Read a decent article on the Open magazine that got me thinking about morality. The article is by this pretty good writer called Manu Joseph. Scores of people jump on to the morality bandwagon every time a celebrity has a bout of infidelity. Though it is a lot of fun to watch people get all gagged up when they are expressing their utter disbelief over the latest transgressions of some so-and-so, I think people miss one critical detail in this whole fidelity-morality extravaganza. Opportunity.
Let me explain. Fidelity is a function of two factors - opportunity and morality. This is why it is easy to say "I would never sleep with Sophia Lauren as I am married and with two kids. And therefore it is morally wrong". If you are a witless fat slob whose idea of a good joke is to quote something from this blog, the likelihood of sleeping with Sophia Lauren is, well, pretty low (And I am being very kind here). So, the limiting constraint here is the lack of opportunity, and not the presence of morality.
Celebrities cross the line more than you or I do because they can, and less because they are less morally anchored than you or I. Or, to put it differently, average Joe would not even have an idea of how difficult it would be to be morally right when the opportunity presents itself.
One of my friends put this beautifully. One fine morning, whilst in college, with this deep thoughtful look on his face, he pronounced - "Samaj saktha hoon be". This elicited the inevitable - "Kya?" from the gang. "Soch ke dekh na, tu hero hai, Sonali Bendre ke saath baarish me naach raha hai, uske baad woh tere saath aa ke pyaar se baat karti hai. One thing leads to the other, etc".
Tum bhi soch ke dekho, samajh jaaoge. :)
Tiger Woods had the opportunity, he crossed the line. The only peeve I have with him is with regard to his bad taste.
Monday, March 8, 2010
Wednesday, August 5, 2009
What price price discovery?
In the financial world, there are some dogmas which participants are keen to reinforce every now and then. The stated justifications for these are mostly on the basis of principle, while the real reasons have generally got to do with more parochial interests (Regulatory arbitrage is one that comes to mind). There are many such dogmas around – the concept of a high-water mark, the notion of insuring bonds to get a higher rating, the idea of low-tax offshore havens, etc. In my mind, the one that has caused the most damage is the notion that liquidity is the holy grail of the capital markets (in fact all markets). We have all been led to believe that liquid capital markets are good for participants, regulators, small investors, governments, everyone else. Why, indeed? Because it aids price discovery. It helps the market know exactly what the market clearing price is for any stock at any point of time.
Creating liquidity in every imaginable market has become a guiding principle for participants that we have often created tradable entities where none should have existed. We want to trade carbon, carbon footprint, grades, virginity?, and many other historical non-tradables. I do not want to enter into the debate of moral questions on trading all kinds of stuff. I am not easily outraged, and more importantly, I would prefer debating on this issue without entering the morality domain. The belief that if anything is tradable, the price would be accurate is ubiquitous. I think this is just plain wrong. Some instruments are meant to be illiquid. In our fetish to create liquidity, we create shallow markets and prostrate before the holy god of price discovery. Merely trading over and over again does not aid price discovery. We merely get to a market-clearing price, and not to a relevant discovered-price.
I think there is an interesting analogy in the science of measurement that might help explain what I am getting at here. There are two interesting terms in measurement – accuracy and precision, both of which give an idea about the efficiency of a measurement but with subtle differences. Accuracy is the measure of how close the measurement is to an actual value, while precision is a measure of how close the measurements are to each other. Accuracy depicts how close we are to the actual quantity. So, in layman terms, accuracy is what is important. Very often, we mistake a precise measurement for an accurate one. According to me, market determined share prices are very precise. Quiet often share prices are “discovered” based on orders accumulated around a point. The more orders that are there, more precise the measurement. But markets do not uncover value accurately. If that were the case, then an index would not move from 8K to 21K in 1.5 years and go all the way back in another 8 months.
Market aficionados will retort saying that there is no “actual” value as far as markets are concerned. Perception is reality, “discovered price” is indeed the actual price. This is a credible argument. One that acknowledges the inherent variability in values of assets based on future assumptions about different factors in the world. But, if this is indeed the case, why do we want precisely discovered prices. Why place the burden of precision on an entity that has no notion of accuracy? The idea of having high levels of precision for an measurement that is inherently inaccurate is absurd. This is like a weather report guy telling you that the temperature for the day should be 23.678 degrees Celsius, but with the caveat that the measurement could be off by 15 degrees on either side. If your range if this broad, your precision counts for pish tosh, a concept with financial markets have never come around to understanding.
