Friday, November 30, 2012

Deleveraging Risk

Just finished a new paper. This one is about a source of risk, we call it deleveraging risk, that affects leveraged investors during crisis the hardest. The idea is that they lose funding (either due to a loss of confidence in themselves or their capital providers) and have to cut their positions to repay their loans. Our assumption is that this hurts short investors more than long ones, as short selling inherently uses more leverage than long positions.

Here is the abstract with a summary of the results:

We assess whether deleveraging events have an impact on the cross section of stock returns. Deleveraging risk is the unique risk attributable to the existence of levered positions. When funding liquidity evaporates and short positions need to be covered, securities with greater presence of levered investors experience a significant shock as the levered investors unwind their positions. Using a unique dataset of equity lending data as a proxy for the degree of leverage in a stock, we find strong evidence of extreme return realizations attributable to the unwinding of these levered positions. We further find that these deleveraging risk events are attributable to (i) discrete liquidity events such as the quant crisis of August 2007 and the Lehman Brothers bankruptcy in September 2008, and (ii) reductions in funding liquidity as reflected in a variety of measures such as TED spread, LIBOR-OIS spread and credit risk of banks that facilitate the provision of levered capital to arbitrageurs. 


Wednesday, November 28, 2012

Academic Papers, Inefficiencies and Alpha.

Here is an interesting article on The Economist a couple of week's ago on academic articles trying to find hidden inefficiencies in stocks markets. The story talks about whether these inefficiencies uncovered by academics have disappeared over time or not.

In Finance, "alpha" is the component of returns that cannot be explained common sources of risk (like the movements of the S&P500) and several academics spend their careers trying to find anomalies that cannot be explained by current models. Thus, chasing positive alpha is what any active manager is trying to get. Of course given the huge number of people (myself included) looking at the same databases, there is always the danger of data-mining, finding patterns that are just flukes (like the Halloween effect, etc.). 

However, there are some anomalies that still persist even after they have been widely published and analyzed. This can either be due to (i) the benchmark models are missing some component of risk, (ii) market frictions (like trading costs or investment constraints) that prevent inefficiencies from being corrected, (iii) behavioral biases that human beings suffer from.

My hunch is, as things often are in life, that the answer lies in a combination them. Anyway, no wonder hedge funds and banks pay top money for good academics to join their ranks.

Monday, October 1, 2012

A good financial innovation

I just read this weekend on the FT about a new UK listed-fund whose goal is give money to cancer research, called BACIT: Battle Against Cancer Investment Trust

The idea to have a plain-vanilla fund-of-funds that will allocate investors' money in 28 other money managersbacking the fund. The interesting twise is that  is that the "... two dozen prominent property, private equity, bond and hedge funds backing the vehicle have also agreed to waive their fees – in full, and in perpetuity – to maximise returns for the scheme."

BACIT will donate 1% of its assets to charity every year. Half of all the proceeds will automatically go to the Institute of Cancer Research, one of the world’s leading cancer drug laboratories, and the remainder will be allocated to charities chosen from a list by shareholders themselves.

That's a nice idea, hope it works. Just departing from the usual 2-20 model should be more than enough to make investors interested.


Tuesday, September 11, 2012

The End of Alpha?

Interesting article on the FT about the end of alpha. While beaten up badly in the past 5-10 years, this is the kind of result that supports the efficient markets theory.

Given the amount of money currently chasing anomalies combined with the increase in the availability of information it will become more and more difficult to beat the benchmark.

A colleague of mine told that once he heard about a candidate for a sales position saying that he "could sell beta like it was alpha". I guess they will have to do it more and more over time...

Wednesday, September 5, 2012

Back to Work - Some Cartoons to Brighten the Mood

Summer is soon going to end. Keeping up the good mood, this post is about my favorite business and academia-related (though not always) cartoon sites.

Now, let's get back to work!

The first one is, which has the one below. I hope that none of the clients to each I have worked as a consultant before thought that!

