An Ode to Gary Becker (from Steve Levitt)

By any academic's' standards, Gary Becker's record is nothing short of phenomenal. He published papers way back in the 1950s, and he's published in the new millennium. Steve Levitt gives us his insights as to why Becker's been so successful:

1. He's incredibly smart
2. He works harder than anyone else
3. He loves what he does
4. He welcomes criticism
5. He's always learning new things

Click here for the whole piece.

Those traits would have made him a success in pretty much any fields he chose. Other than the first one, they're all things in our control, too (no matter our chosen fields).

Becker also has one of the better blogs out there, too (with Judge Richard Posner).

Summer Reading - Freakonomics

Since the Unknown Wife and Unknown Daughter have skipped town and left me with The Lad for the week, I finally got around to reading Freakonomics (I finally gave up on trying to write SAS code when the Disney version of The Hunchback of Notre Dame is playing in the background...). I'll write more on the book later, but in the meanwhile, here are a few quick observations:

1. The book seems to have two themes that finance folks will find interesting - information and incentives.
2. He's amazingly clever at "torturing" his data. Many of the questions he examines have a large number of counfounding factors that make testing hypotheses extremely difficult. Part of his genius seems to be in the way he slices his data in such a way that he can control for many of the confounding factors
3. It's very well written
4. It's got lots of provocative findings that will be great for "water cooler" talk -in particular, his hypothesis that the liberalization of abortion following Roe v. Wade led to the decrease in crime in the 90s.

All in all, a great read, particularly for the non-economist. I now have a lot more examples to use in my classes.

Ah well, it's off to Home Depot, and then we grill... (guys will cook when there's Fire and Danger involved..)

This Week's Carnival of the Capitalists (at Slacker Manager)

This week's Carnival of the Capitalists is up at Slacker Manager. There are two interesting economics-flavored analyses: one by Half Sigma on the economics of cheating, and one from Coyote Blog on Business Relocations and the Prisoners Dilemma. Finally, The Prudent Investor reports on an interesting phenomena on A boom in real estate investment (clubs). Of course, there's also lots of other things you might not regularly read. Stroll around a bit and expand your horizons.

New Finance RoundTable

William Parke at UNC has just started a Finance Roundtable. He's been running the Econonomics RoundTable for some time, and has expanded the Roundtable concept - he now has separate roundtables for Econ, Finance, Law, and Politics. Each Roundtable aggregates new postings from a number of blogs in the subject area, and puts all posts for the previous 24 hours on one page. they're excellent resources.

For the main page, click here. Nicely done.

Classic Trading Mistakes (from The Big Picture)

Barry Ritholtz at The Big Picture has a nice summary list of Classic Trading Mistakes :

-- Letting small losses turn into large losses.
-- Refusing to take a loss at all.
-- Overbetting.
-- Bottom fishing/Catching falling knives.
-- Averaging down.
-- Shorting bulls and buying bears.
-- Confusing the company with its stock.
-- Falling in love with a "story."
-- Following the leader.
-- Buying IPOs.
-- Finding the Holy Grail.
-- Overtrading.
-- Excessive tape watching.
-- Being undercapitalized.
-- Letting the tax tail wag the stock dog.
-- Relying on gurus.
-- Thinking this market stuff is easy.
-- Thinking rather than looking.

My personal favorite (for a turn of a phrase), is "catching falling knives".

For a fuller explanation of the items on the list, go to the original piece that the summary came from at Decision Point.

Summer Reading - Fischer Black

Fischer Black is undoubtedly one of the "inventors" of modern finance. His option pricing formula revolutionalized both academic and practitioner finance. Thanks to Tyler Cowen at Marginal Revolution, I now have a new book to read this summer: Fischer Black and the Revolutionary Idea of Finance, by Perry Mehrling. This passage supplied by Tyler describes Black as possibly having a high-functioning case of Asperger's Syndrome:

He did almost all of his work in an outlining program called ThinkTank, which he used as a kind of external associative memory to supplement his own. Everything he read, every conversation he had, every thought that occurred, everything got summarized and added to the data base that swelled eventually to 20 million bytes organized in 2000 alphabetical files...Reading, discussion and thinking that Fischer did outside the office was recorded on slips to paper to be entered into the database later. Reading, discussion, and thinking that took place inside the office was recorded directly. While he was on the phone, he was typing. While he was talking to you in person, he was typing. Sometimes he even typed while he was interviewing a prospective job candidate, looking at the screen not the candidate.

I've often thought that the most productive academics have what I call "functionial adaptive autism". They seem to have the ability to tune out the outside world for hours at a time when working on a problem. Unfortunately, for some, they find it hard to tune back in. Having read the symptoms of Asperger's, that also seems to fit.

The book's not out in print yet, but I'll pre-order it. Maybe it'll be out before I'm done with Freakonomics (I just got my copy).

Thanks for the tip, Tyler.

O Frabjous Day! Callooh! Callay!

At last! I haven't slain the Frumius Bandersnatch but exams are done, grading is done, most of the students' whining is over, and summer has begun (at least for me). The Unknown Wife and the Unknown Daughter are in Seattle for the week (visiting UW's college roommate), so the Unknown Son (age 6) and I are spending some "guy time" together - eating lots of junk food, leaving the toilet seat up (hey - there's a hinge on it for a reason), and going to see Madagascar today with his best friend who lives down the street.

Life, for the nonce, is good.

Prediction Markets -Another View (via The Big Picture)

As I've written previously, I'm a big fan of prediction markets (both as a classroom tool and as a means of extracting information from dispersed groups). However, Barry Ritholtz at The Big Bicture has a less favorable view:

...In the past, I have very strongly dissed some people’s concept of these markets and their ability to “predict” the future. The primary reason for my view is the unfortunate tendency for some people to place way to much faith in the crowd to know the unknowable.

I have yet to see a reasonable explanation as to why IEM missed Dean's collapse in the primaries; a commentor notes that the American Idol contract on Tradesports had Bice 90% favored in the final minutes -- but lost.

click here for the whole article.

He makes some valid points. One of the shortcomings of most prediction markets (like Tradesports or the Iowa Electronic Markets) is that they're not very liquid. A relatively small trade can move prices significantly. Having said that, I'll still use them in class. After all, where else can you talk about the Michael Jackson Trial in a finance class?

What Are The Most Prestigious Jobs (from Marginal Revolution)

At a recent conference, I heard a colleague say that "being a finance professor is the third best job in the world" Of course, we asked what numbers 1 & 2 were. His answer: "Rock Star, Baseball Player". According to Tyler Cowen at Marginal Revolution, teaching is the 4th most prestigious profession:

I can tell you only what people claim are the most prestigious jobs. Here are the top five:

1. Scientist (really?)
2. Doctor
3. Firefighter
4. Teacher (really?)
5. Military officer

I have yet to cash in on the groupies. Here is the full list and story.

No groupies here, either.

