’s insight of monetary policy as a game between central bankers and rational actors in the economy, with the rational expectations of the players serving to anticipate and subvert the intentions of central policy.

“Time to Build” is considered to be their most important work. It established technological disruptions as one of the drivers of the business cycle, with the lag time of bringing innovative capital assets on line contributing to the uneven effects. This is essentially a supply-side factor in business cycle analysis, and reinforces the futility of monetary fine-tuning.

Does anyone else notice the similarity to Schumpeter’s thoughts on creative destruction?

Update: I finally found an extract of the Nobel committee’s citation, which gives a layman’s explanation of their work and leaves all the horrid math out.

The Libertarian Gap

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(crossposted on Flit(TM))

The Gap, or more formally the Non-Integrating Gap, is a concept at the core of Dr. Barnett’s The Pentagon’s New Map: War and Peace in the Twenty-First Century. But what is the Gap? This question comes to me every time I read a libertarian critic of the concept.

Gap countries are, by definition disconnected from the global rulesets that manage the Core, those states where a disturbingly large proportion of the world wants to get into. I say disturbingly because, all things being equal, there is really no reason for people socially acculturated and biologically specialized to warm climes to make their way in large numbers to nordic nations, but they do. Something pretty special must be attracting them while simultaneously repelling them from their ancient homelands. That something is clear after a bit of investigation, huge waves of horrifying violence interspersed with a daily brutality of individual denigration and lack of the normal rights to live out their lives in control of their own destiny.

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Just peachy

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David at Tradingmarkets.com was nice enough to set me up with a free account to use at their trading site in exchange for mentioning them if I use their ideas. Nice trade I thought, Thanks Dave. It’ll be interesting to see what they have to offer. From the looks of it, it’s oriented towards short term traders, which sometimes I am. The thing to remember with news sites is that the most important factor is the filter in your head. Take the good, chuck the bad. Easier said then done, but nice to keep in mind nonetheless. There are plenty of investment ideas out there, the key is to know how to make use of them.

The portfolio performed fairly well today, with the long Amazon/short Overstock pair doing what they’re supposed to do. Amazon is down 2.2% while Overstock is down 5.5% for a net gain of 3.3%. Dollar wise, the OSTK short position is a little bigger than the AMZN long position, so it’s a nice bonus. Ideally you want pairs to make money in any market. You give up some of the upside on up days to hedge against ugly days like today. Overall, the portfolio is up $107.50 including all commission costs (we’re rich!).

Amazon seems to be keeping above its support I charted out yesterday. Hopefully it will hold.

According to the prospectus, Overstock will distribute shares to the bidders in its secondary auction on May 18, which is tomorrow. They didn’t mention a time frame, however, if they handle it like other secondaries it should be during the trading day.

The thing to watch is of course how the trading progresses after the secondary. This is where that Family Feud analogy comes into play. What do the bidders on the secondary do with the stock after they receive it? Do they flip it at the open? Do they keep it on and hope for the best?

It’s an academic exercise, which is to say it’s useful until the shooting starts. But it’s always fun to play out scenarios. Since I have a vested interest (I’m short OSTK), obviously I play out the ideal scenario first. As of close today, the bidders of the secondary are in the money. OSTK closed at $31.04 today. The secondary is priced at $30.50. Flip it at today’s closing price, and you have a free 54 cents courtesy of W.R. Hambrecht & Co. Ideally they will be nervous. The market is topsy turvy, and that 54 cents instant profit starts to look not too bad compared to the red on their screens. If OSTK opens up anything, I would guess there’s a temptation to sell. They know more supply will be on the market since not every bidder for the secondary will hold. Why not take a little profit? Ideally it will break the print price of the secondary. If it does, then the bidders on the secondary will feel hosed. Ideally they will then want to contain the damage, and flip it ASAP.

That is of course, the ideal scenario.

What’s the worst case scenario? Nobody sells from the secondary. The print price holds, and OSTK goes up. The market rallies, and OSTK gets squeezed. This is hopefully where that AMZN long comes into play. I call it bounce insurance, i.e. if the market bounces, you capture some of that upside.

One rule of thumb I like to follow with scenarios is that usually, you take the best case scenario, take the worst case scenario, and somewhere in the middle is what will happen. Simplistic, but again I like to keep things simple.

Can’t wait to see what happens tomorrow.

Long AMZN, short OSTK