Archive for January, 2008

Similarities between cricket and subprime crisis

January 11, 2008

International Cricket Council’s decision to remove Steve Bucknor from the third test match at Perth has got a lot of criticism from the cricket experts and media. (All the developments after the Sydney Test Match are here; my view of the match is here).

The West Indies cricket board has raised objections over the move (as Bucknor is from WI) and so have number of players who call it a ‘bad precendent’. Their take is it has  set a bad example and teams might be using this example to remove umpires who have given wrong decisions in their future matches.

This situation got me thinking and I can see quite a bit of similarity between the recent financial crisis and “Sydney” crisis.

Even in the recent crisis Fed was in a dilemma; if it didn’t cut the rates it would have invited huge criticism from various sections on account of slowing down of economy and if it cut rates it would invite the same from moral hazard brigade.

Similarly, if ICC did not take a decision it would have invited criticism from supporters of Indian team and when it took the decision it drew flak on the move.

ICC took the decision on 2 broad counts: one to pacify the situation as India had threatened the boycott of the tour and two, India contributes most to cricket’s revenues. Obviously, second reason is not the one which ICC can state formally but it is a well-known fact.

Now as long as it is the first reason it is fine, but it is the second reason it is more worrisome. The purists would say that a team cannot be larger than the game and hence Indian team’s request should not have been adhered to.  Hence, it is a moral hazard in financial parlance.

I think the authorities have to share the blame for not acting fast enough. Like in the financial markets the authorities waited till all hell broke loose, similar is the case with cricket.

  • India has always been uncomfortable with Steve Bucknor and he has given some horrendous decisions against India. ICC could have ensured that he is not umpiring in India’s matches. Prevention is better than cure.
  • More than anything ICC has been ignoring the Aussie behavior for quite long. Bad behavior is bad by calling it “Aussie way of playing” you can’t pass it as good. This aussie stuff has been picked up by most teams and now any series is more popular for the behavior than cricket.  ICC should have taken some tough decisions earlier on. I was actually expecting a  far more worse thing than what happened at Sydney test like a full fledged brawl between the players etc. I hope we see some developments on this
  • Umpiring standards are getting really bad as we move on. This is surprising given the increasing use and presence of technology. It is quite funny when you have an umpire say “not out” and TV screen at the stadium showing he was “out”. And there are many inconsistencies in their decisions. Sometimes, the third umpire is referred sometimes not. Sometimes the umpire gives out but the batsman is sent back on TV replay showing he wasn’t out and sometimes there is no action. Hightime for judicious mix of technology and humans. We can’t be inconsistent when stakes are so high. (Likewise the Central Banks should think beyond price stability otherwise each time we would see similar episodes)

In the end is it a case of Moral Hazard? I think yes. Like, financial markets never learn and keep coming out with fancy products (in the name of financial innovation) and end up asking for Fed’s help. Similarly, cricket teams might ask ICC to intervene in case things don’t go their way in certain matches.

But then moral hazard can be limited by doing things when things are going fine. ICC has got one opportunity to clean the game and I hope it does something fast. Otherwise, just like we see financial crisis get bigger, we will see worse cricket behavior ahead. 

It is thrilling to see when somethings which appear so distinct are so similar. I also posted about the similarity between financial markets research and cricket here and here.

Update: Hariharan Narayanswamy has an interesting article on the same. However, I think in this case the person did not have the bat and was trying to be a bully. It was hight time that he was taught a lesson.


Assorted Links

January 11, 2008

1. WSJ Blog pointsto the recent Bernanke speech. After the speech he says how difficult it is to predict recessions. It also pointsto Bernanke defending Fed independence


2. WSJ Blog points to a discussion whether GDP is the best indicator to look at recession.


3. New Economist revisits recession


4. Mankiw also points to a new survey on recession probability.


5. EPSA blog on impact of climate change on poor.


6. Econbrowser’s post on recession prospects is terrific. Highly recommended.

Is subprime crisis any different?

January 10, 2008

Whenever there is a discussion regarding growth story of an economy, there is this oft repeated phrase: “This time it is different” and how it is going to continue for an extended period of time. And then we have a crisis and all the story is found to be false.  

This phrase has been used so often in the past and found to be untrue that it has become a signal for trouble. So whenever anyone says this time it is different one should instead become careful.