My Friend Irony Was Just Talking About The SEC

In one of the more ironic stories today, the SEC has just undergone an audit, and has discovered some weaknesses (from the New York Times):

The Securities and Exchange Commission, which enforces the rules requiring companies to have audits of their financial statements and internal controls, said yesterday that an audit of its operations, the first ever, had found some weaknesses.

The commission said that it received a clean audit opinion from the Government Accountability Office, which audits government agencies. But the audit cited three material weaknesses in S.E.C. controls, only one of which the commission hoped to fix in the current fiscal year.

...The three material weaknesses were in the areas of recording and reporting enforcement-related disgorgements and penalties, preparing financial statements, and security for information technology.

Ah well, nobody's perfect. They also this week announced another "boo boo":

The disclosure of material weaknesses was the second embarrassment this week for the commission regarding its financial processes.

On Tuesday, it told a Congressional committee that it had discovered that $48 million related to costs for new offices in Washington, New York and Boston, had not been budgeted. It said at least $23 million of that will be spent in the current fiscal year, presumably through squeezing other expenditures. Officials said they might free some money by delaying hiring.

I guess I won't be getting a job with the SEC this year...

Walter Williams Explains the Trade Deficit

When it comes to explaining "economics for the masses", there are few better than Walter Williams. He has a rare gift of making things (as Einstein said) "as simple as possible, but no simpler". In this column at Townhall.com, he does his usual great job and explains the trade deficit:

I buy more from my grocer than he buys from me, and I bet it's the same with you and your grocer. That means we have a trade deficit with our grocers. Does our perpetual grocer trade deficit portend doom? If we heeded some pundits and politicians who are talking about our national trade deficit, we might think so. But do we have a trade deficit in the first place? Let's look at it.

Insofar as the grocer example, there are two accounts that I hold. One is my "goods" account, which consists of groceries. The other is my "capital" account, which consists of money. Let's look at what happens when I purchase groceries. Say I purchase $100 worth of groceries. The value of my goods account rises by $100. That rise is matched by an equal $100 decline in my capital account. Adding a plus $100 to a minus $100 yields a perfect trade balance. That transaction, from my grocer's point of view, results in his goods account falling by $100, but when he accepts my cash, his capital account rises by $100, again a trade balance...

Click here for the enire column, and thanks to Don Boudreaux at Cafe Hayek for the link.

Real Estate Bubbles and REIT Spreads (from Seeking Alpha and The ETF Investor)

I've avoided blogging much on whether or not there's a real estate bubble. However, here's an interesting set of charts from the ETF Investor comparing yield spreads between REIT (real estate investment trusts) yields and yields on the 10-year Treasury.

For those of you not in "the guild", a yield spread is the difference between the yields on two investments (with one of them typically being a risk-free investment like a treasury security). Yields move in the opposite direction to prices. So, saying that REIT yields are lower is the same as saying that investors are willing to pay more today for each dollar of income a REIT pays. In other words, if yields are lower, (all else equal) prices of REITs are higher. Remember -- a yield is the inverse of a Price-Earnings ratio, or "P-E".

Since the yield spread (or REITs yields vs, Treasuries) is lower than usual, that means that REIT prices are higher than usual.

However, I'd caution about making this too generalizable, since REITs are typically invested in commercial real estate and/or apartment buildings, not homes. But, to the extent that prices in the different segments of the real estate market move together, it would indicate that the residentail sector could also be over-valued.

Hat tip to David Jackson at Seeking Alpha for the link. I like pictures, and too many of the books I'm currently reading don't have any...

Superstar (and CEO) Economics (via Stumbling and Mumbling)

The distribution of income in many fields is highly skewed, with the top earner making many, many times the average. Chris Dillow at Stumbling and mumbling looks at a London journalist that makes 11 times the average journalist's salary. He addresses the question: "Why do some people make such statospheric amounts of money". His answer harks back to early work on superstar economics, where tiny differences in ability result in vast differences in income. In short, they make these amounts because:

• They deliver customers (readers in this case). Talk of old-boy networks aside, businesses are built on the principal of making money;
• Their services are duplicable - once an article is written, it can be cheaply distributed to many readers (and even syndicated;
• Average ability is a poor substitute for superior ability. In other words, the payoff to being a little bit better is huge. You can view this in a tournament framework - it doesn't matter if you win by an inch, you still win;
• They have brand recognition.
  

Click here for the whole article.

The same question could be asked of CEOs (and often is, by people who don't understand business): Why do a CEOs at some companies make 500 times what the average worker does?My sense is that the same answers apply.

Reading The Income Statement (from Motley Fool)

For most non-business people, the Income Statement (and the Balance sheet, for that matter) are total mysteries. In fact, the undergrads in my Principals of Finance class have little clue, even though they've taken one (or soemtimes two) accounting classes.

There's a low-tech, relatively jargon-free guide to the Income statement courtesy of the Motley Fool. They illustrate some of the basic concepts using Herschey's financials.

IBM corp. has a more in-depth guide to financial statements here (full disclosure: I was one of the individals that wrote some of the text for the original version of IBM's guide a LONG time ago). The usual disclaimers apply, blah, blah, blah...

CEO Overconfidencs and Bad Investments

This article by Malmendier and Tate titled CEO Overconfidence and Corporate Investment provides strong support that managerial hubris (overconfidence) can explain at least some of corporate investment patterns.

They construct a measure of CEO overconfidence based on the well-known pattern that managers often excercise employee stock options early becasue their personal portfolios are over-weighted in the options. So, they identify CEOs that have options that are deep in the money and yet don't exercise them until the final twelve months before expiration.

They find that overconfident CEOs investments (acquisitions) are more sensitive to internal cash flows. In other words, if a CEO is overconfident and has more cash, he'll use it to buy something. One implication of the study is that external monitoring is most important if you have both an overconfident CEO and high free cash flow.

Nice paper, and a clever measure.

Inequality and Opportunity in America (From Cafe Hayek)

Russell Roberts at Cafe Hayek has been doing a series of posts on the topic of inequality in America (I wish I had this when we discussed this in one of my classes earlier this semester). He closes out the series in this post where he presents data on trends in median inflation-adjusted annual family income from 1970 to 2000. Using Census data, he finds (note: all figures are inflation-adjusted):

• Median household income (inflation adjusted) went from $40,000 to $54,000 over the period;
• Median income for households where both spouses worked went from $50,000 to $74,000 over the period;
• Although a lot poorer than the other groups, median income for female-headed households (with no spouse) went from $21,000 to $27,000 over the period;
• The only group where income remained flat over the period was households that were headed by males with no spouses.
  

It's important to note that these are median incomes. So, they are not driven by the rich getting richer, but by the "typical" household getting richer. So as a whole, almost every group is better off than they were thirty years ago.

Click here for the whole piece. While you're there, check out the earlier ones in the series.

Correction: The series was done by Russell Roberts, not Don Boudreaux (as I originally posted). I blame it on decaff coffee.

