Falkenblog

Any good idea is found independently, and there are always early works that seem to unambiguously imply the ultimate result even if they never really focused on it. So it is with low volatility investing.

Bob Haugen has been touting unconventional investment tactics for decades, starting with The Incredible January Effect published in 1987. Alas, the January effect was one of those anomalies centered on low-priced, small-sized, firms, that usually don't scale well. Do you remember the 'low price' effect? It was popular in the 1980s, along with the size effect, as small size and low priced stocks were highly correlated and both seemed correlated with very high returns. The low price funds are now something anyone associated with them at the time conveniently forgets, because trading them is very costly, like trading options instead of stocks.

Anyway, I saw him being interviewed at a Dutch conference, with the talk 'The Low Volatility Anomaly' on the screen, where he was arguing investors should move their equity exposures to low volatility oriented equity funds. At one point the interviewer asks if 'will you be known as one of the big heroes of the twenty first century?' In sum, I would say he was the first to publish on this, but he didn't know what he found, so the importance of his early work only appears with hindsight, or to those who took his facts and ignored his interpretation and emphasis.

From the WSJ:

While quantitative easing boosts the value of pension assets, it lowers investment returns and increases estimates of future liabilities. Because typical defined-benefit plans are only 70% funded and face liabilities several years longer than their assets, that leads to wider deficits...But many trustees say the best response would be for the BOE to stop buying long-dated gilts and buy bank bonds instead. Not only would this ease bank funding difficulties, and thereby improve the supply of business loans, it would allow gilt yields to rise.

With interest rates at historic lows, pension funds are in a tough spot. If interest rates rise, they will suffer capital losses and actually be in a tougher spot. I'd say this is good reason to avoid bonds that are attached to entities with large, unfunded pensions (eg, states, munis).

When the government tries to improve prices, it creates winners and losers.

Olivier Blanchard is a very well-respected academic economist, and currently also Chief Economist at the International Monetary Fund. He sees today's current big problems primarily due to investors.

• Self-fulfilling outcomes of pessimism or optimism, with major macroeconomic implications.
• Incomplete or partial policy measures can make things worse.
• Financial investors are schizophrenic about fiscal consolidation and growth.
• Perception molds reality.

So, the unsustainability of Euro member fiscal policy is supposedly irrelevant, compared to the insane, self-fullfilling prophesies of investors. As John Cochrane noted, the Euro leaders keep looking for the Big Announcement that will soothe markets into rolling over another few hundred billion euros of debt. Alas, the problem is reality, not psychology.

One of the reasons why I'm a libertarian comes from my experience with financial regulators. They are totally out of their depth, not understanding where risk really lies because the essential information simply can't be grasped by flying in and looking and talking to people for 2 weeks. I have never worked in a financial firm where I felt I understood what was really going on for at least a couple years. They fill out reports conceived by someone ten years ago that would have caught last decade's big error, and come back next year. The good ones, and there are many, realize the futility, but it's a paycheck.

Anyway, now here's the European regulators repeating the mortgage fiasco. Remember pre 2007 regulators encouraged mortgage lending without qualification. Now, the issue is Greek debt. John Cochrane nail it:

Indebted governments have been pressuring banks to buy more debt, not less. As banks have been increasing capital, they have loaded up even more on “risk-free” sovereign debt, which they can use as collateral for ECB loans. The big ECB “liquidity operation” that took place yesterday will give banks hundreds of billions of euros to increase their sovereign bets...So much for the faith that regulation will keep banks safe....They keep looking for the Big Announcement that will soothe markets into rolling over another few hundred billion euros of debt. Alas, the problem is reality, not psychology

The suit against BAC/Countrywide was based on disparate impact, basically looking at averages for Blacks and Latinos vs. EveryoneElse. Presumably they controlled for some kind of credit metric too, but as Thomas Sowell has noted many times, it is common to run a regression looking for discrimination with an incomplete proxy for education like whether they had a degree, then put in a dummy variable for race, and find discrimination by looking at the loading on the race dummy, even though given the lower socio-economic status of minorities the variable omits a lot of other important variables (eg, what kind of school? what kind of degree?).

