Month: July 2016

A simple and plausible model of some of the major stock market anomalies

The paper is entitled Sticky Expectations and Stock Market Anomalies, and it is by Jean-Philippe Bouchaud, Philipp Krueger, Augustin Landier, and David Thesmar, here is the abstract:

We propose a simple model in which investors price a stock using a persistent signal and sticky belief dynamics à la Coibion and Gorodnichenko (2012). In this model, returns can be forecasted using (1) past profits, (2) past change in profits, and (3) past returns. The model thus provides a joint theory of two of the most economically significant anomalies, i.e. quality and momentum. According to the model, these anomalies should be correlated, and be stronger when signal persistence is higher, or when earnings expectations are stickier. Using I/B/E/S data, we measure expectation stickiness at the analyst level. We find that analysts are on average sticky and, consistent with a limited attention hypothesis, more so when they cover more industries. We then find strong support for the model’s prediction in the data: both the momentum and the quality anomaly are stronger for stocks with more persistent profits, and for stocks which are followed by stickier analysts. Consistently with the model, both strategies also comove significantly.

For the pointer I thank the excellent Samir Varma.

Germany fact of the day

Deutsche Bank, which once had pretensions to be Europe’s contender on the global investment banking stage, is now worth just 17 billion euros ($18 billion). When the biggest bank in Europe’s biggest economy, with annual revenue of about 37 billion euros, is worth about the same as Snapchat — a messaging app that generated just $59 million of revenue last year — you know something’s wrong.

I might take out the word “wrong” there, but otherwise I liked the passage very much.  How about “…you know something is up”?

That is from Mark Gilbert at Bloomberg View.

Tuesday assorted links

1. The cow culture that is Dutch.

2. New evidence on the gradual and seventeenth century roots of the Industrial Revolution (pdf).

3. Payments systems and other features of life in Dubai, interesting, by Alice Wilkie.  And is Daesh moving to a gold standard?  In fact it’s always been a substitute for trust.

4. If they put some crummy paintings into British museums and hang them, few people seem to notice or care.

5. “The problem with the Swedish housing market is that there are no houses and there is no market.

6. Abbas Kiarostami has passed away.  Virtually all of his movies are worth watching, and often more than once.

7. The coming Italian referendum.  And how Remain lost.

When will the United Kingdom invoke Article 50?

Or will it at all?

With the resignations of Cameron, Boris Johnson, and now Farage, it seems few leading politicians are keen to “own” Brexit and its consequences.  If those individuals wish to step back from accepting the consequences of Brexit, might that tendency spread more generally?

If your thoughts run along the lines of “they have to do this, otherwise there will be violence in the streets,” or “they have to proceed with Article 50, otherwise British government will have no legitimacy,” I say Beware The They!

They, they, they.  Try he and she.  Word on the street these days is that Article 50 won’t even be seriously considered before the French and German elections, which means Fall 2017 at the earliest.  OK, so let’s say it is October 2017, and Brexit is more unpopular because the intervening uncertainty has created a recession.  Do you, as an individual British legislator, wish to claim an ownership of the process at that point?  If Farage didn’t want to own it, and so quickly realized that, why should you pick up the bag?  Yes I know most individual constituencies, evaluated as constituencies, were pro-Brexit.  But they were also anti-recession and anti-chaos, and so you must choose between giving them the means they want and giving them the ends they want.

It’s already being debated whether Article 50 invocation requires an Act of Parliament or not.  I can’t judge the constitutional issue (can anyone?), but practically speaking it seems to me that if Parliament says it requires their explicit consent than it does.  Similarly, if Parliament washes its hands of the matter, who or what can overrule them and make them vote if they don’t want to?  So I see a few scenarios in this multi-stage game:

1. Parliament wants no vote in the matter, and claims it doesn’t have to vote.  In this scenario, the new PM may not act on it either.  Note that Theresa May was originally pro-Remain, she will believe that Article 50 will worsen the recession and thus her electoral prospects, and she wouldn’t have parliamentary approval as cover for pushing the nuclear button.  If I were in Parliament, with a moderately pro-Leave constituency, I would be rooting for this scenario.  No one acts, but everyone can blame other parties for not acting.

2. Parliament cannot run away from its voting rights, or even positively seeks to assert them.  Under this scenario, commentators may suggest that Parliament as a whole has to desire Brexit, if only to keep its legitimacy.  But recall that before the referendum, Parliament as a whole was about 3-1 pro-Remain.  Why chase after a voting right you don’t wish to have?  If Farage didn’t want to stick around for such an outcome, why should you?  So vote Remain, claim you had initially campaigned along with pro-Remain forces, claim you are sticking to your original electoral mandate, and see what happens to your political future.  Say it is “the others” who are detaching Parliament from the will of the people.

3. The 2017 PM and Cabinet take to the British people an alternative, non-EU vision of what Leave would look like, but they don’t lie too much to make it look so great.  They hold a second referendum, not on Leave vs. Remain per se, but on whether that is a satisfactory target option for a Leave scenario.  In fact they can design the plan to fail simply by being somewhat realistic.  The option fails, and the politicians claim everyone has to go back to the drawing board.  I get sick of my Twitter feed being full of so much Brexit talk for so many years, and I stop following so many British people.