On similar lines, we have an excellent paper (titled ‘Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison’) by Rogoff and Reinhart. They discuss whether this subprime crisis is any different? And they go on to show using various economic data that there is a lot of similarity between subprime and previous crisis 🙂

Thanks to Martin Wolf for pointing the paper. I am sure this paper is going to be discussed widely in most blogs. Read Roubini’s comments on the same.

Read this for a sample:

This time, many analysts argued, the huge run-up in U.S. housing prices was not at all a bubble, but rather justified by financial innovation (including to sub-prime mortgages), as well as by the steady inflow of capital from Asia and petroleum exporters. The huge run-up in equity prices was similarly argued to be sustainable thanks to a surge in U.S. productivity growth a fall in risk that accompanied the “Great Moderation” in macroeconomic volatility. As for the extraordinary string of outsized U.S. current account deficits, which at their peak accounted for more than twothirds of all the world’s current account surpluses, many analysts argued that these, too, could be justified by new elements of the global economy……

We all know the reality….

They compare previous banking crises with the recent one on 5 parameters:

  1. housing prices
  2. equity prices
  3. current account balance
  4. Read GDP growth
  5. public debt as a % of GDP

And on all five, there is quite a bit of similarity atleast at time ‘t’ (the time of recession) and time ‘t-4’. They also look at t+3 but we don’t know the same for the recent crisis. The magnitude differs for instance in equity prices and current account deficit but we see presence of a broad trend.

And how abut the summary?

The correlations in these graphs are not necessarily causal, but in combination nevertheless suggest that if the United States does not experience a significant and protracted growth slowdown, it should either be considered very lucky or even more “special” that most optimistic theories suggest. Indeed, given the severity of most crisis indicators in the run-up to its 2007 financial crisis, the United States should consider itself quite fortunate if its downturn ends up being a relatively short and mild one.


So, the authors fear worse is yet to come. Let’s see how events unfold. However, the best part of the research is their comparison to the recent subprime crisis with the other crisis that originated in developing economies previously:

During the 1970s, the U.S. banking system stood as an intermediary between oil-exporter surpluses and emerging market borrowers in Latin America and elsewhere. While much praised at the time, 1970s petro-dollar recycling ultimately led to the 1980s debt crisis, which in turn placed enormous strain on money center banks. It is true that this time, a large volume of petro-dollars are again flowing into the United States, but many emerging markets have been running current account surpluses, lending rather than borrowing. Instead, a large chunk of money has effectively been recycled to a developing economy that exists within the United States’ own borders. Over a trillion dollars was channeled into the sub-prime mortgage market, which is comprised of the poorest and least credit worth borrowers within the United States. The final claimant is different, but in many ways, the mechanism is the same.


What a thought !!

How about taking this argument further and asking what were the solutions then and can the same be applied now?

Another idea is about applying the same on Indian economy. Is this growth story any different? Many say that India is a consumption driven economy (about 55% of GDP now) and hence the growth story is domestic. So there is not going to much impact of the US recession. Really? Well, India has always been a consumption driven economy and the consumption figures have actually been falling. They are still high but the argument doesn’t stand. How about other ideas on Indian growth story?


1. BTW, there is another paper from Michael Bordo which says “The same old story, only the players have changed”.

2. There is a detailed paper by Rogoff and Reinhart on six centuries of crisis. Shorter version is here

Assorted Links

January 10, 2008

1. Ajay Shah says capital controls are not working

2. TTR points the need to overhaul excessive incentive system in the finance industry.

3. WSJ Blog points to new Bill Poole (of St Louis Fed) speech. It also points to Goldman Sachs view on recession.

4. Mankiw points to the big lie of 2008.

5. PSD Blog onTata’s People Car.

6. Atlanta Fed releases a DVD for disaster management

7. MR points to new blog ranking. This blog ranks 148 amidst all economics blogs.

Second Best Institutions work equally well

January 9, 2008

Reading Dani Rodrik’s work is like walking in windy conditions with wind direction not in your favor. The difference is he does it quite well where most stumble.

When most talk about free markets, he suggests the importance of industrial policy, when most talk about flexible exchange rates he suggests importance of undervalued exchange rates, when most talk about virtues of free trade he emphasises that social safety net is equally important, when most favor financial globalization, he is sceptical etc.

This time he talks about second best institutions, when most talk about getting best institutions (also called first best). He has written about the same few times in his blog and this time he writes a short paper on the same.

What does first best mean?

