Wednesday, April 27, 2011

Short takes

Bankrupt stars: Athletes who lost it all - Yahoo! Sports: CNBC provides a slide show on 15 athletes and their stories who "lost it all" financially. A "look in":

"In 2008, the NBA Players’ Association claimed that 60 percent of pro basketball players go broke within five years of retirement."
REread that sentence. 60%? Wow.

Scott Burns in the Houston Chronicle looks at hedge funds and finds them expensive and risky:

"The massive growth and recent resurgence of hedge funds are strong evidence that a sucker really is born every minute....Debt increases risk, so you'll win big (maybe) or lose big (more likely). One indication you will lose big is simple: Most hedge funds die young. Researchers Burton Malkiel and Atanu Saha found, in 2005, that less than 25 percent of all hedge funds in 1996 were still around in 2004. This produces, they estimated, a huge "survivor bias" in reported hedge fund returns since the records of the failing hedge funds are quietly buried with them.

Over the last eight years the most commonly referenced index of hedge fund performance, the HFRX Global Hedge Fund Index, has trailed the return of the S&P 500 seven times. Over the last four years the S&P 500 beat the hedge fund index three times - and hedge funds are supposed to thrive in bad markets."

Robots help in Japan and not just in the nuclear plants. First it should be noted that to look at any given month in isolation is silly, but if there is a month when emotions may play a larger role it is after a disaster so it is noteworthy that quantitative trading strategies, at least in this case, beat traditional investing immediately following the Earthquake/Tsunami/Radiation events. From Bloomberg:

"A fund that uses mathematical models to trade stocks and sports a beer-swilling robot as its mascot beat Japan’s best money managers last month, when an earthquake and tsunami triggered a nuclear crisis and sparked panic equities selling.

Six computer programs, making all the investment decisions for T&D Asset Management’s Kabu-Robo Fund, generated returns of 1.9 percent in March. The average actively traded fund that invests in Japan lost 6.9 percent during the month, according to Tokyo-based Rating and Investment Information Inc. The benchmark Nikkei 225 (NKY) Stock Average dropped 8.2 percent in the period.

“People tend to go with the herd when there’s a panic,” said Kazuhiro Kunisada, chief executive officer of Trade Science Corp., which designed the programs for T&D’s Kabu-Robo Fund. “Robots just follow the rules.”"

Tuesday, April 26, 2011

Taleb on Risk Management

"All swans are white" is a falsifiab...                         Image via WikipediaFinally.   We all love it when someone makes sense (which admittedly all too often is defined as "someone who agrees with me"), but all too often we hear the same things over and over again even if they are wrong.

For instance, reading the popular press and listening to managers talk about risk management is often an annoying exercise of them trying to convince us they know more than they really know.  (Indeed the same can be said of most newscasts, analysts (political, news, or sports) and all of ESPN but I digress).

With respect to finance, one area where this idea regularly shows up is in the area of black swans.  In the years since Taleb's Black Swan book came out, many (and some students I might add), have droned on about predicting black swans by increasing standard deviations, extending data sets, and other quantitative methods.

Unfortunately, while these steps are all good things to do, they can not predict black swans.  Why? The very nature of a true Black Swan is that it is unpredictable.

Taleb recently tried to correct people's thinking on  the subject.  From Forbes:

“…I’ve been trying to emphasize the true message of the black swan, which is that there are some environments in which rare events are simply not predictable.

“Most people think that they can predict the black swan, that with quantitative sophistication they can get answers. They don’t get the idea that because we can’t predict black swans, then we need to restructure institutions and rethink strategies to be more robust in the face of uncertainty.”
How?  Reduce debt and build in back up plans (even if they are more expensive) (Gee, sounds like our Corporate Finance Discussions after the Japanese Earthquake/Tsunami/Radiation event).   Again from Taleb:
"You have to avoid debt because debt makes the system more fragile. You have to increase redundancies in some spaces. You have to avoid optimization...I hope the message will finally get across because I haven’t succeeded yet. People talk about black swans but they don’t talk about robustness, which is the real lesson of the black swans."

