Thursday, June 30, 2005

Thomas Sowell turns 75

Here's a happy 75th birthday to one of the great thinkers of our time - Thomas Sowell. He's had an amazing life, and written some of the most informative and provocative material out there.

I've been reading Sowell's columns for years (take some time and check out the archives when you have time - they're extremely readable, and worth the time). I sent him an email a year or so back telling him how I've used his columns over the years in my classes. In the email, I described him as "making hamburger out of the sacred cows of our time". A few days later, I received a package from the Hoover Institute containing two signed copies of his books on economics - Basic Economics: A Citizen's Guide To The Economy and Applied Economics: Thinking Beyond Stage One, along with a very gracious letter thanking me for my comments. They've become two of my favorite books, and I'd recommend them to anyone wanting to gain a solid grasp of basic economic principles without having to wade through all the math.

I recently heard him interviewed by his good friend Walter Williams on the Limbaugh show. If he's this sharp, witty, and insightful at 75, I can only imagine what he was like in his earlier years.

Here's a sample of his writing to leave you with (from his "birthday" column at Townhall) :
Three-quarters of a century!

It is hard to believe that I am that old but arithmetic is uncompromising. This means that I have lived through nearly one-third of the entire history of the United States.

The changes in my life -- and still more so in the life of the country around me and in the world at large -- have been almost unbelievable.

Most Americans did not own a telephone or a refrigerator when I was born on June 30, 1930.

...All the dark and ominous times that this country and the world have passed through and overcome in the past 75 years make it hard to despair, even in the face of growing signs of internal degeneracy today. Pessimism, yes. Despair, not yet.

In my personal life, I can remember a time when our family had no such frills as electricity, central heating, or hot running water.

Even after we left the poverty-stricken Jim Crow South and moved to a new life in Harlem, I can remember at the age of nine seeing a public library for the first time and having to have a young friend explain to me patiently what a public library was.

There is much to complain about today and to fear for the future of our children and our country. But despair? Not yet.

We have all come through too much for that.

Happy Birthday, Dr. Sowell. Long may your flag wave.

Decimalization is Coming To Options Markets (from Blogging Wall Street)

Decimalization (quoting prices in increments of $0.01) recently hit stock markets. The decrease in spreads made trading in small mispricings more profitable. This made stock markets more efficient.

Now, decimalization is starting to spread to options markets. Click here for the whole story.

Since options are incresingly used in a variety of arbitrage andrick management strategies, this can only be good news for investors.

Tip-o-the-hat to BlogginWallStreet for the link.

Oh What the Heck, Let's Talk About Kelo

Sorry, I held out as long as I could, but the stress finally got to me. Rather than go on a rant about the recent Supreme Court decision on the Kelo case, I'll just provide a few links to comments by people who are obviously a lot smarter (and funnier, and more talented, and probably better looking... than me:

from Scrappleface, the Day By Day cartoons for the last few days, and this about the Just Deserts Restuarant.

Finally, for some serious commentary, there's none better than the inestimable Steve BainBridge.

There-- I feel much better now. Time for more coffee.

Wednesday, June 29, 2005

Where Should My Money Go? (from the Motley Fool)

How do you decide between 401-k plans, Roth IRAs, and so on? It's a common question. Where Should My Money Go (from the online Motley Fool website) give a brief summary of the best choices. In order, they are:

  1. Any plans (i.e. 401-k) where your employer matches your contribution
  2. Roth IRA (if you qualify)
  3. Employer plans where the employer doesn't match
  4. Traditional IRA
For the logic behind these choices, click here to read the whole article.

The Trouble With Market Reporting (via Stumbling and Mumbling)

I'm always amused by financial reporters' explanations of market movements. We have a hard time dealing with the idea that stock price movements are largely unpredictable. So naturally, we look for patterns (whether they're there or not). Chris Dillow at Stumbling and Mumbling seems to share this view. He has some nice thoughts on the matter (emphasis mine):

Explaining market moves are just easy after-the-fact rationalizations. In weak macroeconomic conditions, a market fall will trigger the line: "market falls on economic fears." And a rise will invite: "market rises on interest rate hopes." It's the same macroeconomic story.

There are several clues to this pin-the-tail-on-donkey approach. One of the best is "after". It hints at causality without stating it. Why not say: "market rose today after I missed my bus"?

Paradoxically, of all the explanations the dead trees give for market moves, they never offer two of the most likely ones. You never see the stories: "market rises but it's just random noise." Or "market rises because risk aversion declines
click here for the whole post.

It reminds me of the classic coin flipping example in A Random Walk Down Wall Street. An economist made a chart that started at $50. He then flipped a coin multiple times. Each time it came up heads, he increased the stock's price by $0.01. Each time it came out heads, he decreased the stock's price by $0.01.

When he gave the chart to a technical trader (while telling him it was of a stock), the trader said it was a clear buying signal .

Alex Tabarrok and Bryan Kaplan Get Freaky

The latest Wall Street Journal Econoblog features Alex Tabarrok and Bryan Kaplan from Geroge Mason University's Economics Department. They apply economic reasoning to the decision of presidents to go to war, hidden fees in car rentals, and a novel idea for deciding whether to fire CEOs. Good stuff.

For those who aren't familiar with these two, the run a couple of excellent blogs: Alex is at Marginal Revolution and Bryan's at Econlog. Both are part of my daily reading list (and my blogroll).

Auctions or Fire Sales?

An auction is a great way to get people to reveal the values they place on things. Ebay is built on the concept, and they've been used to value IPOs.

But, here's one setting they probably aren't the best solution.

Hat tip to Division of Labour for the link.

Note: for those who don't get the reference to Coase, click here. The "Coase Theorem" is one of the most widely mentioned concepts in economics.

Tuesday, June 28, 2005

And Now For Something Completely Different

A friend sent this the other day. It's a bit off topic, but very funny.

And yes, I'm in a strange mood.

Extreme Savers

Kevin at Truck and Barter is blogging about the CNN/Money ongoing series about "extreme savers". These are people that often save 25% (or even half) their gross income.

I have an "extreme saver" in my own extended family - the Unknown Brother In Law. Oh, the stories I could tell: He once saved money while on unemployment, and was able to pay off a $100,000 mortgage in a little over 7 years (on a family income of about $50-60,000 (this was in addition to other savings/investments). And let's not mention the paper bag we found in his basement with about a hundred elastic waistbands from old briefs.

