Saturday, January 31, 2009

A New Excuse: My Prescription Ran Out

The Telegraph (UK) gives us this article on the possibility that we might have "memory pills" (medicines that enhance our ability to learn and remember things more easily:
The medicine has been designed originally to help treat Alzheimer's disease, but could be adapted and licensed for sale in a weaker form within the next few years.

One brand of memory-enhancing pill is being developed by the multinational company AstraZeneca in collaboration with Targacept, an American company, while Epix Pharmaceuticals, also from the US, is developing another.

Both have "cognitive-enhancing effects" which are aimed at treating patients with age-related memory loss.

Read the whole thing here

I expect that if the pills become available in the U.K., they'll make their way her into a black market long before they become legally available. My students have told me that there's a growing use of Adderal and Ritalin among their fellow students when studying for exams.

I can see it now - a student explaining their poor performance on an exam because their prescription ran out.

Oh, the humanity.

Friday, January 30, 2009

Good Bank, Bad Bank By Dr Seuss

Like many kids, mine grew up on Dr. Seuss. One of their particular favorites was "One Fish, Two Fish.

Click here for a banking version from Joshua Brown.

HT: The Big Picture.

Thursday, January 29, 2009

Institutional Portfolios, Alternative Investments, and Liquidity

Before the recent meltdown in hedge funds, one of the regularly stated reasons for superior returns in "alternate investments" was that they are more exposed to "liquidity risk" (i.e. they can't be easily converted to cash without loss of value, and this results in higher required returns). Economics tells us that there's no such thing as a free lunch. So, here's recent (January 17th) story article from the Wall Street Journal that ties the two concepts together:
The ideal investment portfolio is solid and liquid at the same time. Perhaps because this principle defies the common sense of physics, even some of the world's biggest investors have overlooked it.

Now, with billions of dollars trapped in illiquid investments, many colleges and charities are cutting budgets at the worst imaginable time.

Read the whole thing here:

Finance Professors: Hot or Not?

A whiole back, I blogged on a research study by Felton, Koper, Mitchell and Stinson (sounds like a law firm, eh?) using RateMyProfessors evaluations to see whether the students' perceived hotness of their professors was related to their perceptions of professor quality. Crooked Timber (one of my favorite blogs) recently put this table up from the paper:

Just in case you didn't notice, Finance professors were rated as the hottest among the business disciplines (and accounting was rated least hot). So if you're deciding between a PhD in Finance and Accounting, if you want hotter colleagues, choose Finance, but if you want to look better by comparison, go with accounting.

But unfortunately, I definitely bring down the average. Ah well, back to the gym.

Wednesday, January 28, 2009

It's CFA Results Day And The Natives Are Restless

I just noticed a lot of hits today from searches related to "CFA Results". That's because today is the day that the results from the December 2008 Level 1 exam are released (they were actually released about 5 minutes ago). So, there are currently thousands logged into the CFA site and hiotting the "F5" button every couple of seconds.

Good luck to you all. If you passed, congratulations -- you now get to register for the Level 2 exam in June. In case you're wondering, there's enough study time to make it through the exam -- many have done it before you. But, you should get on it as soon as possible -- there are only 129 days until the Level 2 exam.

If you failed, here are some words of wisdom from one of the most well-known posters on the Analyst Forum website (which you should definitely use if you're studying for the CFA exams):
If You Failed
1) You are in distinguished company
I know a college finance professor who took 7 tries to pass three exams. This guy even wrote a college textbook on corporate finance. (That sounds like an apocryphal story, but I swear it's true but there is no way I'm posting his name).

2) Nobody will care
Everybody seems to have this dread that something terrible will happen when they tell their colleagues, boss, significant other, and parents. What will happen is they will say "Wow, hard test. When are you taking it again?"

3) You will be 6 months older when you get your charter.
I was in my late 30's so most of you will be at least ten years ahead of me when you get it even if you fail a few times.

4) You will get a solid foundation to build on for the next two levels
Learning this stuff again means you will learn it better, deeper, and more committed to long-term learning. This will pay dividends over the next couple of exams.

5) You failed a really hard exam
Every year the pass rate is less than 50%. In that >50% who fail number are oodles of smart people who studied hard. There is a ton of material on this exam and you have a career and a life outside of this exam. It's a bear and you don't even need an excuse for failing.

And to those who passed - Congrats and well done.
And I'd add that (as another poster in the same forum said):'s a big deal. But it's not THE big deal. Family, friends, and relationships are much more important in the long run. To paraphrase an old saying, I doubt any of you will say on your death bed "Damn! I wish I'd spent another 100 hour studying so that I passed the L1 exam in December of 08" At least, I sincerely hope not.
Having said that, good luck and congratulations (or sympathies, depending on whether you passed or failed).

As an aside, I tried to log on to Analyst Forum to see some of the posts regarding who passed or failed, and the system wouldn't respond for a a pretty good while. My guess is that there are too many people logging on for the same reasons. Not surprising - AF is a pretty tight community, and some of its members pretty much live on the forum.

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It's Easy Buying A Stake in a Public Company

Here's one of the better explanations I've recently read on the idea of fundamental analysis or "value" investing (from the Ideas Report:
Buying a stake in a publicly traded company is deceptively easy. Log into your brokerage account, type in the ticker of the company whose stock you wish to buy, and—voilà!—you own a stake in the enterprise. Many investors don’t even refer to companies by their name; they simply invoke the ticker symbol. The ease with which stocks are bought and sold obscures the underlying nature of a stock market transaction and invites bad decision-making. The trick is to avoid thinking of a stock as a readily disposable piece of paper and instead consider that you are buying a percentage of a business whenever you purchase a share of stock.
Read the whole thing here

How Do You Choose The Right Chart For Your Information?