Taleb's comments were from a new book entitles the Known, the Unknown, and the Unknowable in Financial Risk Management that I have yet read, but am definitely going to get (even at $60.)

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Volatility and the VIX

We were just speaking of the VIX in class last week. For in SIMM we are buying some puts to protect the portfolio especially over summer break. So these two articles should be of special interest to the class.  

volatility-barrons: Personal Finance News from Yahoo! Finance:
"VIX's main drawback is that it provides only a 30-day snapshot of the expected movement of the Standard & Poor's 500 Index. VIX is composed of a series of the index's put and call options that expire in a month. But because VIX is expressed in a single number, like a stock, most people think they understand it. They rarely realize they are applying a stock-market mentality to the options market—and that is wrong and potentially dangerous, because it creates a false feeling of safety. The options market is far more multidimensional than the stock market.

Right now, VIX futures prices are higher than VIX."

 Bloomberg/BusinessWeek mentions that the while the VIX is low, the skew is high because (despite put-call parity), puts are slightly more expensive than calls.
"The end of the Federal Reserve’s Treasury repurchase program is prompting options traders to pay the most in four years for protection against stock declines, a signal that proved bullish in the past.     
The cost of three-month put options to sell the Standard & Poor’s 500 Index is almost twice the price of calls to buy, the highest ratio since July 2007, according to data compiled by Bloomberg. The last 17 times that so-called skew rose as high, the benchmark gauge for American equities climbed a median 3.9 percent over three months, data compiled by Bloomberg show."

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Monday, April 25, 2011

In the Mind's Eye: Fusing Neuroscience, Economics and Psychology to Learn How People Make Decisions - Arabic Knowledge@Wharton

In the Mind's Eye: Fusing Neuroscience, Economics and Psychology to Learn How People Make Decisions - Arabic Knowledge@Wharton

Good interview from Wharton with their own Joseph Kable. A short excerpt:

"Joseph Kable: Neuroeconomics is a convergence of two influences. On the one hand, it's the neuroscientist who wants to understand what is going on in the brain when people and animals make decisions. They've come to the realization that to really understand the neural processes, you have to have a framework for understanding decisions at a behavioral level, and that's going to come from economics, psychology, judgment and decision-making. You have economists, psychologists, and others who are coming to the realization that neural processes are another source of data that could inform their own theorizing and their own modeling about how people make decisions. This could be a new source of tools for testing theories in economics and psychology."

One more look in? Oh, ok:

"Arabic Knowledge@Wharton: How seriously do people's choices deviate from rational choice theory?

Kable: I am of the opinion that people deviate much less than you might expect, given the popular and academic characterizations of people being riddled with biases and irrationalities. But I also think that as we study them, they reveal that people's minds are rationally maximizing something, just not what experimenters had expected or predicted. "

Sunday, April 24, 2011

Similarities between NFL draft and finance

Buffalo Bills helmetImage via WikipediaDraft week is always one of my favorite weeks of the year. It is a great opportunity to watch forecasting, game theory, emotions, rationality, and behavioral finance/economics interact. Take for instance this quote from Bill Polian of the Colts (formerly of the Buffalo Bills)

On best player available and other strategy - AFC South Blog - ESPN:
"“I think you face three temptations,” Polian said. “The first is that you overvalue positions, i.e. quarterback, and so you try to create someone. Secondly, and it ties together, if you have a need you tend to overvalue players at that need position. It’s just human nature. And then third, you may try to reach, which is the same as overvaluing a player, because you’re trying to hit a home run. You say, ‘Well, if we hit on this player, boy does he have upside.’ And many times the upside doesn’t pan out.

Want more similarities?  These from Michael Silver's  article on the so called 'rogue scout' David Razzano:

"Another trap cited by Razzano: Teams often reach for a perceived need, rather than selecting the player they’ve rated the highest. First-round picks, in particular, can be impacted by an owner and/or general manager’s desire to fall into line with media projections (and to therefore receive high marks from reporters who offer instant draft grades)."        .