The key point is as follows:

In 2007, for example, Countrywide employees charged Hispanic applicants in Los Angeles an average of $545 more in fees for a $200,000 loan than they charged non-Hispanic white applicants with similar credit histories. Independent brokers processing applications for a Countrywide loan charged Hispanics $1,195 more, the department said.

So, they were charging the victims too much. But another narrative of the 2008 crisis is that they foisted loans upon people who couldn't afford to pay them back. Isn't price the key way a supplier rations goods to consumers? As Jesse Van Tol of the National Community Reinvestment Coalition (NCRC) argues: "the major contributing factor to the foreclosures crisis was reckless and irresponsible lending.” By this, I presume he thinks banks lent too much. In 1994 Obama was party to a class-action lawsuit alleging banks rejected too many minorities.

Back in the bubble, I'm sure a lot of borrowers were less worried about closing costs because many builders, non-profits, and even our government's own HUD would bundle those into a loan. The borrower then has a costless call option: if prices rose--as they had for the past 10 years--they would win big, if prices fell they could walk away and leave the bank with the property. Mortgages are non-recourse, banks can't take anything more than your mortgage back. Thus, I don't see the overpaying minorities as victims here so much as greedy dupes who were part of the mortgage fiasco.

So, banks lent too much at too high a price, when not lending enough. These are simply inconsistent allegations, highlighting the no-win situation for bank lenders. With such rules, no wonder political insiders like Peter Orszag, Henry Cisneros, and Bob Rubin are essential banking executive talent.

I remember seeing an update of investment bank analysts, and they separated their ability into two groups: those good at predicting earnings, and those good at predicting stock prices. There wasn't much overlap. So I found a spreadsheet from a colleague's thesis that looked at the Pound/dollar exchange rate from 1973-2005, and noted while there was a pretty boring pattern in purchasing power parity ratio, but the market's value of the pound against the dollar fluttered around it quite a bit. It seems that if for some reason you were the only person in the world who knew the inflation rates in these two countries, your investment strategy would only be marginally attractive.

Paul Krugman argues that the fact that interest rates are currently low in the US proves his standard Keynesian diagnosis is correct. Here he is in the NYTimes arguing again why the fiscal and monetary stimulus dials should be turned to 11:

Early on in this crisis I and quite a few other economists — but not enough! — declared that we had entered a classic liquidity trap ... even large government borrowing won’t drive up interest rates, and you can print as much money as you like without causing inflation...[non-Keynesians] declared that soaring inflation was just around the corner, and that interest rates would spike...

So how’s it going? Interest rates have, of course, remained very low. As I post this, the real interest rate on 10-year bonds is actually negative.

He sounds like a caricature of an efficient markets theorist. Well, Markit's A-tranche for the all their vintage mortgages traded above 99 cents on the dollar at the end of 2006. By the end of 2007 they were around 45 cents, and today they all trade around 7 cents.

I remember GM being a zombie for years and their stock defied my expectations for a decade, but eventually equity owners were zeroed out and they went bankrupt. You can go a long time with negative profits if people are willing to give you credit. Yet as any small business lender knows, the only thing that stops these institutions is a lack of cash. Currently, US debt is so liquid, and has such a strong history, it remains a top credit. Yet it's good to remember that when I was in charge of economic risk capital allocations back in the 1990s for bank, mortgages had the lowest economic risk rating for any non-sovereign debt. Now it is on par with credit cards (ie, the worst credits).

I don't think this is going to end well for US debtholders, but time will tell. I don't expect Krugman to ever say he was wrong regardless given he called for a housing bubble in 2002 to stimulate the economy, and later explained that was an economic analysis, not a policy statement, as if that makes a difference.

The 99% is a story that fits many journalist's favorite narratives about the major problem today: inequality. This seems like altruism, but focusing on the top 1% is also consistent with envy. Many think the top 1% are responsible for the poverty of the 99%, especially the truly poor, those in the bottom quartile. Yet the poor are pretty far removed from anything the top 1% can do. Graduate from high school, get married before you have children, work at any kind of job, even one that starts out paying the minimum wage. Fewer than 10 percent of families that follow his blueprint live in poverty, while 79 percent of those who don't follow the three-step plan end up poor. There is no redistribution scheme imaginable close to this in reducing poverty.

