Saturday, October 23, 2010
Saturday, August 21, 2010
Risk Management pays
This has just come out. www.nber.org/papers/w16178
Ellul, A. and V. Yerramilli (2010). Stronger risk controls, lower risk: Evidence from US Bank holding companies. Cambridge, MA, NBER.
In this paper, we investigate whether US bank holding companies (BHCs) with strong and independent risk management functions have lower enterprise-wide risk. We hand-collect information on the organisational structure of the risk management function at the 74 largest publicly-listed BHCs and use this information to construct a Risk Management Index (RMI) that measures the strength of organisational risk controls. We find that BHCs with a high RMI in the year 2006 had lower exposure to private label mortgage backed securities, were less active in trading off-balance sheet derivatives, had a smaller fraction of non-performing loans and had lower downside risk during the crisis years. In a panel spanning the 9 year period 2000-08, we find that BHCs with higher RMIs have lower enterpise wide risk, after controlling for size, profitability, a variety of risk characteristics, corporate governance, CEO's pay-performance sensitivity and BHC fixed effects. This result holds even after controlling for any dynamic endogeneity between risk and internal risk controls. Overall, these results suggest that strong internal risk controls are effective in restraining risk-taking behaviour at banking institutions.
The risk management index (RMI) measures presence of CRO, if CRO is among the 5 highest paid executives, and relative pay CRO vs CEO. The RMI also considers composition of the board’s Risk Committee (whether there is significant banking experience??), frequency of meetings of risk committee.
Also finds that stock market rewards banks with higher RMI."
Ellul, A. and V. Yerramilli (2010). Stronger risk controls, lower risk: Evidence from US Bank holding companies. Cambridge, MA, NBER.
In this paper, we investigate whether US bank holding companies (BHCs) with strong and independent risk management functions have lower enterprise-wide risk. We hand-collect information on the organisational structure of the risk management function at the 74 largest publicly-listed BHCs and use this information to construct a Risk Management Index (RMI) that measures the strength of organisational risk controls. We find that BHCs with a high RMI in the year 2006 had lower exposure to private label mortgage backed securities, were less active in trading off-balance sheet derivatives, had a smaller fraction of non-performing loans and had lower downside risk during the crisis years. In a panel spanning the 9 year period 2000-08, we find that BHCs with higher RMIs have lower enterpise wide risk, after controlling for size, profitability, a variety of risk characteristics, corporate governance, CEO's pay-performance sensitivity and BHC fixed effects. This result holds even after controlling for any dynamic endogeneity between risk and internal risk controls. Overall, these results suggest that strong internal risk controls are effective in restraining risk-taking behaviour at banking institutions.
The risk management index (RMI) measures presence of CRO, if CRO is among the 5 highest paid executives, and relative pay CRO vs CEO. The RMI also considers composition of the board’s Risk Committee (whether there is significant banking experience??), frequency of meetings of risk committee.
Also finds that stock market rewards banks with higher RMI."
Monday, August 16, 2010
Tuesday, August 3, 2010
Spreading the word on MMT
I've a small defense of MMT on Crikey.
http://www.crikey.com.au/2010/08/02/for-policy-makers-inflation-vs-deflation-is-a-choice-between-two-evils/#comment-88449
http://www.crikey.com.au/2010/08/02/for-policy-makers-inflation-vs-deflation-is-a-choice-between-two-evils/#comment-88449
Wednesday, July 14, 2010
Sheer Lunacy
One of the most exciting bits of research in a long time has crossed my desk: Sheer Lunacy staring at the heavens From the RBS Equity Research team - 7 July 2010, sorry I can't paste a link.
"This paper presents a study of correlations between the moon phases and behaviour of financial markets, and suggests a medium-to-long term trading strategy, which can significantly increase profits. It also takes a quick look at planetary alignments and what could be significant in terms of timing for the coming weeks (really bad for stocks).
For many years, people have been monitoring relations between natural phenomena and industrial performances or markets behaviour in order to be able to estimate future performance and adapt to changes to either maximise the profits or minimise losses. In many cultures, it is well accepted that moon phases could influence peoples’ behaviour, (90 countries in the world today use the Lunar calendar as the basis for time measurement), whereas scientists established its relation to rising and low tides. New moon traditionally symbolise the period of low energy, or energy accumulation period, whereas the time of full moon is the period of high energy or spending period. The question arises of whether this observation could be extended to markets behaviour.
In this paper, we study the performance of 6 indices FTSE 100, S&P 500, DAX, EUROXX 50, Hang Seng, CAC 40 for a period of several decades.
Three scenarios are studied: investing £1000 in an index and holding it for the considered period, and two types of trading strategies, which are described below. The first strategy is buying an index worth of £1000 on the new moon, selling it on the next full moon (usually it is in 14-16 days) and then repeating the process: buying the index worth of the money left after the previous transaction on new moon and selling it gain on the full moon. The second strategy is
opposite to the first one, implying buying an index worth of £1000 on the full moon, selling it on the next new moon, and repeating these steps further.