The article also talks about "group think", basing valuations on what others in the league presumably think the value is, and the risk of "growth vs value."  
 Gee, that sounds so much like finance, I may have to use it in class ;) .
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Wednesday, April 20, 2011

What You Need to Know About Socially Responsible Investing - Yahoo! Finance

What You Need to Know About Socially Responsible Investing - Yahoo! Finance:
"The number of SRI funds in the U.S. has grown to 250 with assets of $316.1 billion in 2010, up from 55 funds with $12 billion in assets in 1995, according to the Social Investment Forum.

Similarly, some funds are devoted to investing based on religious beliefs or other social causes. The Ave Maria funds follow the doctrines of the Catholic Church, while the Amana funds abide by Islamic principles. On the flip side, at least one fund--Vice Fund (symbol VICEX)--takes a different approach. It invests in companies that make things harmful for our health and society, such as casinos and makers of alcohol, cigarettes, and weapons."

Socially responsible investing (SRI) is a frequent topic of conversation in various finance classes. This article serves as a good primer to what SRI means and the pluses and minuses of investing in SRI funds.

Monday, April 18, 2011

US Seeks To Reassure Markets On Debt After S&P Warning -

US Seeks To Reassure Markets On Debt After S&P Warning - "
"The Obama administration on Monday sought to reassure U.S. Treasurys investors, saying Standard & Poor's threat to downgrade America's top-notch debt rating underestimates the country's ability to face fiscal challenges.

S&P affirmed the U.S. federal government's 'AAA' rating but, for the first time, changed its long-term outlook to negative from stable, signaling there's at least a 33% chance that it will downgrade the country's debt rating within two years."

Well of course any issuer would try the same thing.

How ETFs Have Reshaped Investing -

How ETFs Have Reshaped Investing -

"Since March 2009, when U.S. stock markets hit their lows, investors have pumped $57 billion into ETFs holding U.S. stocks. U.S.-stock mutual funds over the same period have suffered withdrawals of $66 billion, according to Morningstar Inc.

In all, investors today around the globe have a total of $1.4 trillion invested in some 3,500 exchange-traded portfolios, according to BlackRock Inc.....

For investors big and small, they have reshaped the basics of investing. They have proved easy to use for creating diversified portfolios. With relative transparency, generally low costs and tax efficiency, they offer access to markets and strategies that were once difficult to enter and exit. For professional traders, they make it possible to turn big positions on a dime either to protect holdings or jump on new opportunities."

Gee, would make great discussions in many classes...From Investments, to SIMM, to Financial Management.

Friday, April 15, 2011

Video looking back at the events leading up to the 2008 crisis by Michael Burry

Remember Michael Burry?  The Doctor/Investor made famous in the Big Short for seeing the mortgage/debt/real estate problems before others.  Here is a reference to him on NPR.

He recently spoke at Vandebilt.  Highly recommend it!

I particularly like the use of "teaser rate" as opposed to just "adjustable rate" mortgages.

HT to Simoleon Sense and ValueInvestingWorld.  Highly recommend.

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Interesting interview with George Soros

George Soros: What if the world isn't worth saving? | Marketplace From American Public Media:

First of all, it should be noted that they are talking about the World Financial System, NOT the world itself!

David Brancaccio did an interesting interview with George Soros for Marketplace. Speaking at the conference at Bretton Woods that is intended to "rethink" economics.

Short version: he thinks that many of the problems now facing America and other countries are not the fault of Governments, but financial intermediaries.

"Obviously, we need financial services and obviously they are beneficial. But to have 7 or 8 percent of the GDP -- that may be too much!"

Good interview. Clearly there are problems, but much good too. I like the ending by Niall Ferguson:
"Most of the financial innovation that began in the 1980s was beneficial, increased economic efficiency and increased the efficiency of the world economy as a whole."

Listen to the interview with Soros here.

Wednesday, April 13, 2011

SSRN-Industry Information and the 52-Week High Effect by Xin Hong, Bradford Jordan, Mark Liu

SSRN-Industry Information and the 52-Week High Effect by Xin Hong, Bradford Jordan, and Mark Liu: "find

Interesting paper. Chances are you have heard of the George and Hwang 2004 article that reports that stocks near their 52 week high did better than firms not near their 52 week high (a strike against weak form efficiency). Now Hong, Jordan, and Liu further investigate this and find that there is a large industry effect and suggest the cause of the findings is an anchoring bias.