A good Christmas gift for the poor would be Roy Baumeister and John Tierney's Willpower, a great little book with timeless advice. It notes that Willpower has an effect on life outcomes as great as IQ, and more importantly, is much more amenable to nurture as opposed to nature. Perseverence, discipline, patience, all take practice, and make you a happier, healthier, and more productive person. The basic premise comes from the Stanford marshmallow experiment, where a group of four-year-old children were given one marshmallow, but promised two on condition that he or she wait twenty minutes, before eating the first marshmallow. Some children were able to wait the twenty minutes, and some were unable to wait. The children able to delay gratification were tested in later adolescence and found to be psychologically better adjusted, more dependable persons, and had higher SAT scores. Given hardly anything is predictive at that age, this is quite remarkable.

Baumeister has spent much of his career as a psychologists studying and designing tests on willpower. He notes it is a finite resource, and so quitting smoking is much harder when you are also studying (the rigorous study of common sense!). But willpower is like a muscle in that it weakens while you use it, but also strengthens the more you use it, so practicing it daily by doing things like standing up straight and not swearing transfers to other areas. Making decisions is exhausting, it depletes one's willpower, so its useful to design simple rules for much of your daily toil. Being low on energy from lack of sleep or nutrition also hurts your willpower. Basically, practice daily acts of self-control to become more productive.

This reminded me of a Eric Kandel's work on brain memories. He won a Nobel prize by looking at snails and finding that long-term memory, unlike short-term memory, involved the synthesis of new proteins. You get long-term memories through repetition in the same way you build muscle through exercise, so if you practice something daily and it becomes a habit--the muscle memory of a golf swing, the neural memory of saying 'please' and 'thank you'--you actually have altered your brain. Your habits are not just abstract character, but have a biological substrate. This surely encourages cryogenics fans who want to freeze their dead heads in vats of liquid nitrogen so that they can be re-animated in the future.

Life is a journey from ignorance and instinct to higher virtues, including the prudence needed in a complex world. Such prudence comes mainly from acting with thoughtful resoluteness towards the many petty people and temptations around us. Willpower is a great book that reaffirms the power within us to become better people.

From Sports Illustrated, discussing the kick return phenom Patrick Peterson, who ran back a 99-yard kick to beat the Rams in overtime:

Peterson, 21, had also ignored instructions. In his case it was an order to not field the ball inside his own 10-yard line. He apologized to Spencer several days later. The two had a long talk, and Spencer informed Peterson that average players need rules. Special players need guidelines. Peterson now has guidelines.

The issue seems to be we remember the emotionally traumatic events more than the physical. From When hurt will not heal, by Chen et al:

The present study examined an important distinction between social and physical pain: Individuals can relive and reexperience social pain more easily and more intensely than physical pain. Studies 1 and 2 showed that people reported higher levels of pain after reliving a past socially painful event than after reliving a past physically painful event. Studies 3 and 4 found, in addition, that people performed worse on cognitively demanding tasks after they relived social rather than physical pain.

I got a copy of Aaron Brown's latest book Red-Blooded Risk, which is kind of like My Life as a Quant by Derman, in that's it's a very personal account of how finance works. I think it's very useful for 50-somethings to write retrospectives like this, because otherwise it's written by people too far removed or too naive. For example Michael Lewis's Liar's Poker is now a classic, but he was a mere bond salesman for 3 years; while his anecdotes were interesting and well-told, his big take-aways on how finance fits with the modern society and the economy were as naive as your typical 25-year old bond salesman.

Brown makes several important points. For example,he notes that the 99% value-at-risk might capture more relevant data, but it needs so much data one should look at 95% value-at-risks. While you can derive this from statistics, it is a practitioner point that clearly is better appreciated from experience. He clearly comes across as someone who understands both the math and how it is applied.