If an investor had invested £1000 in FTSE in 1984, by now he would have approximately £5,130 by holding the index, which represents index performance. Whereas trading FTSE according to moon phases would make a big difference. First, consider buying FTSE on the new moon and selling on the full moon, this would result in £12,116 overall figure for the same period (Figure 1). It means more than double the profits: £11,116 versus £4,130. Contrary, buying on full moon and selling on the new moon would result in only £2,036 overall, as shown in the same Figure. This analysis supports the theory of a correlation between index prices and moon phases.
The similar behaviour is observed in other markets. Figure 2 presents the study of S&P 500 index versus moon phases for the period since 1928 till 2010. Having invested £1,000 in S&P in 1928, by now would outcome in holding £63,864 worth portfolio, while by implementing the proposed moon trading strategy, the value of portfolio would have been £1,502,689."
The evidence is in! Invest at the new moon, sell at the full moon and you outperform!
I've been wasting my time looking for something more fundamental.
"This paper presents a study of correlations between the moon phases and behaviour of financial markets, and suggests a medium-to-long term trading strategy, which can significantly increase profits. It also takes a quick look at planetary alignments and what could be significant in terms of timing for the coming weeks (really bad for stocks).
For many years, people have been monitoring relations between natural phenomena and industrial performances or markets behaviour in order to be able to estimate future performance and adapt to changes to either maximise the profits or minimise losses. In many cultures, it is well accepted that moon phases could influence peoples’ behaviour, (90 countries in the world today use the Lunar calendar as the basis for time measurement), whereas scientists established its relation to rising and low tides. New moon traditionally symbolise the period of low energy, or energy accumulation period, whereas the time of full moon is the period of high energy or spending period. The question arises of whether this observation could be extended to markets behaviour.
In this paper, we study the performance of 6 indices FTSE 100, S&P 500, DAX, EUROXX 50, Hang Seng, CAC 40 for a period of several decades.
Three scenarios are studied: investing £1000 in an index and holding it for the considered period, and two types of trading strategies, which are described below. The first strategy is buying an index worth of £1000 on the new moon, selling it on the next full moon (usually it is in 14-16 days) and then repeating the process: buying the index worth of the money left after the previous transaction on new moon and selling it gain on the full moon. The second strategy is
opposite to the first one, implying buying an index worth of £1000 on the full moon, selling it on the next new moon, and repeating these steps further.
If an investor had invested £1000 in FTSE in 1984, by now he would have approximately £5,130 by holding the index, which represents index performance. Whereas trading FTSE according to moon phases would make a big difference. First, consider buying FTSE on the new moon and selling on the full moon, this would result in £12,116 overall figure for the same period (Figure 1). It means more than double the profits: £11,116 versus £4,130. Contrary, buying on full moon and selling on the new moon would result in only £2,036 overall, as shown in the same Figure. This analysis supports the theory of a correlation between index prices and moon phases.
The similar behaviour is observed in other markets. Figure 2 presents the study of S&P 500 index versus moon phases for the period since 1928 till 2010. Having invested £1,000 in S&P in 1928, by now would outcome in holding £63,864 worth portfolio, while by implementing the proposed moon trading strategy, the value of portfolio would have been £1,502,689."
The evidence is in! Invest at the new moon, sell at the full moon and you outperform!
I've been wasting my time looking for something more fundamental.
Tuesday, July 13, 2010
Culture, Institutions and Risk Management
I've got a lot of ideas buzzing around in my head around the general area of how does risk management interact with corporate culture, institutional architecture (from largest e.g. IMF, to smallest e.g. how you report to your boss), human psychology (with its sub-discipline of behavioural economics), ethics and morality, and neuroscience.
If I had 5 or more people who were willing to come along to a lunch time meeting in the CBD, maybe once every 3 or 4 weeks, for the next few months then I'd be very tempted to run an informal (free, and so possibly I'd just talk off the top of my head sometimes) seminar session on the topic of risk management and culture, behaviour, institutions etc. I find I need a catalyst to do this sort of work, and having to talk to people about something is an excellent catalyst.
Here are some of the ideas that I’d like to discuss:
□ In naïve economics we could just as easily see workers hire capital as capital hiring workers, but we almost always see the latter. What do the various theories that explain this observation imply about the risk management culture? See Chapters 8 and 10 of Bowles .
□ Elinor Ostrom’s work has considered how societies have developed diverse institutional arrangements for managing natural resources and avoiding ecosystem collapse in many cases, even though some arrangements have failed to prevent resource exhaustion. The risk taking ability of a firm can be thought of as a resource. Does Ostrom’s work say anything about the possible design of a risk culture?