: (emphasis is mine)
"We find that the 52-week high effect (George and Hwang, 2004) cannot be explained by risk factors. Instead, it is more consistent with investor under-reaction caused by anchoring bias: the presumably more sophisticated institutional investors suffer less from this bias and buy (sell) stocks close to (far from) their 52-week highs. Further, the effect is mainly driven by investor under-reaction to industry instead of firm-specific information. The extent of under-reaction is more for positive than for negative industry information. A strategy that buys stocks in industries in which stock prices are close to 52-week highs and shorts stocks in industries in which stock prices are far from 52-week highs generates a monthly return of 0.60% from 1963 to 2009, roughly 50% higher than the profit from the individual 52-week high strategy in the same period. The 52-week high strategy works best among stocks with high R-squares and high industry betas (i.e., stocks whose values are more affected by industry factors and less affected by firm-specific information). Our results hold even after controlling for both individual and industry return momentum effects."
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Virginia Tech remembers professor killed in glider crash | WSLS 10

etVirginia Tech remembers professor killed in glider crash | WSLS 10: "BLACKSBURG, VA --

"Meir I. Schneller, professor of finance in the Pamplin College of Business, was remembered by his colleagues and students for his caring and generous nature, his wry wit, deep intellect, and expansive range of interests.

Schneller, a member of the Virginia Tech faculty since 1992, died on Sunday, April 10, in a glider accident.

'Meir was very giving of his time to his students and fellow faculty members. He was ever willing to assist with departmental activities and always volunteered to serve the department when needed, no matter how inconvenient the assignment,' said Raman Kumar, A.F. Oliver Professor of Investment Management and head of the finance department and a longtime member of the faculty. “You could count on him.'"

E-mails filed in suit against Facebook's Zuckerberg

E-mails filed in suit against Facebook's Zuckerberg:
"Ceglia...filed the suit last June, submitting as evidence a personal services contract he signed with Zuckerberg in 2003 to prove he owned 84 percent of Facebook. In an interview with Bloomberg News, Ceglia said he only remembered that contract in 2009 while searching through old files following his arrest by New York troopers on charges of fraud against his wood pellet firm's customers.

Ceglia claims that he agreed to pay Zuckerberg, then a Harvard freshman, $1,000 to write the code for a company he was starting, StreetFax LLC. The contract also claimed Ceglia invested $1,000 in Zuckerberg's project called both 'The Face Book' and 'The Page Book.''

Facebook has called the contract a forgery."
Several things:
* Ceglia is from Allegany County our neighboring county.
* The suit was filed in Buffalo
* I would guess the IPO will be postponed a while longer.

I have to think that just happening to find it is a bit strange, but then again, maybe he has a filing system like mine ;)

Tuesday, April 12, 2011

US Inflation Rate: Inflation Using Volcker-Era Methodology Nearing 10% - CNBC

US Inflation Rate: Inflation Using Volcker-Era Methodology Nearing 10% - CNBC:

Uh, oh...
"Since 1980, the Bureau of Labor Statistics has changed the way it calculates the CPI in order to account for the substitution of products, improvements in quality (i.e. iPad 2 costing the same as original iPad) and other things. Backing out more methods implemented in 1990 by the BLS still puts inflation at a 5.5 percent rate and getting worse, according to the calculations by the newsletter’s web site,

“Near-term circumstances generally have continued to deteriorate,” said John Williams, creator of the site, in a new note out Tuesday. “Though not yet commonly recognized, there is both an intensifying double-dip recession and a rapidly escalating inflation problem"

While not the CEO of WalMart (see the article, you will understand what I mean), my family does own a very small chain of grocery stores even though it is biased since it is only food, I can say that p[rice and cost changes are way up in the past quarter.

Monday, April 11, 2011

Prediction comes true? Wow.