We used to joke that he held onto a buffalo nickle so tightly that there'd be a pile of "you know what" at his feet.

The CNN/Money articles are not in one easy to read place, but you can see them by clicking here - it takes you to a Google search that catches them all.

All joking aside, we could all save and invest a bit more (sometimes a lot more) than we do. One good (and amusing resource) is The Complete TightWad Gazette, which is a compilation of hundreds of money saving tips.

Of course, my brother in law says that the Tightwad Gazette is not hard core enough...

Monday, June 27, 2005

This Week's Carnival Of Personal Finance

This week's Carnival Of Personal Finance is up at Blueprint For Financial Prosperity. Some good stuff there...

This Week's Carnival Of The Capitalists

This week's Carnival of the Capitalists is up at BusinessBlogCast. While your tastes may differ, here are my "picks of the litter":
The Best Advice I Can Give from FreeMoneyFinance. He's been putting together a collection of "best advice" from personal finance bloggers.
Another Exciting Week In Oil Markets from Econbrowser - James Hamilton (a very smart guy) puts current oil proces in context by looking at the 1980s. He knows his stuff, and breaks it down into very understandable terms.
Investment Banking at the Prescott Starbucks from Talking Story With Say Leadership Coaching on a very clever marketing tack taken by one businessman. My father always told me to buy the first round, but I don't think he had coffee in mind.

PowerPoint Presentations

I'm an accademic, so I wear two hats: researcher and teacher (i.e. creating knowledge and sharing it). As a teacher, I try to present material in a way that's interesting, logical, and most likely to be absorbed by my audience. Most of my peers try to do likewise.

However, when I go to conferences or seminars, it seems like my tribe (the clan of pointy-headed nerds) throws everything we know about effective presenting out the window. The first rule of conference presentations seems to be "suck all the life out of your presentation". The second is, "use busy tables with lots of 10-point type".

Here's a nice post on using PowerPoint from Working Smart titled Five Rules For PowerPoint Presentations. It's geared more towards business presentations than to academic ones, but the principles are the same - it's only the implementation that changes.

It also has links to some very nice resources.

Best Film Quotes Of All Time

A few days back, the Unknown Wife and I watched the CBS special on the best film quotes of all time. I was surprised I knew so many of them.

For the film buffs among you, here's the American Film Institure's list of the all time best quotes from film characters. that was used for the ballot.

Hat tip to David Tufte at VoluntaryXchange for the link.

Starting Salaries For Graduates

Here's a CNN/Money article that lists the average starting salaries for members of the Class of 2005. Finance grads come out o.k. - like last year, engineering grads top the list. Still, almost $43,000 a year's not too shabby.

Hat tip to Political Calculations for the link.

Saturday, June 25, 2005

A History Of TulipMania (via Econbrowser)

James Hamilton at Econbrowser shoots some holes in recent comments comparing housing bubbles to the "tulip mania" of the mid-1600s. It turns out that they really aren't that similar after all:

Many folks appear to be convinced that the current housing situation is akin to any of a number of other famous financial bubbles of history. Trouble is, those famous bubbles weren't very much like what most people seem to assume.

...Much of the popular understanding of the Dutch tulip mania is derived from Charles Mackay's delightfully written book, Extraordinary Popular Delusions and the Madness of Crowds , whose first edition appeared in 1841. Nine colorfully narrated pages describe the market for tulips in Holland between 1634 and 1637.It was not until 1989, however, that the record of this episode was really set straight by the careful research of Peter Garber published in the Journal of Political Economy. Garber documented that the spectacular tulip prices recounted by Mackay never applied to ordinary tulip bulbs, whose prices, even at the height of the frenzy, were quoted like produce by the half-pound or pound. The extraordinary prices characterized instead a few special lines of tulips that had been infected by a mosaic virus which in some circumstances produced a particular pattern judged to be beautiful, such as the Semper Augustus shown at the right. But if you liked the effect in a particular flower, the only way to reproduce it would be to cultivate a few buds from the original, hoping to have two or three bulbs in the following year with the same qualities.

Click here for the whole post.

Getting Credit Card Fees Waived (via Sound Money Tips)

Here's some practical advice from Sound Money Tips:
Ever forget to pay your credit card bill on time? You aren't the only one! But what can you do to avoid a late fee? Call your credit card company and ask them (politely) to waive it. Explain that you regularly pay your bill on time and late payment will never happen again. And if the card company rep rejects you? Threaten to cancel your credit card.
Click here for the whole post (it has a link to a great guide on using credit cards effectively).

Thursday, June 23, 2005

Is Your Boss a Psychopath?

Yahoo! Finance has an interesting article titled "Is your Boss a Psychopath?". It begins:
Odds are you've run across one of these characters in your career. They're glib, charming, manipulative, deceitful, ruthless -- and very, very destructive. And there may be lots of them in America's corner offices."
click here for the whole article.

It reminded me of a former job I had as a tax collector for the State of Connecticut. If you want to know what kind of bosses we had, think about the characteristics that make a successful tax collector - a lack of empathy, a bit too much enjoyment from exercising authority, and a strong goal orientation. The person who best exemplifies these traits will end up moving up the food chain. Imagine that package for a boss.

My unit had two supervisors - a short man who wished he was a tall man, and a short woman who I suspect also wished she was a tall man. To add to the fun, we had cubicles, and both supervisors were short enough that you couldn't see them coming until they materialized just outside your cubicle.

Needless to say, I got out of there as fast as I could. Jobs like this had a silver lining - they gave me the incentive to figure out what I really wanted to do for a career. I eventually ended up in academics, so I guess it worked out all right.

Publishing In Academia

As an academic, I find the publishing process to be both the hardest thing I do and the most rewarding (that is, not counting being a father and a husband).

My seat-of-the-pants estimate is that fewer than 1/10 of the academics in my discipline (finance) ever publish even one article over their career in the top-tier finance journals (Journal of Finance, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, Journal of Business, and Review of Financial Studies). Fewer than half have more than two publications in respectable second-tier journals. Only a handful have averaged one article a year (even counting third tier journals) over a ten year period.

