Economics and similar, for the sleep-deprived

A subtle change has been made to the comments links, so they no longer pop up. Does this in any way help with the problem about comments not appearing on permalinked posts, readers?

Update: seemingly not

Update: Oh yeah!

Thursday, June 29, 2006

A comment on Gideon Shalit

First of all, that poor kid and his family. I hope against hope that this ends up all right.

Second, this is bringing a few uncomfortable home truths into the light. David Bernstein (the worst blogger on the Volokh Conspiracy and a man who occupies the curious position of being both a myrmidon of free speech against campus political correctness and a leading light in the campus anti-Semitism police. But nevertheless, someone who has to be taken seriously as representing at least some part of public opinion) has suggested that instead of invading Gaza, the IDF ought to threaten to carry out a massacre of prisoners if Shalit is harmed (to "retrospectively institute the death penalty for terrorists" in Bernstein's post, but I don't think any of his commenters were fooled).

This is of course insane; the current policy of invading Gaza is somewhat dodgy with respect to the Geneva Conventions but it is at least consistent with the actual aim; find Shalit. To simply threaten to carry out a massacre of prisoners if he is harmed is surely to send the message to the terrorists that IDF soldiers are valued much more highly than civilians, and that imprisonment in an Israeli jail is basically a death sentence. I cannot think of a worse policy for a country which is constantly under threat from suicide bombers to carry out.

The element of home truth, however, is that Bernstein's reaction to this (and the reaction of Israeli and worldwide popular opinion) rather exposes the pious lie that civilian deaths are in some way more morally important than soldiers. This has always been bullshit - people are people, and no doctor on earth has said "congratulations Mrs Davies, a bouncing baby combatant". The IDF is prepared to move heaven and earth and David Bernstein is prepared to counsel war crimes on behalf Gideon Shalit precisely because he is a soldier, and the military defends its own. This isn't a criticism at all, because it could not be any other way.
0 comments this item posted by the management 6/29/2006 04:09:00 AM

Monday, June 26, 2006

The Cave-in theory of economics

My four year old boy came up with this piece of philosophical poetry at the weekend. I think it has echoes of Ezra Pound.

Rock, Rock, Rock the boat
Gently down the stream
Merrily, merrily merrily merrily
Life is but a TUNNEL

Truly he is his father's son.

Hmmm, this blog appears to have degenerated into a parish magazine of the 1970s, and I suspect that the frequent promises to do something about the Stephen Levitt review might be losing their ability to retain readers, so here's a little economic thought (btw, a contribution to financial theory which might have been better put on D^2D is here on the Guardian blog). I've been reading Perry Mehrling's biography of Fischer Black (capsule review: disappointing) and thinking once more about the Capital Asset Pricing Model. Specifically about one little quasi-inconsistency (as in, I don't think it's serious enough to bring down the mathematical structure of the theory, but it makes the economic interpretation a lot more difficult to fathom) in the concept of beta as a measure of covariance risk.

The idea is this; consider a stock with negative beta (this makes it clearest but there is no loss of generality here). In other words, it's a stock which you own because it tends to move in the opposite direction from the market. That's an attractive quality for which you are prepared to pay a premium (in the sense of accepting a lower return from negative beta stocks), because it reduces the risk of your portfolio. I'll set out the CAPM equation below:

(1) Expected return on your stock = Risk free rate of return + beta (Expected return on market - risk free rate)

(where beta is, in this case, a negative number).

Now this equation is set out in terms of "expected" values ex ante, which means that it is basically unfalsifiable in the Popperian sense. In order to actually use it for practical purposes (and, biographers of Fischer Black, spare me any claims that a full intertemporal CAPM is what people really use for practical purposes; I went to business school and you can't fool me), you have to assume that "expected" refers to the large-sample properties of the underlying data generating process, rather than to a metaphysical "true" expected value. This means that you have to be prepared to make statements like:

Conditional on a market return of X, the expected return on your stock is equal to:

(2) Expectation of return on your stock : X = Risk-free rate of return + beta (X - risk free rate).