Employment is Destiny (From Truck and Barter)

Want to have a boy child? Become an accountant or steelworker. According to a study in the Journal of Theoretical Biology (as cited by Ian in Truck and Barter),

In the population as a whole in Britain, roughly 105 boys are currently born for every 100 girls, according to the study, The Sunday Times newspaper said.

But according to calculations by chief researcher Satoshi Kanazawa, for engineers and other "systemisers" [a description given to a form of cognition considered more "male"] the ratio is 140 boys per 100 girls.

Nurses and the like produce around 135 girls for every 100 boys, the study found.

Click here for the whole article.

Although not addressed by Truck and Barter, I think there's another possible reason for the linkage between parental job and offspring's sex. If higher-testosterone individuals are attracted to these professions, and these same individuals are more likely to have male children, you could see a relationship between parents' careers and the sex of their offspring that has little to do with the actual career.

I'm assuming that the sample is a cross-sectional one. So, there could be a spurious correlation effect. Of course, if it's the job that's driving the sex of the child, you could test it by looking at children in parents who had one child while in a "feminine" job and one while in a "masculine" job. This way, you've controlled for the non-job characteristics, and are splitting out the effect of the parent's job on the offspring's sex.

Update: here's a link to the article, courtesy of JoanneJacobs.com

Smart People Think More Like Economists - Part 2 (from Econolog)

In a previous post, I referenced a study that indicates that smarter people think more like economists. Arnold Kling at Econolog links to yet another study that supports this notion:

Daniel J. Benjamin and Jesse M. Shapiro write,

Using data from the National Longitudinal Survey of Youth (NLSY), we show that individuals with greater cognitive skills make consumption and personal financial decisions that more closely resemble the predictions of economic theory. Individuals with greater cognitive ability are more likely to participate in financial markets, are more knowledgeable about their pension plans, accumulate more wealth, and are more likely to participate in tax-deferred savings programs.
I think it's almost tautological that smarter people Thanks to Tyler Cowen for the pointer

Hat tip to Arnold for the link (and to Tyler Cowen at Marginal Revolution, who posted the link that led him there).

What is The Social Security Trust Fund, Anyway (from Vox Baby)

Andrew Samwick at Vox Baby is one of my "go to guys" for all things related to Social Security. While a lot of academics are maligned (rightfully so, IMHO) for being both linguistically dense and unconnected to the "real world", he represents the bright side of academia: intellectually honest, willing to go where the data leads him, and dedicated to stating things (as Einstein one said) "as simply as possible, but no simpler". He's started a new set of posts on Social Security. The first one answers the question on everybody's mind (well, not really, only the nerds and policy wonks among us), "What the Heck is the Social Security Trust Fund, Anyway?":

Think of the Trust Fund as a line of credit that the Social Security system extends to the rest of the government. The balance in the Trust Fund is simply the current value--principal plus interest credited at the Treasury bond rate--of all the withdrawals that the rest of the government has made historically on that line of credit to pay for things other than Social Security.

Click here for the whole article.

Finally, he makes the point that one benefit of private accounts is that they would pre-fund future liabilities in such a way that the government can't appropriate the money for other, non-Social Security purposes.

Click here for an archive of his earlier Social Security posts.

This Week's Carnival of The Capitalists

This week's Carnival of The Capitalists is up at Ideologic. There's a higher than usual finance/non-finance ratio of links in this week's Carnival. Here are the finance/venture capital ones:

Patri Friedman at Catallarchy summarizes a talk given by John Bogle on what he calls the “Cost Matters Hypothesis” - an alternative explanation to the Efficient Market Hypothesis on why most mutual funds do not beat the market rate of return over the long term.

Ironman at Political Calculations discusses excerpts from a speech given by Rob Arnott at an investing conference in his post: Indexing Fundamentals.

Barry L. Ritholtz at The Big Picture rounds up Real Estate statistics, commentaries, and ideas for your reading pleasure.

Micro Venture Capital - I need some for my venture and I am sure there are others like me. M.Simon from Power and Control discusses an article by a MIT Professor and wonders if a new breed of Venture Capitalists can emerge to finance Micro Ventures?

Businessorati of BusinessWorks Inc provides information about alternate source of financing-Small Business Innovation Research (SBIR), a federal funding program.

John Dmohowski of Drakeview says, Mergers and Acquisitions are favored exit strategies for Venture backed firms and IPO activity continues to remain depressed.

If you have time, wander around the various booths in the Carnival. These Carnivals are a great way to find new blogs that you otherwise might never wander across.

Five-Thousand Hits

Financial Rounds just had it's 5000th hit (and only about half were my own). It's extremely small potatoes in the bigger blog pond, but I'm pretty happy given that it's only been up since late February. Thanks for coming back, and tell all your friends!

Not The Same Old Treasurer's Job (From CFO magazine)

The corporate treasurer's job used to be simple and fairly straightforward. The controllers counted the money, and the treasurers made sure the firm had money to count. They dealt largely with short-term, working-capital issues.

This article from CFO magazine's online site, titled "Treasuring the Treasurer" lays out some of the ways the treasurer's job has changed. The job now often includes:

• Spending more time with operational units to understand how treasury ops can support the company's profit centers (i.e. making sure financiang structure matches up with operational needs);
• More involvement in designing and implementing hedging strategies to mitigate foreign exchnage risk;
• Working with marekting and sales to structure payment options for customers
• Working in concert with the investor relations department (after all, they already work with credit analysts, so talking to analysts on the ewquity side is a natural extension).
  

In summary, the job is a lot more comprehensive and varied than in years past. Nowadays, the treasurer is much, much closer to the CEO. It's worth a read, and suitable for class use.

Cisco Systems - Making a Market For Stock Options

Here's an interesting article from CFO magazine titled "Making a Market For Stock Options" on Cisco Systems' proposal to use market processes to value employee stock options. It was likely sparked by the Financial Accounting Standards Board's revised Statement 123R, which will require the expensing of employess stock option grants.

For the uninitiated (and I had to check with a friend that works in this area myself to be sure), employee stock option (ESO) grants differ from "standard" options in a number of ways - they're typically issued at the money, have up to a 10-year term to expiration, and can't be exercised for a time generally in the neighborhood of three years. In addition, they're non-tradable, unlike standard options.

These factors (particularly the non-tradability festure) result in the employee's portfolios being overweighted in the ESO. So, to diversify, employees often exercise ESOs early (which wouldn't be optimal with a standard option). As a result, it's likely that ESOs are considerably less valualble than their "standard" counterparts. If you want to see some academic work on these valuation differences between ESOs and publicly traded options, see "Early Exercise and the Valueation of Employee Stock Options" by Kulatilaka and Marcus (abstract available on the SSRN) or "The Cost of Employee Stock Options" by Bettis, Bizjak and Lemmon (also available on SSRN).

Cisco's move is most likely motivated by hopes that the market will assign lower values to the options than would models such as Black-Scholes. Based on some of the festures of ESOs, it's likely to be the case. However, since Cisco's new proposed securities will be tradable, they probably won't be exercised early to the same extent that the ESOs are.

