The Economist - Christmas Issue III - Barbecues

My apologies to my vegetarian friends, but who doesn't like a good barbecue? The last article that I enjoyed reading is about the American barbecue culture.

I guess that in Brazil, Argentina, and Uruguay we have a similar love for a good barbecue but use much less seasoning than in the US. Here a good barbecue goes with "farofa" made out of yucca (or manioc) flour (difficult to explain its taste unless you have tried it, but think about sand that tastes deliciously).

Food is such a strong way to make people bond... Traveling around Italy, France , and Spain just chasing their regional cuisine is an amazing experience and one of the joys of living in Europe.

The Economist - Christmas Issue II - Expats

The second article I enjoyed reading in The Economist is a piece on the experiences of Western expats in China, and of Chinese expats in the West.


I leave a question to my readers. Would you prefer to live an expat's life (with all the perks involved) in a dictatorship growing like crazy, or stay in "old" Europe with its small growth rates?

The Economist - Christmas Issue - Lucky to be in Business School

One of my favorite past-times during the Holidays season is to read the Christmas issue of The Economist. There are lots of "not-so-serious" articles on a wide range of topics that makes for an excellent reading.

In the next three posts I'll talk a bit about three of them that drew my attention.

The first ones is about life in academia and the unmatched expectations of doing a PhD (specially in humanities).

It must be really difficult to finish your PhD in Literature and have no place that would have paid you no more than 40k USD / year anyway. Not mention the fact that currently it takes about 7-8 years to get a PhD in those fields. A newly minted Finance PhD in the US gets around 170-220k / year. European salaries are much lower than that (apart from LBS and INSEAD) but still much better than what a humanities PhD would get.

I've been very lucky to be in a field where PhDs are highly paid (thank you Wall Street and the City for raising our outside option value) and that it is something that I love. At least in my case, the expectations I formed over the five years seemed close to what I ended up getting.

Vizualization

This link has a very interesting (and beautiful) use of Internet data that looks at geotagged photos to determine movement patterns of tourists and locals in several cities of the world. The photos are constructed by Eric Fisher. I found through this post (hat tip to my wife for sending it to me!):

http://trendland.net/2010/10/20/eric-fischer-maps-photographs-of-locals-vs-tourists/#

The pic on the link above is for NY. For Barcelona it is amazing how different traffic is between the two (Red are tourists and Blue are the locals).

Like someone said in the comments, the compilations looks like a Pollock painting.

What a month!

I apologize to my few readers for the lack of action in this blog. I've spent only 5 days in the past month at home and it has been difficult to find time to post. I hope to publish a few interesting things I've saved over the next week or so.

Anyway, I have spent the past 10 days in the US working with my co-authors in Georgetown. It is amazing how working face-to-face really speed things up. As usual, progress was slower than expected, but nevertheless we did good work on all the papers and should be able to submit at least one before the end of the year. DC is really a great city. Very international, full of good restaurants and with a very nice vibe. I highly recommend a visit to anyone.

Still a long way

Lots of student and non-Brasilian friends ask me about the Brazilian economy and its recent emergence as an economics power house. I usually tell them that we have gone a long way, but still have a million problems to solve.

This graph below (from the FT's Beyond BRIC's blog shows the composition of Brazilian exports since 2002 split between primary and manufactured goods. Much of the increase in primary goods can be explained by the commodity price boom (both in prices and Chinese demand).

This is all fine in simple monetary terms, but if Brazil ever wants to be at the frontier of development we serious need to begin developed higher value-added products (and research). Otherwise we will be the granary of the world (with good caipirinhas and samba) and that's about it.

Life Must Be Tough for Some People

It must be really hard to be a real estate agent in Florida...

Man vs. Machine

Since the "flash crash" in May, there has been lots of talk about how computer trading algorithms  (i.e. algo trading) can crash the market by overwhelming the market with sell orders triggered after some event-based signal takes place.

Using computers to trade in the milisecond frequency makes it almost impossible for human beings to beat machines because there is no way to match their trading speed.