If valuing assets is a mugs game, if variance is going to be high, if market dynamics are going to influence prices way more than actual changes, if a change in unemployment rate in the US can take the share price of a local pharma company down sharply, then why should we insist on creating liquidity and aiding price discovery. This piece from Paul Wilmott from New York Times discusses the notion of liquidity and price discovery well.
Leaving aside the question of whether or not liquidity is necessarily a great idea (perhaps not being able to get out of a trade might make people think twice before entering it), or whether there is such a thing as a price that must be discovered (just watch the price of unpopular goods fall in your local supermarket — that’s plenty fast enough for me).
I remember a time when real estate prices of places close to the LSE were higher than ones 200 meters further away – merely for the fact that orders entered into systems in these offices could hit the LSE sooner. We are talking nanoseconds here. If this does not make people look at the financial markets and go – Oh my god, what have we created here? I don’t know what will.
Apparently, this madness is finally being debated. Our fetish for liquidity has led to a scenario where High Frequency Traders account for 50% of NYSE volumes. As ever, this article uses myriad high-falutin words like Flash trading, frequency rebate etc. Finance need not and should not be this complex. If it gets to this level, we should be stopping and restarting.
Nicolas Nassim Taleb wrote a book on randomness in markets called “Fooled by randomness”. The fundamental premise in the entire book is that people do not realise the role randomness plays in life, and in financial markets. That randomness is there is undeniable, and perhaps can be managed. What is more difficult to handle is the fact that inevitably (and periodically) people create structures and thought processes that do not acknowledge the inherent randomness in life (and financial markets).
Why should stock prices trade every day? Why should stock prices be given to the final decimal? We could just have a system that says stock A trades between Rs. 50 and Rs. 55. They announce results on the third Thursday after each quarter ends. The stock can be traded for a week after their results are announced – from the Monday after the results are announced to the Friday. Beyond this, there will be a week in the middle of the quarter when stock A will be open to trade. Prices will still be “discovered”, liquidity will still be there, randomness will be acknowledged, there will be little mark-to-market madness, and insider trading will be non-existent. Mutual funds will not be able to publish NAVs. If there NAVs change from when they publish it to when you read it, the NAV publishing is useless anyway. This is a small price to pay, I would argue. There would be fewer people participating in the price discovery game. This may not be a bad thing.
Weather forecasts often go wrong. The financial market is often like weather forecast. Except that instead of having a weatherman give his thoughts, we have about 25 who contribute their data-points for the daily temperature, and we take the average as a benchmark for the day. Can any of these forecasts change the temperature for the day? Can more estimates improve our accuracy of our prediction? If both these answers are no, then we are probably better off with one guy trying to tie all the dots. All people in the country will have to live with the fact that the temperature could be between 28 and 32 degree Celsius. It is far better than them assuming that it is 30 degree Celsius, when in fact it could be anywhere between 14 and 46.
Imagine the number of weather forecasters freed up to do less damage to the world than they were originally doing. Now, multiply that number by a million. That would probably be the number of resources that can be taken away from harm-creating financial jobs, if the world could shed its fetish for price discovery.
Creating liquidity in every imaginable market has become a guiding principle for participants that we have often created tradable entities where none should have existed. We want to trade carbon, carbon footprint, grades, virginity?, and many other historical non-tradables. I do not want to enter into the debate of moral questions on trading all kinds of stuff. I am not easily outraged, and more importantly, I would prefer debating on this issue without entering the morality domain. The belief that if anything is tradable, the price would be accurate is ubiquitous. I think this is just plain wrong. Some instruments are meant to be illiquid. In our fetish to create liquidity, we create shallow markets and prostrate before the holy god of price discovery. Merely trading over and over again does not aid price discovery. We merely get to a market-clearing price, and not to a relevant discovered-price.
I think there is an interesting analogy in the science of measurement that might help explain what I am getting at here. There are two interesting terms in measurement – accuracy and precision, both of which give an idea about the efficiency of a measurement but with subtle differences. Accuracy is the measure of how close the measurement is to an actual value, while precision is a measure of how close the measurements are to each other. Accuracy depicts how close we are to the actual quantity. So, in layman terms, accuracy is what is important. Very often, we mistake a precise measurement for an accurate one. According to me, market determined share prices are very precise. Quiet often share prices are “discovered” based on orders accumulated around a point. The more orders that are there, more precise the measurement. But markets do not uncover value accurately. If that were the case, then an index would not move from 8K to 21K in 1.5 years and go all the way back in another 8 months.