Beating The Market Index (via Catallarchy)

Can you beat market indices like the S&P 500? Here's an interesting article by Rob Arnott, editor of the Financial Analysts Journal (coauthored with Jason Hsu and Phil Moore) that claims just that. The article, Redefining Indexation, argues that capitalization-weighted indices such as the S&P systematically over-weight overvalued companies. The argument can be summed up as follows: Cap-weighting biases the index more towards firms that have experienced share price increases (firms with increasing share prices tend to have greater market caps). So, the index is relatively overweighted in overvalued stocks and underweighted in undervalued ones.

When they use alternate constructions of a "market weighted index (like using book values rather than market values), they find that their strategy outperforms the S&P by between 1.65% and 2% per annum. A good piece, and worth a read.

Hat tip to Don Lloyd at Catallarchy for the link.

Payday Loans on 60 Minutes

CBS did a segment tonight on "payday" loans (hey, when they're not doing political pieces, they're pretty good on occasion). For the uninitiated, here's how a payday loan works. Imagine you're short of cash, and need to borrow $200 until payday (next week). The lender will lend you the $200 to be paid next week for a $10 fee (i.e. $200 now for $210 to be paid back in a week) . Not a bad deal, eh?

If you work out the math, although it's only 5%, it's 5% per week. This is equivalent to 260% per year even without taking compounding into effect, and works out to over 1100% annually with compounding (yes, that's right, 1100%).

For a link to the segment, click here.

I have family members who almost lost kneecaps to loan sharks (and no, I'm not exaggerating - I grew up in a heavily Italian immigrant mill-town, and a lot of my family managed taverns and bars). They got better terms than this.

It's ironic this came on the television as I was correcting final exams for my students. Although we spent a fair bit of time calculating the interest on loans like these, less than half got this problem right.

Maybe I should start a payday loan service to students...

UPDATE: One of the regular commenters on this blog (The Cynical Professor) sent a link to a site with lots of information on "predatory" lending": www.predatorylending.org. "Predatory lending" is a politically loaded term (kind of like "greed") that means different things to different groups. Regardless of your take on the topic, the site seems pretty interesting. While typing in the link, I found out that if you type in "predatorylending.com" instead of .org, you get sent to a site advertising various loans (ironic, eh?).

New Credit Risk Guidelines (from Calculated Risk)

Calculated Risk recently posted a piece on new credit risk guidance given by regulatory agencies, including the Office of the Comptroller of the Currency, the FDIC, and the FED:

In the guidance, the agencies point to several "product, risk management, and underwriting risk factors and trends that have attracted scrutiny":

· Interest-only features that require no amortization of principal for a protracted period;

· Limited or no documentation of a borrower’s assets, employment, and income (known as "low doc" or "no doc" lending);

· Higher loan-to-value (LTV) and debt-to- income (DTI) ratios;

· Lower credit risk scores for underwriting home equity loans;

· Greater use of automated valuation models (AVMs) and other collateral evaluation tools for the development of appraisals and evaluations; and

· An increase in the number of transactions generated through a loan broker or other third party.

All of these areas of concern are addressed with tighter lending requirements in the various provisions of the new guideline. These include tighter controls to detect mortgage fraud, better controls on third party originations, more stringent appraisal guidelines and more.

There's also a fair bit of material on home equity loans and high loan-to-value lending - well worth reading. Click here for the whole piece.

It's good information to use when talking about credit risk with your classes. It could spark a good discussion in class on how recent market forces have changed the level of risk exposure of banks nowadays, and on how banks can better manage that risk.

And We Think The SEC is Intrusive (From Overlawyered)

Here's the unbelievable story of the day (from Overlawyered):

... "In an attempt to crack down on insider trading, the directors of companies quoted on Spain's stock exchange will have to come clean, on a twice-yearly basis, about anyone with whom they are having an 'affectionate relationship'. ... Company directors must also provide information about their wives or husbands and family, but it is the idea of a 'lovers' register' -- in which bosses could have to admit to having affairs or out themselves as gay -- which has sparked reactions ranging from disbelief to fury among businessmen." (Tony Jefferies, The Scotsman, May 12; Giles Tremlett, "Bosses told: list assets -- including lovers", The Guardian (UK), May 11; Amaya Iribar, "When love is a conflict of interest", El Pais/INA Daily, May 16).

I think Spitzer is pushing for this as part of his inevitable upcoming political campaign.

Update: Warren Meyer at Coyote Blog has a better idea:

...Knowing a few Spanish gentlemen, though, I wonder if there will be some who will have the tendency to exaggerate and tack on names. I would be tempted to submit a list of all the wives of male Congressmen. I guess I should start working on my submission in case this approach is adopted by the SEC. Lets see now ... Paris Hilton, the Olsen twins, Laura Bush, Maria Shriver, Martha Stewart, Lassie, the Little Mermaid, ...

click here for the whole thing.

I like the idea, but once the list was disclosed, I'd have a hard time explaining Ariel to my kids (or Paris Hilton to anyone with any sense of taste whatsoever...)

The Mystery of "Chethood"

Alex Tabarrok at Marginal Revolution and Brad Delong examine why there are so many "Chets" (less-quantitatively skilled deal makers) in investment banking, and why they make so much. The post started off with this question from Alameida at Unfogged:

I have here a special, economics-type query which I direct to Brad DeLong, among others. Here's the thing: I have known many investment bankers in my day. Hell, I'm related to plenty of investment bankers, even if only by marriage. Many of these men are stand-up guys, fun to be with, always up for smoking a few bowls and playing golf. Others are asshole blowhards....

All of them, however, have the same basic character type, which I will call 'Chet'. Chet is a hail-fellow-well-met sort, cracking jokes all the time (some of most of which may be 'politically incorrect', because he doesn't care about things like that). Chet is tall, probably tan, and has big white teeth like a mouthful of chiclets.... Chet is a member of country clubs, and has a thin wife, and two adorable kids, etc. etc. If you close your eyes and imagine a picture in a silver frame on an end table in an apartment on 84th and Park, then you know what Chet's kids look like (super cute!).

Delong answers:

...A bigger part of this answer is that there are four relevant human capabilities here: the ability to master details, the ability to quickly grasp what the salient issues are and follow them through to their conclusion, the ability to work like a dog, and the ability to size up people--figure out quickly who will actually produce something useful and who will not, who will hang tough and who will easily bid more, who will soften if wooed and who will stay hard-nosed. Next to nobody has all four or even three of these capabilities in world-class measure. Fewer people than you think have even two. And for someone who has one of the other three--mastery of detail or skill at analysis or the ability to work like a dog for ungodly periods of time--mastery of Chet-hood is a very valuable and lucrative skill.

Alex chimes in:

Pushing the model a bit further I suggest that detail mastery, analytical thinking and working like a dog are more open to meritocracy than sizing people up because to size people up it helps to get them to like you and that is more culturally bound than the other skills. Minorities may rise to the top more quickly in fields that emphasize the first sets of skills than in those that emphasize the latter. Birth in general, connections etc. are also more important for the latter set of skills. Thus in America, it's Chet not Vijay even though Indian Chets surely exist in just as high a proportion as WASP Chets.

