Regulate Perfect Markets? - !

There's a short but interesting post up at Arnold Kling's blog. It is asked whether "imperfect government regulators [can] protect imperfect investors from themselves"? On the one hand it is argued that markets are efficient, which should speak in favor of deregulation. On the other, indications of market irrationality should speak in favor of regulation.

Now, markets are efficient in part because they are regulated: shareholder-elected boards have to disclose information to bondholders, securities-exchanges are centralized to enhance liquidity, banks have to be sufficiently capitalized etc... So it's not that straightforward to claim a link between market efficiency and deregulation. And Bainbridge whom is quoted in the post as speaking for deregulation, says "that it takes a theory to beat a theory". Out in the reality based community, of which Popper should be, I suppose, one of its first members, it just takes some good observations to beat a theory; so one might really wonder what Bainbridge is up to here.

Back to Kling's question about what government can do: Can't even the most imperfect government protect investors from overstating their creditworthiness to each other thereby avoiding repeated overspeculation? I think so and would suggest that self-regulation (not widely, if at all, used in this area today) would either fail or lead to too heavy collateralized positions, i.e. underspeculation.

And I can't refrain from reusing the formulation of the question, let's try each other's political standpoints through it:

Can imperfect government forces protect imperfect citizens from other imperfect government forces? - The conservative would sound an emphatic yes!, personally I'm not that sure.

Can imperfect government forces protect imperfect propertyholders from other imperfect propertyholders forces? - Here most of us agree for once, it seems.

TradeSports "More Efficient" than Iowa Markets

We already have one winner in the U.S. Presidential Elections. Today Bloomberg has a hedge-fund manager praising the mertits of the betting exchange TradeSports:

Iowa Presidential Futures Market Surpassed by Dublin Exchange
Oct. 18 (Bloomberg) -- The University of Iowa's market for
U.S. presidential futures, founded 16-years ago, has been
overtaken by a Dublin-based exchange that is now 25 times larger.
Investors betting on the race between President George W.
Bush and Democratic challenger John Kerry have purchased
contracts worth more than $4 million on Intrade, better known by
its Web address. The Iowa Electronic Markets, a
not-for-profit wagering system, has a potential payout of
``TradeSports is a more efficient market and a deeper
market,'' said ... a money manager at Peconic Management Company,
a hedge fund in Bedford Corners, New York.
``I probably watch this more than any human being.''...

And there really seems to be some turnover these days in the Bush vs. Kerry betting market. Currently, the market for contracts paying out 100 in the case of a victory for G.W. Bush stands at 53.8-54.1, a bid-ask spread of less than 1% of a very volatile contract value. A market liquidity that is, at least as relative to TradeSport's maximum contract sizes, well at par with most financial markets.

Crude Rhetoric

Greenspan held a speech on Friday concerning the runup in oil prices. You have probably by now read at least a couple of comments upon it. Otherwise, here are a few of them, in the NYT, Washington Post, some more critical from Barry Ritholz, and have my take as well when you're at it: Greenspan really tried to tell the markets not to worry - oil prices will come down, he says. Look at long term crude contracts, oil for delivery in 2010 is cheaper that today's squeezed up oil, he tells us. And he is right. But what do you have, beyond the rhetoric well sounding of the wording in the speech? A crude oil market at $55 a barrel, only slowly getting cheaper to $35 a barrel out in 2010. All prices that are far above those of the old OPEC target-band. Could we now please see any central bank actually using these figures for macroeconomic prognosis work instead of wringing them into suggestive and misleading verses like these?
FRB: Speech, Greenspan--Oil--October 15, 2004: "Prices for delivery in 2010 of light, low-sulphur crude rose to more than $35 per barrel when spot prices touched near $49 per barrel in late August. Rising geopolitical concerns about insecure reserves and the lack of investment to exploit them appear to be the key sources of upward pressure on distant future prices. However, the most recent runup in spot prices to nearly $55 per barrel, attributed largely to the destructive effects of Hurricane Ivan, left the price for delivery in 2010 barely above its August high. This suggests that part of the recent rise in spot prices is expected to wash out over the longer run."

Demand Driven Oil Squeeze

Today, oil prices continued their climb and, as WSJ (subsription) writes, "Benchmark light, sweet crude futures for November settled at a new record of $53.64 a barrel, up 33 cents on the New York Mercantile Exchange". For an analysis of this development, I have been reading Barry Ritholz's highly interesting posts on the subject and have from my much more limited perspective quite naturally very little to add. Except of course that the futures and swaps market for crude still points to only a slow decrease in prices, and the chart below that underlines what Barry says about the oil price increase being driven primarily by increased demand from China. Crude oil prices in red, Chinese net imports in white, all from the Bloomberg system.