Market aficionados will retort saying that there is no “actual” value as far as markets are concerned. Perception is reality, “discovered price” is indeed the actual price. This is a credible argument. One that acknowledges the inherent variability in values of assets based on future assumptions about different factors in the world. But, if this is indeed the case, why do we want precisely discovered prices. Why place the burden of precision on an entity that has no notion of accuracy? The idea of having high levels of precision for an measurement that is inherently inaccurate is absurd. This is like a weather report guy telling you that the temperature for the day should be 23.678 degrees Celsius, but with the caveat that the measurement could be off by 15 degrees on either side. If your range if this broad, your precision counts for pish tosh, a concept with financial markets have never come around to understanding.
If valuing assets is a mugs game, if variance is going to be high, if market dynamics are going to influence prices way more than actual changes, if a change in unemployment rate in the US can take the share price of a local pharma company down sharply, then why should we insist on creating liquidity and aiding price discovery. This piece from Paul Wilmott from New York Times discusses the notion of liquidity and price discovery well.
Leaving aside the question of whether or not liquidity is necessarily a great idea (perhaps not being able to get out of a trade might make people think twice before entering it), or whether there is such a thing as a price that must be discovered (just watch the price of unpopular goods fall in your local supermarket — that’s plenty fast enough for me).
I remember a time when real estate prices of places close to the LSE were higher than ones 200 meters further away – merely for the fact that orders entered into systems in these offices could hit the LSE sooner. We are talking nanoseconds here. If this does not make people look at the financial markets and go – Oh my god, what have we created here? I don’t know what will.
Apparently, this madness is finally being debated. Our fetish for liquidity has led to a scenario where High Frequency Traders account for 50% of NYSE volumes. As ever, this article uses myriad high-falutin words like Flash trading, frequency rebate etc. Finance need not and should not be this complex. If it gets to this level, we should be stopping and restarting.
Nicolas Nassim Taleb wrote a book on randomness in markets called “Fooled by randomness”. The fundamental premise in the entire book is that people do not realise the role randomness plays in life, and in financial markets. That randomness is there is undeniable, and perhaps can be managed. What is more difficult to handle is the fact that inevitably (and periodically) people create structures and thought processes that do not acknowledge the inherent randomness in life (and financial markets).
Why should stock prices trade every day? Why should stock prices be given to the final decimal? We could just have a system that says stock A trades between Rs. 50 and Rs. 55. They announce results on the third Thursday after each quarter ends. The stock can be traded for a week after their results are announced – from the Monday after the results are announced to the Friday. Beyond this, there will be a week in the middle of the quarter when stock A will be open to trade. Prices will still be “discovered”, liquidity will still be there, randomness will be acknowledged, there will be little mark-to-market madness, and insider trading will be non-existent. Mutual funds will not be able to publish NAVs. If there NAVs change from when they publish it to when you read it, the NAV publishing is useless anyway. This is a small price to pay, I would argue. There would be fewer people participating in the price discovery game. This may not be a bad thing.
Weather forecasts often go wrong. The financial market is often like weather forecast. Except that instead of having a weatherman give his thoughts, we have about 25 who contribute their data-points for the daily temperature, and we take the average as a benchmark for the day. Can any of these forecasts change the temperature for the day? Can more estimates improve our accuracy of our prediction? If both these answers are no, then we are probably better off with one guy trying to tie all the dots. All people in the country will have to live with the fact that the temperature could be between 28 and 32 degree Celsius. It is far better than them assuming that it is 30 degree Celsius, when in fact it could be anywhere between 14 and 46.
Imagine the number of weather forecasters freed up to do less damage to the world than they were originally doing. Now, multiply that number by a million. That would probably be the number of resources that can be taken away from harm-creating financial jobs, if the world could shed its fetish for price discovery.
Monday, July 27, 2009
Greenhouse gas emissions, India and China
The good professor has this article on his blog http://blogs.ft.com/maverecon/2009/07/does-poverty-give-a-country-the-right-to-pollute-the-atmosphere/#more-4091 .(The professor is one of the best Economics bloggers around and one of my favourites.)
Usually, I try to resist the chip-on-the-shoulder response to articles on the western media, but this time I thought the article was painting a wholly inaccurate picture and chose to comment. My comment was as follows
Dear Sir,
An interesting article. But unlike your usual articles, there are some specious bits of reasoning which are thrown in into the mix here. 1. You say that the NBP's are wrong to say "your ancestors broke it, you fix it". Mainly because their ancestors dramatically increased population.
Your exact rant reads thus - The logic in the argument of the NBPs comes unstuck especially badly here. If the overdeveloped world is held accountable for the choices of past and present generations that produced large past emissions of CO2E and resulted in today’s high atmospheric concentration of CO2E, then surely today’s inhabitants of China and India should be held accountable for the individual and collective choices of past and present generations of Indians and Chinese that have resulted in the oversized populations of these countries? The selective application of the ‘your ancestors broke it, you own it’ logic by those who advocate special lenient treatment for today’s poor countries in global efforts to reduce greenhouse gas emissions is deeply intellectually dishonest.
Sir, I cannot imagine you actually drew out this comparison. The previous generation of OECD's pillaged the world. The previous generation of NBP's had kids (because they were poor and did not know about contraceptives, by the way). I agree with your original contention that inter-temporal punishment is morally unjustifiable. But your counter-argument is built on spurious ground.The argument from the NBP's need not be stated as "It is our turn to pollute". It can be interpreted as "You have taken the lead in polluting, now take the lead in cleaning up". A stance that I find very justifiable, morally.
2. You set out to try to establish that per-capita comparisons are incorrect. Your passage says - First, the externality associated with greenhouse gas emissions relates to the total amount added to the atmosphere, not to the amount emitted per capita. A given quantum of CO2E emissions does an equal amount of global harm, regardless of whether it is produced by 2 over-fed Americans or Europeans or by 100 under-fed Indians. Those who bang on about per capita emissions appear not to understand the ‘technology’ of the global environmental externality created by CO2E emissions.From here on you draw the conclusion that per-capita emissions are an inaccurate measure.
It is undeniable that overall emissions matter to the world's well-being and per-capita is but a diversion. But when on the issue of determining how we can morally justify how much EACH country can pollute, per-capita measure is perhaps as good as any other. Would the world stop writing articles on global warming if India were broken down into 30 smaller countries, each not being big enough to be part of your global 20?
3. When you start your argument, you get in your disclaimers early; and further hedge your positions well by citing the precautionary principle. I guess George Bush's justification for the Iraq war could have been constructed on similar grounds. 1) Weapons of Mass destruction are a bad thing 2) Human-made WMD are capable of destroying the world (and very quickly) 3) That WMD can be created by some dictator-run state is a reality. Invoking the precautionary principle, one should attack everyone in sight. The green-mongers have succeeded in depicting anyone debating climate-models as someone who is out to destroy this world.
The debate on how much we need to do is very crucial to the debate on who has to do what? In the current setting, the way you have put things, it appears as if the OECD countries have woken up to the threat posed by global warming, have taken a lead in cleaning the act for the world and given the time constraint everyone (read NBPs) has to chip in. An alternate interpretation could be, the OECDs have had their fun, now that they are losing out, they are throwing the toys out of the pram. The NBPs perhaps have this view.
OECD carrying the moral high-ground on the global warming debate. Now, that is hilarious.
In case it was not obvious, I am from one of the NBPs that you have mentioned. And although I am sceptical of the climate models (from a scientific point of view), I agree to the premise that the entire world must pull together to reduce emissions. I also agree that India and China should do more to reduce emissions. What I disagree with (and vehemently) is that the OECD countries should be pontificating on moral high ground.
My stand on this global warming debate is straightforward. India should fight tooth and nail against any restrictions, be it on geopolitical or moral grounds. I belong to the Henry Kissinger school of thought - His guiding philosophy was that foreign policy should serve the national interest.
On the more global issue of global warming, I think the debate should cover the grounds on which scientists are claiming that the world is heating rapidly. Invoking the precautionary principle in defence of going green is unacceptable in a world full of vested interests. As a student of science, I am inclined to give credence to scientists' claim that the globe might be warming. On the same basis, I think there should be room for healthy scepticism for the scientists and their models.
The world is already reeling under the impact of one group of self-appointed geniuses believing the infallibility of their models; we can ill-afford another screw up like this. Let us by all means reduce CO2 emissions; but let the freedom to question these models not disappear either.
After all, it was only 35 years ago when the world was damn scared of the Ice age; and even these scientists will tell you that climate changes will take a century to take shape.