Now this is a cool flowchart - it works you through the decision process in deciding the rigth chart to best display your data. It's from The Extreme Presentation Method, which is a pretty good resource for those who regularly have to do these things,

Here's another diagram from the same site - it lays out process you go through in designing a presentation
HT: The Big Picture

Tuesday, January 27, 2009

Everything You Ever Wanted To Know About Credit Defautl Swaps - But Were Never Told (from RGE Monitor)

Jim Mahar over at just linked to a fantastic explanation of Credit Default Swaps. Here's the opening lines:
Credit default swaps (CDSs) have been identified in media accounts and by various commentators as sources of risk for the institutions that use them, as potential contributors to systemic risk, and as the underlying reason for the bailouts of Bear Stearns and AIG. These assessments are seriously wide of the mark. They seem to reflect a misunderstanding of how CDSs work and how they contribute to risk management by banks and other intermediaries. In addition, the vigorous market that currently exists for CDSs is a significant source of market-based judgments on the credit conditions of large numbers of companies--information that is not publicly available anywhere else. Although the CDS market can be improved, excessive restrictions on it would create considerably more risk than it would eliminate.
It also has a very nice diagram of a typical CDS (and we professor types like diagrams we can use in class, eh?)

Read the whole thing here

Biases in Implied Volatilities

There's a pretty substantial literature on biases in analyst's earnings forecasts. They usually define bias as a difference between the last estimated forecast of earnings and actual earnings. Here's a somewhat related paper - on errors in implied volatility estimates. In their paper "Implied and Realized Volatility in the Cross-Section of Equity Options" Manuel Ammann, David Skovmand and Michael Verhofen examine whether implied volatilites differ systematically from realized vlatilities, and whether those differences are related to firm risk (beta) size (market cap),growth opportunities (market/book), and momentum. Here's the abstract:
Using a complete sample of US equity options, we analyze patterns of implied volatility in the cross-section of equity options with respect to stock characteristics. We find that high-beta stocks, small stocks, stocks with a low-market-to-book ratio, and non-momentum stocks trade at higher implied volatilities after controlling for historical volatility. We find evidence that implied volatility overestimates realized volatility for low-beta stocks, small caps, low-market-to-book stocks, and stocks with no momentum and vice versa. However, we cannot reject the null hypothesis that implied volatility is an unbiased predictor of realized volatility in the cross section.
Read the whole thing here.

HT: CXO Advisory Group

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Monday, January 26, 2009

Some Exceptional Students

Over the weekend, I had the opportunity to go to the graduation dinner for one of my students. It's times like these that make me realize just how much I enjoy being a professor. Like many (if not most) of my tribe, I get my share of clueless, unmotivated slackers in my classes (luckily, not that many). But since I run our student-managed fund and work closely with the students sitting for the CFA exam, I also get to see the absolute best students our college has to offer. This weekend was a perfect example.

The guest of honor for the evening had taken several different classes with me, had been very involved in our student-managed investment fund, and had passed the CFA level 1 exam before he graduated. I'd guess that I've gotten to know him better than any student I've had in the last 12 years or so - he took one of the first investment classes I taught at Unknown University, and has been a constant presence in my office since. Among the other guests (along with about 25 family members) were his three closest friends from our finance program (one graduated with him in December and two this last June). I consider all four of them to be "my students", and they were a fun bunch to have - all extremely bright, hard working (well, most of the time), and passionate about finance. So (like I do with the Unknown Kids), let me brag about them a bit:
  • Two of the students had GPAs north of 3.9, and the other a GPA of 3.6.
  • In their graduating classes, one was given an award as the top accounting student (he was a dual major), and one as the top finance student
  • Two have already passed the CFA level 1 exam and plan sitting for Level 2 this June, the third just missed the LEvel 1 exam the first time and just re-sat for it this last December (I have no doubt he nailed it this time), and the fourth is sitting for it in June
  • Among the four, we have one who's an auditor for a Big 4 accounting firm (he hopes to move to their transactions advisory group and eventually to a PE firm), one who'll be in a commercial lending training program for one of the largest banks in the country, one who works for a hedge fund, and one who has an interview for a mid-office position at a major investment management firm.
They're to a one all great kids. I'm looking forward to seeing what they accomplish over the next twenty years or so, and hopefully seeing them start families and make their way in the world.

It was fun watching the four of them at the party. They're a close knit bunch, and there's a friendship among them that I hope will stand the test of time. And, their wife, fiancee, and girlfriend all seem to get along (there's one of each, and the fourth is currently single and unattached, so the other three joke that they get to live a "single" life vicariously through him).

Well done, lads.

Sunday, January 25, 2009

Doing Homework

The semester at Unknown University is now under way. So to kick it off, here's a chuckle. Back in the day, I remember getting a bit goofy while studying. But of course, I couldn't move like that since I'm a typically rhythm and coordination-challenged guy (but I repeat myself).

HT: Rate Your Students

Thomas Sowell on "Affordable Housing"

Like most things Sowell writes, it's worth a read:
Behind the housing boom and bust was one of those alluring but undefined phrases that are so popular in politics-- "affordable housing."

It is hard for me to know specifically what politicians are talking about when they use this phrase. But then politics is about evoking emotions, not examining specifics.

In looking back over my own life, I find it hard to think of a time when I didn't live in affordable housing.

Read the whole thing here

HT: Carpe Diem

Friday, January 23, 2009

Defending VaR - But You Still Need Common Sense

I recently blogged about an article by Joe Nocera in the New York Times Magazine. Suni Reyent at Seeking Alpha just wrote a response.

One of the common criticisms of VaR by Nassim Taleb (and others) is that it incorrectly models the distribution of stock returns (or of whatever asset that VaR is being applied to) as a normal distribution. This would be a serious flaw, since the distribution of returns of many assets are leptokurtotic (i.e. have fatter tails than a normal distribution).

In this piece, Reyent discusses how VaR is applied in practice, and adds that it often adjusts for the non-normality of returns. Having come from a practitioner's background, she's worked with this stuff often, so she knows what she's talking about.