Tyler Cowen at Marginal Revolution gives us some excerpts from a recent talk he gave to graduate students on how to be successful at publishing. I'd say that his two best pieces of advice are "doing first things first", and caring about what we do. As the day goes on, you'll find plenty of non-essential things to waste your time on. If we get the most important things done first, we have the freedom to slack off a bit later. In addition, if we're truly enthused about what we're doing, it's easier to do the little things that make a difference between "almost there", and "done".

Bryan Caplan at Econolog responds adds his $0.02 here. He largely agrees with Tyler, but has the best line of the day:"Referees are on average a useless lot." The line resonated with most of my peers when I ran it past them. In fact, King at SCSU Scholars has a nice piece titled "Send your referee to Gitmo" (remind me not to referee any of his pieces).

Regarding time management and productivity in general, I'd highly recommend "Eat That Frog" by Brian Tracy. The title comes from an old saying, "The first thing you should do every day is eat a live frog. After that, you can rest east that for the rest of the day, nothing else you have to face will be as difficult". Of course, a steady diet of frogs is hard to keep up...

Wednesday, June 22, 2005

Forecast For Blogging - Light

I'll be out of town for the next few days - visiting family (and my Outlaws). I might not have much access to a computer, so blogging will be light.

Tuesday, June 21, 2005

Ohio Marketing Professor Convicted of Insider Trading

From Yahoo News:

A federal jury on Monday found a well-known marketing professor guilty of insider trading and conspiracy for tipping off friends about a merger in an insider trading deal that netted them $880,000.

Ohio State University professor Roger Blackwell was convicted of telling others about Kellogg Co.'s plan to buy Worthington Foods Inc. before the agreement was announced in October 1999. Blackwell, on Worthington Foods' board of directors at the time, was not allowed to disclose the pending acquisition to others.

...Prosecutors said Blackwell faces up to 10 years in prison.

Click here for the whole story.

Over the years, I've occasionally heard information from MBA students (and from friends working on the Street) that could have resulted in some nice trading profits . So far, I haven't succumbed to the temptation. Stories like this are a good reminder why.

A Dollar Saved is Better Than a Dollar Earned (redux)

Yesterday, I made a reference to a post that showed that a dollar saved is better than a dollar earned. I'd like to elaborate on that theme today and show how "small" savings and changes in lifestyle can make BIG differences over time if invested for the long term.

If you want to see what a small change like giving up expensive coffee can make, here's the "Cheap coffee vs. Starbucks" calculator, compliments of Sound Money. Assume that you give up one $3 latte a day, and go with office coffee instead (actually, that would probably help you kick the habit altogether). Then, assume you invested the money saved in a mutual fund that averaged 10%. After 20 years, you'd have an additional $35,000 (give or take), and after 30 years, you'd have an additional $102,000.

As I tell my class, "if that don't light your fire, your wood's wet".

The Princess Bride Meets The Land Shark

Thanks to the miracle of caffeine, my second brain cell just kicked in. Unfortunately, this is what it latched onto. Imagine if the Princess Bride (one of best cheap rentals out there) were remade with rubber sharks? (link courtesy of the Evangelical Outpost). It's almost inconceivable.

Maybe they'd just seen this.

Must. Get. More. Coffee.

Monday, June 20, 2005

The Carnival of Personal Finance (New!)

I'm a big fan of "Carnivals" (roving sites dedicated to one theme or another that collect submissions on various topics). There's a new one called the Carnival of Personal Finance, and it looks promising. The inaugural CPF (maybe that should be reworked so that it could be "CFP"?) is up at ConsumerismCommentary. Here are a few posts I found particularly interesting:
Jim at Blueprint for Financial Security has a nice series on the entire process of buying a house (from soup to nuts). It's worth checking out for those buying their first one - we've bought two in the Unknown Family so far, and I still learn new things from articles like this. Given the magnitude of the decision to buy a house, it behooves all of us to learn as much as we can.

JLP at All Things Financial has a nice piece on comparing interest costs of 15, 30, and 40 year mortgages.

Nickel from Five Cent Nickel drives home the point that it's important to control costs with a post titled a dollar saved does not equal a dollar earned. For example, if you are in the 2o% marginal tax bracket, cutting your expenses by a dollar is as good as earning an additional $1.25.

Finally, Jonathan, the author of MyMoneyBlog, gives some tips on the fine art of fighting over the check. My personal favorite is #4 - the "pre-emptive strike". If you have any good strategies to add to the list, send them in.

Of course, these are only my picks. As the ads often say, "your results may differ".

Sunday, June 19, 2005

Miss a Day (or 10) and You Miss a Lot

Many people believe that you can "Time" the market. I believe that markets are efficient (i.e. that prices already reflect all available information, and that you can't beat the market). So, I don't think market timing makes a lot of sense (particularly timing based on relatively simple rules).

But, what if you "time" the market wrong? What if you miss only a few of the "good" market days? Nejat Seyhun of the University of Michigan recently looked at this issue, and found that the over the period from 1963 to 1993, a capitalization-weighted market index earned 11.83% annually. However, miss only the 10 highest-return days in that period, and the average annual return drops to 10.17%; miss the 40 best days (an average of a little more than one day per year) and the average return drops to a little more than 7% annually.

So, a relatively few high-return days provide a disproportionately large portion of the market's overall return. There's lots of other good stuff in Seyhun's study, and it's quite readable.

The moral of the story: buy an index fund and keep your money in it!

Super Size My Grade

In the last few days, there's been a bit of talk in the blogosphere about grade inflation. Much of it seems to have been sparked by a recent paper written by Eric Maurin and Sandra McNally which examines grade inflation resulting from French students rioting in 1968. The students were subsequently admitted to better universities than they otherwise should have as a way of mollifying them.

Mark Thoma at Economist's View is doing some work in the area. In a recent piece, he shows the grade book from a 1949 principles level history class. It breaks down to a class GPA of 2.22, with only about 9% getting A's.

