Rortybomb writes:
The most innovative product for a financial firm is one that always has volume and, sometimes, always has volatility. Many investors would prefer neither, they would prefer their investments boring. So there’s a clash here.
Is there a bias in financial innovation?
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“Many investors would prefer neither, they would prefer their investments boring. So there’s a clash her”
Then why do they buy these “innovative products”?
I think that’s correct. Volatility attracts traders and increases volume. Market-traded financial products survive through a good volume of trade.
One word: Nonstationarity.
I have to agree with Doug here.
Many “investors” are actually gamblers.
Hate to say it, but I prefer boring investments! See…I’m in my 50s and just want to protect what I have and get 6% or so.
Of course in the 80s, I was buying new issues. That was fun.
Bernie Madoff was an expert in innovative investment that was boring.
When the market went up 12%, his investment vehicle returned 10.1%.
When the market went down 5%, his investment vehicle returned 9.8%
When the market went up 2%, his investment vehicle returned 9.9%.
When the market went down 1%, his investment vehicle returned 9.7%.
Boring. Safe. Innovative.
Some of his “competition” filed complaints based purely on the returns being boringly predictable in exciting markets. They could not explain the returns he was delivering based on any known innovation, his description of his innovation.
And he was hardly innovative, but his strategy wasn’t much different than that of say Lehman, other than Lehman’s innovation being legal.
Vibram five fingers are minimal shoes for the barefoot people. It is an innovative approach. Vibram fivefingers make you feel much freer due to the flexibility and light weight. Besides, five fingers can strengtenes your metatarsal ligaments and muscles and shape your feet. However, I can’t always run on safe terrain. Running in the five fingers shoes is as close as you can get to running barefoot and still have some protection. So I like vibram shoes very much.
“I’m in my 50s and just want to protect what I have and get 6% or so.”
Why not 5%?
“Innovation is how to hide what it is, what is necessary to convince people not to believe their eyes.”
But to really create several trillion in phantom too-good-to-be-true wealth from nothing requires the innovative explanation for the safety of the risk so innovatively hidden.
The idea that loans to people with no income and no assets were at all rational, much less safe, required a “sound theory”. The innovative theory that not only are markets always pricing risk, reward, and true value correctly, but that markets always correctly predict the future made the stuff of jokes at the time seem serious and rational. The comedians were saying the emperor had no clothes before he had completely disrobed, but the markets proclaimed his clothing more lavish the more he took off.
By the way, the true financial innovators in 2006/7 were the ones who found ways to buy naked credit default swaps by finding the right people in Goldman who could convince AIG to do idiotic deals. They were correctly predicting doom, and used innovation to profit. But their innovation required low volume, not high volume. Goldman, who made a lot of profit from being the agent for the bucket shop operation, knew the innovation was profitable only if it was low volume.
I am wondering where all the advocates of using the market to predict the future are.
Why weren’t they pointing to the 50% plunge in BP stock two months before the blowout and drill rig sinking disaster? Maybe because the plunge took two months to happen after the event?
I bet Al Gore will be seen as an evil innovator in a few years – he’s already been accused of being a greedy environmentalist, selling the myth of environmental disaster unless we move away from fossil fuels, just so he can profit in his green investments. Are the true financial innovators the ones who have been investing in green over the past three decades when everyone knows the environmentalists are always wrong?
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