The book tries to deal with how to manage risk, mainly from the point of view of a hedge fund, or something where one is looking at a bunch of strategies. That is, in my experience as a risk manager at KeyCorp, most of our risk there was incidental as a market maker with customer flow, and such risks were rather trivial once one had 'rogue trader' risks under control. His view is more like if you are looking at a book with pairs traders, a momentum trade on government debt, and other such strategies.

Brown mentions early on that he is thinking about risk differently than the standard model, where risk is a cost, and return a benefit. He never really boils it down to something concrete, but rather over the course of the book tries to argue about his view of risk that is qualitatively different. It's kind of like trying to present the meaning of life, not with an aphorism, but rather a bunch of examples. On one hand, this can get you closer to the truth, on the other hand readers can come away confused.

As any professional realizes, however, the gestalt nature of 'risk' limned in this book is the way risk feels to most people--something important and hard to pin down, like meaning and justice--and so Brown's experience is illuminating and should save people a lot of time rediscovering these insights themselves (better to learn via a book than trial-and-error). I'm very sympathetic to the idea that standard risk models are misleading.

Brown's book is very opinionated and has the feel of a smart guy looking at lots of real situations. I think for big ideas, such as risk, meaning, and justice, it's good to have strong beliefs weakly held. That is, you only learn in these ambiguous domains by taking stands, trying to defend them, learning from the process and adjusting your prior prejudices.

It's a cliche to say risk management is the combination of art and science. You need to know something about history, statistics, and programming to be useful as a risk manager. You also need common sense, and that is best informed by experience, which is greatly abetted by reading insider memoirs like this.

A Northwestern grad student (just like I used to be) blogs on academic papers over at A Fine Theorem, and I was struck by this snippet:

The benefit of capitalism can’t have much to do with profit incentives per se, since (almost) every employee of a modern firm is a not an owner, and hence is incentivized to work hard only by her labor contract. A government agency could conceivably use precisely the same set of contracts and get precisely the same outcome as the private firm (the principle-agent problem is identical in the two cases).

This is wrong. I've worked in small and large firms, and in either case, being part of any initiative that makes money increases your pay and stature rather clearly. Now, the bigger the firm, the more people involved in any initiative, and the more people will exaggerate their involvement with successful projects and downplay their involvement in losers. But the bottom line is the bottom line, and the best way to get your boss to appreciate you more is to help him make more money for the firm. The scope of your command is rarely specified in detail, though increases in scope are the most obvious ways of increasing your power when the 'contract' comes up for renegotiation: work is a repeated game. The government principle has a very different objective function than the private firm principle, the former with a diverse set of stakeholders to satisfy, often with vague and inconsistent objectives, the latter to simply make more profits.

It's true that some people, especially those in over their heads, who are overpaid, dislike productive and smart direct reports because they sense their boss will recognize an attractive replacement. Yet even here the incentive clearly exists for this bad boss to be replaced by his boss, because his boss is not optimizing this position in that case (and watching the bad bosses employees leave when they recognize this is a really good signal that their boss is not a good one). It's also true that salaried employees like cashiers and secretaries may not be proactive about increasing their stature within the firm and simply follow orders, but their bosses recognize this and so are less likely to increase their responsibility.Every ambitious worker tries to make more with less all the time, because they can quantify this, which is the best way to go into an annual performance review. Just because you do not have shares in the firm does not mean you aren't highly incented to make money for shareholders, because the shareholder desire for more profits truly trickles down.

If this kid doesn't appreciate this, he's missing a big part of what makes private organizations work as they do. The nice thing is that it isn't a really fragile result like some of these theoretical models based on the types of agents and some envelope theorem. Common sense tells you the more you appear to be creating profits, the better your future will be in the firm and the industry, and the best way to appear to create profits is to actually do so. Economics, as Tom Sargent notes, is 'organized common sense.' Unfortunately, while you can formalize and thus teach models, you can't formalize and teach common sense, which is why game theory is so ambiguous on these important matters.