Read the article here.

Woman Auctions Off Her Virginity

This is off the usual Financial Rounds fare, but sometimes I can't resist. First here's the article:
They say you should value having sex for the first time. That’s why I’m auctioning my virginity online—and the bidding is up to $3.8 million.

When I put my virginity up for auction in September, it was in part a sociological experiment—I wanted to study the public's response. Now it seems that the tables have turned, and the public is studying me.

You can read the whole thing here. Since i just had my third cup of coffee, a few random neurons started firing, and a few random thoughts popped out (my good friends would argue that "random" describe most of my thoughts). I realize that some of them are a bit finance-geekish, but if you don't like them, you're welcome to start your own blog:

  1. Wasn't there a punchline going something like ",,, now we're just haggling over terms", and a movie about this?
  2. I don't think I'll show this to the Unknown Daughter. I read somewhere that a dad's first obligation to his daughters is to keep her off the "stripper's pole". Hey dad - you failed.
  3. For some reason, I'm thinking about the issuance of overvalued securities.
  4. There are probably some good applications of behavioral finance and auction theory here. However, I'm not going there.
  5. Clientele effects are not just for dividends
  6. "Hot" vs. "cold" issue markets
  7. There's a moral-hazard spin in here somewhere
Finally, what would happen if someone won the auction and purchased the right, but decided not to exercise it? Would that mean that the lady in question would have to remain celibate? If so, there's a real contracting problem (with severe agency problems) and a real need for post-transaction audits.

That's all I have for now. Feel free to add your comments. But remember, this is a (mostly) family-friendly and safe-for-work blog.

Cost of Corporate Borrowing is Up

Because corporate borrowing costs were low in recent years, many companies loaded up on debt. Now, much of that debt is coming due at a time when companies have experienced slowdowns. Here's a recent article from the NYTimes Online, titled "Cost of Borrowing Zooms up For Corporations":
Like consumers and homeowners, America’s corporations binged on easy credit when times were flush, racking up huge debts. Now the bills are due, and paying them back will not be easy, or cheap.

This year alone, more than $700 billion in corporate loans will come due, according to Standard & Poor’s. That is the size of the federal bailout of the financial sector. Many companies were counting on being able to borrow more money to meet those obligations and kick their debt farther down the road.

But with the credit markets still tight, corporations are being forced to pay much higher interest rates than they did a few years ago, putting more strain on balance sheets already hammered by falling profits and a grinding recession.
Read the whole thing here

Thursday, January 22, 2009

"Piggybacking" In the Brokerage Industry (From Knowledge@Wharton)

Are market makers "naive providers of liquidity -- uninformed players operating from behind a firm Chinese Wall", or do they trade on information they get from insider trades? According to a new study by Christopher C. Géczy, adjunct finance professor and director of the Wharton Wealth Management Initiative and Jinghua Yan, a research analyst at Tykhe Capital, it looks like the second possibility is looking a lot more likely.
The Wharton researchers, in a detailed parsing of four years of insider trading at 15 of Wall Street's largest brokerages, find that market makers executing insider trades at these firms appear to act on information gleaned from those trades.

The evidence can be seen in the more aggressive prices they set for the company's stock following an insider trade. Put another way, compared to their peers, market makers affiliated with the brokers used by insiders post more aggressive ask quotes during periods when insiders trade. The study was undertaken using information from trades made between March 1999 and November 2003.

"Academics and, to some degree, those who trade in the market, might assume that market makers are there simply to take the other sides of trades and provide liquidity, whereas it looks as though they may have, and may act on, information," says Géczy. "What we found is that there is a leakage somewhere along the lines in the information transmission channel between the investor -- in this case, company insiders -- and ultimate trades, and the way information is transmitted into the market in the form of buy or sell orders."

They also find that the pattern becomes far less pronounced following the passage of Reg .FD.

It's worth a read - the study has a lot of implications both for the models we use to describe market-making behavior, and for regulators of financial markets. Plus, it's thorough and well written.

Read the article describing the study in Knowledge at Wharton here, and you can get the actual study on SSRN here.

Stock Market Conditions and Finance Careers

Lately I've been talking to a lot of students who have concerns about how the current job market will affect their careers. So, I decided to revisit a forthcoming article in the Journal of Finance article by Paul Oyer of Standford titled: The Making Of A Banker: Macroeconomic Shocks, Career Choice, and Lifetime Income. He studies a group of Stanford MBA graduates from the 60s. Here's the abstract:
I show that stock market shocks have important and lasting effects on the careers of MBAs. Stock market conditions while MBA students are in school have a large effect on whether they go directly to Wall Street upon graduation. Further, starting on Wall Street immediately upon graduation causes a person to be more likely to work there later and to earn, on average, substantially more money. The empirical results suggest that investment bankers are largely "made" by circumstance rather than "born" to work on Wall Street.
In the introduction he says:
I estimate that a person who graduates in a bull market and goes to work in investment banking after graduation earns an additional $1.5 million to $5 million relative to what the same person would have earned if he or she had graduated during a bear market and had started his or her career in some other in dusty.
It's an interesting example of how circumstances often make people's careers. It also illustrates the huge differences in career earnings across industries.

You can read a working paper version of the article here.

Wednesday, January 21, 2009

Stock Markets and Inaugurations

Yesterday, the Dow dropped approximately 4%, and the S&P500 dropped by a little over 5% on Inauguration day. This was the worst "inauguration market" day in history. So now we'll wait to hear the talking heads either say how there's a correlation (or even a causation) between the two, or explain how there's not.

In reality, it was probably more due to State Street Bank's disappointing earnings numbers - their stock plunged almost 60% on the news, and led many other financial stocks down. If markets are efficient (and they are, relatively speaking), Obama's inauguration should already have been priced in.

