Posts Tagged ‘Markets’
Two Important Links
If you do nothing else intellectual this Sunday, do these two things:
(1) Read Tyler Cowen’s NYTimes column on how the bestowing of political favors was at the heart of the financial crisis and how we’re about to make the same mistake with health care.
(2) Remember Norman Borlaug. He is the scientist who led the “Green Revolution“. In my opinion, he would be a strong candidate for the man who did the most good for the most people in the second half of the 20th Century. And the mainstream media will not make nearly a big enough deal of his death at 95 compared to that of Ted Kennedy.
Is Money an Emergent Phenomenon?
The two economists that have most informed my view of the current macroeconomy are Arnold Kling and Scott Sumner. In both cases, their models and explanations make sense to me. They use solid reasoning and evidence; I don’t feel I’m getting a lot of hand waving. Unfortunately, at first glance, their views seem mutually exclusive. Kling believes business cycles are the result of many planning errors by individual agents (for example, this recent post and this follow up). Sumner believes business cycles are the result of contractionary monetary policy by the central bank (for example, this recent post and this one).
How can they both be right? I think they are operating at different levels. Yes, individual agents make their particular planning decisions. In aggregate, these decisions drive monetary variables like interest rates, exchange rates, liquidity demand, etc. However, these variables then feed back into the next round of planning decisions. Moreover, at least some of these plans take into account the effect of the agent’s actions on the monetary variables. So you get classic chaotic/complex behavior with temporarily stable attractors, perturbations, and establishing new regimes. There may even be aspects of synchronized chaos. I think the monetary variables are the key emergent phenomena here. They are like “meta prices” that provide a shared signal across just about every modern economic endeavor.
Food for thought. I’m going to keep this in mind when processing future articles on the economy and see if it helps my thinking.
Specifying a Climate Bet
As I mentioned in the comments on this post, I am currently in the process of negotiating a bet on Anthropogenic Global Warming (AGW) with another blogger. The challenges are interesting, so I thought I’d give you a peek inside the sausage factory.
You Can’t Pick Winners at the Seed Stage
[EDITED 05/08/2009: see here] The majority of people I’ve talked to like the idea of revolutionizing angel funding. Among the skeptical minority, there are several common objections. Perhaps the weakest is that individual angels can pick winners at the seed stage.
Now, those who make this objection usually don’t state it that bluntly. They might say that investors need technical expertise to evaluate the feasibility of a technology, or industry expertise to evaluate the likelihood of demand materializing, or business expertise to evaluate the evaluate the plausibility of the revenue model. But whatever the detailed form of the assertion, it is predicated upon angels possessing specialized knowledge that allows them to reliably predict the future success of seed-stage companies in which they invest.
It should be no surprise to readers that I find this assertion hard to defend. Given the difficulty in principle of predicting the future state of a complex system given its initial state, one should produce very strong evidence to make such a claim and I haven’t seen any from proponents of angels’ abilities. Moreover, the general evidence of human’s ability to predict these sorts of outcomes makes it unlikely for a person to have a significant degree of forecasting skill in this area.
Revolutionizing Angel Funding
[EDITED 05/08/2009: see here] We are finally ready to go semi-public with our revolutionary new angel funding concept! For the last year, Dave Lambert (the Tiltboy also known as Diceboy) and I have been working on an alternative mechanism for delivering seed funding to technology companies. [REDACTED 05/08/2009: see here].
Here’s the summary. The market for seed capital is clearly broken. Most individual angels will only do about 1 deal per year, which means their portfolios lose money 40% of the time due to insufficient diversification. Even premier angel groups like the Band of Angels say they only do about 8 deals per year. Our math says you need to do 125 to achieve good diversification. On the other side of the table, only 14% of entrepreneurs who want angel funding will find it. Those that do will spend about 6 months looking for money instead of building their businesses.
This is a sorry state of affairs for a market where the overall annual return is 25%+. Here’s a straightforward application of portfolio theory that can fix it. Have a large enough pool of money so one entity can do 125-200 deals per year. Then use an online screening process to give founders a yes or no in two weeks. Obviously, there are a ton of details beyond this, but those are what we’ve spent the last year figuring out. If you’re curious, let me know in a comment here and I will contact you privately.[Links to files REDACTED 05/08/2009: see here].
Brilliant or Crazy? I Really Don't Know.
Apropos of Rafe’s last post on Complexity Economics, I ran across an economic stability proposal that is either brilliant or crazy. I both haven’t thought it over enough and am probably not qualified to determine which.
Must Read Article on the Financial Meltdown
Via Tyler Cowen at Marginal Revolution, an excellent article in Wired about how one formula, embodying one assumption, catalyzed the meltdown. I recommend you read it and ponder it. There are many useful lessons for modeling complex systems in general.
However, I will summarize for those of you short on time. A fundamental problem in securitization is figuring out how different components of a security are related. Think of it as measuring how well the components are diversified. The more independent the components, the less risk embodied in the security. Thus AAA rated tranches of mortgage-backed securities are supposed to be very safe because the components are supposed to be highly independent.
A Chinese mathematician named David X. Li had an insight. You don’t have to analyze the dependencies directly, you just have to observe the correlations in the market prices of the components. Then you can compute these really tight sounding confidence intervals on the correlations of various components because you have all this market data. Of course, the market can’t take into account what it doesn’t understand. So you see a bunch of 25-sigma events. At least, your model says they are 25-sigma. Oops!
Society According to Kevin: Part 1
How Our Moral Compasses Fail Us
From the comments on my Introduction to this series, it appears I have discovered a controversial topic. Good. My first objective will be to illustrate why we cannot rely on moral compasses to guide society. After some thought, I have decided to break the topic of moral compasses into two posts: how they fail and why they fail.
Society According to Kevin: Introduction
I was recently having a conversation with a mutual friend of Rafe’s and mine. Like the two of us, he’s quite smart, well educated, and socially aware. I respect his thinking a lot. However, during the course of this conversation, it became clear to me that he holds what I think of as an overly moralistic view of human behavior.
From my perspective, it seemed like he thinks that people’s behavior is governed primarily by an internal moral compass rather than incentives. So if you want to change their behavior, you should redirect their moral compass rather than adjust their incentives. People who don’t adjust their behavior are defecting from society and should be sanctioned.
I encounter this view quite often in my social circle and this instance inspired me to write a series of posts to explain how I think things actually work. You’re free to disagree with me, of course. In fact, I expect most people to disagree with me. But I’ve thought rather hard about this issue and I’ll put my model up against the moralistic view when it comes to predicting a population’s average behavior or choosing an effective policy prescription.
Poetic Justice in the Financial Crisis
Bloomberg reports that Credit Suisse has decided to pay managing directors’ and directors’ bonuses in the form of an ownership interest in the bank’s toxic mortgage-backed assets. The value of these assets will emerge over the next eight years as the assets mature or default. This is outstanding! The executives have to lie in the bed they made. Of course, this would have been better if they did this prospectively back when the executives were the making decisions that created these securities. But perhaps banks will adopt some sort of similar long term performance measurement mechanism going forward.
Via Volokh Conspiracy via Megan McArdle via ClusterStock.
Possible Insight 