Robert Wright announced today that he is scaling down his Bloggingheads.tv site, in part because as a business it clearly has no potential to make money. The basic problem, he found, was that his site tried to have people on both sides talk about issues, as opposed to what is much more popular, having people who agree with each other talk to each other (MSNBC, CNN, Fox):



Too bad, because I'm a big fan. It's rational to listen more to people you agree with because you think what they saying is more correct than others, so I don't find this a bad faith equilibrium. But on the other side, I do like listening to those I disagree with more on the radio drive time because invariably the host, and especially the callers, will come up with a horrible argument for their side. I much more enjoy listening to this when my intellectual adversaries are speaking than when someone says something stupid as an argument for something I agree with. That is, many (most?) people I agree with on taxes, abortion, affirmative action, war, etc., agree with me for reasons I don't think are correct or relevant.

From the LA Times back in 2005:

"If you paid your mortgage off, it means you probably did not manage your funds efficiently over the years," said David Lereah, chief economist of the National Association of Realtors and author of "Are You Missing the Real Estate Boom?" "It's as if you had 500,000 dollar bills stuffed in your mattress."

He called it "very unsophisticated."

Anthony Hsieh, chief executive of LendingTree Loans, an Internet-based mortgage company, used a more disparaging term. "If you own your own home free and clear, people will often refer to you as a fool. All that money sitting there, doing nothing."

The financial services industry is doing all it can to avoid letting consumers be foolish. Ditech.com touts home loans as a way to pay off credit cards, and Morgan Stanley says they're a good way to fund education expenses. Wells Fargo suggests taking a chunk out of your house to finance "a dream wedding."

Nothing like spending your market value capital gains on fancy weddings. When people say that we should return to common sense, the problem is, how do we know what that is? (presumably this is code-speak for everyone should now agree with my hindsight diagnosis and cure).

Paul Krugman's wife, Robin Wells, came out with a piece arguing Occupy Wall Street's issues are something economists should address. I wonder whether she thinks biologists should all teach about creationism because so many students believe in some sort of transcendental spark to life. Probably not. I do think there should be classes on free markets vs. Keynesian debates led by different professors, because it's not like this issue isn't always there, but I don't think OWS has made this any more pressing.

In 1971 Robert L. Trivers gave us the idea of reciprocal altruism, the idea that helping someone else although incurring some cost for this act, could have evolved since it increases the chance that such niceness might be returned some day. This really expanded the conception of self-interest to be semantically indistinguishable from altruism in many cases. Biologists have observed this behavior in bats, where they share blood harvested, but only with those who share with them.

the Low Volatility ETF LVOL, put out by Russell-Axioma, tries to capture the low volatility goodness via a circuitous route. First, it takes into account beta, and momentum in some unspecified way, which makes it a really hard thing to nail down. What most amused me, was that it calculates the return to the lowest volatility third of the Russel1000 index. It then selects a portfolio of about 100 stocks that track this index. The idea is that you find the target portfolio, and then, instead of using that portfolio, you use stocks correlated with it.

Downloading their current holdings, the equal weighted beta is 0.91--low, but not by much. The average 90-day volatility of their holdings is 39%. In contrast, the SPLV low volatility ETF simply takes the 100 stocks from the S&P500 with the lowest volatility over the past 12 months. It has an average beta of 0.6, and an average volatility of 28%. The Russel 1000 itself has a 90-day of vol of 50%, and a beta slightly above 1. In short the SPLV ETF delivers 'low vol' more simply, and more efficiently, by focusing on the characteristic, not the factor.

A recent paper by Aurthur J. O'Connor and Famecount looked at 30 top brands from June 2010 through June 2011, and found that number of Facebook fans was correlated with the stock price. Looking at the charts below, I can see how it's pretty significant. You can't see these graphs very well, but the vertical axes are price, the horizontal are Facebook fans.



In my 1994 dissertation I found that if I counted up stories in Nexus, these stories counts explained the relative ownership percentage of mutual funds in regressions that included price, size, and volatility. That is, in the context of these other variables, stocks more frequently in the new tended to have larger mutual fund ownership. One could imagine fund being both more aware of these companies, and having an easier time explaining their ownership in these companies.

Contemporaneous correlations are one thing, predictions another. Stocks with higher volatility generate more news than less volatile firms. Such stocks are then ‘in play’, and so become relevant to the investor interested in deviating from the index. Further, they create a default value, in that once everyone seemed to have internet stock in their portfolio, or some exposure to residential real estate, it seemed prudent to also have some, especially if one were indifferent. Given short constraints and overconfidence, this increased focus on volatile stocks leads to lower future returns. I imagine this might be interesting to look at whether this is more useful as a short-term momentum indicator, or a longer-term mean-reverting signal. The trick for the longer term predictability, is that you need a survivorship bias free data set with historical data going back several years, so I doubt that Facebook or Twitter have enough data to test anything with a horizon greater than 1-week.

Dave Cowan and Sam Wildeman at GMO have a new paper, Re-thinking Risk (check here or here if that doesn't work), that makes the argument that the poor performance of high beta stocks makes perfect sense. Their idea is that high beta stocks actually are leverage with a put option, because unlike a levered fund where you can lose 2 times your investment (200%), a beta=2 portfolio can only lose 100%. In their words:

The point here is that the form of leverage offered by high beta is different in an important way from explicit borrowing. Investors should prefer this kind of leverage, and, in an efficiently priced market, they will accept a lower return for it. As we will show, the performance of high beta is not a product of excessive demand, but rather a reasonable and rational consequence of the fact that it provides a convex payoff to the market.

Their analysis highlight the fact that 'risk' has two meanings. One is the risk people intuit, the other the technical metric in financial theory that generates a return premium. The risk that generates a risk premium is solely a function of expected covariance with some risk factor. Convexity just means the average expected risk in the future is nonlinear, but there's still a simple linear function of this expected covariance that should relate to the expected return. Convex payouts in options may seem less risky, and indeed are often sold via the pitch that they have 'limited downside.' If losing 100% is risk reduction for you, your broker probably has you on speed dial.

The key insight in Black-Scholes-Merton wasn't the basic formulation, which was well-known at that time among practitioners like Edward Thorpe, it was rather that one should use the 'risk free rate' to discount future payoffs. This was surprising, and though it was proved later much more simply by Cox and Rubinstein in their binomial pricing model, they figured it out first and deserve their accolades.

Convexity generates option value only because of its effect on expected values, not because of a 'risk premium' in the technical sense. That is, the 'option premium' above the 'intrinsic value' is purely a risk neutral expected value. The convexity in payoffs should show up in the expected returns, which should show in average returns over a large enough sample. As the authors note, high beta stocks under perform historically in the US and internationally, so it is implausible to say this is simple a 'peso problem' of having a small sample.

I was reading Joe Morganstern's review of George Clooney's latest movie, and was struck by this line:

Mr. Clooney is a star at the peak of his powers, playing the sort of person we're seldom privileged to meet—a whole man, which is to say a flawed and foolish man who is basically good, and who gets a precious shot at being better.

There's a lot of profundity in that little snippet. I've notice several big think commentators today started or do movie reviews (Steve Sailer, Frank Rich, John Podhoretz, Michael Medved). The ability to articulately critique pop-fiction is deceptively deep, I guess.

I was listening to Jeffrey Hummel's recent talk (see here, scroll down to his picture). He argues the US federal default is inevitable, using the following reasoning.

Federal Tax revenues as a percent of GDP have consisntently been bumping up about 20% since 1951. Even in WW2, when federal taxes were highest as a percent of GDP, tax revenues never broke 25% of GDP.


Meanwhile, top marginal tax rates, corporate rates, and capital gains tax rates have basically declined, though bouncing about quite a bit.


This suggests the 20% barrier is some kind of structural barrier in the system: people adjust their effort and tax avoidance to generate basically the same percentage of GDP over a variety of tax rates.