Jonathan Macey on Director Capture

Jonathan Macey is one of the "Big Dogs" of academic writing in corporate governance. He is the Sam Harris Professor of Corporate Lay, Corporate Finance, and Securities Law at Yale (and Deputy Dean of the Law School. He's written a boatload of books on the topic, and over a 150 articles in scholarly journals. In this piece (where he's guest blogging at the Icahn Report, he discusses the concept of "regulatory capture."
In the academic world, particularly among political scientists and economists, "capture" occurs when decision-makers such as corporate directors favor certain vested interests such as incumbent management, despite the fact that they purport to be acting in the best interests of some other group, i.e. the shareholders. The problem of capture and the theories associated with the idea of capture are most closely associated with George Stigler, and the free-market Chicago School of Economic thought. Among the more interesting and important theories of Stigler and other proponents of capture theory is the idea that capture is not only possible, in many contexts it is inevitable.
Read the whale thing here

Tuesday, January 20, 2009

The Academic Finance Job Market

I recently saw this analysis of the job market for econ Ph.D.s on the Economist's Free Exchange site:
On the debit side, much attention focused on the fact that the AEA-run website, where potential employers of PhD economists advertise their positions, has added a new section called "Suspended or Cancelled Listings". Here it is noted that a "non-trivial economic downturn" has forced some employers to suspend or cancel job searches. As of December 28th, a week before the actual interviews, 84 previously advertised searches had been called off, representing 5% of the number of jobs available by the reckoning of the director of the AEA, John Siegfried.
Read the whole thing here.

Since the Financial Rounds readership includes a pretty good number of finance academics, I thought I'd share some observations on the Academic Finance job market. Unlike the Econ one (which takes place pretty much at the AEA meeting), the Finance market is 2-tiered. The first part takes place at the Financial Management Association (FMA) annual meeting in early October, and the second part happens at the American Finance Association (AFA) annual meeting that takes place in conjunction with the AEA meeting in early January.

The very top schools (the top-20 or so) tend to interview only at the AFA (there are a few exceptions, but only a few). But the 2nd-tier and third-tier schools for the most part attend only the FMA meeting (the upper-tier of these schools will also interview at the AFA). Most of the following observations are based on the FMA market. Here are a few themes I've seen or heard about from colleagues, job-seekers, or friends (either at Unknown University or at other schools).
  1. Like in the econ market, there have been more canceled searches than usual. My sense is that between 5% and 10% of searches have been canceled due toi funding for the position getting yanked.
  2. Probably as a reaction to #1, it seems like there are more schools this year who got their acts together and scheduled fly-outs early than in previous years. This makes sense, since there's a distinct possibility of a search being pulled as budgets deteriorate. So, the "smart" schools worked harder to bring out candidates and "seal the deal" while they still had funding (once a position is accepted the school almost never pulls the position). I know of several doctoral students (one here at Unseen University and two more at the Unseen Alma Mater) that had multiple flyouts by December 1.
  3. Likewise, job candidates seem more risk-averse than in previous years and much more likely to accept early offers. Both "our" student and the two at my Alma Mater had accepted positions by mid-December.
  4. Putting this all together, is seems like a larger than usual portion of the FMA market seems to have cleared by December.
I do see a couple of common characteristics for students who've done well at FMA. As far as scoring interviews goes, the most important factors seemed to be:
  1. They have completed, polished working papers. If they're shooting for research schools, it's not that important how many they have, but it's critical that they are well polished and have the potential to be published in good journals (i.e. they ask an interesting question and have good results). If they're shooting more for balanced schools, the level of the potential publishing outlets isn't as important as at research schools. But here, numbers seem to help, too.
  2. They have very strong good recommendations from their advisors. In addition, they typically had advisors (or other faculty) who "beat the bushes" for them - made phone calls, called in favors, etc...).
  3. Credible evidence that they would be finished with their dissertations when they show up to teach next year. Schools are very leery of hiring someone for a tenure track position who will be wasting their first year finishing their dissertation. In effect, that person would have one less year to do the work necessary for tenure.
For those who got interviews, the next step was converting them into campus visits (no one ever got hired off a conference interview). Converting seemed higher for:
  1. Candidates who had a good grasp of their topic: during the interview, they could not only discuss their dissertation in "academese", but also in plain language with good illustrations, analogies, and so on. In addition, when they were asked a question, they could answer it with good linkages to the literature in their field.
  2. Candidates who were comfortable with the interview process. There's an old joke that an extroverted academic is one who looks at YOUR shoes when he talks to you. So, the bar isn't that high - it's not necessary to be the "life of the party". In fact, that would be a bad image to give out. But being able to talk comfortably with interviewers helps them to picture you as the guy in the next office over.
  3. Those that could present a good reason why they were interviewing with the particular school. This often comes down to "I think I'd be a good fit with your faculty because you have Professors X, Y, and Z who work in this area", or "Your applied focus fits well with my industry experience in A, B, and C". After all, a school doesn't want to wast an interview on a candidate that they doubt would be interested in the school if offered a position.
These things might seem painfully obvious, but I was on the hiring committee that interviewed candidates at the 2007 FMA meeting. It was surprising how many candidates made obvious errors, had no clue how to write a cover letter, how to discuss their research, or knew almost nothing about Unknown University.

I got the sense that many of these students either hadn't been prepped well by their advisors, or simply hadn't listened to the advice they'd received. So have the faculty at your schools put you through the wringer before you go on the job market, and research your schools - it'll pay off.

Remember - you want to be like Stuart Smalley - good enough that you have a high probability of eventually getting tenure (i.e. they should see you as a capable researcher), smart enough to contribute to others' work (you should seem to be interested in others' research and good at commenting on it/working with others) and people should like you (after all, they might have you in the next office over for the next 20 years). Just remember that Smalley is a spoof and not a real person.

If any of my readers have other insights or observations about the FMA market, feel free to chime in.