The type of institutional reform promoted by multilateral organizations such as the World Bank, IMF, or the World Trade Organization is heavily biased towards a best-practice model. It presumes it is possible to determine a unique set of appropriate institutional arrangements ex ante and views convergence towards those arrangements as inherently desirable. One of its apparent virtues is that it enables cross-national comparisons and benchmarking: institutional performance can be measured by, say, counting the number of days it takes to register a firm in different countries or settle a commercial dispute in courts.

And what are second best? 

I shall argue that dealing with the institutional landscape in developing economies requires a second-best mindset. In such settings, a focus on best-practice institutions not only creates blind spots, leading us to overlook reforms that might achieve the desired ends at lower cost, it can also backfire. I will elaborate on this point using illustrations from four areas: contract enforcement, entrepreneurship, trade openness, and macroeconomic stability.

Read on to understand his perspective in the four areas. The paper is bound to create controversy as most of his work does. I would be looking forward to application of his ideas.

However, whenever I read on development economics, this and this comes to my mind 🙂



Uncertainity about asset values may ultimately be worse than losses

January 9, 2008

Eric Rosengren of Boston Fed says so in his recent speech(WSJ Blog also covers the same).

It is a good talk on housing markets and draws experience from events in New England and Japan. He then applies the learnings from these events in the recent crisis.

He begins like this:

On your list of New Year’s resolutions, I would include not listening to pundits who claimed:

 1)  …that housing prices could not go down, nationally;
 2)  …that triple-A ratings meant no default risk;
 3)  …that calculating fair market value was easy for mortgage products.


Finance Ministry’s Working Paper series

January 9, 2008

Thanks to this article from Suman Bery I realised that Finance Ministry (of India) has started its working papers series.

The papers are available here. There are just two of them as of now. On a quick glance, both look quite good. The first one on services is a detailed analysis of the sector and second one from Arvind Virmani looks at the problems going ahead for Indian economy.

An excellent initiative from Finance Ministry to research and publish the papers. I hope to see more papers in future.

Another thing is it could have added the working paper link as a new feature at the top of the homepage. It would have led to better visibility.

1. Here is Planning Commission’s working paper series.

Assorted Links

January 9, 2008

1. WSJ Blog points to dispersion of views in Fed. It also pointsto speeches from Possner (of Philadelphia Fed) and Rosengren (of Boston Fed).

2. WSJ Blog also points to a new OECD report that says inflation has been rising in the 30 member countries. Its assorted links post is also quite good

3. MR points to number of foreclosures in counties. MR also says fiscal policy would not help in spurting the economy

4. Rodrik’s new paper

5. EPSA Blog on role of foreign aid.

6. TTR on anti-business textbooks in Europe. Interesting article. Mankiw also points to the same and provides a free link as well.

7. Menzie Chinn covers a few papers presented at AEA conference

8. Ajay Shah updates the critical appointments list

9. Suman Bery on Indian economy

10. Stigilitz warns of stagflation cometh.

Understanding Regulation

January 8, 2008

Here is another superb piece from Shleifer. It is actually a speech he gave at EFMA in 2004.

What he says is this:

The American and European societies are much richer today than they were 100 years ago, yet they are also vastly more regulated. Today, we live in houses and apartment buildings whose construction – from zoning, to use of materials, to fire codes – is heavily regulated. We eat food grown with heavily regulated fertilizers and hormones, processed in heavily regulated factories with publicly monitored technologies, and sold in heavily regulated outlets with elaborate labels and warnings. Our means of transport, including cars, buses, and airplanes, are made, sold, driven, and maintained under heavy government regulation….

The extraordinary pervasiveness of government regulation in our lives raises a number of questions. Is regulation generally a good idea, as the positive correlation between its growth and the growth of income seems to indicate, or has it been an obstacle to economic and social progress? Have the USA and Western Europe grown in spite of it? How much regulation of a particular activity is appropriate? Does the nature of the activity being regulated, or the characteristics of a country, influence the optimal choice? Is the level of regulation we observe in fact an outcome of efficient social choice, or are other factors as or more important?

He then reviews basic theories of regulation and looks at how regulation can help us achieve more efficient outcomes.

Highly recommended.

How do economists think about cities?

January 8, 2008

Edward Glaesar of Harvard University is one of the best urban economists you can come across. For a profile of all his work so far see this.

