This one is from the new blog, Constructive Economics, written by Abraham Othman. The premise of the post is to imagine a hedge fund devoted to altruism — not profits — and ask how the fund could operate most effectively:
It would attempt to move market prices as much as possible. For instance, imagine a binary security the hedge fund has calculated should be priced at x but is instead trading at y. A normal hedge fund would try to optimize their trading to move the price as little as possible, in order to maximize their expected return. A charitable hedge fund would instead run the same optimization in reverse, trying to push the price as close to x as possible.
It would be an activist fund with a focus on jobs, or the environment, or some other charitable cause, instead of profits (or the lack thereof caused by managerial incompetence).
It would be selective about the short positions it takes. Inasmuch as market prices can be self-fulfilling prophecies (and I’d like to write more about this idea at some point), the fund would use this power selectively, to reward the good and punish the evil. So a charitable hedge fund would try to provoke raids on Halliburton but buy Greek bonds.
I tend to think the fund couldn't do much good. What should it do? Assume that it can only buy and sell securities, it cannot, say, try to assassinate the leader of North Korea. Operating in liquid markets only subsidizes smarter traders without much lasting effect on price. What illiquid market could it find to secretly manipulate? Should it operate in markets where opposing traders cannot go short? An extreme Hayekian might suggest the fund would help the world best by maximizing profits. Should it punish socially irresponsible managers who otherwise are getting off scot-free, basically by shorting their stocks?
For the pointer I thank Bill Mill.
Addendum: Along not totally unrelated lines, here Henry Manne defends insider trading to Fama and French.