□ Animal spirits have been blamed for many things going wrong and right in an economy. Discussion can be made on Akerlof and Shiller’s treatment of fairness, corruption and bad faith, why do central bankers have power, and why are there people who can’t find a job.
□ Vernon Smith’s analysis of the interplay of constructivist rationality (the deliberate use of reason to design structures) and ecological rationality (emergent structures from small scale, non-teleological interactions) and its relationship with Hayek’s ideas.
□ Viewing Adam Smith’s two works as two sides of the same coin – trading in reputation and social status, and the trading of goods and services.
□ What do we make of Don Ross’s idea that we have a major economic question in saying how an individual makes a decision given that there are a number of semi-independent modules in the brain that may have conflicting goals? And what about his idea that it makes sense to ascribe some psychological attributes as emotions and drives to firms? This seems intimately involved in the concept of a corporate culture, and gives us some philosophical arguments that we can use to put a corporate culture on a firmer analytical foundation.
Akerlof, G. A. and R. J. Shiller (2009). Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism, Princeton University Press.
Bowles, S. (2004). Microeconomics: Behavior, Institutions and Evolution, Russell Sage Foundation & Princeton University Press.
Ostrom, E. (2005). Understanding Institutional Diversity.
Ross, D. (2007). Economic Theory and Cognitive Science, The MIT Press.
In this study, Don Ross explores the relationship of economics to other branches of behavioral science, asking, in the course of his analysis, under what interpretation economics is a sound empirical science. The book explores the relationships between economic theory and the theoretical foundations of related disciplines that are relevant to the day-to-day work of economics—the cognitive and behavioral sciences. It asks whether the increasingly sophisticated techniques of microeconomic analysis have revealed any deep empirical regularities—whether technical improvement represents improvement in any other sense. Casting Daniel Dennett and Kenneth Binmore as its intellectual heroes, the book proposes a comprehensive model of economic theory that, Ross argues, does not supplant but recovers the core neoclassical insights and counters the caricaturish conception of neoclassicism so derided by advocates of behavioral or evolutionary economics.
Because he approaches his topic from the viewpoint of the philosophy of science, Ross devotes one chapter to the philosophical theory and terminology on which his argument depends and another to related philosophical issues. Two chapters provide the theoretical background in economics, one covering developments in neoclassical microeconomics and the other treating behavioral and experimental economics and evolutionary game theory. The three chapters at the heart of the argument then apply theses from the philosophy of cognitive science to foundational problems for economic theory. In these chapters economists will find a genuinely new way of thinking about the implications of cognitive science for economics and cognitive scientists will find in economic behavior a new testing site for the explanations of cognitive science.
Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations, Bantam Books.
Smith, A. (2007 (1749)). The Theory of Moral Sentiments, Dover Publications.
The foundation for a system of morals, this 1749 work is a landmark of moral and political thought. Its highly original theories of conscience, moral judgment, and virtue offer a reconstruction of the Enlightenment concept of social science, embracing both political economy and theories of law and government.
Smith, V. L. (2008). Rationality in Economics: Constructivist and Ecological Forms. Cambridge, Cambridge University Press.
If I had 5 or more people who were willing to come along to a lunch time meeting in the CBD, maybe once every 3 or 4 weeks, for the next few months then I'd be very tempted to run an informal (free, and so possibly I'd just talk off the top of my head sometimes) seminar session on the topic of risk management and culture, behaviour, institutions etc. I find I need a catalyst to do this sort of work, and having to talk to people about something is an excellent catalyst.
Here are some of the ideas that I’d like to discuss:
□ In naïve economics we could just as easily see workers hire capital as capital hiring workers, but we almost always see the latter. What do the various theories that explain this observation imply about the risk management culture? See Chapters 8 and 10 of Bowles .
□ Elinor Ostrom’s work has considered how societies have developed diverse institutional arrangements for managing natural resources and avoiding ecosystem collapse in many cases, even though some arrangements have failed to prevent resource exhaustion. The risk taking ability of a firm can be thought of as a resource. Does Ostrom’s work say anything about the possible design of a risk culture?
□ Animal spirits have been blamed for many things going wrong and right in an economy. Discussion can be made on Akerlof and Shiller’s treatment of fairness, corruption and bad faith, why do central bankers have power, and why are there people who can’t find a job.
□ Vernon Smith’s analysis of the interplay of constructivist rationality (the deliberate use of reason to design structures) and ecological rationality (emergent structures from small scale, non-teleological interactions) and its relationship with Hayek’s ideas.
□ Viewing Adam Smith’s two works as two sides of the same coin – trading in reputation and social status, and the trading of goods and services.