Market Learning: Adjusting NFP for Hurricanes

Today at 14.30 CET the U.S. employment report is due. Economists expect about 150 thousand jobs to have been added during last month. It is however unclear how much of the effects from hurricanes such as Ivan that were visible at the time these expectations were formed. Historically, severe hurricanes in the Mexican Gulf has had an important effect on the non-farm pay rolls numbers, making them much lower that the consensus estimates. And looking at the worst hurricanes, it seems that even the bond-market has been surprised by the hurricane effects, trading up bond-prices (yields down), on the day the non-farm payroll figures have been released far below estimates because of the storm impact. However, now they seem to have learned the lesson. Following are the yield changes on 10-year U.S. treasuries on NFP announcement days after severe storms. All the NFP figures, though not shown in the table, were announced far below the estimates, and then later revised upwards.

Date......Hurricane.....10-yr UST yield chg bps.
Aug 1992.......Andrew.......-12.3
Sep 1996.......Fran.........-11.4
Sep 1998.......Bonnie.......-1.8
Sep 1999.......Floyd........-0.6

For each time, the market has been successively less surprised by what the hurricane has done to the statistics. That said, keep in mind that there is only four observations in the table. Anything could happen today!

57 Channels (and Nothin' On)

How come that with so many channels competing for the viewer's attention on the TV, there can be, as in the lyrics to the Bruce Springsteen song, as many as "57 CHANNELS (AND NOTHIN' ON)"? Even though some of us have tastes that differs from each others, free media such as TV and radio often display a strong tendency to serve only the mainstream. Indeed, even though the preferences of the audience may be diverse enough to make you think about landscapes at least as wide as a river delta, one often talks about if it were a river, dominated by a "mainstream".

To making an extra viewer able to watch a channel costs virtually nothing compared to the cost of producing the content. So my first though was that this in itself causes the market to fail to fulfill viewers preferences. The case however, is according to my simple investigation (outlined below), rather the reverse. With a large enough number of broadcasting stations, all viewers will be able to find stations that perfectly match their taste. Furthermore, the market will easily produce a mix of stations that maximizes viewer's welfare under standard assumptions.

So what's the problem then? Well, out here in the Blogosphere, it seems to me that my analysis holds, we have many blogs and good allocation. Also, Abiola Lapite (in a discussion on his blog preceding this post) thinks radio in the future will give us a myriad of stations producing a varied content. But when it comes to TV, and much of radio today, I guess fixed costs still keep the number of stations down. It is also easy to get the impression that there are even fewer production companies than TV-channels, and that the channles mostly are dealing with repackaging of the productions into an ever more streamlined mix.

And scarcity of stations may make the market's perfect allocation to collapse: Viewers with odd tastes far out in the media landscape that don't share their tastes with enough co-viewers, cannot support a whole station. So if they still keep the radio on or stick to the screen, they effectively lose much of their market power when settling for the next best. And when viewers off the mainstream are sidelined, the market moves the stations towards the mainstream. Which makes even more viewers seeing their favorite stations shutting down. Which all in all produces a spiral, which might in worst case, eventually result in 57 channels and nothing on.

Public service broadcasting should hence have opportunities under these circumstances. Not by competing with the commercial stations, but by offering alternatives. The goal for them should not be to have as many viewers on simultaneously, but rather to have as many viewers finding at least something they like and wouldn't find elsewhere. And tax funding shouldn't really be any more problematic than the fact that the average consumer more or less has to contribute via vendors and advertisers of common consumer goods, to some 57 channels that really doesn't show anything better than the barely acceptable.

Note: The same mainstream collapse happens in the "Vendors on the Beach" problem, and in the "Median Voter Theorem". However, these models does not illustrate the market success with many enough stations. Mathematically, they seem complex and has lead to some discussion among researchers over solutions ( as mentioned in this nice overview, again via Abiola).

Model: Viewers sits in a media landscape, an n-dimensional "tastespace", where their position define their preferences, and viewers close to each other have similar tastes. The effort for a broadcaster to change his product is small when moving between fulfilling preferences of two viewers sitting close to each other. This ordering of tastes might seem a very strong assumption. Consider however how well even a single line might do: "50's classics", "60's hits", "70's favorites"; here we have an arbitrary number of dimensions. Viewer density at each location is v(x). Stations sit in the same landscape, a station at a specific point perfectly satisfies viewers at that point. Viewers at x share their attention equally between station at x, but view nothing else. Station density is s(x), v and s are both positive non-zero real numbers and x an n-dimensional vector. Stations move continuously along the direction where v(x)/s(x) increase the most trying to increase profits from advertising. Hence, in equilibrium: s(x)=const*v(x); that simply stops stations from moving. Total utility derived hereof by all viewers in any point is v(x)*U(s(x)), remember that only broadcasters on the same location compete, not viewers. For utility to be maximized, the derivative of utility with respect to the station density have to equal in all points: v(x)dU(s(x))/ds = constant with x (d for partial derivative here). With our solution, then s*dU/ds = constant, which is satisfied for U=const*ln(s). Under the standard assumption of log utility the market's allocation is optimal!