Usually, I try to resist the chip-on-the-shoulder response to articles on the western media, but this time I thought the article was painting a wholly inaccurate picture and chose to comment. My comment was as follows
Dear Sir,
An interesting article. But unlike your usual articles, there are some specious bits of reasoning which are thrown in into the mix here. 1. You say that the NBP's are wrong to say "your ancestors broke it, you fix it". Mainly because their ancestors dramatically increased population.
Your exact rant reads thus - The logic in the argument of the NBPs comes unstuck especially badly here. If the overdeveloped world is held accountable for the choices of past and present generations that produced large past emissions of CO2E and resulted in today’s high atmospheric concentration of CO2E, then surely today’s inhabitants of China and India should be held accountable for the individual and collective choices of past and present generations of Indians and Chinese that have resulted in the oversized populations of these countries? The selective application of the ‘your ancestors broke it, you own it’ logic by those who advocate special lenient treatment for today’s poor countries in global efforts to reduce greenhouse gas emissions is deeply intellectually dishonest.
Sir, I cannot imagine you actually drew out this comparison. The previous generation of OECD's pillaged the world. The previous generation of NBP's had kids (because they were poor and did not know about contraceptives, by the way). I agree with your original contention that inter-temporal punishment is morally unjustifiable. But your counter-argument is built on spurious ground.The argument from the NBP's need not be stated as "It is our turn to pollute". It can be interpreted as "You have taken the lead in polluting, now take the lead in cleaning up". A stance that I find very justifiable, morally.
2. You set out to try to establish that per-capita comparisons are incorrect. Your passage says - First, the externality associated with greenhouse gas emissions relates to the total amount added to the atmosphere, not to the amount emitted per capita. A given quantum of CO2E emissions does an equal amount of global harm, regardless of whether it is produced by 2 over-fed Americans or Europeans or by 100 under-fed Indians. Those who bang on about per capita emissions appear not to understand the ‘technology’ of the global environmental externality created by CO2E emissions.From here on you draw the conclusion that per-capita emissions are an inaccurate measure.
It is undeniable that overall emissions matter to the world's well-being and per-capita is but a diversion. But when on the issue of determining how we can morally justify how much EACH country can pollute, per-capita measure is perhaps as good as any other. Would the world stop writing articles on global warming if India were broken down into 30 smaller countries, each not being big enough to be part of your global 20?
3. When you start your argument, you get in your disclaimers early; and further hedge your positions well by citing the precautionary principle. I guess George Bush's justification for the Iraq war could have been constructed on similar grounds. 1) Weapons of Mass destruction are a bad thing 2) Human-made WMD are capable of destroying the world (and very quickly) 3) That WMD can be created by some dictator-run state is a reality. Invoking the precautionary principle, one should attack everyone in sight. The green-mongers have succeeded in depicting anyone debating climate-models as someone who is out to destroy this world.
The debate on how much we need to do is very crucial to the debate on who has to do what? In the current setting, the way you have put things, it appears as if the OECD countries have woken up to the threat posed by global warming, have taken a lead in cleaning the act for the world and given the time constraint everyone (read NBPs) has to chip in. An alternate interpretation could be, the OECDs have had their fun, now that they are losing out, they are throwing the toys out of the pram. The NBPs perhaps have this view.
OECD carrying the moral high-ground on the global warming debate. Now, that is hilarious.
In case it was not obvious, I am from one of the NBPs that you have mentioned. And although I am sceptical of the climate models (from a scientific point of view), I agree to the premise that the entire world must pull together to reduce emissions. I also agree that India and China should do more to reduce emissions. What I disagree with (and vehemently) is that the OECD countries should be pontificating on moral high ground.
My stand on this global warming debate is straightforward. India should fight tooth and nail against any restrictions, be it on geopolitical or moral grounds. I belong to the Henry Kissinger school of thought - His guiding philosophy was that foreign policy should serve the national interest.
On the more global issue of global warming, I think the debate should cover the grounds on which scientists are claiming that the world is heating rapidly. Invoking the precautionary principle in defence of going green is unacceptable in a world full of vested interests. As a student of science, I am inclined to give credence to scientists' claim that the globe might be warming. On the same basis, I think there should be room for healthy scepticism for the scientists and their models.
The world is already reeling under the impact of one group of self-appointed geniuses believing the infallibility of their models; we can ill-afford another screw up like this. Let us by all means reduce CO2 emissions; but let the freedom to question these models not disappear either.
After all, it was only 35 years ago when the world was damn scared of the Ice age; and even these scientists will tell you that climate changes will take a century to take shape.
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