Thoma's own work indicates that grade inflation is more pronounced among assistant professors, teaching assistants, and instructors, and not as much of a problem among associate or full professors. This isn't surprising - those lower on the academic food chain have an incentive to game the system for higher evaluations, and grade inflation is one means to that end. He provides some stats:

Here's one measure across faculty rank, %A (other measures also show this). We have three levels of courses, level 1 is principles and level 3 is upper division. Here are the numbers:
Full professors (%A in Levels 1, 2, 3)
26% 31% 35%

Assistant professors (%A in Levels 1, 2, 3)
30% 45% 42%

Adjunct professors (%A in Levels 1, 2, 3)
38% 50% 42%
For comparison, the grade distribution from 1949 given above has a %A of 9% for a level 1 class (13/140).
Click here for the full posting.

Thoma also provides a link to gradeinflation. com, which has a lot of data on trends in grades for a wide variety of schools over time. A casual look at the numbers shows that the typical school's GPA has gone up by around 0.2 since from 1991 to 2002. Looking at the numbers, it also seems like that the inflation is less for lower-tier public schools (particularly non-flagship ones), but I can't back that up with hard analysis.

As is often the case on issues like this, the comments following Thoma's piece are almost as good as the piece.

Saturday, June 18, 2005

The Investment Idea That Keeps On Giving (from

There's been a lot of research on "socially responsible" investing. It generally shows that (not surprisingly) this investing style significantly underperforms non-constrained investing. Steve Bainbridge has his own idea for a fund - investments that will tick off the "right" (or is that the "left") people. He's accepting investment ideas, so drop on over and chime in. All the usual suspects have been named already, so you'll have to work a bit.

Note: if you want to read some serious thoughts on the costs of socially conscious investing, here's a piece by Gezczy, Stambaugh, and Levin available free on the SSRN. So, Steve's idea will cost you, but you can justify the losses under the heading of "entertainment".

Friday, June 17, 2005

Teaching and the Mystery of Pat

Unlike a lot of my peers, I actually enjoy teaching the Introductory Finance course. Since it's the core finance requirement for the College of Business, all business have to take it. So, most of my students aren't Finance majors, and many of them have serious deficiencies in their math skills and problem solving skills. This comes out mostly from seeing their approach to what they call "learning".

Robert Talbert at BrightMystery tells a story about about a student in his class, named Pat (Ugh! Now I need some "mental floss" to get that image out of my head) for angrogenous anonymity's sake. It hits the nail on the head. Pat didn't want to hear questions, only answers:

So the problem wasn't Pat's skill with the material so much -- the processing skill was the problem. Accordingly, when Pat would ask me a question such as, "Can you tell me how to do problem 7?", I would say: Let's start by asking the right questions. What are you being asked to do in this problem? What information is given to you in the problem statement? And what do you know from the course, your reading, or your work on other exercises that will help get you to the goal? I made it a point to NEVER give Pat explicit help on content unless it was a last resort -- Pat absolutely HAD to cut the apron-strings from me an learn how to approach, analyze, and solve a problem alone, or else Pat's chances for success in a future career or even making it through college didn't look good.

If Pat needed help on content, I'd ask: Where have you worked out, or seen worked out, a calculation like this before? What are the relevant rules? And so on. Because all the content Pat needed had been done in class, in the readings, or in the exercises; 9 times out of 10, Pat was like every other student in the class and just hadn't paid attention in lecture, done the exercises, or read the examples -- or was making some basic algebra mistake that Pat needed to learn how to catch on Pat's own. My questions were intended to get Pat to go back and seek out the content information Pat needed and evaluate Pat's own work, because that's how it would work in a problem-solving or test setting when I can't give explicit directions on content.

Pat sent me an email just after midterms that said something like: I now understand why I am not doing well in your class. My learning style is such that you have to show me exactly what to do, or else I can't do it. But you always answer my questions with more questions, which isn't showing me exactly what to do. So from now on, please show me exactly what to do first, and then I should be able to do it. My response was something like: Pat, we've been doing this every day in class -- I work a few problems at the board all the way through during lecture, and then I give you exercises that are based on the stuff you've seen. So you are seeing me show you what to do, and yet you're still having difficulty solving problems on your own. So perhaps your assessment wasn't quite right, and we should be working on your problem-solving skills in office hours.

Click here for the whole post. Of course, Pat's mother intervened, and the email response to her was priceless (and much, much more gracious than I probably would have been). I'll probably save it in a text file for future use. Make sure to read the comments to the post too.

Since I teach a course that non-finance majors have to take, I run into a lot of "Pats". In the core class, they don't learn all that many concepts/tools/techniques (and most of them seem to be related to , but they do have to learn how to use them in a wide variety of settings (i.e. time value shows up as "the price of a bond is the present value of the cash flows" or "the NPV is the present value of the inflows less the cost")

However, the only way top learn how to recognize the "simple" problem behind the seemingly complicated one that they can't seem to solve is to muddle through a lot of exercises and learn how to ask the "right" questions. Unfortunately, the only way to learn how to ask the right questions is to experience the frustration resulting form asking the wrong questions.

Kind of like life.

Hat tip to Joanne Jacobs for the link.

Wednesday, June 15, 2005

Free Wi-Fi is Best With Coffee!

Luckily, Panera isn't among the restuarants cutting back on Wi-Fi. However, I have to drink a lot of coffee to keep the wait staff off my back (not that there's anything wrong with that).

Live 8 Tickets, IPOs, and Dutch Auctions (oh my!)

Q: What do Live 8 tickets and IPOs (Initial Public Offerings) have in common?

A: They're both underpriced and sell in the aftermarket for a higher price than they did initially.

The IPO underpricing phenomenon has around for many years. For the layman, here's what "underpricing" means in the context of an IPO (or a ticket sale): A company goes public, and shares are offered to the public at, say $20. The shares often (not always, but frequently enough) trade much higher by the end of the next few days. In the case of Google, the stock was initially offered at an initial price of $85. The stock's price closed trading at the end to the initial day at $100 (it had actually been much higher during the day, but that was the closing price). Since Google issued 15 million shares, that's an additional $210 million dollars that Google could have received in the offering, but didn't.

Is this bad? From a strictly financial standpoint, underpricing merely means that the issuing firm (or concert promoter) left money on the table. Subsequent trading allows the market to revalue the shares to what it thinks they should be, rather than the price set by the issuer.