The FT last week had a very interesting story on how two (independent) Norwegian traders exploited a flaw in the algorithm of a U.S. firm to make money out of illiquid Norwegian stocks. So far so good, but the traders have been handed suspended prison sentences for market manipulation and a fine equal to their trading profits.

I find these charges a little odd. How come a computer that has a built in set of rules is not "manipulating" the markets when it places their orders? Two investors, doing a careful research job, find a flaw in the strategy and placed their bets, taking up the risk along with it. What's wrong with that? T

he U.S. firm is to blame for having a poor algorithm in the first place.Unfortunately this reminds me of that story saying that financial firms enjoy the profits but ask someone to bail them out in case of losses.

It's alive!

Those things don't happen often (at least not as often as I hoped!), but here is the link to my latest paper. It is joint work with Reena Aggarwal and Jason Sturgess (from Georgetown University)

To those of you interested in knowing a bit more about my research, this is it. Any comments are highly welcome!

Does Proxy Voting Affect the Supply and/or Demand for Securities Lending? 

We use a comprehensive proprietary data set consisting of shares available to lend (supply), shares borrowed (demand), and loan fee to study the securities lending market in the United States. We provide a better understanding of the securities lending market; examine the role of institutional investors in the voting process by analyzing the supply of lendable shares around the time of a proxy vote; and to address some of the issues related to empty voting we examine the changes in borrowing demand around the time of a proxy vote. On average, 19.57 percent of a firm’s market capitalization is available for lending, 3.3 percent is actually borrowed, and the annualized loan fee is 42 basis points. During our sample period, 2005-2009, there are 105,143 proxy agenda items. At the time of a proxy vote, there is a significant reduction in the supply of shares available to lend because institutions restrict or recall their loaned shares prior to a vote. The reduction in the supply of lendable shares is most pronounced in cases associated with significant events such as mergers, and with agenda items for which ISS recommends voting AGAINST the proposal. Our findings are consistent with institutional investors responsibly recalling shares, hence reducing supply ahead of material proposals. Most of the increase in loan fee around the time of a vote is associated with the reduction in supply which is related to the desire of institutions to vote their shares. We find statistically significant evidence of increase in demand however this increase in demand is economically small relative to the reduction in supply. In contrast, we find that the large increase in loan fee around the time of the ex-dividend date is driven by an increase in borrowing demand for cash flow reasons, with no change in the supply of lendable shares.

Why There is No System Like Capitalism...

Many in Brazil are fond of socialism, tough none moved to Cuba or China. Here is maybe why:

Alphas, Betas, and Sales Pitch

On Friday I had lunch with a colleague that told me about a job interview when he used to be at Goldman Sachs for a position with on the sales team.

Being asked how good he was at sales the candidate - an Insead MBA student - said:

"I will sell your beta as if it were alpha."

If I was sure he came up with this answer on his own, I would have given him the job on the spot. Maybe I would prefer that he had told the truth and explained how he could sell high beta as a good market timing move, but I still fiound it a greant answer. For those of you that don't remember.know what is the difference between beta and alpha, here goes a (maybe not so) simple explanation.

In modern models returns are explained as a function of their exposure to underlying risk factors (like the stok market, liquidity, etc.). A fund that takes up lots of market-related risk will have a high "beta" relative to the movements of the stock market. Thus, any over-performance relative to market would simply be due to higher exposure to risk rather than a superior managerial skill (i.e. a high "alpha") possessed by the fund's manager. Alpha is the return over an above the expected given the fund's exposure to sources of risk.

Handling mobile phone calls during a class

A colleague sent me this link on how a professor (in Asia) reacted to a student picking up the phone and answering during a lecture.

Is this the way to go forward?

Una profesora de cuidado en Yahoo! Video

Another year begins!

European schools usually start their academic year about a month after US schools do. Tomorrow it 's my turn and I begin teaching the Capital Markets course to 1st MBA students. It is always exciting to meet a new class and get to know students.

For those of you visiting the blog for the first time, welcome! I hope you like what you read and keep coming back!