A lot of people will tell you that this is basically the definition of beta; a number which tells you what the "sensitivity" of your stock to the market return, with "sensitivity" defined in terms of conditional expectations. However, a bit of thought about the equation above shows that this can't be literally true. For example, let's think about the case when the market return is minus 100%.

The misleading equation (2) above would suggest that our stock would go up quite a lot; if the beta was close to -1 we'd expect it to nearly double. But of course, this can't possibly be the right answer. Our stock is part of the market, so if the market has had a return of -100% (ie, it has gone to zero), then our stock must have gone to zero as well.

Is this a silly technical point of no empirical relevance? Not at all. Stock markets do go to zero, more often than you'd think (the Russian stock exchange did so pretty emphatically in 1917 for example). I don't have the data to hand but I would not be surprised to find out that as much as a third to a half of all stock exchanges that have ever existed have gone to zero. The point here is that the simple linear interpretation of beta as a factor that lets you read off your stock's expected return from the market return is wrong. Beta is an empirical measure of the normalised covariance of a stock with the market, which is consistent with all sorts of underlying distributions. As the example of considering what happens in a market collapse shows, the copula[1] which links the marginal distributions of your stock and the market has to give very strong interdependence at extreme values in the lower tail of the distribution; empirically, one thing we know about stock returns is that dependence increases markedly even in crashes much less serious than the one I talk about above.

But the problem actually goes much deeper; the previous paragraph suggests that this is something that can be dealt with by taking a slightly more nuanced approach to one's estimation of CAPM type models and I don't think that's true. I think that the real problem here is the one that's missed by all equilibrium models; that there is an implicit assumption that the ground rules of the optimisation problem are in some way stable and this assumption is empirically wrong. To put this in the bluntest terms possible, you are not entitled as an economist modelling financial risks, to ignore the possibility of something like the Second World War or the Russian Revolution. The whole of the Fischer Black biography (and indeed, Black's own books; Mehrling gives a very accurate account of Black's economics although not nearly a critical enough assessment) is shot through with this fundamental error; Black's oddball economic arguments almost always rely at a crucial stage on being able to assume away idiosyncratic risks by diversification, which is tantamount to ignoring the very low probability events that can't be insured against or made smaller by sharing them precisely because when they happen, they sweep everything away in one fell swoop.

In Martin Weitzman's Bayesian theory of the equity risk premium, very small probabilities of very bad events are a big driver of the economic behaviour of the whole system, leading to empirically observed behaviour that doesn't seem to make sense when you only observe the system in equilibrium. I think that one of the central insights of (Post-)Keynesian economics is that this is a very general point about economics; that an important motivating factor is the fear of very bad events that are not part of the model. This is also a big reason why there is a liquidity preference and I think it's Paul Davidson's main theoretical insight; that the reason why central bank money is special is that it is the asset that can be converted into consumption at a moment's notice even if everything goes to hell. As a wise man once said to me, life is but a tunnel, and the thing about tunnels is that although most of your time spent in them is a slow incremental progress forward toward the light, it does well to consider once in a while that there is a risk of the damn thing caving in.

[1] In talking about copulas here, I am bullshitting a bit; this is the way I think about modelling the kind of thing I am talking about here, but if I was a better mathematician I would be talking about the bivariate distribution (stock, market) as a representation of the entire multivariate distribution of asset prices. Here's a rather good diatribe against copulas; the general theme is "it's much more complicated than that", which was also the battle cry of the copula posse when the enemy was simple correlation coefficients, and in such a manner does science progress.
0 comments this item posted by the management 6/26/2006 04:14:00 AM

Wednesday, June 21, 2006

The Female Of The Species

I can't help but noticing that while the Stay At Home Mom Wars (for or against) have been raging through one part of the blogosphere, the Blow Job Wars have been raging through another part. They are both really quite astoundingly vituperative.