The New York Stock Exchange in 1882 by America...Image via WikipediaBefore's Blog (and before BonaResponds so I had some time ;) ), I wrote a weekly newsletter on finance.  I remember well writing about an article (but can not find it) maybe a decade ago about the future of the NYSE.  One of the people thought it would make a good bowling alley.

I liked the idea and have used it in class to demonstrate that while historic and traditional etc, the NYSE has changed so much that the floor of the exchange is not really needed as it used to be.

Then in 2005 the idea that the NYSE property was not being used to it's fullest potential in this piece that suggested residential properties. 

Well it is now 2011 and the NYSE is building is being renovated to-------host parties!  Really.

From NYSE gets a Facelift:

"The New York Stock Exchange has lost most of its famous shoulder-to-shoulder bustle in the age of computerized trading. So it's hoping its status as an icon of American finance will be a popular draw for cocktail receptions, analyst presentations and other festivities."

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Friday, April 08, 2011

American Airlines CEO says fuel crisis coming - Apr. 8, 2011

American Airlines CEO says fuel crisis coming - Apr. 8, 2011: "
'We're facing another fuel crisis, and crisis is not too strong of a word,' said American Airlines CEO Gerard Arpey, speaking at a conference of business journalists in Dallas."

Class: compare this to the Alaska Air story.

Thursday, April 07, 2011

Airline CFO: Hedging Saved Us $400 Million - CNBC

Airline CFO: Hedging Saved Us $400 Million - CNBC:

"Alaska Air begins to hedge about three years in advance. Each quarter, the company adds an incremental amount to that position (usually an extra 5 to 7 percent of its future consumption) until it hits 50 percent. It’s a strategy that is constant, regardless of volatility in the energy market.

“Our program is really designed to be price agnostic. We go into the market and buy at current prices and what it is, is what it is,” Pedersen explained.

Since it uses caps only, the company says it remains insulated from major hedging losses if prices suddenly drop—like they did in 2008 when crude oil plummeted more than 70 percent in less than 6 months."

Wednesday, April 06, 2011

Casey B. Mulligan: Why People Pay Income Taxes -

Casey B. Mulligan: Why People Pay Income Taxes -
"From a financial point of view, underpaying taxes looks like a high expected return investment: a 99 percent chance of keeping the, say, $10,000 that you underpaid the Treasury and a 1 percent chance of having to pay the $10,000 plus a $1,000 penalty (on average, you get $9,790 for every $10,000 you hold back from the Treasury).

Some economists have tried to reconcile low penalties with high compliance, arguing that people obey the tax laws for non-economic reasons – people want to be honest and pay their share. Or perhaps individuals don’t understand that any one person’s tax payment is not critical to the functioning of our government, while the aggregate of millions of tax payments are."


Is Texas Instruments Overpaying? -

Is Texas Instruments Overpaying? -

By now you have seen the news that Texas Instruments is buying National Semiconductor. On class yesterday we discussed it a bit and whether the premium was too high. From the NY Times:

"It is paying $25 a share in cash — a premium of 78 percent over National Semiconductor’s closing stock price on Monday. It is a stock that has traded in a narrow range in the last two year, rising just 2.25 percent for the year until Tuesday. It last reached $25 in November 2007.

Citigroup analysts note that the offer values National Semiconductor at a “noticeable premium” of 19.1 times its estimated price/earnings ratio for 2012. Nomura points to a multiple of 4.4 times enterprise value to 2011 sales, against a ratio of 3.8 for comparable companies.

Romit Shah, an analyst with Nomura, argues that Texas Instruments is overpaying for National Semiconductor. He said the the cost synergies in the deal are “immaterial” and that big semiconductor acquisitions “have a terrible track record of generating shareholder value."

Tuesday, April 05, 2011

Book Indicates Wrigley Faithful Care More About Beer Prices Than Winning: Chicagoist

Book Indicates Wrigley Faithful Care More About Beer Prices Than Winning: Chicagoist:
"Moskowitz and Sports Illustrated senior writer Jon Wertham analyzed economic data related to baseball at Wrigley Field in relation to attendance and found that, more often than not. the one factor that tended to lead to decreases in attendance was increases in beer prices, even as tickets to Cubs games became more expensive.
Not really surprised but noteworthy finding none the less. Clearly the right sign on the estimate. And I am sure people consider the total price of the game and not just the price of the ticket.