One reason that underpricing occurs is that there's an agency problem. The underwriter (or promoter) sometimes makes a "firm commitment" on the IPO, where they take on the risk that the issue won't sell out. So, if there are unsold shares (or tickets), they have to buy them from the company. Since this exposes them to a significant amount of risk if the issue doesn't sell out, they rationally price the shares/tickets "to sell" (i.e. at a discount from what they perceive as fair value. In fact, there's some evidence that "firm commitment" IPOs are more underpriced than those sold under a "best efforts" contract.

Another reason for underpricing is more benign - the underwriter (or concert promoter) merely guesses wrong. One way to correct for this is to use alternate methods of setting the price of the offering. For example, some firms going public set their initial offering price via a "dutch auction", prospective buyers send in sealed bids where they reveal how much they'd be willing to pay for how many shares. Here's an example of how this could work for a concert (or a stock issue):

Assume that there were 5 tickets for sale (it's a small concert). Here's what potential buyers say they'd be willing to pay:
  • Jim states that he'd be willing to pay $15 for a ticket.
  • Charlie would be willing to pay $20 each for two tickets
  • Amy would be willing to pay $30 each for two tickets
  • Bill would be willing to pay $40 each for two tickets
  • Jacque would be willing to pay $50 for a ticket
  • Melissa would be willing to pay $55 for a ticket
  • John would be willing to pay $60 for a ticket
In a dutch auction, you'd start at the highest price and go down the list until you've sold out the allotment. At the $40 price, the market would "clear" (i.e. all tickets would be sold). The tickets would therefore be sold at $40 each, netting the promoter $200.

The alternate would be for the promoter to guess what price would clear the market. What would happen if the price were set at $15? Some sort of mechanism other than price would have to determine how the tickets were allocated, like "first come, first served, or bribing the investment banker (er, promoter). If so, the individuals who value the tickets more than $15 would buy them from the initial holders in the aftermarket (like on Ebay, which conducted their own recent IPO using a dutch auction).

Hat tip to Catallarchy for the link.

Statistically Insignificant Significance

Caution: Heavy statistical "nerd speak" ahead. If you don't know (or care) what a standard error is, move on and read the latest Lileks piece before the math harshes your mellow.

Often a researcher will conduct two tests - the results from one will be statistically significant, and the other won't. However, they'll often fail to note that the difference between the two results isn't itself statistically significant (I don't even want to think about how may times I've done this). Andrew Gelman at Statistical Modeling, Causal Inference, and Social Science has a very nice and simple (given that we are dealing with statistics, after all) example of this phenomenon (and yes, that's the singular form):
Let me explain. Consider two experiments, one giving an estimated effect of 25 (with a standard error of 10) and the other with an estimate of 10 (with a standard error of 10). The first is highly statistically significant (with a p-value of 1.2%) and the second is clearly not statistically significant (with an estimate that is no bigger than its s.e.).

What about the difference? The difference is 15 (with a s.e. of sqrt(10^2+10^2)=14.1), which is clearly not statistically significant! (The z-score is only 1.1.)

Click here for the whole post, and a hat tip to Mahalanobis for the link.

Monday, June 13, 2005

Contango, Anyone?

James Hamilton is a very well respected economics professor at the University of California-San Diego. He wrote a classic econometrics text on Time-Series Analysis (IMHO one of the best on the topic ever done). Now it turns out that he also has a blog, titled Econbrowser.

He's got lots of interesting stuff there, but this post, explains one of the most important questions of futures markets: what is the relationship between the current price of a commodity (like oil, for example), the expected future price of that commodity, and the current price of a futures contract on the commodity?

It's well-suited for a class in derivatives before you dive into the math of the relationship: easily understood and explained in a low tech way, relatively math-free fashion. In addition, it touches on a number of critical concepts: interest and storage costs, cost of carry, convenience yield, backwardation, and contango.

Highly recommended.

This Week's Carnival of The Capitalists (at Byrne's Marketview)

This week's Carnival of The Capitalists is up at Byrne's Marketview. It has the usual incredibly diverse set of posts from a large cast of characters. Here are some of the more "finance/econ" related ones:
--Peter at Fund Universe details the 5 most common investor errors today. Point three is particularly salient: Hedge funds and private equity accounts are not a seperate asset class at all, and it's dangerous to diversify your way into a "hot", volatile, illiquid investment like them.

--Joshua Sharf at Three-Letter Monte ("An MBA/MSF Pursues a CFA") examines pass rates for the CFA exams, and looks at how a changing perspective on which exam should be done when has affected test-takers' activities.

--Tony Straka of The Prudent Investor - seeing too many bubbles is treading on dangerous ground: he wonders if "Conundrum" is short for "Surefire indicator of future recession" in Greenspanspeak. Whether or not that's true, I have to ask: Do you really want to further limit what Mr. Greenspan permits himself to say?

--Barry Ritholtz at The Big Picture looks at how Britain is following the same path as the US, with high consumer debt, increasing interest rates, and even a real-estate bubble. Scary.

Thursday, June 09, 2005

A Primer on Yield Curves

Lately there's been a lot of discussion about the "yield curve" (how it's getting flatter, what this could mean, etc...). But, many of Financial Rounds' non-professional readers might not know what a "yield curve" is. Fear not - here's a quick (and hopefully relatively painless) primer:

A yield curve is a visual (graphic) representation of the relationship between the maturities and interest rates on a given class of debt securities. The most commonly referred to yield curve is the one for U.S. Treasuries. To make one, simply plot the yields of the various treasury securities on on the "Y" (vertical) axis and the years to maturity in the "X" (horizontal) axis. The left hand side of the "X" axis has the shortest maturity security (the 3-month T-bill), and the maturity increases as you move rightward along the line.

Yield curves normally slope upward (i.e. interest rates on longer-term bonds are higher than those on shorter term ones), but not always. For an excellent description of the various shapes of the yield curve, go to a piece by Smart Money called One Bond Strategy: The Living Yield Curve.

It gives examples of times that yield curves have been upward-sloping (the "normal" yield curve), downward-sloping (also known as an "inverted" yield curve), flat (where long-term and short term rates don't differ much) or even "humped". It's also got an extremely cool applet that shows how the yield curve changes over time.

Hat tip to Barry Ritholtz at The Big Picture for the link.

Cat vs. Ceiling Fan

Disclaimer: the following material is neither finance nor economics related. However, it is funny as all get out.