Here's my $0.02: I've worked in sales, and am (Admittedly) not nearly as smart as either Alex or Brad. While in the mutual fund industry, it seemed that the best deal makers were typically not the best academically. This is not to say that they weren't intelligent, but their intelligence was of a different sort - what's known a "emotional intelligence". They had an uncanny ability to know how to read people, when to push (and how), and when to back off. They also had "big brass ones".

The comments in Brad's thread are particularly instructive. I heard once that arrogance comes from comparing your strengths to someone else's weaknesses. We have a natural tendency to look down on those with "different strengths". I see this in academia - the researchers look down on the non-researcher teachers as not having the ability to publish in top journals, the profs bringing in the big consulting $$ look down on the pure researchers as being out of touch, and so on.

It takes a lot of inputs to do a successful deal on Wall Street - you need some quants, some "people readers", and a lot of grunts. Investment banking houses have a bit of the "old boy" thing going on, but they're mainly about making money - the "Chets" of the world bring a valuable skill to the table, or else they wouldn't make the $$ they do.

Artificial Intelligence For $13

Every once in a while, I see something that truly amazes me. Back in the early 80s, I had some grad student friends doing dissertations on Artifical Intelligence. At the time, the topic was almost "Star-Trekkish". After all, who could believe that a computer program could actually learn? Now, thaks to Alex Tabarrok at Marginal Revolution, I learn that you can buy this for less than $15. It's a little toy with an embedded AI chip that plays 20 questions. Extremely cool.

In case you're interested, it;s the brainchild (pun intended) of Robin Burger, who wrote a DOS program on a floppy back in 1988 that he handed around to his friends. They would play the game and give the disk back. In later versions, he uploaded it to the Web, so people can play world wide.

The 20 questions game is one of my kids' favorite diversions (and a lifesaver on long car trips, even if they do it mostly with characters from Disney videos). We came across The 20 Questions Website this weekend, and they love it.

This Week's Carnival Of The Capitalists

This week's Carnival of the Capitalists is up and running over at AnyLetter.

Fed Watching (from Calculated Risk)

Tim Duy is a faculty member in the Economics Department of the University of Oregon. Prior to that, he was a Fed-watcher for the private consulting group G-7. He will be writing a regular piece for Economist's View on the Fed. Here's a bit from his first piece:

The secret to remember is that Fed Watching is not about your interpretation of the economy or what you would do if you were a Board member. That approach will lead you down a bad road. The secret is to interpret the data as the Fed sees it, and remain agnostic about whether the policy is wrong or right.

Click here for the whole piece, titled "The Art and Practice of Fed Watching". And a tip-o-the-hat to Calculated Risk for the link.

Borrow Against Your House To Invest

JLP at All Things Financial comments on a recent Jonathan Clement's column (online subscription required) in the Wall Street Journal. The gist of the idea is pretty simple - borrow money against your house (at under 6% currently) and invest in the market. I thought I'd put in my $0.02 (and yes, it's out of pocket, not financed with a second mortgage):

1) It's true that you receive a 4% spread. It's actually a bit greater than that. The next two points will address why

• First, the mortgage interest is tax-deductible, so the after-tax borrowing cost is significantly lower. If you're already over the standard deduction, any additional mortgage interest you pay will result in additional tax deductions. As a result if you're in the 25% marginal tax bracket, your after tax borrowing cost would actually be 4.5%.
  
• While the investment in stocks will result in taxable dividends and/or capital gains, these can be minimized by choosing tax-advantaged investments. For example, index funds throw off relatively low dividend payouts, and have very low portfolio turnovers. So, the tax liabilities on these accouts would either be minimal or largely deferred. In other words, the after tax borrowing cost is significantly lower than 6%, and the after-tax return will be affected less than the after-tax interest cost.
  

2) However, although the spread is pretty good, it's important to note that this strategy is equivalent to investing "on margin" (buying stock with a loan financed by a loan). While the terms of the loan are better than you'd get on a margin account (and you avoid the probelm of margin calls), it's still a risky strategy. Any leverage in an investment magnifies both the return and the riskj significantly.

3) I don't buy the statement that you've tied your house to your investments (except in the VERY loose sens of the phrase). In the event that you sell the house, you can liquidate sufficient funds from your portfolio to pay off the loan. The major risk would be if both the house AND your portfolio had gone down in value. Of course, this is a problem mostly if you've over-leveraged your house. So, leave yourself some slack.

In summary, it's probably not a bad strategy, but it's definitely not for the naive investor. A person would have to be very cognizant of the risks involved. I'd add that (since I believe in efficient markets, the best investment strategy would be a buy and hold, index fund strategy.

Betting On Social Security Reform

After so much talk by the left that Social Security is too important to "gamble" on by allowing private accounts (it's...hold on now...TOO RISKY). So, it's ironic to hear that Tradesports.com has a contract that allows you to bet on whether or not private accounts actually go through. At present, the consensus is that there's only a small chance - the December-2006 contract is currently trading at only $0.29 on the dollar.

I'm a big fan of prediction markets like Tradesports and the Iowa Electronic Markets. Thet're good examples of how markets aggregate available information into prices. I use them as examples in my introductory finance class to illustrate efficient markets, since valuing an Arrow-Debreu securoty (i.e. one that pays off $1 if an event occurs and $0 otherwise) is a lot easier to grasp than valuing a stock or bond.

Thanks to Tyler Cowen at Marginal Revolution and to Chris Masse for the heads up.

New Additions To the Blogroll

Here's a few new blogs that I've been watching lately:

1) VC Adventure: Run by Seth Levine, a principal with Mobius Capital (a VC firm that invests primarily in high-tech, Internet related firms) It's interesting for a couple of reasons. First, because Levine writes often about what's going on in the blogging/tech world (they've got investments in Technorati, Newsgator, and Feedburner). And second, because he spends a lot of time peeling back the curtain on what goes on inside a VC firm.

2) The Jim Garven Weblog: Run by Garven, a Finance Prof (ah, another one) at Baylor University. He teaches classes in risk management & financial engineering, and does research in options and futures, corporate financial risk management, and insurance economics.

3) RiskProf: Run by Martin Grace, a risk management professor at Georgia State University. He blogs on liability law, insurance, and economics.

Sniglets (from VoluntaryXchange)

David Tuft of VoluntaryXchange is taking a trip down memory lane (courtesy of Chicago Boyz) - sniglets. Let's not forget my favorite one from back then:

expresshole (n.) : someone who goes through the express lane at the supermarket with far more than the maximum allowed number of items (usually when you're in a rush, and usually tries to pay with a check they write out carefully on the spot).

Academics In Industry

Paul Kedrowski at Infectious Greed writes about an interesting study in the journal research Policy:

...Researchers are more productive at producing papers when they shift from academia to industry, and then they become more productive again if/when they come back into the academic fold.