 

Tips on Lectures

One of my colleagues sent me this very interesting video with tips/comments on how to improve the quality of lectures. This link below contains the full list of videos at Harvard's Derek Bok Center for Teaching and Learning

http://isites.harvard.edu/icb/icb.do?keyword=k1985&topicid=icb.topic650252&panel=icb.topic650252%3Arwatch%248%3Fentry%3D18850%26watchfull%3Dt&state=popup&view=view.do#a_icb_topic650252

Hat tip to JCVD.

MBA Rankings

I love rankings and this post here, by the guy who created the Busines Week one, analyzes the big MBA rankings out there. IESE makes #1 in the Economist ranking, but this seems to be the worst ranked of all.

To be honest, I think IESE has one of the best but not the best MBAs in the world. We have some top-notch departments and a few characteristics that makes us unique in the world.

That said, I believe that the writer has the usual U.S. bias in his analysis, downplaying European schools a bit.

My two cents on this is that the top 3 things are:

1. Salary 2-3 years after graduation (PPP-adjusted)
2. Student diversity (US schools could do better here, IMHO)
3. Faculty commitment (tough to measure but it makes a world of a difference to students)

Any opinions?

Another Interesting Graph

One of interesting (and bad) features of this recession in the US is the much larger increases in unemployment. This graph here from calculatedrisk.com is interesting:

Not only employment fell by more than other recessions, but it is been taking longer than others to recover.

There and Back Again

The usually great Emmanuel Derman has a nice description of how the financial crisis turned into a "real economy" crisis. For all incoming students of the Capital Markets course, this is one of the things we'll discuss in class:

° After the financial crisis everyone got scared about the future and stopped buying the crap they don't really need.

° The companies that make the crap people don't really need, anticipating a decline, laid off people, sometimes preemptively.

° The laid-off people then had to stop buying not only crap they don't really need but some of the things they actually do need.

° That affected the companies who make things people really need, and so they laid off people too.

° If everybody would just start buying stuff they don't really need then pretty soon everyone would be able to buy the stuff they really need.

Even will all the talk of the emergence of the BRICs The world economy stilldepends a lot on a healthy US economy. The last round of indicators showed that the sky is more cloudy than it was last quarter. Will the US come up with another large stimulus package? Is this going to rattle ond markets or are we still going to see the low yields observed today?

Qualities of a Sucessful PhD student

Sometimes I have MBA students interested in pursuing a PhD or just curious about what it takes to get one.

This article is spot on in describing what are essential qualities of sucessfull PhD student in any field.  I particularly agree with this:

"There's a ruinous misconception that a Ph.D. must be smart.
This can't be true.

A smart person would know better than to get a Ph.D."

I hope that my blogging helps to make me a better and more productive writer...

Combining things in new ways

Many times, doing research is a matter of putting together existing things in a new way that nobody thought before. 

I saw this Ted Talk given Blaise Agüera y Arcas, the architect of Microsoft's Bing Maps, showing the integration of live information (not just photos, but also live video) with maps in amazing ways. Given the advances in computing power and networks we havebeen seeing, there are lots of amazing things to be seen in the near future. It's about 8mins long, but worth the watch.

If only people got that sense of amazement when I presented my work... :)

Behavioral FInance

Wow. Summer is busy even after classes are over! I thought I'd have more time to post but, as usual, we can't get what we want... Anyway, this is an interesting article that appeared in the FT about a hedge fund that uses behavioral finance techniques to invest.

Personally, I believe that behavioral finance brings essential insights on how financial models should strive to incorporate the idiosyncracies of human behavior rather than to take the easy way out and assume that investors are perfectly rational. However, up to now at least, I think that behavioral finance is still at a point in which is more like a collection of results challenging the current paradigm ("mainstream" finance) but still not able to come up with a good alternative theory. I'm not sure it ever will given how "strange" human beings can be whenever money is involved (or generally).

Altogether the article is very interesting and contains a useful introduction to behavioral finance. The trading strategy looks interesting too! Here is the beginning:

Before you even started reading this article, it had already been electronically scanned and its language examined by dozens of computers at hedge funds and investment banks.