I just finished this paper from him titled ‘The Economics Approach to Cities’ and was quite impressed. The usual urban policy emphasises place over people but economics looks at it the other way round. This means say you are building a road, the urban policy would look at how it would help city transport, but economists would look at whether the road helps give them more choices. At the end, urban policy focus would also lead to better choices for people but the focus is not on people. Whereas economists would first look at whether the welfare of the individuals is increased or not.

I haven’t read at all on urban economics but his paper is an excellent primer on the same. He discusses the various models which explain the mobility decisions of people and firms. I liked this expression which explains what helps people choose various locations:

Income + Amenities – Housing Costs – Transportation Costs

He builds his around this expression. Read the entire paper to understand the approach.

I was wondering whether we could apply the approach to Mumbai which is being pitted as an International Financial Centre. (See the various articles etc on the same here)

MIFC looks like a report which is place based. The first question is if Mumbai becomes an IFC what extra choices would people have? Would it mean better housing conditions? Would it mean people have more and better transportation choices other than local trains?

The report does have a chapter on urbanisation but is it enough? The chapter talks about new ideas needed to reform Mumbai’s infrastructure but there are just a few suggestions. The focus seems to be on how Mumbai’s strategic location and if we don’t get our act together other cities (like Dubai, Shanghai etc) would gain.

I think the report would have found more takers if the focus would have been on urbanisation reforms and how that can enable Mumbai become an IFC rather than the other way round. There are just too many problems in Mumbai and only a person living there can appreciate them.

I understand that because these reforms would take time and the MIFC would loose the race. But that is reality. One simply can’t shrug it. Efforts need to be made to make Mumbai a better city first (giving people ample choices) and IFC can follow.

One of the ideas behind MIFC is to draw talent towards Mumbai. I just have one thought. Suppose someone does come from say New York on great expectations. If the company doesn’t have suitable accommodation and he/she has to search for one and travel in local trains (or even takes a car), I am sure they will catch the next flight back home. Coming to Mumbai and staying at five star hotels and travelling to Nariman Point is a lot different than making Mumbai a home. And that is reality.

Assorted Links

January 8, 2008

1. Ajay Shah has an excellent post on expenses in fund management in India

2. WSJ Blog posts on what to use monetary policy or fiscal policy for the current mess.

3. WSJ Blog points to 2 papers discussing How efficient are cricket and tennis players

4. ECB often uses the word vigilance. WSJ Blog points to  research over whether the word works in lowering inflation expectations. The answer is not really. Meanwhile Trichet believes inflation is a worry.

5. New Economist points to new blogs.

6. Mahalanobis points to an interesting story on value investing

7. Mankiw has a graph which says recession odds are rising.

A short note on Finance and Growth

January 7, 2008

This has been one of my favorite topics- How finance leads to growth. I have posted many a times on the subject ( see this for instance).

I came across this superb short note on the topic written by Aubhik Khan of Philadelphia Fed. It is basically a crisp literature survey and explains how various papers have gone on to show how finance helps in growth.

The note was written in 2000 and since then substanitial research has taken place in the subject. Like now we know access to finance is as important, finance helps reduce poverty, research on whether financial globalization is helpful etc. Keep posted for more developments.

Importance of legal system

January 7, 2008

The importance of an effective legal system is well known. I came across this excellent paperfrom Shleifer et al on the same.

The team discusses why people do not believe in legal system and how badly it effects economic activity. One should check out the way they explain how a capitalist goes on to hire a manager given different legal system.

The main finding of the paper is:

The question addressed in the following sections is how to get more people to use the legal system? We believe that court and police reforms should not be the starting point, since those reforms are likely to take a long time. The legal system must begin to be used with the existing courts and police. To do so, legal reform should begin with the adoption of legal rules that the courts find usable, and that private parties find cheaper to rely on than other methods of resolving disputes. Such rules should have several obvious but important characteristics.

First, bad rules — that keep people from using the legal system because they prohibit, or fail to support — legitimate market activity, need to be abolished.

Second, the new rules should to the extent possible follow business practice, thereby enabling private parties to continue their business activities but to rely on courts rather than crime to resolve disputes.

Third, the new rules should help the courts resolve disputes by telling them what to do in the cases where existing laws are most conspicuously incomplete. In particular, courts, with their extremely limited resources, should be able to verify whether violations of these rules have occured.

Is spirit of cricket dead?

January 7, 2008

I am sure most would say “YES” after the test match at Sydney that ended yesterday.