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What's The Best Estimator of The Equity Risk Premium?

I'm teaching advanced corporate finance this semester. As usual, I spend a fairly large chunk of time on the Weighted Average Cost of Capital. One of the issues in the CAPM approach to estimating the cost of equity is what estimate to use for the market risk premium.

So of course, I has happy to find a paper by Aswath Damodaran titled "Equity Risk Premiums (ERP): Determinants, Estimation and Implications." Here's the abstract:
Equity risk premiums are a central component of every risk and return model in finance and are a key input into estimating costs of equity and capital in both corporate finance and valuation. Given their importance, it is surprising how haphazard the estimation of equity risk premiums remains in practice. In the standard approach to estimating equity risk premiums, historical returns are used, with the difference in annual returns on stocks versus bonds over a long time period comprising the expected risk premium. We note the limitations of this approach, even in markets like the United States, which have long periods of historical data available, and its complete failure in emerging markets, where the historical data tends to be limited and volatile. We look at two other approaches to estimating equity risk premiums - the survey approach, where investors and managers are asked to assess the risk premium and the implied approach, where a forward-looking estimate of the premium is estimated using either current equity prices or risk premiums in non-equity markets. We close the paper by examining why different approaches yield different values for the equity risk premium, and how to choose the "right" number to use in analysis. (In an addendum, we also look at equity risk premiums during the market crisis, starting on September 12, 2008 through October 16, 2008.)
It's not a quick read - it runs 77 pages with tables and all. If you have the time, you can read it here.

In case you don't want to plow through the whole thing, here are a few things I found interesting and/or useful:
  • He provides an excellent overview of the different approaches to estimating the ERP (surveys, historical ERPs, Implied (from valuation models) ERPs, Default Spreads, Option Pricing Model-based estimates, etc...), along with their strengths, weaknesses, and ways they can yield different results.
  • He examines determinants of ERPs (T-bill rates, the T Bill-TBond spread, etc...)
  • He examines how well various approaches predict future ERPs
On that last point, here's a table from the paper that lays it out pretty well:

So, it looks like premiums implied from DCF valuation models do the best job of predicting future ERPS. But even then, their predictive power seems pretty low - a correlation of 0.758 implies an R-squared of 0.57 for predicting the future year's ERP, and the correlation of 0.376 fbetween the current Implied ERP and the next 10 years' ERP works our to about a 14% R-squared.

Having said that, the paper will definitely make it's way in to my class this semester.

Monday, January 19, 2009

Stressed? Smash a Plate!

Stressed Japanese workers are paying for the chance to smash plates against a wall to ease credit crunch blues

Stressed workers are flocking to The Venting Place in Tokyo where they pay to hurl crockery against a concrete wall, reports the Daily Telegraph.

I'll suggest it to our dean. I think this could be big around midterms and finals.

Analysts' Recommendations and CEO Dismissals

Here's a pretty interesting governance piece, highlighted recently on the Wall Street Journal's Dealbook: Chief Executives Beware- Analysts May Seal Your Fate:
An academic study found corporate boards are more likely to be influenced by the recommendations of equity analysts following the 2002 rule change that separated the analysts from investment bankers. The study conducted by professors at the Paul Merage School of Business at the University of California in Irvine and at the Jesse H. Jones Graduate School of Management at Rice University in Houston, found that this increase in trust in analysts meant that boards are more likely than in the past to fire an under-performing chief executive based in part on analyst recommendations.

The paper is titled CEO Dismissal: The Role of Investment Analysts as an External Control Mechanism, and it's authored by Margarethe Wiersema (of UC-Irvine) and Yan Zhang (of Rice University). It's a pretty good example of the way that regulatory changes affect the impact of various monitoring agents. My take on it is that post SOX, boards are much more likely to "yank the cord" on CEOs following a whole host of "bad news" events (earnings disappointments, product recalls, etc...). I bet that'd make for an interesting research topic for someone (offered free of charge - I'm not going to pursue it).

You can read a PDF of a working paper version of paper here.

Sunday, January 18, 2009

Robert Shiller at Authors@Google

Robert J. Shiller (finance professor at Yale) is one of the more well-known academics in the public sphere. He's written a couple of best-sellers ("Irrational Exuberance" and "Subprime Solution"), created the Case-Shiller Index of home prices, and just testified before the Bicameral Hearing On the Subprime Crisisr. In case you're interested, here's the video:

And if you want more Shiller, here's a video of his recent authors@Google talk on his "Subprime Solution" book:

HT: The Big Picture

Caffeine and Hallucinations

My students would say that this explains too much about met:
People who take in the caffeine equivalent of three cups of brewed coffee (or seven cups of instant) are more likely to hallucinate, a new study suggests.

The researchers found that people with a caffeine intake that high, whether it came from coffee, tea, chocolate or caffeinated energy drinks or pills, had a three-times-higher tendency to hear voices and see things that were not there than those who consumed the equivalent of a half-cup of brewed coffee (or one cup of instant coffee).
Read the whole thing here.

My students (and many of my friends) know that I drink about 2-3 cups of caffeine daily. In my younger days (when I weighed about 130 lbs) I would average about 7 cups a day.

"Roses are red, violets are blue, I'm schizophrenic... and so am I"

Saturday, January 17, 2009

Testosterone and Traders

Are successful traders born, or made? Here's some evidence supporting the latter, from the Washington Post:
A new study has found that men who were programmed in the womb to be the most responsive to testosterone tend to be the most successful financial traders, providing powerful support for the influence of the hormone over their decision-making.
Read the whole thing here

Friday, January 16, 2009

Hugh Chavez and Reputation Capital

Venezuelan predident and general all-around jerk (I can think of better descriptors, but this is a generally family-friendly blog) Hugo Chavez was a very good example of a free cash flow problem on a national scale. He was flush with cash from Venezuela's huge oil reserves, and used oil wealth to play the part of loudmouth and anti-US demnagogue. Along the way, he hammered many of the large-multinational oil companies with increased taxes, nationalization of their oil fields, and raids on their offices.

Now, with oil prices dropping, the Venezuelan economy is sputtering, and Chavez is suffering from cash shortages. So, he's reaching out to the same companies he previously gave the boot to (while seizing their assets). He's offering them access to Venezuela's oil fields. But it looks like his past actions might be causing some second thoughts:
Under the current bidding rules, the onus for financing the new projects lies with the foreign companies, even though Petróleos de Venezuela would maintain control. Banks might balk at such a prospect. Distrust also lingers in dealing with Petróleos de Venezuela.

"An agreement on a piece of paper means nothing in Venezuela because of the way Chávez abruptly changes the rules of the game," said a Venezuelan oil executive who has had dealings with oil companies from China, Russia and other countries.

Imagine that - reputation capital actually matters.

I've used Chavez for years as a walking, talking (or, at least, braying) example of country risk. Now I can him for an example of teh efdects of losing reputation capital, too.

Of course, I'm sure psychology professors get to use him in examples too.

Another Investment Banking Blog

I was recently reading Mergers & Inquisitions (one of my regular reads), and saw this a mention of the blog titled Investment Banking Resumes. It's written by Anna Maria D'Souza. Here's her profile:
I am a headhunter and have nine years of experience in recruiting senior investment bankers. I have a mission to help young people to start and build an investment banking career.
If you're considering a career in investment banking, the site looks like it'll be well worth your time. A lot of the site is very "inside baseball", with information on compensation packages of star performers. But there are also a lot of useful tips on resume writing, cover letters, etc...

It'll be added to my blogroll the next time I Update

Thursday, January 15, 2009

Morgan Stanley Advertisement on SNL

Here's an oldie but goodie from Saturday Night Live, compliments of Barry Ritholtz (who seems to find a lot of these things).

While you're at it, check out Hulu's videos - they have an amazing library of clips (and even entire shows), some of which date back to the 70s.

Stopping the Tenure Clock

Most people have misconceptions about stopping the tenure clock due to extraordinary circumstances (what does it involve, when can you do it, etc...).

I know I did - it's not something that people talk about often, and some people view it as a weakness or failure. Luckily, Inside Higher education recently published a pretty good article titled Ignorance About "Stop the Clock" Policies that touches on a lot of the major issues.

In a nutshell, stopping the clock merely means that a tenure track faculty that would have to go up for tenure five years after starting would be held to the same standards of research (and teaching), but would have six years to make the grade. In other words, if a school required five articles in :good" journal to be published in five years' time, the faculty member would then have six years to publish the five articles.

It was particularly timely for me because I've been thinking about stopping mine for the year as I deal with the Unknown Son's cancer treatment. For a while, I was trying to convince myself that I could handle it all (teaching research, and my family). But sometimes you just can't. So this week, I went to my Dean, and he had no problem stopping my clock for the year. I told him I'll still teach my classes, since that actually serves a good break from the medical stuff. And in fact (though I didn't tell him this), I'll likely get as much (if not more) research done as last year. But now there's a lot less stress, and I can take whatever time I need to spend on my son without having to worry about whether or not it'll affect my tenure.

Wednesday, January 14, 2009

Levered ETF Math

Many people use levered ETFs to either leverage (i.e. double) or hedge their exposure to an index Unfortunately, their results can often differ from what they expect. This Wall Street Journal gives a good explanation why in this article. It's a good illustration how volatility makes geometric and arithmetic averages differ.

Education Bureaucrats

Here's a great video on the "value added" from educational bureaycrats

HT: Mungo at Kids Prefer Cheese.

Tuesday, January 13, 2009

VaR: The Good, The Bad, and The Ugly (with a Black Swan or Two Thrown In)

Joe Nocera at the NY Times recently wrote a very long (and very nice) piece on current risk management practices titled Risk Mismanagement. Among the topics touched on:
  • A short, intuitive, and accurate explanation of VaR (Value at Risk)
  • A pretty good history lesson on the development of VaR at JP Morgan in the late 80s and early 90s.
  • You can't have an article on risk management without Nassim Taleb*. So, of course he makes an appearance.
  • A description of some of the ways VaR is used in practice. Not surprisingly, the "testbook" treatment of VaR doesn't come anywhere close to telling the whole story.
And even better, it's a pretty easy read. Check it out here.

* Paul Wilmott has said (tongue in cheek, I'm sure) that he mentions Nassim Taleb occasionally on his blog because it increases traffic from Google searches. That's definitely not something I'd do. No. Never. Well, hardly ever...

Stock Picking Ability and Value Investing

Andy Kern and Welsey Gray are two finance doctoral student who also run the blog Empirical Finance Research. They've just put a study up on SSRN titled "Fundamental Value Investors: Characteristics and Performance." In it, they examine the investment recommendations of a fairly large and sophisticated community of fundamental value investors (the folks at
The data in this study are collected from a private internet community called (VIC), proclaimed by the founders to be an “exclusive online
investment club where top investors share their best ideas.”1 The site has been heralded in many business publications as a top-notch resource for anyone who can attain membership (Financial Times, Barron’s, Business Week, and Forbes among others). The site was founded by Joel Greenblatt and John Petry, both successful value investors and managers of the large hedge fund Gotham Capital. It was created with $400,000 of start-up capital to be the site with “the best-quality ideas on the Web” (Barker (2001)).

The investment ideas submitted on the club’s site are broad, but are best described as fundamental value plays.
What do they find? Here are their conclusions:
We find that value investors are not focused on high book-to-value stocks, but instead focus on intrinsic value (discounted value of after-tax free cash flows generated by a business) and signaling factors in the market (e.g. open market repurchases, insider buying, activist activity). These investors also tend to favor smaller stocks with a value bias for long positions and small growth stocks for short positions. We also determine that value investors are fairly one dimensional and utilize only a few tools when making their investment decisions. This suggests that professional investors may suffer from limited attention and resource deficiency.