At MarketPsy Capital in Santa Monica, California, remote servers will have rated how positive or negative it is on the economy and checked for emotional content on thousands of companies. Finding nothing useful, the computers will then move on.

If you can meet with Triumph and Disaster And treat those two impostors just the same;

Yesterday was a tough day to Brazil. We played beautifully in the first half, but failed miserably in the second, losing to the Dutch by 2-1. 

Today we have Argentina vs Germany, and Spain vs. Paraguay. Now that Brazil is out, I'm 150% behind Spain.

Tomorrow we have the 2010 Wimbledon final. In the tunnel that leads to Wimbledon's Centre Court, the players pass under two lines of poetry in Rudyard Kipling's ``If'' poem (the title of this post). Very inspiring for victories and defeats.

Here is the whole poem read by Roger Federer and Rafa Nadal:

Clearly there was something wrong with this...

From Brad DeLong's blog he quotes this article:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent. Pay rose just as dramatically. From 1948 to 1982, average compensation in the financial sector ranged between 99 percent and 108 percent of the average for all domestic private industries. From 1983, it shot upward, reaching 181 percent in 2007.

I'm a true believer of the contribution to society by financial instutions, but when they are generating more profits than other industries, there is clearly something wrong going on....

Equity Premium Puzzle

Today I received a very interesting email from one of my MBA students. Here is what he wrote:

"Professor Saffi,

I noted an article of interest on one of the financial blogs I read, titled "Revisiting the Equity Premium" (http://blogs.reuters.com/felix-salmon/2010/05/20/revisiting-the-equity-premium/). The blogger advances three main points in the article;
1) most managers are not sure why they use an equity premium of 5%-8%

2) That two noted researchers indicate the premium is really 0%-2%
http://alephblog.com/2009/07/15/the-equity-premium-is-no-longer-a-puzzle/
http://falkenblog.blogspot.com/2009/07/is-equity-risk-premium-actually-zero.html

3) That we assume that equities MUST yield more than treasuries based on efficient market hypotheses, however, rather than must, we should be using the word HOPE and recognize the incentives in the system and that the past will not reflect the future.

Please let me know what you think."

Here is my reply:

At the end of the day, the magnitude of the risk premium depends on the risk aversion of investors and the future cash-flows of firms that capture productivity gains (i.e. their average returns). The idea behind using past data is exactly to try to have an estimate of its current value, which can also fluctuate over time. Is it possible that investors have been greatly exaggerating this future estimated performance? Yes, it could. In my humble opinion, this is also related to the Malthusian theory that mankind won’t be able to keep raising food productivity. People have been saying that for 210 years and we’re still going strong

To be honest, one reason why managers don't why they use 5-8% is because most have never seriously studied its determinants. This guy here probably doesn't as well:

Schrager then continues her argument with this:

“Equities are inherently riskier than Treasuries. Equity prices must ultimately reflect and compensate investors for that risk or no one would hold them in their portfolio.”

I’m not sure where that “must” comes from: maybe it’s some kind of corollary of the efficient markets hypothesis. Investors certainly hope that returns on equities will be commensurate with the risk that they’re taking. But there’s no rule saying that any given asset class will “ultimately reflect and compensate” those hopes. After all, if there were such a rule, then really there wouldn’t be any risk at all!

This has nothing to do with the efficient market hypothesis. We could still have rules for things that are inherently uncertain (just think about quantum physics or the Heisenberg uncertainty principle). There is nothing that says that the equity premium MUST be around 5% in the future, it is just our current understanding of it that allows us to forecast this. Sure, some factors are likely to reduce the premia, like taxes, transaction costs, and etc, but saying that the market premium is zero seems a bit of a stretch to me.

Not as bad as it seems...

Personally I think that the likelihood of any sovereign default of Spanish bonds is much lower than thought by the financial press. If you're read the FT it feels like Spain will follow the path of Greece really soon, when in my opinion, the situation in the UK is not much better.

Anyway, a friend of mine (Jason Sturgess) sent me this picture below that is really interesting to show the linkages between EU countries. While Greece's overall impact is very small, with Spain things have a much bigger magnitude.

Exciting Day

Today I finally got the teach the first case study I've written:
  
Volkswagen AG: Valuation in 2009

This is a case on multiples valuation based on Volkswagen around on May 2009, right at the peak of the crisis.

I think the session went well and students enjoyed themselves. Hope I'm right!

Stock Analysts are Still Optimistic

The picture below comes from a McKinsey report (you need to register to read it all) showing that stock analyst tend to be overoptimistic.

Two things draw my attention:
i) In 2008, because of the crisis, the difference between January forecasts and the realized EPS is huge (almost 40%).

ii) The over-optimism in itself is not that surprising given the skewed incentives analyst have. Not even with regulatory changes seemed to have reduced the problem.

Complexity

Today I followed this link from Brad Delong's and read a very nice story on how quickly the Internet would change the business model of TVs. Here is the into:

"I gave a talk last year to a group of TV executives gathered for an annual conference. From the Q&A after, it was clear that for them, the question wasn’t whether the internet was going to alter their business, but about the mode and tempo of that alteration. Against that background, though, they were worried about a much more practical matter: When, they asked, would online video generate enough money to cover their current costs?

That kind of question comes up a lot. It’s a tough one to answer, not just because the answer is unlikely to make anybody happy, but because the premise is more important than the question itself.

There are two essential bits of background here. The first is that most TV is made by for-profit companies, and there are two ways to generate a profit: raise revenues above expenses, or cut expenses below revenues. The other is that, for many media business, that second option is unreachable.

Here’s why...."

 The article then goes on and talks about how too much complexity can destroy societies. This reminded me of Collapse by Jared Diamond, which I highly recommend, on what made several different societies collapse over our history.

More important that how TV will be affected by the Internet, is how Western developed countries (Europe, the US, and Canada) will manage their complexity and the emergence of China.

Profits

I still think that the US Treasury might make a profit on assets it bought during the crisis:

Martin Wolf @ IESE

Today we had Martin Wolf giving a special lecture at IESE on  "Development and Globalization after the Crisis". His daily column on the Financial Times is very good and interesting, I recommend it to everyone. It was nice to meet him in person, but it is a shame that I don't have the slides of his presentation to show. It was also very good.

In summary, he is still very worried with the recovery of developed economies in the future. The fiscal outlook looks bleak for US/Europe and that the recovery can only be sustained if the private sector can replace public spending.

Hedging World Cup Risk

Today I was walking around Barcelona and saw this interesting time-deposit offer from Banesto (a local bank). They promise you 3%/year, but IF Spain wins the World Cup, the investor gets 4%.

Around the World Cup we see all kinds of offers like this (in Spain, the UK, and Brazil at least): buy a flat-screen TV and if Brazil wins you get another one, etc.

An interesting question is how much money does the bank expects to spend with this offer? How should  this be hedged?  Of course, based on historical probabilities they won't lose a dime, but with Spain being one the favourites, what to do to at least find an estimate? 

Supose that the bank's reinvestment rate is 4%. If Spain does not win the World Cup, they make a 1% profit. If Spain does win, they make zero. The expected return is the 1%*(Prob Win), which looks good on their side given previous history.

I wonder if they could hedge this against a portfolio of online bets held by betting houses. 

Any ideas? This might turn into a nice exam question or topic for the derivatives course.

Incredible Mistake

This story is in Spanish, but it is so good that I had to post the video here. Basically, the Romenian army wanted to help the humanitarian effort in Haiti by sending a battalion of mountain troops and 2,000 tons of supplies. However... their defense ministry messed up the names and sent everyone and everything to Tahiti instead!

I guess this is the kind of mess that we only expect to see in financial markets!

UPDATE: Just found out it was a hoax. I guess I should have done my due diligence better! :) Nice one though.