What could have been a great test match was turned into a death of cricket. It seemed only winning mattered and Australia can do anything to get the win. I agree India played badly but the Aussie behavior on the field was so attrocious that one couldn’t help but get angry.

The Aussies were celebrating the win as if they had earned it. We all know the 8 decisions that went against India (the catches of Australians were not given but non-catches (or doubtful) of Indians were given) and without the umpire’s help Aussies couldn’t have won. The worst was the third umpire also ruled decisions against India when it was obvious Andrew Symonds was out. When umpires favor a side, we usually say the team played with 13 players (11 players and 2 umpires), but ion this match it was 14 players ( 11+2 and one third umpire). And they claim this victory was special. Sure mate, we hope you continue your winning streak in this manner.

Andrew Symmonds was out thrice in the first innings and was not given out and went onto score 161 runs, He took the wicket of Dravid when latter wasn’t out. And Symmonds was given the Man of the Match for his effort. Whose effort may I ask?

I just loved the entire test match for the hypocrisy around the match. The same Australians who started all these mind games on the field were discussing ethics etc in the game. The Ricky Ponting indicating Ganguly was out and umpire obliging was icing on the cake. I mean what is going on Mr. Ponting? If you are doing such things, do them discretely as cameras are watching.

And the racism issue? Most know this old Aussie tactic. They should all get a PhD in the science they have dubbed as “Mental disintegration”. The media, players start targeting a key player before the series and stick to it. They put so much pressure on him to perform that the poor guy has to be really tough to give it his best.

Well, if any other team files a complaint I am ok. But Australia, give me a break. I have only one thought to this. Their Phd didn’t work against India so they decided lets do something different and filed a racist comment against Harbhajan Singh. And the refree without any evidence has slapped a ban against Harbhajan Singh. If this was followed earlier where on players’ complaint other players can be banned, I am sure most Aussies would have had a winning streak here as well.

I just hate Aussies for bringing this game to such low levels. Even West Indies was a champion team but didn’t behave that way. Infact it is still the favorite of many cricket watchers and all want them to really come back to the position they once held. Such was the spirit of their game.

What was once a gentleman’s game isn’t anymore the same. There have been champions who bring more pride to the game, but here we have a team which has brought such a bad name to the game. They call it the Aussie brand of cricket. Well if that is a brand then it isn’t cricket.

The teams should now rally and say we wouldn’t tour Australia. They shouldn’t be the only ones who have the right to not to tour Sri lanka, Pakistan etc. We should also say we would not tour Australia unless they mend their ways.

Many teams have since then picked these Aussie brand and we see many a series where mind-games are played. It is sad that it all has to come to such low levels but I don’t see how else it could have been solved. The cricket teams and administration should try and being the cricket of old asap.


1. It is just amazing to see the way the media has reacted to the events. And not just the Indian media but Aussie media. This one by Peter Roebuck says it all:

India has been dudded. No-one with the slightest enthusiasm for cricket will take the least satisfaction from the victory secured by the local team in an SCG Test match that entertained spectators at the ground, provided some excellent batting but left a sour taste in the mouth. It was match that will have been relished only by rabid nationalists and others for whom victory and vengeance are the sole reasons for playing sport. Truth to tell the last day was as bad as the first. It was a rotten contest that singularly failed to elevate the spirit.

2. Despite all this Ricky Ponting continues to defend him and his team. He thinks that relations have been cordial between the teams and is amazed by the buzz around this match. This time I am surprised.

3. Peter English rightly tells Ponting to open his eyes and understand the problems he has created. Roebuck even says Ponting should be asked to go. Meanwhile, Prem Panicker points how Mike Procter put a ban on Rashid Latif for appealing for appealing for what wasn’t a catch.

4. Allan Border and Steve Waugh defend Aussie behavior sayingit is cultural differences which have led to the problems. I really do not understand this. A bad behavior is bad, by calling it “Australian way” doesn’t mean it would become acceptable. If monkey is unacceptable to Aussies then talking about one’s wives and girlfriends aren’t exactly fun or kind words.

I have always thought that the way the game was moving, we are sure to see some big problems in future, which has happened now. Efforts should be made and Aussies be reminded that no one would play with them if they don’t improve. If that means to change their “cultural traits” be it.