□ What do we make of Don Ross’s idea that we have a major economic question in saying how an individual makes a decision given that there are a number of semi-independent modules in the brain that may have conflicting goals? And what about his idea that it makes sense to ascribe some psychological attributes as emotions and drives to firms? This seems intimately involved in the concept of a corporate culture, and gives us some philosophical arguments that we can use to put a corporate culture on a firmer analytical foundation.
Akerlof, G. A. and R. J. Shiller (2009). Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism, Princeton University Press.
Bowles, S. (2004). Microeconomics: Behavior, Institutions and Evolution, Russell Sage Foundation & Princeton University Press.
Ostrom, E. (2005). Understanding Institutional Diversity.
Ross, D. (2007). Economic Theory and Cognitive Science, The MIT Press.
In this study, Don Ross explores the relationship of economics to other branches of behavioral science, asking, in the course of his analysis, under what interpretation economics is a sound empirical science. The book explores the relationships between economic theory and the theoretical foundations of related disciplines that are relevant to the day-to-day work of economics—the cognitive and behavioral sciences. It asks whether the increasingly sophisticated techniques of microeconomic analysis have revealed any deep empirical regularities—whether technical improvement represents improvement in any other sense. Casting Daniel Dennett and Kenneth Binmore as its intellectual heroes, the book proposes a comprehensive model of economic theory that, Ross argues, does not supplant but recovers the core neoclassical insights and counters the caricaturish conception of neoclassicism so derided by advocates of behavioral or evolutionary economics.
Because he approaches his topic from the viewpoint of the philosophy of science, Ross devotes one chapter to the philosophical theory and terminology on which his argument depends and another to related philosophical issues. Two chapters provide the theoretical background in economics, one covering developments in neoclassical microeconomics and the other treating behavioral and experimental economics and evolutionary game theory. The three chapters at the heart of the argument then apply theses from the philosophy of cognitive science to foundational problems for economic theory. In these chapters economists will find a genuinely new way of thinking about the implications of cognitive science for economics and cognitive scientists will find in economic behavior a new testing site for the explanations of cognitive science.
Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations, Bantam Books.
Smith, A. (2007 (1749)). The Theory of Moral Sentiments, Dover Publications.
The foundation for a system of morals, this 1749 work is a landmark of moral and political thought. Its highly original theories of conscience, moral judgment, and virtue offer a reconstruction of the Enlightenment concept of social science, embracing both political economy and theories of law and government.
Smith, V. L. (2008). Rationality in Economics: Constructivist and Ecological Forms. Cambridge, Cambridge University Press.
Nice summary paper from FedNY here. Provides further evidence that it was a lack of regulatory willpower that helped cause the crash.
"Our conclusions are:
(1) The volume of credit intermediated by the shadow banking system is of comparable magnitude to credit intermediated by the traditional banking system.
(2) The shadow banking system can be subdivided into three sub-systems which intermediate different types of credit, in fundamentally different ways.
(3) Some segments of the shadow banking system have emerged through various channels of arbitrage with limited economic value…
(4) …but equally large segments of it have been driven by gains from specialization. It is more appropriate to refer to these segments as the “parallel” banking system.
(5) The collapse of the shadow banking system is not unprecedented in the context of the bank runs of the 19 th and early 20th centuries: …
(6) …private sector balance sheets will always fail at internalizing systemic risk. The official sector will always have to step in to help.
(7) The shadow banking system was temporarily brought into the “daylight” of public liquidity and liability insurance (like traditional banks), but was then pushed back into the shadows.
(8) Shadow banks will always exist. Their omnipresence—through arbitrage, innovation and gains from specialization—is a standard feature of all advanced financial systems.
(9) Regulation by function is a more potent style of regulation than regulation by institutional charter. Regulation by function could have “caught” shadow banks earlier."
"Our conclusions are:
(1) The volume of credit intermediated by the shadow banking system is of comparable magnitude to credit intermediated by the traditional banking system.
(2) The shadow banking system can be subdivided into three sub-systems which intermediate different types of credit, in fundamentally different ways.
(3) Some segments of the shadow banking system have emerged through various channels of arbitrage with limited economic value…
(4) …but equally large segments of it have been driven by gains from specialization. It is more appropriate to refer to these segments as the “parallel” banking system.
(5) The collapse of the shadow banking system is not unprecedented in the context of the bank runs of the 19 th and early 20th centuries: …
(6) …private sector balance sheets will always fail at internalizing systemic risk. The official sector will always have to step in to help.
(7) The shadow banking system was temporarily brought into the “daylight” of public liquidity and liability insurance (like traditional banks), but was then pushed back into the shadows.
(8) Shadow banks will always exist. Their omnipresence—through arbitrage, innovation and gains from specialization—is a standard feature of all advanced financial systems.
(9) Regulation by function is a more potent style of regulation than regulation by institutional charter. Regulation by function could have “caught” shadow banks earlier."
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