Click here for the whole piece.

Bob Anre at Truck and Barter chimes in with a possible explanation:

Maybe they got an original idea that is applicable in the real world? I find it odd that students go from undergrad directly into graduate school and expect to produce interesting research. A lot the graduate students here aren't really sure what they want to do for their dissertation. I have about twenty ideas and most of them can be traced back to my work experience in one way or another.

Click here for the whole post (the comments are particularly on point, too).

My own sense from doing financial academic research is that the best work is done by people that take the time to deeply understand the institutional details of whatever they're writing on. Unfortunately, the way a lot of my tribe try to do this is to read articles in academic journals written by academics, rather than by talking to people who are actually doing whatever they're researching.

To talk to (gasp!) actual practitioners might seem like an obvious step, but it's surprisingly rare. One of my grad school classmates did her dissertation on IPO syndicates. She spent hours and hours talking to investment bankers to see how THEY viewed the process and made decisions. As a result, she probably knows more about what IB's actually do and how they think than many who've been researching the area for far longer.

How To Blog Like A Rock Star (From Nykola.com)

Every once in a while, I like to "metablog" (i.e. blog about blogging). Ambra Nykol over at Nykola.com has been metablogging, and has a piece titled, "how to blog like a rock star". Here's a summary of part 2 of the series:

• Do not check your web stats each day (sorry, I'm too neurotic)
  
• Avoid "get hits quick" schemes (I call this "linkslutting"). And no, articles on tradesports.com contracts on the Michael Jackson case don't count. But, in case you're interested...
• Write like everybody's reading
• Genuinely comment on other people's blogs
• Join an alliance or two
• Specialize
• Draw readers, not tourists
  

Click here for the whole post, and here for part 1 of the series. It's definitely worth a read. My sense is that the successful bloggers show a window into who they are, and their blogs have a focus and a personality.

Why Are Startups Like Peacocks? (From Ventureblog)

Asymmetric information is one of the key concepts in modern finance. One setting where it often plays out is that managers (or owners) of a firm have better information about their firm's prospects than do the people they're trying to get funds from. So, the financiers can't easily separate the good firms from the lemons. So, they set terms based (depending on which model you believe in) either on the firm being the "average" quality or on it being the worst quality.

This gives the party with better information an incentive to somehow reveal their true quality. We commonly refer to this as "signaling" - the manager/owner takes some action that supposedly shows that it's a "good" company.

The problem is that the low-quality firm would like to be able to send the same signal, so that it will also be seen as a good firm.

So, in order for a signal to be credible ("non-mimicable" in economicese), it has to be costlier for the poorer quality firm to send than for the better quality firm. For example: firms don't like to cut dividends once they're raised them. So, raising the firm's dividend level is easier for the firm where the managers have confidence that the firm will be able to sustain the new, higher payout than for weaker firms.

Kevin Laws at VentureBlog uses this concept to explain how venture capitalists look at certain characteristics of startup firms to separate the good ones from the rest. He's also got a great analogy that I'll probably use in my class involving (of all things) peacocks:

Peahens like long tails, so a peacock with a big beautiful tail is more likely to mate and produce offspring. But that just pushes the problem back a level – after all, peahens shouldn’t like long tails if it makes their mates (and thus their children) more likely to be eaten.

Except that they have another incentive: they want to mate with only the best peacock to maximize their children’s success. But it’s hard to tell a good peacock just by looking at it (I know I can’t). You can’t tell if he’s healthy, has good eyesight, and can run fast. Since the peahen only sees the peacock during the mating ritual, she has to guess.

The tail resolves this dilemma. After all, it makes the peacock pretty easy for predators to spot and catch. It takes a clever, fast, healthy peacock to have such a ridiculous disadvantage and still survive. The bigger the tail, the bigger the disadvantage and the better the peacock has to be to survive. Though not useful by itself, it is useful in instantly communicating something that would normally take a long time to observe. For peacocks, size does matter.

By now, the relationship to venture financing should be obvious. Some features venture investors seek in a company are not directly related to the chances a company will succeed. Instead, many of the items are “peacock feathers” – ways for a venture investor to besure the company is not just puffing up for the mating ritual.

Very nice. Click here for the whole post.

Student Caught Cheating In Corporate Ethics Class (from JoanneJacobs.com)

This semester has been an all-time high (or would that be "low") for cheating - I (or a TA on the day I was away at a conference) bagged 4 students cheating on exams. Now, courtesy of JoanneJacobs, I hear this little tidbit about the student at the University of Delaware who got caught cheating during a quiz in a corporate ethics class.

To add to the irony, UD is known as a center for corporate governance.

Heh.

Finance Blogs In The News (From Seeking Alpha)

This just came across Reuters recently (courtesy of Seeking Alpha):

The financial blogs cover a wide spectrum. At one end are the very personal accounts by individuals who have had money problems, are digging themselves out, and want to share their story with the world. At the other end are rabid day traders whose entire blog entries consist of over-the-counter ticker symbols with "Long!" or "Short!" written next to it. In the middle are blogs by professors, brokers, mortgage bankers and stock market hobbyists.

...And now, a list to get you started. Here are some spots that list most financial blogs, as well as a few standouts.

• http://seekingalpha.com/. The mother of all investment blogs with links to everything stock market, venture capital and economics.
• http://pfblog.com/. A big, busy blog by a 29-year-old seeking to retire at age 40 with at least $1 million. It's full of personal finance and investing tips, well organized, with links to many, many other money blogs.
• http://www.soundmoneytips.com/2005/04/the_personal_fi.html. This is a list of most financial blogs. It's also a money tips blog of its own, that appears to have a writer AND an editor. Consequently, it's shorter, snappier, and smarter than a lot of the competition.
• http://www.fivecentnickel.com/. Short and sweet and focused on family finances. Newish, so there's not too much there yet.
• http://allthingsfinancial.blogspot.com. A fee-only financial planner's musings on stocks, savings, inspirational books and more.
• http://frugalforlife.blogspot.com. Where the self-proclaimed cheapskates chill. Lots of links and content for folks who are convinced they can save as much through smart household management as they can make in the stock market -- especially these days.

Unfortunately, I didn't make the cut...(sniff!).

Only The Good (don't) Die Young: Survivorship Bias and Statistical Inference (from Catallarchy)

Patri Friedman at Catallarchy has some great thoughts on survivorship bias. In the first post, Selection Bias and Risky Strategies, he writes about payoffs to players in poker tournaments. He writes:

...The same thing happens in the poker tournament world. Certain styles of play trade EV for variance, allowing people to build up huge stacks occasionally, but usually go bust. Such players often win tournaments - but that doesn’t mean they are playing right. How many times do they fail for each victory? Do they fail more often compared to the money they win than a more conservative player? Some of these “maniacs” are smart players, carefully choosing their gambles and maximizing their returns. But some of them, frankly, are just maniacs, gambling and getting lucky, and giving the false impression that high-variance play is the way to go, because we don’t notice the hundreds of people playing that way and losing.