5. The grief is so much in India that leading Business dailies have mentioned it in their editorial sections: ET ( I think they shouldn’t play unless issues are addressed), BS (I agree mostly to what it says)

6. Also read this funny piece on Symonds.

Assorted Links

January 7, 2008

1. Mostly Economics Blog is the second best South-Asian blog according to this list. Not bad considering the best is Ajay Shah’s Blog. New Economist also points to the list.


2.WSJ Blog discusses whether recession is just a matter of semantics? Meanwhile unemployment figures crossed the recession threshold. Another articlesuggests that subprime not as severe as S& L crisis.


3. Greg Mankiw congratulates Raj Chetty


4. Rodrik on political economy, he points to a paper which addresses whether trade leads to lower wages and higher inequality.


5. New Economist on the recession.


6. Econbrowser discusses weakening economy.


7. Ajay Shah discusses whether fiscal policy should be used for stability.


8. TTR points tosubprime losses being exaggerated.

Managing India’s capital account

January 4, 2008

Dr YV Reddy has given a nice speech on the subject at Hyderabad on Jan 3, 2007.

He discusses the economic thinking behind the subject and offer Indian perspective. He says a pragmatic approach has to be taken and one cannot rely on the developed country model.

The effectiveness of capital account management should be viewed from several angles. Let me mention a few. First – impact on exchange rate expectations. Second – the counterfactual, namely what could have happened without capital controls at a particular juncture? Third – the short term impact versus the long term effectiveness. Fourth – the overall regime of current account management in the country concerned, to thwart capital account transactions in the guise of current account. The regimes governing repatriation and surrender are also relevant here. Fifth – the administrative framework and overall effectiveness of administration in the country, in a given legal and institutional framework. Finally, by all accounts, in terms of both growth and stability, China and India, who do manage capital account rather actively, have performed exceedingly well in all the recent years.

Read the entire speech for more details. And yes, the empirical research he mentions I have covered it earlier here.  So, now you know I have been advising you to read the right things. 🙂

Roads vs Cars, Airports vs airplanes etc etc

January 4, 2008

Reading the comments over Ratan Tata’s much awaited People’s car has made me wonder over the infrastructure issues in India. (Read in favour views here and here. And against view here) For the uninitiated the car is going to cost just Rs one lakh (about $ 2,500 in today’s currency) and will be the cheapest car in the world. Hence we are seeing a lot of commentary over the subject. The car would be unveiled in Autoexpo 2008, an automobile exhibition in New Delhi on Jan 10, 2008.

India is facing really tough problems like these:

  • We have numerous cars, but not enough roads
  • We have enough airlines and airplanes now, but not enough airports
  • We have train tracks but trains don’t run on the same – like the harbour line from Vashi to Belapur. It could help decongest the trains quite a bit.

Infrastructure takes time to develop and because of little urgency shown earlier we have a huge deficit at hands. On the other hand, the things which help human beings utilise infrastructure like cars, motorcycles, airplanes etc have expanded big time leading to big management problems for authorities.

I am all for the People’s car but it is going to be a big-big concern for already jammed roads. And the jams are not just in large cities but more and worese in small towns. Reason?  Easy financing schemes (that is what the adverisers call it and we now know we should be careful) have made it easier for people to afford cars, motorcycles. As roads haven’t changed, we have jams all over.

Infact, the problem has become so bad at some places that one has to be a town expert (knowing all roads, sub-roads) in order to reach his work or home. The traffic has become so huge that a minor disturbance in a main highway leads to chaos like the National Highway 2 got disrupted at Agra and as a result the traffic from Kanpur to Delhi was disrupted. The jam ran upto almost 2-5 kms.

So, what do you do? Do you stop Tata from making cars? Do you stop ICICI from giving auto finance? Clearly both are not the right choices. People’s car would make car available to many, ICICI auto finance provides debt and using the equity one can buy the motor cycle/car/truck.

But then the issues with infrastructure are also a reality and one cannot just ignore it. The roads etc would take time to build and in many cases the traffic actually is more than the capacity of the new road. Hence we would have the policy dilemma for some time to come.

Assorted Links

January 4, 2008

1. Ajay Shah points to his list of 2007 articles. He also updates his earlier post on the critical appointments held for this year.


2. WSJ Economics Blog points how vote buying works in Africa. It points to a paper that says Fed should publish revised inflation forecasts.