Here are the projected Federal expenditures from the Congressional Budget Office

I found this little aside in Gary Gorton's 2010 Journal of Economic Literature review of 2008 financial crisis books--The Big Short and The Greatest Trade Ever--pretty funny:

Some of the most interesting material in the books concerns how hedge funds operate. Opening a hedge fund is problematic. The founder has a secret. Either the secret is that the founder has no new ideas. Or, the founder’s secret is a new idea. If the founder has no new idea, that cannot be revealed. If the founder has an original idea, he also can’t share it with investors because they might steal it. “Competitors might figure out the trade for themselves and buy the same insurance, driving up the cost. That made Paulson reluctant to provide details of his trade. It was a stance that made it more difficult to raise money” (Zuckerman, p. 127‐8). Indeed, Paulson’s friend Jeffrey Greene does steal the idea. Michael Burry has the same problem: “If I describe it enough it sounds compelling, and people think they can do it for themselves. . . If I don’t describe it enough, it sounds scary and binary and I can’t raise the capital” (Lewis, p. 58).

By the time I had capital to set up a low-vol strategy fund myself I was soon in litigation that exhausted my capital, but when I didn't have capital and was trying to convince others, a common reply was, 'why isn't everyone else doing it?' Now the problem is everyone is doing it (low vol investing).

A take away is that hedge funds are all fundamentally opaque. Another is that you can't start a hedge fund unless you or a very close associate, has at least a million or two to invest.

You can teach statistics, but unfortunately, you can't teach people not to overfit data. The problem is that it is too tempting to look at some data, keep applying different inputs and functional forms, until you fit the data. In some sense, that's what a good model does, so the objective, maximizing the R2, is encouraged.

Margin Call was an excellent movie, in terms of its direction and acting. The nightime scenes were emphatically in the darkness of night, even though every time I've worked after dark, we simply turned on all the lights (for some reason they would have meeting in the dark with ominous screens lit around them). Life isn't as simple and clear as in movies, which is why I like them when they are good.

But, the key was in creating an event that provokes a crisis, one that engenders all sorts of soul searching, backstabbing, pain, and ultimately resurrection. The event in this case was that the fired risk manager, the always awesome Stanley Tucci, highlights that the value-at-risk is greater than the value of the firm. Now, they don't say what horizon this VAR was for, but that doesn't really matter. The key is, everyone supposedly knows 1) the value of their portfolio and 2) stress-test and value-at-risk numbers for that portfolio. Presumably, as best as I could make out, the really shocking VAR used current 'volatilities' as opposed to stale historical ones, which given the VIX was at 15 for a long time, then peaked at 80, could have been an issue.

Since when was a parameter like 'volatility' not presented with the results? In my experience, management isn't well versed on VAR details, but they are good on what makes a relevant stress test or assumed volatility, so I can't imagine this being as important as the movie implied (ie, they all got together for a 4 AM meeting and decided to cover their exposure the next day). The idea that someone updated VARs for current volatilities, and discovered their portfolios were too risky and had to be exited immediately, is pure Hollywood.

The risk, presumably, was merely from their pipeline of assets that they held in the process of creating various derivatives. If that was their total risk, they had an incredibly high leverage.

But, that's all sniping. I thought it was a pretty good movie. The problem is that if you discovered that mortgages were overpriced in 2008 by 20%, that wouldn't imply the amount of panic showed in the movie. You would have weeks, if not months, to exit positions, not the 'day' the movie used. Big mistakes like that are systematic errors that are not going to change overnight. Even Enron's stock took months to fall, so it's never the case you have to sell your entire portfolio of an asset overnight, especially for something correlated with so many highly liquid alternative assets.

I'm a big fan of Mixed Martial Arts, and take classes where I punch pads and bags, which is very cathartic. I would never actually spar with someone, taking punches to the head, however, because I don't think the brain takes such punishment well. In last Saturday's prime time UFC battle, two heavyweights were involved, and only 60 seconds into t he fight Brazilian Junior dos Santos connected right behind Velasquez's left ear (see above). It didn't look like much, but this part of the brain controls your motion, and it clearly disrupted those circuits.

As Velasquez explained after the fight, he 'saw everything but his body wasn't reacting.' Thus, he was fully conscious but momentarily defenseless (not defending yourself is cause for stoppage). Most knockouts involve some momentary loss of consciousnesses, often when the head twists from a punch to the chin or jaw, so this was rather interesting.

