Archive for July 9th, 2009

Burt Malkiel gives a thumbs up to behavioral finance

July 9, 2009

Greg Mankiw pointed to this superb interviewof Burton Malkiel. His book Random Walk to Wall Street is stuff of legends and takes everyone to his college days.

Barron’s: The first edition of A Random Walk Down Wall Street was published in 1973. With the benefit of hindsight, is there anything you would have written differently?

Malkiel: I can tell you honestly that it would be pretty much the same take. What I suggested in 1973 is that investors would be much better off if they had simple, low-cost index funds.

But there weren’t any index funds in 1973. The first one available for the public wasn’t started until 1976, by Vanguard.

We have a lot of information about how index funds have done, as well as the typical actively managed mutual fund. I find that consistently two-thirds of active managers are beaten by the indexes, and those that beat the index in one year are not necessarily the ones who beat it the next year.

Over a very, very long period, sure, there are a few people who have outperformed the index. But you can almost count them on one hand. I still believe — even more strongly than I did in 1973 — that most investors would be much better off having at least the core of their portfolio in a low-cost index fund.

The term “random walk” has become so ingrained in the investing culture. What does it actually mean?

For me, it simply means that prices are unpredictable. It also has a technical meaning that, in fact, there are certain statistical properties of prices suggesting that there is no way you can predict the future price based on what has happened in the past. And, therefore, technical analysis is really useless.

Now, the market is not actually a perfect random walk. There is a book, co-authored by my friend [MIT professor] Andy Lo, called A Non-Random Walk Down Wall Street. I don’t know how he got that title! He concludes that you can look at statistics and say, “You actually do fail the random-walk hypothesis on many occasions.” But the market is very close to a random walk.

His take on behavior finance:

When A Random Walk was fist published, behavioral finance was much less prominent than it is today. What kind of contribution have the behaviorists made?

I teach behavioral finance in my course on financial markets, and I believe the contributions are really very great. Now, behavioral finance doesn’t give you a way to beat the market. But it teaches us a lot of lessons about how to avoid mistakes. The behaviorists teach about overconfidence — that we’ve got some illusion of control, and that we tend to trade too much. And that’s absolutely right; it’s a wonderful lesson for investors.

Ibbotson Associates data suggest that, over the long haul, the markets have an average annual rate of return of something like 9½% since 1926. But average investors don’t make anything like 9½%, because they tend to get in at the top and out at the bottom.

What about portfolio managers who say they can use behavioral finance to exploit opportunities?

I don’t believe that at all. I haven’t found any of them who can exploit those opportunities. The bubbles are only so clear in retrospect.

This is a welcome development. You generally don’t see economists who are advocates of efficient markets to have a benevolent view on behavioral  finance. Another big message of behavior finance which is misunderstood by most- it does not teach you about making money.

Superb insights.


UK Financial Sector Fix Plan Version??

July 9, 2009

Seeing the number of reports on financial sector after the crisis/recession, it will be a gigantic effort to reconcile them all.

After numerous plansin US, Uk is also busy taking out a series of reports on financial sector.

First there were aseries of reports on N.Rock, Banking Act – 2009, the much discussed Turner Review, report on future of UK International Finance Centre, and now a new report on reforming financial markets.

This document sets out the Government’s analysis of:

  • the causes of the financial crisis which has led to the world economy being hit by the worst global economic downturn for the last 60 years;
  • the actions already taken to restore financial stability; and
  • further reforms necessary to strengthen the financial system for the future.

Most reports talk about the same thing – increase capital ratios, curb leverage, make regulation sharper with teeth (however it is more important to get people who want to regulate) etc etc. What is the point of having same reports over and over again?

What is worse is as Buiter points in his blog:

The Chancellor of the Exchequer, Alistair Darling takes the cake in the bigger is better stakes.  He appointed “Win” Bischoff, the former chairman of Citigroup (appointed interim CEO for Citigroup in December 2007 after Chuck Prince bit the dust), to co-chair the writing of a report on UK international financial services – the future, published on May 7, 2009.  That’s rather like asking the Ayatollah Ali Khamenei to write a report on who won the Iranian presidential election.  It really is the most ridiculous appointment since Caligula appointed his favourite horse a consul.  You will not be surprised to hear that the report does not consider the size of UK banks to be excessive.

After reading these numeorus tomes on finance, one thing is sure- governments really want to curb financial sector and its excesses. However, by making so many me-too reports one just gets a feeling that they are just rushing into it.


IMF WEO and GFSR Update

July 9, 2009

IMF has released its update of economic outlook and global financial markets. It has revised its growth upwards for 2009 and 2010:

The global economy is beginning to pull out of a recession unprecedented in the post–World War II era, but stabilization is uneven and the recovery is expected to be sluggish. Economic growth during 2009–10 is now projected to be about ½ percentage points higher than projected in the April 2009 World Economic Outlook (WEO), reaching 2.5 percent in 2010. Financial conditions have improved more than expected, owing mainly to public intervention, and recent data suggest that the rate of decline in economic activity is moderating, although to varying degrees among regions.

Despite these positive signs, the global recession is not over, and the recovery is still expected to be slow, as financial systems remain impaired, support from public policies will gradually diminish, and households in countries that suffered asset price busts will rebuild savings. The main policy priority remains restoring financial sector health. Macroeconomic policies need to stay supportive, while preparing the ground for an orderly unwinding of extraordinary levels of public intervention. At the same time, given weak internal demand prospects in a number of current account deficit countries, including the United States, policies need to sustain stronger demand in key surplus countries.

For India it has increased growth for 2009 from 4.5% to 5.4%  and for 2010 from 5.6% to 6.5%.  The global economies are still under severe stress. The growth forecasts have been revised lower for Euroarea, East Europe, Latin America and Africa. Only for Developing Asia the forecasts have been revised higher and that too because of China and India. For 2010, the growth forecasts are higher except for Spain.

Revisiting Civil Code vs Common Law

July 9, 2009

There is a large literature which says common law countries have better institutions  (as in legal system, financial system etc. ) compared to civil law countries. Though Business Historians don’t agree and call it “ill-informed understandings of the past.”

Anyways, a new paper by Acemoglu et al says things are not as bad with civil law code as it is made out to be. Voxeu has a write-up from the authors on the same. In this paper they use an event study- invasion of  Europe by Napoleon- top understand whether the kond of institutions set up were effective or not:


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