3.Mankiw points to an article that says of the many thousands of mutual funds only 31 managed to beat the index each year from 1999 to 2006. He also points to this article which says number of economists favor John Edwards as next president

4. Time forRodrik humour J

Assorted Links

January 3, 2008

1. WSJ Blog points to a paper where the analysts have converted the house prices and rents into a P/E ratio and have said house prices are likely to fall further. This is why US is US. Their research work is exemplary and is amazing the way each expert analyse the events in his own way. This makes the subject richer.

It also points to another paper which suggests FOMC should not be there in the forecasting business.


2. WSJ Blog points to data releases that suggests recession fears worsen further. Read the expectations of various economists in 2008


3. Mankiw points to one Bob Shiller financial product not finding acceptance.


4. MR is an extremely refreshing blog. I don’t know where it gets all the articles from. MR points to this funny story about visa god. It also points to this write-up on how Hillary and Obama’s economic philosophies.


5. Ajay Shah on FII


6. TTR reflects on the sub-prime crisis

Should we believe in financial advertisements?

January 2, 2008

I have always taken advice on financial products – mutual funds, stock-selection etc. with a pinch of salt. The thinking goes back to the basics of finance- no matter how good you are, you just cannot predict the price of a share, bond etc. The best information you have is today’s price. Hence, none of the advice really works.

Despite this, we see huge marketing activity in financial sector. We have TV channels, newspapers dedicated to covering financial markets offering advice, suggestions etc. They are sponsored by financial companies who offer stock tips, mutual fund recommendations etc?

This superb paperfrom Mullainathan and Shleifer (one of the best minds in the business) analyses the financial advertisements. They use the behavior finance angle to explain how these finance firms advertise their wares (as Mullainathan is a behavior finance expert and Shleifer makes sense to anything and everything)

In this paper, we compare traditional and behavioral models of persuasion. In the traditional model (Stigler 1961), persuasion is communication of information. “Advertising may be defined as the provision of information on the availability  and quality of a commodity” (Stigler 1987, p. 243). In other words, persuasion involves offering information in order to change beliefs. In the behavioral model, in contrast, persuasion does not aim to change existing beliefs. Rather, characteristics of the product are integrated into the prevailing beliefs of the customer using either factual or spurious messages. There are few outright lies, but many more insinuations aimed at harnessing a pre-existing and possibly false belief.

That is excellent stuff.

They take this idea to test how financial products are advertised and focus on mutual funds (MF). They say a financial product can highlight return, risk or both in their products. Their finding is MF advertise returns when markets are doing well, and risk when markets are doing badly. Ideally, if you believe in your MF, the stance shouldn’t change. But MF know their business. They know people are aware of the market movements and anything contrary to their beliefs will not be accepted. They do a further break-up and find MF advertise growth funds in good times and value in bad times. 

The conclusion is even better:

This conclusion on the nature of persuasion bears on a key question in the analysis market efficiency in general, and price bubbles in particular, namely whether financial institutions play a stabilizing role. Previous research has focused on one form of professional activities, namely arbitrage, and has shown that institutions often play a destabilizing role (DeLong et al. 1990, Brunnermeier and Nagel 2004). But, as Kindelberger (1978) has  recognized long ago, institutions play another important role: they can facilitate or discourage the speculation by individual investors.

Our analysis shows that, at a minimum, financial institutions encourage speculation rather than contrarian behavior through their persuasion strategies. If such persuasion works (something we do not show), its effect is to destabilize prices.

But there is also a broader point. This paper, like Mullainathan and Shleifer (2005), shows that competitive markets in information deliver what consumers want. This, however, need not be the whole truth, or even the data most needed for consumers’ well-being. Whether public policy can improve on these outcomes remains a wide-open question.

The paper is quite a lesson and we see this happening rampantly in Indian financial markets. I pointed out that most mutual fund companies are coming out with infrastructure funds. Why? One reason is that infrastructure is a buzzword but this paper also helps in making us understand that MFs are simply acting on the existing beliefs in the investors.

We are bombarded by the word infrastructure from media and this makes us believe that it is going to be the sector to invest as everybody is talking about it. So, MFs are doing nothing but cashing in.

Now, I don’t mean to say infrastructure is a hype. It is a must if Indian economy has to grow. But this simple ‘name-game’ will not help.  We need viable infrastructure projects and not much emphasis is given to this. The media doesn’t cover this well enough to give you a clearer picture.  Like the way we know which infra stocks went up, we also need to know what were the new projects, the status of the old projects etc. No one seems to care about all this and this is when things get scary.

%d bloggers like this: