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....