The application for financial economists is that when analyzing only the firms which "survived", you end up with a skewed picture. As I was putting together a piece on mutual funds, Friedman followed up with a second post titled Wall Street's Shell Game, which pretty much stole my thunder. He starts off with this analogy:

Get a list of email addresses of people interested in sports betting. Say you have 32,000. Email 16,000 of them to say that the home team will win this week’s big team, and 16,000 to say the home team will lose. Now, half of the people will have gotten the correct prediction, and the next week, you do the same thing with them. After 5 weeks, you’ll have 1,000 email addresses of people who have seen you pick the winner five times in a row!. Now you pitch your 1-900 number or paid email list subscription to this amazed group.

If you consider that there's thousands of mutual funds, at least some are likely to beat the market 5 years running. It's entirely possible that there are some managers that can continue to sonsistently beat the market. However, you can't tell which are good, and which are lucky.

For a discussion of this idea, see a recent post titled "Is He Good, or Is He Lucky?" Which explains that decause there's such high variance, even beating the market by 2-3% annually over a five year period could result from chance the vast majority of the time.

For those with an academic bent, there have been quite a few academic pieces on the effect of survivorship bias in capital market research. In mutual funds research, one of the major data sources is the Carhart database, which includes data on both surviving and failed mutual funds. For a link to some of Carhart's research (on the SSRN), click here.

Personal Financial Files

All Things Financial has a good list of what to have in your personal financial files. It's pretty good, and suggested a few items I hadn't considered. We never want to think about these things, but in the event of death, having everything in one place makes it much easier for survivors.

To these items, I'd add the information on your life insurance policy.

Click here for the whole list.

Chronicles of Narnia Trailer (from VoluntaryXchange)

David Tufte at VoluntaryXchange provides this link to the trailer for the upcoming (in December) Disney film The Chronicles of Narnia: The Lion, the Witch and the Wardrobe.

Unlike David, I AM a big fan of Lewis' writings (both fiction and non). In fact, we just finished reading TLTWTW for the first time to the Unknown Son and the Unknown Daughter. Although they're only 6 and 4 respectively, they were absoluted entranced. I can't wait for the film.

Of course, I won't tell the kids until it's closer to release, or I'll never hear the end of it.

This Week's Carnival of The Capitalists

This week's COTC is up at A Penny For Your Thoughts. For those with a Finance bent (or is that, "for those who are financially bent"?) there are a couple of outstanding finance pieces in this week's group:

Single vs. Multiple Variable Analysis in Market Forecasts (from The Big Picture) which touches on the whole issue of the talking heads (or investment managers) who argue that simplistic rules can be used to predict either stock market either in the aggregate or for individaul companies.

Hedge Fun Hijinks, (from View From A Height) which discusses some ways that hedge funds may have been manipulating stock prices in the recent MCI/Qwest/Verizon takeover battle

and last but not least, Morningstar's Auction IPO, courtesy of The Conglomerate Blog (a Law Blog out of Marquette).

Of course, if you want non-finance related stuff, there's plenty to see at the various booths of the Carnival.

Happy Mothers' Day

Here's wishing a happy Mothers' Day to all those who either are (or have) Mothers.

Alhough some migfht not care for it, here's a cartoon that hits the spot:

Beauty Secrets of Credit Score Stars [Fool.com: Motley Fool Take] May 6, 2005

I have two minds about the Motley Fool - on the one hand, they have excellent info on personal finance matters. On the other, they often miss the mark on stock picks, since they don't seem to believe in market efficiency. Here's a great example 0f the first set of articles. This short piece on credit scores lists some of the major factors that affect them (I know, I've posted a lot on the topic, but it's important). As usual, it's written with the layman in mind. Here are the characteristics of the absolute highest credit scores:

• Between four and six revolving accounts (meaning credit cards).
• At least one "installment" tradeline (e.g., a mortgage or auto loan) in good standing.
• A few accounts around 20 years old with a long history of positive use. (To get into the 800 range, you need 10 years of positive account history.)
• Around 30 years of credit use.
• No late payments (or other account blunders) for at least the past seven years.
• Very few credit inquiries (no more than one to three in a six-month period).
• No derogatory notations -- collections, bankruptcies, or bad accessorizing. (Just kidding on that last one.)
• Debt levels on credit accounts of less than 35% of their overall credit limit.

Click here for the whole thing. The article also lists a number of steps to take if you want to shine up your credit score.


Beauty Secrets of Credit Score Stars [Fool.com: Motley Fool Take] May 6, 2005: "Beauty is only skin deep. Particularly to your banker, who knows that it's what's in your credit file that really matters."

Market Efficiency - Is He Good, or Is He Lucky? (From VoluntaryXchange)

David Tufte at VoluntaryXchange has a good piece on market efficiency. It deals with the question, "If a money manager has beat the market over the last N years, how likely is it that he was good, vs. how likely is it that he was lucky?"

A theorem of "folk finance" is that it is easy to beat the return of an asset market. A corrollary is that an investor can be informed by paying attention to claims made by others that they have in fact done this.

This is nonsense. Nonetheless it is a fairly popular belief.

Mahalanobis summarizes a paper that looks at this. Understanding the body of the post probably requires some Ph.D. finance classes, so let me translate.

The example at the bottom of the page is built around a hypothetical manager who can consistently beat the market by 3% (that would be an enormous advantage, and it isn't at all clear that anyone has ever done that well). Yet, you can only be 65% sure that this manager will beat the market over the next 25 years.

How is this so? The reason is that the volatility of the market and individual portfolios is so large that one lucky or unlucky year is enough to screw things up.

What does this mean for the casual investor who may pay attention to advertisements that claim that such-and-such a manager has beaten the market for (say) the last 5 years? It means that the odds are 51/49 or so that this manager is above average. On the bright side, this is a bit better than the 50/50 chance that any manager you find in the yellow pages (or even with a poster stapled to a telephone pole) is above average.

P.S. This economist-who-does-finance-too's inside view is that a big difference between economics and finance Ph.D.'s is that the former accept that they can't beat the market, and the latter think that no one but them can beat the market.

Click here for the whole article.

I agree that some finance Ph.D.s seem to believe that market efficiency doesn't apply to them. However, it's not limited to them. A few years ago, I had a colleague (finance prof) tell me that I should buy Enron, because it was selling at $5 (off from its 52-week high of $50). Just last year, I had a lengthy conversation with an accounting prof who was convinced that she could pick stocks by reading the footnotes in the annual report carefully.

It reminds me of the story (probably apocryphal) that 7 out of 10 Americans believe that they're above average drivers. For guys, it's 8 out of 10.

It's that time of year

It's that time of the academic year - the final week of the semester. The best way to describe it is by an old joke (which I tell to my students):

You look out your window one morning and see a bobcat in your tree. So, you call animal control, and this old Gumby-looking character shows up with a pole with a loop on the end, a heavy canvas sack, and a shotgun. So, you ask, "what're those for?"