The second is that always has funny things (at least if you have gone through a PhD)

The final one is It has lots of Seinfeld-kind of jokes that sometimes takes time for you to understand :)

Monday, July 16, 2012

Steve Jobs' Biography

I have finally managed to read Steve Jobs' biography by Walter Isaacson and I highly recommend it to everyone. Here are some thoughts that came to my mind:

i) How geniuses often have nasty personalities. Maybe there is some reversion-to-mean going on here: we all have qualities and flaws, but those with extraordinary abilities often have extraordinary flaws. I think that being a perfectionist also made Jobs highly critical of everything (both people and objects) and is personal life seems to have suffered a lot because of it.

ii) Most of us can actually own a masterpiece made by a reputed genius (at least in terms of design and innovation at the time. I guess this is a first in the history of mankind.

iii) On a corporate strategy level, the book highlights how dividing firms by divisions can really hamper innovation and cooperation. One of the reasons that Apple is what it is arises because all products are developed and marketed by the company as a whole. Focusing on creating just a few excellent products also helps. I guess that if you are good enough to concentrate your bets on a few products can give you a big advantage over competitors.
Ah, and one more thing...

iv) How luck plays a huge part in anything we succeed in life. Humans are very good at rationalizing successes and failures but many things turn out the way they do by pure chance (or fate if you are religious). Given his peculiar personality Jobs could easily have put himself into a deep hole that he wouldn't be able to get out of.


Tuesday, July 10, 2012

Why Brazil Won't Take Off

Today the FT has a story on Brazil's growth pains that starts with Corinthians, the second most popular Brazilian team, fielding a Chinese player to help it sales in China

The player in question, Chen Zhizhao, neatly summarizes why Brazil still has a long way to go if the country really wants to take off:

“In China, not much people [are] interested in football. The children are studying too much.”

Given the current state of Brazilian education, awful at all levels, there is no way the country can ever compete in human capital-intensive industries. All that is left is being good as a primary goods exporter. Even at that, we also need to get serious about infrastructure.

I wish I could be more optimistic about my own country...

Tuesday, July 3, 2012

Upcoming AFA meetings

Nice, the upcoming American Finance Association meetings will be held in nice cities for at least the next 5 years. Shame they never arrange something in Hawaii...

January 4-6, 2013 (Friday, Saturday, & Sunday)....San Diego, CA
January, 3-5, 2014 (Friday, Saturday, & Sunday).....Philadelphia, PA
January, 3-5, 2015 (Saturday, Sunday & Monday)....Boston, MA
January 3-5, 2016 (Sunday, Monday & Tuesday) San Francisco, CA
January 6-8, 2017 (Friday, Saturday, & Sunday) Chicago, IL  

Monday, July 2, 2012

If you can't be part of the solution...

The UK is trying hard to be part of the problem...

Often I wonder why UK politicians are so much against their current EU deal (not the Euro). As my mother used to say, if you can't be part of the solution, at least don't be part of the problem...

Thursday, June 7, 2012

Working with family

Just read an interesting article on working with family on today's FT.

My parents had a business together for more than 10 years (after a good run it went bust in 92 following yet another failure of a stabilization plan) and I totaly relate to the 100% work-mode that it becomes.

"Working with a sibling or spouse can be heaven or hell, depending on the pairing. Luke Johnson has some words of wisdom and warning..."

Tuesday, June 5, 2012

Online Cheating

Read this interesting article on cheating in online courses. I've never really been a believer in online education. I think we are still far away from being able to create the same engagement that a good teacher can generate in class.

Evaluation is even more difficult online, especially because student numbers are usually very high. Cheating among MBAs is usually much less of a problem but it does happen more often than you think.

Wednesday, May 30, 2012

Flight to Safety is Not a Good Sign

It looks like it will soon be crunch time for Greece (and the Euro)...

From Business Insider:
  • The yield on the US 10-year bond has just fallen below 1.7%. UPDATE: the yield has just hit 1.6713%, a brand new record low.
  • In Germany, the 10-year has fallen to a new record of 1.33%.
  • UK borrowing costs have hit a record low of 1.73%.
  • In Finland, the yield on the 10-year is 1.624%. You guessed it, that's a record low.
  • Sweden: The 10-year yields 1.405%. Same deal.
  • In Australia, the 10-year has dropped close to a record low of 3.061%.
  • Canadian 10-year yields at 1.87% are close to a record low.
  • Japan's 10-year: 0.85%.
  • Swiss 10-year: 0.59%.
"Get the point?
All around the world, people are clamoring for the safety of government debt..."

Thursday, May 24, 2012

More on Facebook

This is a long but interesting article on the story behind Facebook's IPO. His view is even more pessimistic than mine but the P/E analysis is quite interesting. Anyway, the stock is currently trading at $32 / share, almost 20% below the offer price.

FB may still surprise investors with a new source of explosive growth that nobody, but that is lot to count on to justify paying 60x multiples.

Thursday, May 17, 2012

A while ago I posted about my bearishness of the Brazilian stock market. Putting my money where my mouth is (was), I bought two securities in February and the other day somebody at work asked me how did it go.

I closed the trade almost two months ago (way before the current turmoil) and made money itself on the position, but after the transaction costs (wasn't investing a lot since I don't have much!) I just broke even.

Here are the details of the two securities and their current price (could have made LOTS of money if I had stayed put):

1) The first was an Ultra-short ETF on the Brazilian index (in US$)
Bought it @ 13.43 on 16-Feb 
Sold it     @ 15.15 on 13-Mar. (12% profit)
Since then it has gone up 70% if we take today's price.
2) The other was a put option on the MSCI Brazil ETF, with strike 50 and maturity in Jan/2013.
Bought it @ 3.15 on 16-Feb 
Sold it     @ 2.9 on 13-Mar. Total (8% loss)
Current price @ 5.8 17-May (100% increase) The underlying is now around 51.5.

Major lessons learned: if you trust your trade, stay put and let it develop. Be VERY careful with bid-ask spreads and commissions.

I think there has been some panic selling in the past few days. Maybe it's time to buy another lottery ticket again! :)

Tuesday, May 15, 2012

Facebook Valuation: Worth $100bi?

I was just reading in the FT that Facebook has raised its price range before the IPO. If they get what they want, the company will be valued between $93bn and $104bn.

The final project of the Corporate Finance course I taught earlier this year at Cambridge asked students (split in groups) to value Facebook. The highest valuations were around $80bi and that, often, involved some heroic growth assumptions.

Aswath Damodaran has a nice blog post with his valuation of the company, with a figure aroun $71bi. People from FT's Lex column also has an interesting calculator that you can play out with on your own (not sure if it open to non-subscribers).

At $100 billion, if I could I would surely short Facebook from the second day of trading. It will be interesting to see what the first-day price change will look like.

Either people are true believers that Zuckerberg will pull out another magic cash-flow rabbit out of his hat or....

Thursday, May 3, 2012

New Journal and more on "Publish or Perish"

Following an earlier post on the "Publish or Perish" pressure in academia today I received an email about a new journal in Finance, the Critical Finance Review, edited by Ivo Welch.

In line with Matt Spiegel's comments, the editorial line of the new journal is to give more chance to controversial papers and "non-result" ones. I believe that the profession benefits from both. Hope the journal catches on and becomes a force among Finance research outlets.

Friday, April 13, 2012

Double standards (as usual)

This week the Brazilian president visited the U.S. and kept on complaining about the "monetary tsunami" caused by the lax monetary policy followed by developed countries' Central Banks.

I'm always amazed by how she forgets that this same easy money helped to pump up growth rates in emerging markets not such a long time ago.


Thursday, March 15, 2012

What a Hectic Couple of Weeks!

On top of finishing the two courses I was teaching this term, the past two weeks have been the busiest ones I've had research-wise this year, with deadlines to submit papers to two of the three major conferences.

The first one was for the European Finance Association meeting in Copenhagen in August 2012. The second meeting, whose deadline is today, is the American Finance Association meeting in San Diego in January 2013.

In the end I managed to submit three papers.

Here they are: 
  (with Reena Aggarwal and Jason Sturgess, both from Georgetown University)

Thanks to all of my co-authors for the hard work. Let's get those babies in!

Now is back to revising them all and submit them to journals.

Make Voting More Transparent

Last December I recorded a podcast talking a bit about one of my papers and its implications to the real world.

Here is the link if you are interested.

Great editing job by Judge's team!

Saturday, March 10, 2012

Publish or Perish

This is a great article by Matthew Spiegel (editor of the RFS) on the current status of publication requirements and the fact that referees ask for too many robustness tests and changes rather than evaluating whether or not the article has passed the bar to be published.

I maybe biased due to not having that many years down the road but here is my take. Of course referees usually make great suggestions and help to improve a lot a paper, but Matthew is right that often the need to play the game of pleasing referees makes papers unnecessarily long and the review process more annoying to everyone. 

The fact that introductions are now four times longer than in the 80s is great example of this gaming taking place. In the end, as economists say, it all boils down to setting proper incentives.

Thursday, February 16, 2012

Transaction Costs, Brazilian Markets and Exotic Securities

Wow. I'm amazed by the frictions to trade more exotic stuff. I wanted to buy some put options on the Brazilian index in the UK or the US. It took me almost a month to set up an account and complete the wire transfer. I had to sign million of forms and it took almost 10 days for the first transfer to be approved.

Bid-ask spreads are transaction costs are high! If anyone is interested, thos are the two securities I selected:

1) One is an Ultra-short ETF on the Brazilian index (in US$), so if I get it right I'll get both the market fall in domestic terms, plus the currency depreciation (the real is seriously overvalued).

2) The other is a put option on the MSCI Brazil ETF, with strike 50 and maturity in Jan/2013.

Let's see what happens...

Wednesday, February 1, 2012

Moneyball and Academic Finance

This weekend I saw "Moneyball", the movie with Brad Pitt based on Michael Lewis' book. It has an enterntaining story and I highly recommend it.

One aspect made me think about academia. In the movie, the assistant GM says that teams should really aim for players that produce runs, which in the long run in what a team needs to generate wins. In academia nowadays all that people care are about publications in A journals (i.e the home runs) rather than publications in lesser-ranked journals (i.e. everything else).

I'm not sure whether having a team of heavy hitters is socially optimal!

PS - A friend of many wrote a very interesting post on the movie as well.

Friday, January 27, 2012

Scary News

This graph on British GDP is very scary:

It shows that the economic recovery following the start of the recession is actually worse than the one observed during the Great Depression in the 30s.

In my humble opinion, it seems that the dosage of the austerity medicine is killing patients all over Europe.  

(Outsourced from Brad Delong's blog post)

Sunday, January 15, 2012

Next US President?

It is becoming more and more likely that the US presidency will be contested by Obama and Mitt Romney. For those that don't know anything about him (like me), here is Vanity Fair's article on him. I found it a bit unfair on the private equity culture but it's still a good read.

Friday, January 6, 2012

Some ramblings on Brazil - Part II - Outlook

 Following up on my previous post, on this one I plan to talk a bit about the country's current situation and some (big) challenges and problems it has to solve, and quickly! Having spent the previous three weeks in Rio allowed me to chat to friends, listen to taxi drivers, and read the general news printed on newspapers to get a feel of "sentiment".

Unfortunately, my opinion is that we have all the signs of a bubble ready to burst. Outrageous real estate prices, overvalued currency, etc... Although things have improved a lot and it is obvious that great advances have been made, there are some clear signs that things are getting a little out of line. I heard someone say the other day that Brazil's growth was more of a catch-up with the present (following the lost decade in the 80s) than a new dawn that would allow the country to move up into developed status.

Everything in Rio is horribly expensive, with some things being simply ridiculous. When I moved to the UK in 2002,  living costs were way cheaper than in London. I felt like a king whenever I came back for holidays even though I was on a PhD stipend. Nowadays, things are radically different. Most things are cheaper in London and even rental prices, long a plight of London's non-investment bankers, are very close to the ones you pay in Rio.

Let me look at a few factors that might pose a problem:

i) Global Economy: I've actually been more negative about global growth prospects than now. My guess here is that the world will do better than consensus expectations while Brazil worse. Signs from the US indicate that the economic might be getting back on track while China seems to be managing to avoid a hard landing. Big risks to be careful are: (i) the Euro-mess is not sorted (God knows that politicians are trying hard to cause a disaster) (ii) the US recovery is derailed because of the presidential elections; and (iii) real estate markets crash in China. The main danger to Brazil comes from China. Its demand for raw materials have increased tremendously in past years, both in volume and prices. This was great for Brazil but the country's increasing reliance on primary products is dangerous in case international demand goes down. Since 2006, terms of trade have improved by more than 30% and if simply returns to the same levels it will have a big impact on how the current account balance is financed.

ii) Credit Growth: Because of high interest rates and some other problems, private debt to GDP ratios have always been way lower than international averages. Economic growth was bound to make (and was helped by it) grow. And grow it did. In 2003, credit amounted to 24.6% of GDP (for comparison it is way more above 100% in the US and the UK). It went to 40.5% in 2008 and reached 48% in Sep/2011, with an average growth rate of 16.3% even after the crisis period in 2009. Brazilian families' debt levels are at an all-time high and a decrease in growth or an increase in interest rates might trigger a wave of defaults that bring the house the down.

iii) Monetary / Fiscal Policy: Brazil has an official inflation target of 4.5% with 2% upper/lower bound. In 2011, it hit the upper bound but the Central Bank seems to have accepted inflation run above the target rather than increase interest rates (or implement other "macroprudential measures" as they say here) and reduce growth (always a politically tough call). Given that the public sector share of GDP keeps growing and the government does nothing to control a little its expenditures, worrying about inflation should be on investors' minds unless the Central Bank decides to change its current stance.

iv) Real Estate Prices: I might be biased since I've spent all of my time in Rio and the city had lots of good things going for it, but real estate prices are just surreal at the moment. From 2006 to 2010 prices increased by more than 150% and in 2011 alone went up by 35%. A square meter in Leblon costs around 6,000 pounds which is more than in Barcelona and similar to London. You can feel the same kind of madness that was going on in London circa 2008 and we all know how that turned out to be. Even if the nothing happens with the country as a whole, real estate in Rio is doomed to crash. When? I'd wish I knew.

All of these factors are in one way or another related to each other and while Brazil is now enjoying a virtuous cycle, things can change to a bad equilibrium and fall into a vicious cycle (kinda of like Spain and the UK at the moment). Alas, like in many countries, politicians haven't been using the good times to prepare for future lean years.

In the final post of this series I'll talk about the main challenges for the future.

Sunday, January 1, 2012

Some ramblings on Brazil - Part I - Recent Past

Hello everyone. 

Happy Holidays! I'm currently in Rio enjoying the break under 30-degree weather (well, it's actually raining at the moment) rather than semi-freezing in London (to be honest the weather has been great this year).

As I take a break from meeting family & friends, eating good food, and preparing classes for my upcoming course at Cambridge, I sat down and started thinking a little about the current economic situation of Brazil and my humble predictions for the near future and I thought that this would make an interesting post to share. I'll start with a quick overview of the recent past. On the next post, I will talk more about some of the economic bottlenecks and my view on what is going to happen. I hope it is not too long! 

My biggest concern is that Brazil is quickly approaching a ceiling given its current structure. I'm very skeptical about whether the country can sustain 4-5% growth or not and I am seriously worried that the burst of the current bubble is just around the corner. Anyway, here is my take on the near past:

Following years of bad macroeconomic policies in the early 90s, the Brazilian Social Democrats party (the PSDB) finally put the house in order and pushed through some needed economic reforms (breaking up inefficient state monopolies, budgetary expenditure checks and balances, etc.). These reforms are really what made the "growth miracle" seen under former president Lula's Workers party (the PT) possible, riding the good international climate and the benefits of the sudden emergence of a large set of consumers enjoying better economic conditions. The country had given up so many growth opportunities before sorting out its inflation problem that a huge pent-up potential was unleashed after the Real plan, the privatization of major companies, and the improvement of the international situation after the late 90s financial crises.

To Lula's merit and contrary to many people's opinions (including mine), he didn't messed up with the economy and carried on the same sensible policies implemented by the PSDB. His party was strongly against the Real stabilization plan, the fiscal responsibility law, and the banking reforms (to mention just a few), which are now touted as the ones that enabled Brazil to withstand the nasty effects of the crisis. I'm not even going to talk about the large corruption schemes that have taken place after Lula stepped into power. What makes me the saddest is that he could have achieved so much more and squandered the opportunity to implement structural change at a time when the global climate was very favorable.

Unfortunately, if you look at the reforms that Brazil desperately needs to shift up a gear, nothing has really happened in the past 10 years. Labor, pension and tax law reforms are major bottlenecks of growth and will stifle any chance of sustainable long term growth beyond 3-4% a year. All of these changes need constitutional reforms that are very difficult to pass through parliament, specially under Brazil's crazy multi-party political system. Lula decided not to fight to push them through, opting to making minor changes through regular legislation, and even those were mostly a waste. His successor, Dilma Roussef, appears to be following the same path as well.
Nonetheless, here we are: Brazil is the current darling of markets. Dozens of large companies are trying to enter the country, the expansion of consumer credit is booming, and it will host the 2014 World Cup and 2016 Summer Olympic Games.

Things look great, but now what? Stay tuned for the next post!