I’ve been reading the “Beyond Scarcity” series on FTAlphaville recently, and it’s made some very interesting points. The posts argue that the current economic environment is deflationary with regard to goods. I think that is true, and one of the reasons is because of technology. Firstly technology is constantly making everything more efficient and because of global competition this is both reducing the production costs and making goods cheaper. Secondly technology is causing structural unemployment, which means less people have money to spend and there is less money flowing around the economy. Other factors causing deflation are the tight monetary conditions, the aging population, and potentially the effects of quantitative easing.
There’s a great article here on estimating correlations and means when you have missing data in your datasets. It uses the Expectation Maximisation algorithm to calculate the missing values, and what is interesting is how much the implied correlation changes after applying EM.
The New York Times has a great interactive graphic on How the Giants of Finance Shrunk, then Grew, Under the Financial Crisis. It’s really interesting seeing how, if the Market Capitalization of each firm is represented as an area, the each firm shrinks massively during the financial crisis, and now how the firms are rebounding.
A post over at the New York Times is arguing that one of the main causes of the financial crisis was inadequate quantitative models – models that tended to understate risk because they failed to provide a realistic model of the way the world works – neither incorporating risks such as a failure of liquidity, nor the complexities of human behaviour.
I certainly agree that the current stable of models which are in widespread use are inadequate given that the competitive market has made the spreads on trades so tight that there is no longer any buffer to cover the many short-falls in the models. Back when vanilla options were an exotic trade, the trader would incorporate plenty of fat in their options trades. Intense competition, a market that has steadily grown over the past 20 years (notwithstanding small glitches), and increased familiarity with the trades has served to camouflage the risks the traders were running in their options books.
A while ago, I created a Mathematica plot comparing the Great Depression, the Tech Crash and the Oil Crisis with the current financial crisis. This analysis was inspired by a chart I saw last year comparing these recessions with our current situation. Anyway, I thought it was worth bringing the chart up-to-date.
[Edit] The original chart I saw was this one.[/Edit]
Some interesting papers have come out on the “Credit Crunch”.
- Leveraged Losses: Lessons from the Mortgage Market MeltdownThis paper provides a good overview of the financial market turmoil occurring since August 2007, and discusses how the crisis might impact other areas of the economy.
- A Black Swan in the Money Market
This paper examines the sudden jump in spreads between the overnight and term inter-bank interest rates.
Here are some more financial blogs that seem good:
- The Aleph Blog – Investment strategies and advice (seems pretty US-centric)
- The Epicurean Deal Maker – Sarchastic, sardonic and humerous insight into Wall Street
- Going Private – The Sardonic Memoirs of a Private Equity Professional – This is an absolutely hilarious blog about the world of Private Equity. Excellent!
- A Fist-full of Euros – An interesting blog focusing on European finance/economics/politics.
This past week has been facinating in the financial markets. After a long slide downwards, the markets tumbled at the beginning of the week, and now they are bouncing back upwards.
Initially the market dive looked like it was triggered by worries over the problems with the Monoline Insurers.
The Fed responded by cutting interest rates by 75 basis points on Wednesday. This seemed to have little effect with various indices falling even further. It did however seem to have a dramatic effect on the probability that the US will go into recession.
On Thursday we found out that Societe Generale lost $7 Bln from trader fraud (leading the market wags to dub it “Shock Gen”. This seemed to have little negative impact on the markets with the indices all shooting upwards. They are all up today, albeit not as much as yesterday. It looks like the momentum is leaving the bounce.
So could the massive falls be attributed to Soc Gen selling out of their positions and realizing their losses? Can some of the market euphoria be attributed to proposed monoline bail-out?
I guess we’ll see how next week develops!