UPDATE2:  The story did appear in Spanish news, but THEY didn't do their due diligence. The story was in fact a hoax from a Romanian website. Nothing like blaming others... ;)

Spanish Mess

Paul Krugman has written a nice summary of how Spain has reached its current (poor) economic situation.

http://krugman.blogs.nytimes.com/2010/02/09/anatomy-of-a-euromess/

The comparison with Germany is also nice. We can definitely see all the rent income earned by Germans who invested in Spanish real estate. I bet that if we look at the UK we might see the same thing.

I wonder what will happen with the deficit as this rental income (due to smaller demand for real estate) goes down.

Financial Bets

This is funny: the directors of the Indianapolis Museum of Art waged an online bet with the New Orleans Museum of Art which depends on who wins the Super Bowl this Sunday (the Indiana Colts play the New Orleans Saints). The losing city will lend a good paiting to the winning one for three months (Indianapolis waged a Turner, while New Orleans waged a Claude Lorrain).

Here is a quick suggestion for how to solve the problem with the Chinese yuan overvaluation: if the US has more medals than China during the next Summer Olympic Games, the Chinese agree to revalue their currency by say 20%. If they lose, the US government refrains from calling for a revaluation for at least 20 years...

Something to Relax the Eyes

Possibly my favorite painting:

I really should have gone to the d'Orsay last time in Paris. I'll pay the National Gallery a visit next time I go to London to see its cousin.

Myth of the American Over-spending

I enjoy seeing a statistic that changes my preconceptions about an issue. Over this decade I've read many articles about the excess spending by American consumers and how people were buying cars, flat-screen TVs, etc...

This article by Doug Henwood shows the share of consumption relative to GDP with and without medical expenses. I guess the UK picture would look completely different given the impact of NHS.

I guess this yet another good reason to improve the health-care system in the US.

Poor Haiti!

Poor people in Haiti, who seem to have been hit by every possible man-made and natural disasters know to mankind.

Hope that they can receive as much help as they sorely need and can rebuild/improve their country quickly.

For those of you who would like to help, here is a Google-page with well-known organizations that are accepting donations for the relief effort.

http://www.google.com/relief/haitiearthquake/#utm_campaign=en&utm_source=en-ha-na-us-sk&utm_medium=ha&utm_term=haiti%20support

So Long Holiday Feeling!

Wow, it doesn't even feel like I just came back from a very pleasant holiday break in Brazil! This is a gone be a busy couple of weeks!

This Friday there is a deadline (the 2010 FMA meeting in NYC in October), I'm finishing a revision to re-submit a paper to the RFS (fingers crossed for me!) and "own" things to three different sets of co-authors. in very orthogonal projects. Luckily - or not - one of them works right next door to me. so I can always negotiate a small extension...

I guess the alternatives to have to work a lot are much worse. Finding interesting and useful ideas were the most difficult aspect of the PhD (and always a challenge). Hope my (poor) time management skills kick in and everything gets done fast.

Anyway, dinnertime and then back to work!

Freezing Europe - From Space Edition

Most of you know about or having been feeling the effects of the cold snap hitting Europe and the US. The UK has been particularly hit by it and today the BBC showed one of the prettiest pictures I've seen so far:

I really wish that sub-orbital flights were cheap enough such that I could go take a peek of Earth from above. I wouldn't mind getting rich either... This company (based in Barcelona) has a really cool business model. I hope they succeed!

Paul Krugman on Crises

For my (few) non-academic readers, every January Econ and Finance academics get together for the AEA/AFA meetings, the most important conference we have. (Off-topic: for anecdotes on how cheap economists are during these meetings, check this WSJ article)

This year they took place in Atlanta, where I heard was freezing relative to the nice weather in San Francisco last year. On top of presenting papers, interviewing job market candidates and going out for dinners with old friends, people also get to attend panels and luncheons with speeches by top people.

I just read Paul Krugman's summary of his Nobel luncheon speech on financial crises. It's a very good piece looking the effects of the current financial crisis relative to previous currency crisis.

Every time I think about currency crises, I think about Mark Twain's quote:  "History does not repeat itself, but it often rhymes."