Archive for April 17th, 2008

The cost of Active Investing

April 17, 2008

I have been looking for this paper for quite sometime. It is from Kenneth French (the one who collaborated with Eugene Fama on various landmark papers). The abstract says it all:

I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society’s capitalized cost of price discovery is at least 10% of the current market cap. Under reasonable assumptions, the typical investor would increase his average annual return by 67 basis points over the 1980 to 2006 period if he switched to a passive market portfolio.

I am yet to read the paper. Will add comments if I manage to read it.  Here is a profile of the paper.

Double standards in the 2 ongoing crisis

April 17, 2008

It is not very often we see two crisis at a global level. I haven’t seen such times when we are seeing both financial crisis and food crisis happening together.

Though, the policy responses for both has been really different. The financial markets/experts have given a big thumbs up for all the Central Bank and government intervention but have given a big thumbs down for the government intervention in the food crisis.

The interventions in financial markets are justified as it could paralyse the entire economy but if given for food then it is said it leads to market distortions/against free-market philosophy etc.

This is actually double standards at its best. Any intervention leads to distortions be it any market. For instance, bailouts of Bear Stearns and Northern Rock though justified as important it leads to issues of moral hazard and is against the philosophy of “survival of the fittest”. In 2001, several large firms were shown the door but smaller firms in finance  are provided the support.

So, it is true that the various interventions by several governments (I have highlighted a few cases here) will not result in the desired benefits, but so is the case with finance. The central banks have pumped in huge liquidity but it is seen that firms are still holding on to whatever finance is available and are not willing to lend or borrow. Isn’t it much like hoarding or using a euphemism- saving themselves for worst times to come?

The WSJ/Mint article shows financial firms are not disclosing correct LIBOR and this is leading to false market signals. They are disclosing rates lower than the actual as they are afraid higher rates will show that they are distressed.  This is leading to overall lower interest rates as most lending/borrowing is done at LIBOR plus rates. So, there is a problem everywhere.

Did people learn anything from previous financial crisis? Nothing at all. It is still the same. Numerous research has been done to show nothing has changed (see this as well) and no lessons have been learnt.  So, it can’t be said this crisis is different and hence intervention is needed.

So either we should not support government intervention at all and let markets solve the problem by itself. Or, we should understand the fact that in any crisis the response is much the same- government interventions and market distortions.  There are no easy solutions/answers.

IMF- euphemism at its best

April 17, 2008

Euphemism is basically double standards. I read this IMF GFSR April 2008 third chapter titled “Market and Funding Illiquidity: When Private Risk Becomes Public” . The summary is here.

IMF has very cleverly and neatly replaced the word bailout/central bank intervention by saying “When private risk becomes public” :-) 

Overall it is a nice chapter on how different kinds of liquidity mechanisms are at work and how comples things have become. For a primer on liquidity see this primer as well.

Assorted Links

April 17, 2008

1. Econbrowser on the hot  topic-  commodity arbitrage

2. Johnson has a terrific post titled Gravity and modern economist

3. ID Blog discusses whether microloans should be used for consumption or not

4. MR points to a really confusing paper title

5. WSJ Blog points to Fedspeak

6. Krugman on why oil prices are rising?

7. Mankiw has a nice humor

8. Ajay Shah on global turmoil. Monetary Policy frameworks are inconsistent everywhere and we just can’t at other central banks as benchmarks. There is some more criticism from Ajay Shah here.


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