I'm not a big cat fan (or even a fan of small cats, for that matter). However, this just cost me a cup of coffee, which I sprayed all over my keyboard (compliments of Neal Boortz).

Cat vs. Ceiling Fan (wmv file)

Does this make me a bad person?

Update: Apparently Steven Bainbridge (the Professor of the Vines) is also not much of a cat fancier. Yet another reason I like his blog.

Update2: Apparently, the clip is cut from a longer piece that might have been part of a "viral marketing" effort by Nokia. And yes, in the longer clip you can see the cat run off afterwards, so he's o.k. Knowing cats, he'll find some way to extract payback.

Based on all the hits I've gotten from this, maybe I should run a cat video of the week...

Wednesday, June 08, 2005

Housing Indicators (from Calculated Risk)

Calculated Risk lists a few indicators that he finds useful for "checking the pulse" of the housing market. They're worth tracking in the months to come:

The Mortgage Banker's Association's weekly survey on mortgage applications. It has a seasonally-adjusted purchase index that tracks purchase loans. The figure shown in CR's latest post indicates that purchasing activity has been fairly stable since January of '04.

The National Association of Home Builders's monthly House Market Index, which is based on surveys of home builders.
Click here for the whole post.

Bainbridge on Tenure and Academic Freedom

I usually don't post on academic freedom issues (after all, I'm untenured, and therefore have none...). However, Steve Bainbridge has some unusually cogent (and pungent) remarks on the topic:
I believe in both tenure and academic freedom, but I don't believe the academic life should be a sanction-free zone. If you screw up badly enough, there ought to be consequences. Apparently Brooklyn College agrees:

A Brooklyn College professor who described religious people as "moral retards" said he is dropping his bid to become chairman of the department of sociology after the college's president expressed outrage over his views.

Click here for the whole thing.

Overconfident CEOs and Bad Acquisitions

A couple of days ago, I wrote about a New York Times article on some of the causes of "Bad Mergers". Managerial overconfidence often plays a major role in really, really bad decisions. This recent piece on the SSRN by Matthew Billett and Yiming Qian, titled "Are Overconfident Managers Born or Made? Evidence of Self Attribution Bias From Frequent Acquirers " seems to indicate that managers learn to be overconfident. Here 's the abstract:
We explore the source of managerial hubris in mergers and acquisitions by examining the history of deals made by individual acquirers. Our study has three main findings: (1) Compared to their first deals, acquirers of second and higher-order deals experience significantly more negative announcement effects; (2) While acquisition likelihood increases in the performance associated with previous acquisitions, previous positive performance does not curb the negative wealth effects associated with future deals; (3) Top management's net purchase of stock is greater preceding high order deals than it is for first deals. We interpret these results as consistent with self-attribution bias leading to managerial overconfidence. We also find evidence that the market anticipates future deals based on an acquirer's acquisition history and impounds such anticipation into stock prices.
Self-attribution bias refers to our natural tendency to attibute good results to our own skill, and bad results to external factors. Billet and Qian's evidence supports the notioin that managers fall prey to mself-attribution bias and get overconfident following the completion of an acquisition, First, (and not surprisingly), they find that successful acquisitions by a manager lead to subsequent acquisitions. However, they also find that subsequent acquisitions do significanlty worse than initial ones. So, they probably should have quit while they were ahead.

Yet another paper I wish I'd thought of.

Statistics, Coin Tosses, and Expected Values

In class, I often illustrate the concept of expecvcted value with the example of a game where a coin is tossed - if it comes up heads, it pays a $2, if it comes up tails, it pays $1. If the coin is a "fair" one, the expected value of the coin toss is $1.50. If the coin is not a fair one (i.e. if the probability of a head is, say, 75%), the expected value is not $1.50. In the case where the probability of a head is 75%, the expected value is (0.75 x 2.00) + (0.25 x 1) = $1.75.

Now I find out (according to Andrew Gelman at Statistical Modeling, Causal Inference, and Social Science) that a coin can't be biased - the probability of a flipped coin coming up heads MUST be 50%:
The biased coin is the unicorn of probability theory—-everybody has heard of it, but it has never been spotted in the flesh. As with the unicorn, you probably have some idea of what the biased coin looks like—-perhaps it is slightly lumpy, with a highly nonuniform distribution of weight. In fact, the biased coin does not exist, at least as far as flipping goes.
Dang! I guess I'll have to get a new analogy.

Tuesday, June 07, 2005

Did SOX Lower Companies' Values?

Here's a great article on market-based evidence of the costs of Sarbanes Oxley. It's evidence strongly suggests that stock market participants expected the costs of SOX to exceed its benefits. According to this working paper by Ivy Zhang (doctoral candidate from the University of Rochester) titled Economic Consequences of the Sarbanes Oxley Act of 2002, announcements of legislative events that indicated an increasig liklihood of passage of SOX were associated with significantly negative subsequent stock market reactions. Here's the abstract (emphasis mine):
This paper investigates the economic consequences of the Sarbanes-Oxley Act through a study of market reactions to legislative events related to the Act. I find that the cumulative abnormal return around all legislative events leading to the passage of the Act is significantly negative. The loss in total market value around the most significant rulemaking events amounts to $1.4 trillion. I then examine the private benefits and costs of major provisions of the Act by investigating the cross-sectional variation in market reactions to the rulemaking events. Regression results are consistent with the hypothesis that shareholders consider both the restriction of nonaudit services and the provisions to enhance corporate governance costly to business. The results also show that Section 404 of SOX, which mandates an internal control test, imposes significant costs on firms.
I've highlighted the most striking fact in the abstract - that there was a massive loss in firms' values due to the very negative perception of SOX (and particularly Section 404 which mandated tests of internal controls). The paper has a number of features to recommend it: it provides a very nice timeline of the events leading up to SOX, it's got a great survey of the literature, it breaks out the effects of various provisions of the law (like sections 404 and 401), and it looks at the effect of SOX on firms with weaker vs. stronger existing governance structures.

Zhang examines the market reactions to 17 different announcements surrounding the passage of SOX. She shows that the stock market lost approximately 20% in total value (after correcting for other factors) around these 17 announcements. Interestingly, the losses in firm value were greatest for firms with weaker governance, indicating that the expected costs of compliance for these firms outstripped the expected benefits.