Our analysis of value investors’ investments suggests that value investors do have
stock picking skills. Utilizing the BHAR and the calendar-time portfolio regression
approaches, we find evidence that value investors reliably outperform the market.
A very nice paper, and well worth a read. While you're at it, check out the Valueinvestorsclub site - as a guest you can read the recommendations with a three-month lag. Some of them are pretty interesting.

Monday, January 12, 2009

Time To Get Back To Work

As I get ready to start another semester at Unknown University, this reminds me - I need to check in with my graduate assistant.

Great List of Business-Related Movies

Business Pundit has put together a great list of business-related movies. He lists a number of good finance-related ones that I bring up (and sometimes show clips from) in class. They include:

Other People's Money, with one of my favorite finance film characters (Larry the Liquidator) giving one of my favorite speeches.

Wall Street, with the immortal Gordon Gekko's "Greed is Good" speech.

Stand and Deliver (not really a business movie, but still one of my favorites).

Trading Places (with my favorite trading floor scenes ever).

Glengarry Glen Ross, with another great speech (Caution - not safe for work)

It's a Wonderful Life (a great illustration of an old fashioned bank run)

For another list, go to Larry Ribstein's BusFilm site.

HT: Newmark's Door

Sunday, January 11, 2009

The Cheech and Chong Indicator

In my continuing quest to bring you the most up-to-date market research, I give you the Cheech and Chong Indicator (compliments of Minyanville, which is almost always good for a laugh):
August 12, 2008, a date which will forever live in infamy, for that was the date I discovered and first made public the stunning relationship between the career arcs of the comedic dope-smoking duo Cheech & Chong and economic devastation. What is this relationship? Simply put, I discovered that the popularity of Cheech & Chong is inversely correlated to the movement of the United States stock market. In other words, the more popular Cheech & Chong are, the less popular stocks are.
Read the whole thing here.

Another Blog - The Investor's Consigliere

What can I say. They had me at the name.

Saturday, January 10, 2009

The Annual Korn-Ferry Board of Directors Study

Whether you're a researcher or practitioner in the field of corporate governance, the annual Korn-Ferry Survey of boards of directors is a must read (I even cited an earlier version in my dissertation years ago). Here's a bit from the overview in the beginning of the survey
...It is more work and less play for today’s corporate directors, and, perhaps surprisingly, they seem to like it that way. A high level of job satisfaction is one of the trends identified in the 34th Annual Korn/Ferry International Board of Directors Study, which also found that directors serve on fewer boards but work longer hours.

In addition, boards are actually smaller today. According to analysis of information reported in the proxies of 891 FORTUNE 1000 companies, we found that boards average 10 directors in size, with only two being full-time company employees. Women and minorities have been very successful in achieving directorships,
when viewed historically over three decades. But, the proxy data reflects that their numbers per board remain small and growth appears stalled.

Our survey shows that the placement of restrictions on the number of boards on which a director may serve remains fairly high in North America and Europe, and, perhaps not surprisingly given this fact, we found a loosening of mandatory retirement rules.

The image of a director’s job also may be improving. Recruitment remains challenging, especially for companies in North America, but boards appear to be having greater success recruiting directors with specialized skills.
Read the whole thing (for free) here.

CareerJournal: The Best and Worst Jobs

Here's a nice piece from Career Journal on a recent survey of "best and worst jobs".
The study, released Tuesday from, a new job site, evaluates 200 professions to determine the best and worst according to five criteria inherent to every job: environment, income, employment outlook, physical demands and stress. ( is published by Adicio Inc., in which Wall Street Journal owner News Corp. holds a minority stake.)

The findings were compiled by Les Krantz, author of "Jobs Rated Almanac," and are based on data from the U.S. Bureau of Labor Statistics and the Census Bureau, as well as studies from trade associations and Mr. Krantz's own expertise.

One theme that sticks out is that math skills are in style: six of the top ten jobs require some serious math chops. In fact, the top three spots are listed as "Mathematician", "Actuary", and "Statistician", and there a few more in the 11-20 range.

Of course, one man's meat is another man's mess, so a terrible job for someone else might be a great one for you, and vice-versa. In the end, you'll be happiest if you find a career that fits your passion. But until you figure that out, take more math classes.

Read the whole thing here.

Friday, January 09, 2009

Be Careful Who You Delegate To

As usual, Scott Adams nails it. Rule # 1 should be "be careful who you delegate to".

Rule #2 should be "Don't tick off your secretary (or anyone else's)".

Thursday, January 08, 2009

R.I.P. Richard John Neuhaus

Although this is a bit off topic, I just learned (from the Evangelical Outpost) that Richard John Neuhaus recently passed away. He was one of the lights of the evangelical community, and wrote a marvelous essay titled Born Towards Dying (and no, it's not maudlin at all). Here's a snippet:
It was a couple of days after leaving intensive care, and it was night. I could hear patients in adjoining rooms moaning and mumbling and occasionally calling out; the surrounding medical machines were pumping and sucking and bleeping as usual. Then, all of a sudden, I was jerked into an utterly lucid state of awareness. I was sitting up in the bed staring intently into the darkness, although in fact I knew my body was lying flat. What I was staring at was a color like blue and purple, and vaguely in the form of hanging drapery. By the drapery were two “presences.” I saw them and yet did not see them, and I cannot explain that. But they were there, and I knew that I was not tied to the bed. I was able and prepared to get up and go somewhere. And then the presences—one or both of them, I do not know—spoke. This I heard clearly. Not in an ordinary way, for I cannot remember anything about the voice. But the message was beyond mistaking: “Everything is ready now.”
I can just imagine the conversations he's having now. Read the whole thing here.