War Really Sucks

We've seen ugly pictures of the victims of aerial bombing in the Swedish press, even in the G. W. Bush-friendly leading Swedish conservative daily, Svenska Dagbladet.

Daniel Davies comments the bombings in a post called "The Leg question" at Crooked Timber:
"Apparently, we are bombing the town of Fallujah. Apparently, we are doing this because the residents refuse to co-operate with our wishes by not "handing over" the notorious terrorist Abu Mussab al-Zarqawi. Apparently, we will continue to bomb them until they do so."
Really weird, but well in line with the low probabilities discounted at Tradesports of finding the high-profile terrorist leader in question. To get 100 given that Zarqawi is captured before year end costs only about 30. Even weirder is the apparent lack of any solid political objective for this military campaign. Remember that U.S. forces invaded Falluja earlier this year, thereby contributing to 100 of its soldiers losing their lives, presumably together with countless others. Regrettably, that military victory was not followed by any political success: the town soon thereafter slipped out of U.S. control. And I don't suppose anyone has seen any new plans for administrating Falluja this time. Or?

Last Employment Report Before Election

Greg Ip writes in the WSJ about Friday’s big event, important not only for the financial markets, the last employment report before the elections. It is likely to impact the debate due later that day between Bush and Kerry on domestic issues. Ip presents the White House's bullish estimate, and the market's more modest one. A Cleveland Fed report is cited in order to explain why the so called household survey's figures differs from the more trusted payroll figures that paint a grim picture for the last couple of years.

Political Debate Over Jobs Intensifies
Bush Team Hopes for Lift
From Friday Payroll Data;
Revisions to Get Attention
Staff Reporter of THE WALL STREET JOURNAL [subscription required]
October 5, 2004
Friday's data will be the last released before the Nov. 2 election. While markets will focus on the Bureau of Labor Statistics' jobs report for September, politicians might pay more attention to revised data for the period from March 2003 through March 2004.
A memo from the president's Council of Economic Advisers estimates that the payroll-employment figure for that period could be revised upward by 288,000 jobs, and conceivably by as much as 384,000. In August, nonfarm payroll employment stood 913,000 jobs, or 0.8%, below the level when President Bush took office.
Wall Street economists on average expect nonfarm payrolls to have risen 145,000 in September from August, according to a survey by Dow Jones Newswires and CNBC, with hurricanes having depressed the total by about 50,000
The staff study found that when the most reliable part of the household survey is compared with the payroll survey, "both measures ... show a surprisingly similar picture of the weak labor-market performance that has prevailed during this recovery relative to previous business cycle periods."

Cleveland Fed economists Mark Schweitzer and Guhan Venkatu note in their study that the household survey's employment total can be distorted by problems in extrapolating from a sample of 60,000 households to the total population, because of uncertainty surrounding population estimates.

The economists look instead at the percentage of the working-age population that is employed, which they write is "more informative and less problematic" because it factors out population. The authors say that in the nine post-World War II recoveries prior to the most recent, this "employment to population ratio" fell on average 1.5 percentage points in the 18 months after recession began. By the three-year mark, it was down less than half a point.

After the most recent recession began in 2001, the ratio tracked the postwar average for the first 18 months, but then continued to decline. By the three-year mark it was down 2.2 percentage points from the peak.

"This picture is strikingly similar" to the poor performance of payroll employment relative to previous recoveries, they write. The authors estimate payroll employment rose 3.7% in the first three years of the nine previous business cycles, but is still down 1.5% in the latest.

Bush Knows Osama bin-Laden Attacked USA

Reading about yesterday's debate between Kerry and Bush, you could find one reassuring piece of information. The U.S. intelligence crisis, revealed by the WMD flap, is not entirely bottomless. At least the U.S. President claims to know who attacked his country on September 11: "The president, fusing the Sept. 11 attacks with the war against Saddam Hussein, said he never dreamed of sending troops into combat until 'the enemy attacked us.' That gave Kerry an opening to remind voters, 'Saddam Hussein didn't attack us. Osama bin Laden attacked us.' Finally, an exasperated Bush responded, 'First of all, I know Osama bin Laden attacked us.'"
Thanks to Oliver Willis, who also links to video clips from the debate, for the pointer.

Popular Posts