What genuinely frightens me is that there is presumably quite a significant overlap between these two communities, so some people might have been involved in both wars at once. Women with weblogs who have opinions on both work-life balance and fellatio have been living in the blogospheric equivalent of the Democratic Republic of Congo these last few weeks.

Update: The editorial staff of D-Squared Digest, namely me, are fond of a quiet life and would thus just like to emphasise that we mean no disrespect at all to any of the weblogs linked above; at times the writing in some of these wars is titanically fantastic, albeit that you do have to read about ten thousand words of the stuff before you have the slightest clue who is who and what is going on. It's rather like Tolkien that way. By way of recompense to my infuriated female readers because I know this is the sort of thing you like, here are a couple of links to the story of a man whose scrotum exploded. Note that he preserved quiet dignity and a sense of humour throughout, which rather puts all that childbirth nonsense in perspective.
0 comments this item posted by the management 6/21/2006 09:24:00 AM

Tuesday, June 13, 2006

Pompous Post Poker

One of the Euston Manifesto drafting committee (Damian Counsell of "Pootergeek") has challenged me to a game of Pompous Post Poker. I am at a bit of a disadvantage in terms of familiarity with his material (AFAICS he is kind of the British Steven den Beste) but I think I have decent game anyway and good google skills so it would be a bit poor of me to bottle it. So here we go. He thinks my Darfur post from the Guardian blog a few weeks back was pompous, so the ball is in my court. Fair enough, I think this post of his was more pompous. Your move, Damian. (I am on a freebie to the football the next couple of days but when I come back I will be able to give the nation's second favourite sport, PPP, my full attention.)

btw, he is having "problems with his spam filter" (charitable interpretation) or "a slightly self-serving finger on the delete button" (other possible interpretation), so I would point out that as of 2000 BST today, the posts he is replying to on that comments thread are not (are much easier to argue against) the ones I wrote.
0 comments this item posted by the management 6/13/2006 11:48:00 AM

Wednesday, June 07, 2006

Not in my fucking shed you don't, young man

Apparently Yvonne Ridley, the RESPECT candidate for people who think that Gorgeous George is a little bit too considered in his opinions and not friendly enough to the nutterist wing of Islam, has been telling Muslims in Forest Gate to "not co-operate with the police". Gosh how irresponsible.

I wouldn't worry though. My experience of Muslims is that in general, they have their heads screwed on, and they have a realistic view of teenage chemistry experiments. Even if I was quite a fundie myself, I think that if the kids next door started fucking about with dangerous chemicals in the flat above my favourite cafe, I would turn them in simply on health and safety grounds. I have no reason to doubt that the Muzzies of Forest Gate are any less rational.
0 comments this item posted by the management 6/07/2006 03:34:00 AM

Friday, June 02, 2006

Books news

If any readers are shopping in the Piccadilly branch of Waterstones today, I can offer the following tip: the copies of "Londonistan" by Melanie Phillips are in the "Fiction" section, while the copies of "Londonstani" by Gautam Malkani are all in the "Current Affairs / Politics" section. It took me most of my lunch break to move them all but I think it was worth it. (There are still a few copies of Londonstani in a promotional display by the tills that I didn't have the nerve to pick up).

Update: Most of my readers are devil-may-care, fun-loving souls like myself. However I do know I have a small but substantial audience in the wowser, bore and killjoy communities. For them, I agree that those books will need to be moved back by Waterstone's employees, and indeed some of those employees are likely to be on or near minimum wage. However, get real people. They are paid by the hour and they are not allowed to go home early if all the books happen to be tidy; they have to hang around shifting books about the place whether or not some customers have been playing situationist pranks. I do not accept that, considered in the strict economic sense, I have created "extra work" for them; the entirety of the surplus-value which is alienated from them is alienated by the capitalist system, not me.

Update Update: Of course it's a joke, I didn't really waste an hour on that project you stupid bastards.
0 comments this item posted by the management 6/02/2006 03:35:00 AM

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