"I'm going up into the tree, and I'll try to snare the cat with this pole & loop. Then, we'll put him in the sack".

"How about the gun?"

"Well, you hold it, and if the cat comes down, shoot him"

So, the animal-control guy climbs up the tree, and (once he's out of sight because of the leaves), a terrible shriek is heard, followed by swearing and the sounds of fighting. This goes on for several minutes, and the old guy shouts down, "Shoot! Shoot"

You call back, "I'm afraid I might hit you instead of the cat!"

He yells, "It don't matter - we can both use the rest!"

At this point of the semester, both my students and I can use the rest. Luckily, I'm just about done with writing my exams, and then all I have to do is give them and grade them.

Still, I wouldn't mind if someone just shot me. I think that would be fine with my students, too. We can both use the rest.

Quote of the Day (via Catallarchy)

This Rush Limbaugh quote comes courtesy of Scott Scheule at Catallarchy

We don’t have an unfair distribution of wealth in the world, we have an unfair distribution of capitalism.

I'll echo the amen (or should that be "ditto?")

Busfilm - A Blog On Business In the Movies

I try to use movie illustrations and pop culture in my classes as much as possible. Along those lines, I just came across this blog called Busfilm run by law prof Larry Ribstein. He also runs Ideoblog, which is outstanding in its own right.

Busfilm is dedicated to the ways that business is portrayed in film. I'd recommend it to anyone who teaches any of the business disciplines. He also has an as yet unpublished article that goes into the topic at great length. It's a great read.

Now I have a few more movies to mine for classroom illustrations. A great idea - my students give it two thumbs up!

First sell short, then sue (from Overlawered)

Overlawered asks an interesting question. If a lawyer short-sells a stock and then sues the company in a class action suit, should they be deemed insiders?:

"There is some evidence that plaintiffs and their attorneys are profitably short-selling the stock of the companies they intend to sue," writes Moin Yahya of the University of Alberta law faculty in a new paper called "The Legal Status of 'Dump & Sue'" (SSRN, Mar. 9). Strategic litigants or their attorneys thus stand to capture two distinct strands of revenue: one from the eventual settlement of the suit, the other from the profits they capture after their adversary's stock declines on the announcement of the suit. (Alternatively, some lawsuits might be rendered profitable by the gains from short-selling even though they never win settlements at all.) Does insider-trading law as it currently stands prohibit such goings-on? Not necessarily, since litigants and their lawyers don't ordinarily count as "insiders" in conventional terms. But given securities regulators' goal of upholding what they call market integrity, it's hard to see why they would not want to prohibit the sleazy practice. For a dissenting view, see Larry Ribstein (Apr. 11).

My question is why the lawyers short-sell when they could buy a high-delta (delta is the change in option price from a unit change in the price of the underlying stock) put option, since taking that tack would have higher expected profits. The obvious reasons are:

1. Unwillingness to make the up-front commitment of $$ necessary to buy the option (the short-sale takes no immediate cash
2. The higher risk inherent in the option strategy.
3. The firms chosen as targets don't have traded options.
   

The last possibility is that lawyers can't figure out the optimal strategy. Given the predilection of lawyers to make money, I doubt that's a credible explanation.

New Additions To The Blogroll

I finally got around to updating my blogroll. Like with most blogs (and my waistline), it seems to grow over time. Here are the latest additions:

My Money Blog - a personal finance blog that contains a lot of helpful tips on savings, credit cards, etc...

All Things Financial is another personal finance blog, but it's run by a fee-based financial planner in Texas. I was in that industry (financial planning) about 20 years back. The fee-based planners have better incentives to give unbiased advice, since they don't get paid on commission.

The Financial Accounting Blog - not updated frequently enough, but usually has interesting stuff with more of an accounting twist.

Inside Sarbanes Oxley - a good example of a blog targeted to a narrow market. It contains links to news, books, discussion boards, and jobs, and all things SOX-related

The Economics Roundtable - has a great aggregator that puts recent posts from over 50 economics blogs on one page.

Jacqueline Mackie Paisley Passey - a 20-something, soon to graduate libertarian economics student in Washington State.

The Securities Law Blog - Commentary, analysis and news on securities, finance and corporate law.

Check them out. If you have any other suggestions for good finance or econ blogs let me know.

I'm particularly interested in finance-related blogs (particularly by academics).

Where Have the Directors Gone?

This article from Fortune magazine highlights another unintended cost of Sarbanes Oxley. It's getting harder and harder to attract good directors. According to their data, half of the outside directors at Fortune 1000 companies are quitting. As for the reasons:

Simon Francis, a partner at executive-search firm Christian & Timbers, attributes a lot of empty board seats to conflicts of interest, perceived or real. "For example, it's now viewed as bad form for the chairman of the audit committee to also sit on the executive-compensation committee, or vice versa," he says. "You can't be both gamekeeper and poacher." Further shrinking the pool of outside-director candidates are restrictions on how many outside boards a CEO may join. In 2001, according to an exhaustive study of corporate boards' composition by executive-search giant Korn/Ferry International, just 23% of U.S. companies had such limits. Now more than half (51%) restrict CEOs to no more than two outside directorships.

Click here for the whole article.

The good news is that director compensation is rising. Now, if I can only get a few directorships...

Congratulations To Kevin Brancato

Congratulations to Kevin Brancato at Truck and Barter - he's graduated with his "plumbers' license". I remember when I got mine - I told my family, "Now that I have a Ph.D., I'll be expecting a little more respect. From now on, that's DOCTOR butthead".

Carnival of the Capitalists

This week's COTC is up at Incite.

"

Smarter People Think More Like Economists (from Econolog)

Bryan Caplan at Econolog believes that better educated people are more likely to think like economists. With the exception of some of my more left-wing academic friends, I'd have to agree with him.

Economics is based on the idea that there are always tradeoffs, and that every action has a cost. I think that better educated people grasp those concepts more easily.

Caplan writes:

More educated people think more like economists. It's one of the big findings in my piece in the 2001 Journal of Law and Economics. And that's controlling for income, income growth, job security, gender, ideology, and party. It's a big effect, too: Every step up a 7-point educational scale matters about 9.3% as much as an economics Ph.D.

He then goes on to discuss a Hearst Report on "The American Public's Knowledge of Business and the Economy,"from back in the 1980s:

...My interpretation: More educated people are a lot more likely to favor exceptions because they grasp, in a rudimentary way, the fact that pushing up the wages of low-skilled workers causes unemployment. Of course, this insight is so unpalatable that most well-educated people support the existence of the minimum wage anyway. But their support is plainly less dogmatic than that of their fellow citizens.

Click here for the whole article. It's not new ground, but as usual, it well stated. The debate going on in the comments is also instructive, and far more interesting because of the back-and-forth.

UPDATE: I inadvertantly attributed this to Arnold Kling, when it was actually written by Bryan Caplan. It's been corrected (sorry, Bryan...)