All in all, a great paper, and a hat tip to Larry Ribstein at Ideoblog for the link.

Monday, June 06, 2005

This Week's Carnival Of The Capitalists

This week's Carnival of the Capitalists is up at Galatime. As usual, it's an eclectic bunch of posts, some from blogs I'd never seen before. However, search costs are always huge, so here are a few you might want to read first:

Upsetting the Balance of History from Et tu bloge on the Law of Unintended Consequences

Finance Fault Line? from View From a Height on hedge funds, Long Term Capital Management, and market crashes

Christopher Cox at the SEC from EGO on the new nominee for Cahirman of the SEC.

Browse around and see what strikes your fancy.

Sunday, June 05, 2005

Why Do Bad Takeovers Happen To Good Investors?

Takeovers are exciting: the financial press like them, investors of the target often make out financially, and CEOs of acquirers get to run bigger firms (and make more money). The New York Times has a nice piece titled "What Are Mergers Good For?". The article talks at length about bad mergers (how and why they happen). As far as business press reporting, it does a much better job than usual. Some of the highlights:
  • Acquirers often use deals to mask declining performance;
  • Executives of merging firms have a lot of of money at stake - executive compensation is often tied to the size of the firm, In addition, there's stock and option holdings to consider.
  • There's little monitoring involved.
  • There are some good quotes by Robert Bruner (a very well known University of Virginia B-School professor), who has a book coming out shortly on the topic, titled "Deals From Hell: M&A Lessons That Rise Above The Ashes" that looks interesting (it was just reviewed in last week's Wall Street Journal.
In short, it's a good illustration of agency problems in play (and suitable for classroom use). There's also a really cool graphic on the first page. Make sure to click on it.

Hat tip to The Big Picture for the link.

Update: Bruner has a very nice (and quite readable) summary of the evidence on the outcomes of mergers on the Social Science Research Network, titled "Does M&A Pay." The paper's pretty readable by academic standards (in fact, I've gone over it with my undergrads). However, in case you don't feel like wading through it, here's the abstract:
Following the largest M&A wave in history, it is appropriate to assess the evidence on the profitability of this activity. One popular view is that merger activity is highly unprofitable. Does research sustain this view? This paper reflects on what it means for M&A to 'pay' and summarizes the evidence from 12 informal studies, 120 scientific studies from 1971 to 2003, and five surveys of the scientific evidence published in 1979, 1983, 1987, 1989, and 1992. This review comments on the several formal and informal research approaches and highlights findings for the broad activity as well as niches of special note. The mass of research suggests that target shareholders earn sizable positive market-returns, that bidders (with interesting exceptions) earn zero adjusted returns, and that bidders and targets combined earn positive adjusted returns. On balance, one should conclude that M&A does pay. But the broad dispersion of findings around a zero return to buyers suggests that executives should approach this activity with caution.

Mandelbrot and Investment Risks (from The Prudent Investor)

Caution: discussion of statistics ahead.

According to Yale Professor Emeritus Benoit Mandelbrot, much of current established financial theory is on shaky ground. He has a book out, titled "The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward." In it, he claims that markets are much riskier than we think, since much of current theory is based on the idea that market prices change continuously according to the bell shaped curve we call the normal distribution.

In actuality, he says, market prices show far more discontinuities (jumps) than a normal distribution would assume. As a result, these large price movements contribute a lot more to portfolios' performance than the theories currently used (like the CAPM) would allow for. As an example, in the 1980s, 40% of the total investment gains over the period came fromjust 1/2 of 1% of the days.

So, there's a lot more chance of getting really hosed (sorry, he calls it "the chance of ruin") than you might think, and you should hold a much more diversified portfolio over a wide variety of asset classes (i.e. not just stocks and bonds, even if they're in different sectors or countries).

Hat tip to The Prudent Investor for the link.

Saturday, June 04, 2005

Wash Your Hands!

One of the problems with being a teacher is that you catch a lot more colds (or worse). Eric Rasmusen passes some good advice:
Steve Sailer reports that Clinton and Bush both use hand sanitizer (such a Purell) to avoid getting colds after shaking hands at rallies, and that it works. We should think about doing the same.
A year ago, the Unknown Son underwent some treatment that involved a stem-cell transplant (he's doing fine now). As a result, his immune system was virtually nonexistent for several months, and even a small infection could have been life threatening. So, we washed our hands (or used Purell) constantly.

Even now when I give an exam there's invariably at least one student that's coughing, sniffling, and in general hawking up all over the paper. So, I leave the exams for a few days before grading. Once I get to them, I take great care to not touch my eyes, nose, or mouth before washing. It's a bit neurotic, but I don't think I had a cold all year. - which is pretty amazing when you consider the number of people I come in contact with each week.

Creating REALLY Big Data Sets

Blogging may be light the next few days - I'm in the process of putting together some really large (> 100 meg) data sets for a research project.

It's like I told one my empirical methodology professors in grad school - " A lot of people say that the size of your data set doesn't matter. It's more about how you use it. But, it's always the ones with the small data sets that say that".

Friday, June 03, 2005

More on Oxytocin and Trust

Lynne Kiesling of Knowledge Problem weighs in on the recent study that's hit the news on the link between Oxytocin and trust.
This neuroeconomics research (and similar research by Kevin McCabe (see his trust post from April), and others) is important on several levels. At its most fundamental level, neuroeconomics is probing the connections between the brain and human action, and this is one strand of that fundamental research. But it's the implications for human action that I find most fascinating. Think about the great puzzle that is the move from personal exchange to impersonal exchange that occurred slowly over the early medieval period around the Mediterranean. I claim that the move to impersonal exchange, grounded in formal and informal legal institutions that facilitate exchange, is at its core the main reason for the great prosperity and plenitude that we enjoy and have enjoyed for over two centuries.

Click here for the whole post.

In a later post, she also links to Randall Parker at FuturePundit who has a nice post on some of the research on the topic.

Organizing Your Finances - Part 5 (From All Things Financial)

JLP at All Things Financial continues his series on organizing your finances and your files. This one (part 5 in the series) covers Personal Documentation and Life Insurance

Here are the previous installments in the series:

Part I

Part II

Part III


Thursday, June 02, 2005

Short-Selling Real Estate (via The Big picture)

It's been argued that the inability to short-sell residential real estate could be one of the factors that differentiate real estate bubbles from stock market bubbles. Not any more. The Chicago Mercantile Exchange (CME) already has a letter of intent to introduce derivatives contracts based on housing price indices (they're being developed in conjunction with Macro Securities LLC, a firm associated with Robert Shiller).

However, has already started trading contracts in this market, called "hedgelets". These contracts allow individuals to trade contracts based on housing indices in selected major metropolitan markets (at present, Chicago, New York, Los Angeles, Miami, San Diego, and San Francisco).

The two contracts are based on different indices. Other than that, I'm not sure what the differences are. Watching the development of new ways of spreading, shifting, and pricing risk management tools is always interesting, particularly when there are multiple instruments and vendors in play. Competition is an extremely important part of the process of financial innovation.

Hat tip to The Big Picture for the link.

Cox Nominated For Chairman of the SEC

This just in (via the Wall Street Journal Online):
WASHINGTON -- Acting quickly, President Bush named conservative Rep. Christopher Cox to lead the Securities and Exchange Commission Thursday. Mr. Cox would succeed William Donaldson, who Wednesday announced he is stepping down after 28 months

...Mr. Cox, 52, a member of the House Republican leadership, has a wide-ranging background, from foreign policy and economic issues to homeland security. He has represented California in Congress for 16 years. Before that, he was a corporate finance lawyer in private practice and served as a senior counsel in the Reagan White House.

...The SEC position is subject to Senate confirmation, a process that left Mr. Cox bruised once before. He was in line for an appointment to the U.S. Court of Appeals in 2001 when Democrats suddenly gained control of the Senate. Facing opposition from at least one of his home state's two Democratic senators, Mr. Cox realized he faced a difficult fight to win confirmation to the bench without a guarantee of success. He withdrew his name. The holder of a business and a law degree, he has voted for legislation to make it easier for companies to defend against securities fraud lawsuits.

Click here for the whole article (subscription required).

Oxytocin and Trust (via Econolog)

Arnold Kling at Econolog points us to a very interesting experiment highlighted at it was sparked by previous research (cited below) that indicates that receiving a "trust signal" increases the body's production of oxytocin):

The researchers, led by Ernst Fehr of the University of Zurich, investigated whether this effect can be produced simply by getting people to inhale oxytocin rather than stimulating them to produce it. Such chemicals, they explain, can easily enter the brain when sniffed.

In the game, investors were allotted 12 monetary credits, each worth 40 Swiss centimes (32 US cents), and asked to decide how much to give to the trustee. The participants knew that the investment would be quadrupled, and that the trustee could then decide how much, if any, to hand back.

Investors were more willing to part with their cash when they inhaled the potion, Fehr's team reports in Nature1. Of 29 subjects given oxytocin, 13 handed over all of their cash. Only 6 of the 29 subjects given a placebo to sniff invested all 12 of their credits.

I Googled "oxytocin and trust", and found out that earlier research found that oxytocin levels in subjects became elevated if they were given a signal that THEY were trusted:

This is the first report that endogenous oxytocin in humans is related to social behaviors, which is consistent with a large animal literature. Subjects are put into a social dilemma in which absent communication, cooperative behavior can benefit both parties randomly assigned to a dyad. The dilemma arises because one participant must make a monetary sacrifice to signal the degree of trust in the other before the other's behavioral response is known. We show that receipt of a signal of trust is associated with a higher level of peripheral oxytocin than that in subjects receiving a random monetary transfer of the same average amount. Oxytocin levels were also related to trustworthy behavior (sharing a greater proportion of the monetary gains). We conclude that oxytocin may be part of the human physiology that motivates cooperation.
Arnold asks, "What do you think will be the first practical application of this finding". The article referenced above indicates that it might be useful in treating conditions like autism, where social bonds are hard to make (or with economics and finance faculty, for that matter).

I could also see it being used in sales or negotiating settings (or at the singles bar...).

Hey, would I steer you wrong?

Hedge Fund Statistics (from Seeking Alpha)

David Jackson at Seeking Alpha provides some interesting statistics on hedge funds (it's from this recent Barron's article, which is (unfortunately) paid subscription only). They come from the Hennessee Group's annual survey of hedge fund managers. Among the more interesting facts:
  • Hedge fund assets were up 27% (year over year), vs 34% in the prior year
  • 28% of hedge fund capital was from funds of funds
  • 33% of hedge fund managers said they turned over their portfolios between 2 and 5 times , and 25% had a turnover of more than 5x (the "turned over more than 5x" percentage was up from 20% the previous year)
  • Most funds still charge a 20% performance fee, but there was a slight increase in management fees (it appears that relatively more funds charged management fees of 1.5% rather than 1%).
He makes a good point that hedge fund abnormal returns (alpha) will be harder to maintain as these funds gain more and more assets.

It's also interesting to note that turnover on these funds has increased, making hedge funds less tax efficient. How much of an impact this will have for the typical hedge fund holder is not clear: if the investor is an institution or qualified plan, not at all. If not, my guess is that it still won't make too much difference. My guess (totally unbacked by data) is that hedge fund investors are focused on the either the chance of high returns or the low correlations between hedge funds and other asset classes.

Wednesday, June 01, 2005

Organizing your Finances - Part 3 (From All Things Financial)

JLP at All Things Financial continues his series on organizing your finances and your files. This one lists Death and Estate Related Information you should give to whoever will be handling your affairs.

There are also a couple of previous installments in the series: here and here.

Graduation Speech (from Mr. Sun)

After Neal Boortz's The Commencement Speech You Need To Hear, this one by Mr. Sun may be the best one yet:
  • Make a list of the things you want to do before you die. Be as open to your heart as you possibly can. Now, throw that ridiculous piece of trash away and get your ass to work. The ball is over, Cinderella:
  • Contrary to what you may have heard about business, you should not think outside the box. You should get your green-as-grass self back in the box and don't come out unless it's to bring me some hot coffee and do my work so I can take credit for it. Welcome to the working world, Rookie.
Click here for the whole thing. Hat tip to Joanne Jacobs for the link.