Monday, April 04, 2011

Redesigning Banking with Behavioral Economics in Mind - Technology Review

Redesigning Banking with Behavioral Economics in Mind - Technology Review:
"A bank was once primarily a place—a building with marble floors and high counters that you'd enter to deposit or retrieve your money. Cash machines and online banking moved the experience away from the lobby, but those were only extensions of the traditional ways banks thought about business. So when Josh Reich and Shamir Karkal, two MBA students at Carnegie Mellon University, went looking for ways to innovate in banking, they decided to start from the other direction, designing the mobile and online banking experience first and building the business around that.

They teamed up with Alex Payne, an engineer who was one of the first employees at Twitter, and set about creating BankSimple, .....To design the experience, they looked for insights from behavioral economics, which relies on psychology to understand economic decisions.

Interesting! Will definitely use on Behavioral Finance class!

Sortino Ratio

Last week we had a hedge fund manager in SIMM and he spoke of the Sortino Ratio. It was a new topic for most in the class so we will be going over it again in today's class so so I might as well share it.

Most investors are more concerned with losses than gains. Thus a measure such based on variance or standard deviation may unintentionally penalize a fund that is measured using symmetric measures.
The Sortino Ratio aims to reduce this problem by using a set Target (for instance zero) and only counts the observation if it is below the target.

From The Curious Investor:

"The Sharpe ratio is a slightly more exacting portfolio risk calculation in comparison to the beta and alpha combination, but, for all intents and purposes, delivers similar information in that it attempts to quantify how much a portfolio strategy made in excess of the volatility (risk) it assumes. The Sortino Ratio is an adjustment on the Sharpe Ratio in that it only penalizes downside volatility. This is done by creating a value known as downside deviation which is based on some minimum acceptable return (MAR) which is a rate of return that an investor can set. This could be 0%, if you want to judge your portfolio on how well it operates with respect to never losing money."

The SharpInvesting Blog has some examples of historical ratios as well as more on how to calculate:

"The Sortino Ratio differentiates between this positive and negative volatility by replacing standard deviation with downside-volatility. Downside-volatility is the volatility of returns below a minimal acceptable return (MAR). The MAR is usually set at 0%. Distribution of returns is analysed below this MAR. The denominator of the Sortino ratio is calculated only with data from periods where performance was below the set MAR. This differentiates the “positive” and “negative” volatility."

Don't want to do it yourself? Here is a calculator for it (I should note I did not check its accuracy) as well as directions on how to set up in Excel from CuriousInvestor.

I would add that dropping the positive numbers (instead of setting them equal to zero or the Target) seems to make more sense.

Friday, April 01, 2011

Get it right a few times and get overconfident? Seems so.

Very cool finding.  Alas I can not find the paper in a format to share.  However, here is the abstract.
Hilary and Hsu have a cool paper that suggests not only do a few correct forecasts lead to overconfidence, but that investors (and analysts) can themselves predict this overconfidence. 

We examine whether attribution bias that leads managers who have experienced short-term forecasting success to become overconfident in their ability to forecast future earnings. Importantly, this form of overconfidence is endogenous and dynamic. We also examine the effect of this cognitive bias on the managerial credibility. Consistent with the existence of dynamic overconfidence, managers who have predicted earnings accurately in the previous four quarters are less accurate in their subsequent earnings predictions. These managers also display greater divergence from the analyst consensus and are more precise. Lastly, investors and analysts react less strongly to forecasts issued by overconfident managers"

Note the last sentence which is VERY cool. Investors realize the increased likelihood of overconfident managers and react accordingly.

Cite:  Hilary, Gilles and Hsu, Charles, Endogenous Overconfidence in Managerial Forecasts (March 18, 2011). INSEAD Working Paper No. 2011/39/AC. Available at SSRN:
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