MMA is less dangerous than boxing because in boxing concussed boxers are basically kept vertical via standing 8 counts and the nature of boxing where it isn't nearly as easy to finish someone; the result is a lot more brain punishment. In MMA a woozy fighter can dispatched many ways, often by tackling him and then applying a rear-naked choke that is pretty benign (not that I would want my sons doing this).

Norman Mailer was a famous American writer who died in 2007, who wrote with great forcefulness. People can still have interesting things to say (or in Mailer's case, say them in an interesting way), yet still be moon-bat crazy in many areas of their lives. So, listening to this video on Youtube, I was taken by this passage:



Marx's Das Kapital is utter bullcrap, and makes Joseph Smith's Book of Mormon seem like Euclid's Elements. It was before the marginalist revolution, so did not understand 'value', instead thinking all value came from labor. To note how stupid this is, think about someone spending 10 hours writing a paper--does this make it worth '10 hours' worth of 'steel'? Depends on what came out, and probably its worth is inversely correlated with the time spent on it. You can see a nice summary of its irrelevancy by going to the Wikipedia on volumes 1, 2 and 3, and note that the economic arguments are not even used by Marxist economists today (falling rate of profit? recessions becoming wider every time? Surplus value?).

The total return to Momentum was impressive for many decades. It's a simple strategy, basically going long past winners and short the losers, hoping they continue to win and lose. Interestingly, the past returns should go only up to the prior month, because there's slight mean-reversion at the one-month horizon, so most people use the returns from months t-12 through t-1. This highlights the non-fractal nature of stock returns, in that there's momentum in the data from 3-18 months, but mean-reversion at the shorter and longer frequencies.

Hayek' Road to Serfdom argued that a major problem with socialism was that it encouraged the most ruthless and illiberal to rise to the top. As they find their plans untenable, they will be forced to apply force to achieve their aims, so those willing to apply such force will tend to be most successful in such systems. A problem with modern politics is that as only dissembling narcissists can succeed, politicians at all levels become such pathetic losers.

Recently my school board voted for busing to rectify the achievement gap that results from the new Somali immigrants who cluster at certain schools. This has made certain elementary schools have lower scores than others, and so their solution is to spread the Somalis around. That this only superficially rids one metric of inequality while not actually raising Somali scores (except through the theory of osmosis), and making my little guys take a longer bus ride across town, makes me almost want to run for the school board. Today's election in my little town consisted solely of school board elections, and it has polarized the town [note: we voted the busing advocates out].

I don't care about schools so much that I would allocate 15 hours a week to them, so I looked for someone being elected who shares my views. Unfortunately, reading their position statements, they all speak in platitudes similar to those spoken by senators and presidents, making statements that no one disagrees with.

Here's various takes on the softball question of how they would approach the School Board Governance Policy (which is never defined):

"the idea behind governance – clearly defining the roles of the superintendent and board – is a good one. If all parties commit to transparency and accountability, this model could work...."

"Board focus should be on achieving results and maintaining direct communications with stakeholders. Policies should state what should and shouldn’t be done..."

"Every group – like the Eden Prairie School Board – needs a set of rules, bylaws, or a governance policy..."

“I support coherent governance because it provides a comprehensive and systematic way for the Eden Prairie School Board to guide and monitor operations and results of the district..."

The rest of their vision statements are so vapid one might as well just know that first and foremost they all want to be liked by everyone, and think that being trite and vague are the best ways to that end. These aspiring politicians are afraid of saying anything that people might actually disagree with, but then if everyone agrees with you, you really aren't saying anything interesting. As George Orwell noted in his classic Politics and the English Language, the great enemy of clear language is insincerity. It's a dominant strategy. Remember Barack Obama's response to Rick Warren's question as to what he thinks about abortion: 'that's above my pay grade.' This was a stupid answer (he has an opinion and it would affect policy), but it probably worked out better for him than articulating his true beliefs. In a democracy the winner has to pander to a rabble--though there are better and worse among them.

This is a major reason why I prefer a smaller government, because at least businessmen pursues their own advantage more openly and honestly, whereas government workers pursue their self interest hypocritically and under false pretenses. Petty school board nominees are now aping our betters, and bringing the level of discourse down to a point where everyone is afraid of a Kinsley gaffe.