Fama and French Have a Blog

There are few finance academics who's work is more well known (and cited) than Eugene Fama and Kenneth French. It turns out that they just started blogging. In their first few posts, they've touched on the bailout, government regulations, whether the recent turmoil is evidence against market efficiency, and more. You can read it here - I'd highly recommend adding it into your feed reader. After all, it's Fama and French (need I say more?)

And a thanks to regular reader Jeff V. for the tip.

Another One Out of The Nest

I just got an email from one of my favorite "frequent flier" students. He holds the record for taking the most classes from me -- three different classes, one of which he took twice (the student-managed investment fund class).

He just found out that he got the job he was hoping for. It wasn't his dream job (an assistant analyst position at an Investment Management firm), but in this economy, it's a pretty good one. It's back office, but since he's taking the CFA Level 2 exam this June, he has a good chance of networking himself into the front office in the next couple of years.

Since I run the Student-Managed Fund at my school and am heavily involved in helping the students work towards the CFA exams, I end up getting to know many of our best students (neither the student managed fund nor the CFA scholarships are open to everyone, and I play a significant part in deciding who gets in for both programs). So I consider both groups to be "my" students, no matter what other classes they take (and with who) while they're here at Unknown University.

All in all, it's a good way to start the year. I definitely get paternal (in the old sense of the word) with my students. So it's a little bit of "Proud Father" moment. Schmaltzy, but I'll take it.

Wednesday, January 07, 2009

Marsalis Gives A Smackdown to Today's Students

Last semester, I had a particularly toxic group of part-time MBA students. By the third week, I started thinking of them as the M-B-Abies. By the seventh week, I thought of them as the Uberwhiners. But by the end, they had earned the designation of the MBAstards. So this hit a nerve:

I'm not bitter - I'm just sayin...

An Excellent Resource On Investment Banking Interviews

I've been a long-time reader of Mergers and Inquisitions (at least, I've read it since its start).

The guy who writes it ("The Inquisitor") has a couple of years experience in investment banking, but left the industry a while ago to pursue other interests. He writes most often on the process of getting a job in investment banking, what the life of a low-level investment banking scut-puppy is like, and so on. He's funny, seems to know his stuff, writes well, and links to this blog, so I couldn't ask for more.

A student of mine is going today to visit an alumni at a major investment bank. The alum is an Managing Director at the firm and has taken the student under his wing. He invited the student to spend the day at the bank, and is having him squired around by a couple of mid-level folks to help the student learn more about the firm and hone his pitch for when he gets his internship interview.

As part of his preparation, I had the student read all of M&I's posts. He also bought this guide the M&I blogger put together, titled Breaking into Wall Street: 200 Investment Banking Interviews and Answers. He had me look it over and give him my impressions. So here they are:

If you're trying to get a banking job (or even a job in investment management), buy this guide before you go on your interviews. Don't ask questions - just buy it. It lists quite a few technical questions (like "what are the three financial statements, and how do they link together?", or "when do you capitalize and when do you expense outlays?") along with clear, succinct answers. But more importantly, it spends a lot of time on how to put together a consistent, compelling "story" about yourself that will sell well with an Investment Bank (or at least, how to avoid saying things that will get you eliminated).

The biggest mistake most new applicants make is that they don't take the time to put together a consistent narrative about who they are and why it fits with the firm at which they're interviewing. This guide will help them to do thexactly that.

The only addition I'd like to see is a few pages on structuring a resume - what to do and what to avoid. I realize the author provides that service for a fee, and might be considering doing that as a separate guide. But putting this in the guide would make it even better. However, even with that shortfall, this guide is worth its cost many times over.

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Monday, January 05, 2009

Serious Nerd Humor

If you're a stats nerd, you might find this amusing. If not, just move along.

For more of the same, go to XKCD.

Interview With Baupost Group President Seth Klarman

Seth Klarman, is the president of Boston hedge fund the Baupost Group. He's known as one of the savviest value investors around, having earned a 26% average annual return over the last 26 years. In fact, he was asked to write the foreword to the latest edition of Graham and Dodd's classic "Value Investing."

Here's an interview he gave to the Harvard Business School Bulletin back in December. In it, he talks about why he's a value investor, target returns (he doesn't believe in them), the credit crisis, and much more.

Read it here

Sunday, January 04, 2009

40 Facts About Sleep

Here are some interesting sleep facts from the National Sleep Research Project. Since we're having a baby in April, this caught my eye:
...a new baby typically results in 400-750 hours of lost sleep in the first year.
Only that much?

HT: Craig Newmark

Saturday, January 03, 2009

Update on The Unknown Son

So far, Unknown Son is recovering nicely from his surgery on Monday. It looks like he'll be getting his chest drainige tube out today. That means the only tube left in will be the IV that gives him fluids,

Last night he ate two small pancakes with peanut butter (a taste he got from his DaD), he even took a couple of short walks (about 50 feet). Today, we'll go for as many walks as he can handle.

In the meanwhile, there are always videos. For now, it's the Muppet Movie. What can I say - I believe in a classical education.

It'll still be a couple of days before he gets discharged, but for now - Wocka Wocka Wocka.

Updated 1:30 -- he just got the chest drainage tube out, and they've capped his IV (it was only giving a minimal amount of fluid, anyway). So, he might conceivably be home tomorrow. But we'll see.

Friday, January 02, 2009

What Topics Do I Blog About The Most?

Here's a word cloud for Financial Rounds I made at Wordle (click on the image for a larger version).
Wordle: Cloud1
For those who aren't familiar with a word cloud, it's a graphic representation of frequencies - the more often a word appears, the larger the word in the cloud.

Looks like I've been blogging a lot about the credit crisis --not all that surprising, when you stop to think about it.

How Do Stocks Perform During and After Recessions?

Here's some (as Barry Ritholtz calls it) "recession chart porn":

HT: The Big Picture