4. The trickling, tortuous uncertainty through Fall 2017 is so economically costly that everyone realizes a decision must be made and soon.  “Leave” is the only decision which is focal, because of the referendum, and so Leave is set in motion and Article 50 is invoked.  You will note that this scenario, while it sounds plausible, is a bit at odds with waiting until Fall 2017 to begin with.  So the reality of waiting today has to lower the probability of this one somewhat.

5. The trickling, tortuous uncertainty through Fall 2017 is so economically costly that everyone realizes a decision must be made and soon.  “Leave” is a more focal decision, but it still takes years to negotiate and consummate, thereby ensuring the uncertainty continues to kill the British economy.  “Leave” therefore is discarded through political shenanigans and Remain rules the day because only the status quo ex ante can be brought about so quickly.

6. In the meantime, the EU does something really stupid, which includes the steady insulting of the British people and government, and almost everyone in the UK wants to leave by Fall 2017.

6b. In the meantime, Putin does something really stupid, and English opinion shifts strongly to Remain and Remain comes about through emergency national security channels.

7. In the meantime, the French and German elections require those governments to reassert at least partial control over their borders vis-a-vis immigration.  This right is then offered to the UK, if only verbally, and the support for Leave more or less collapses.  There is the beginnings of negotiation for a new EU treaty, in the meantime a bunch of EU nations including the UK break the rules of the old treaty, yet without being punished.  This strikes me as one of the more plausible scenarios.

I get how #4 and #6 pretty clearly lead to actual Brexit, as does one branch of #2, but when you look at these scenarios as a whole, I don’t think the chances for an actual Brexit are so overwhelmingly high.  The key obstacle is getting so many pro-Remain legislators to attach their names and reputations to a scenario which Johnson and Farage already are running away from.  That is just not so easy.

Didn’t the Sex Pistols sing about “…now I got a reason to be waiting”?

Yes, British legislators do have a reason to be waiting.  They are waiting.  Should that reason become stronger or weaker over time?  Why think that “weaker” is so obviously the correct predictive answer?  There is no clear deadline forcing their hand.

In the 1960s and 70s, America and the UK had riots all the time.  I’m not saying this is good!  (Though it did lead to an excellent Clash song.)  But once underway, in fact it is politically acceptable in many situations, or sometimes even politically desirable.

Addendum: Here are a few more points to consider:

a. Parliamentary systems behave very differently when off their steady-state stability path.  There is now a power vacuum, no courts to produce definitive rulings, and the executive and legislative branches of government end up as bankrupt at the same time and in the same ways.  Things are stuck and the traditional local comparative statics simply do not work.  So our usual intuitions for what is supposed to happen in British politics may not be so reliable, and indeed few people had predicted the outcomes the country has received so far, including all the resignations.

b. The status of the Queen will either go up a lot or down a lot.  Many people still believe, if only in inchoate form, that she is there for moments of constitutional crisis.  But a moment of truth is coming where she will have to cough up her creative ambiguity, or not!  If she does nothing, which I consider the more likely scenario, the monarchy will become all the more irrelevant.  If she issues a pronouncement of some kind, she will either be a grand heroine or look pretty bad.

c. In some ways the EU had taken on the “backstop” role formerly held by the British monarchy.  This is not widely understood.  And indeed without the EU, it seems British politics is quite chaotic.  This is a huge embarrassment for the Leave forces, and few if any of them foresaw this or are willing to admit this now.  But that is in fact how British politics has been evolving over decades.  To a keen reader of Bagehot, however, this does not come as a surprise, and it is another reason why the Leave vote was a huge mistake.

Why Brexit will not be easy, installment #1437

A contentious EU-Canada trade agreement is at risk of becoming bogged down in a spat between EU capitals and Brussels over whether national parliaments should get to ratify the deal.

The European Commission has waded into sensitive political territory by suggesting that, legally, the wide-ranging accord could simply be approved by national trade ministers and by the European Parliament to take effect.

While EU leaders are highly supportive of the trade deal, known as CETA, the commission’s push for a streamlined adoption has raised the prospect of an ugly power struggle even as the bloc seeks to cope with the trauma of Britain’s vote last month to leave the EU.

At stake is whether a total of 38 different national parliamentary chambers, including in some cases regional assemblies, should have a binding say. In addition to the commission’s belief that this is not required under the EU’s treaties, a pressing political concern is that it could be the death knell of a deal that took five years to negotiate.

The outcome of the tussle could also have implications for how complicated it will be for post-Brexit Britain to negotiate a trade deal with the EU.

That is from Jim Brundsen and Duncan Robinson at the FT.  And Canadian exports are far more resource-intensive, and less services-intensive, which ought to make that free trade agreement especially easy.

I’ve seen various articles suggesting Britain has only about twenty trade negotiators and the country will look to New Zealand (!) to borrow expertise in this area.  In other words it will rely on immigrants of a sort.  What does that tell you about the level of preparation?

Wolfgang Munchnau on Twitter suggests that Tory leaders can deliver and support only hard forms of Brexit, without EEA or a real trade agreement.  The French are talking about no longer spending the money to cut off migrants in Calais and instead letting them cross the channel so the British can deal with it themselves.

People, this already isn’t going well!

Monday assorted links

1. A revisionist take on Elie Wiesel.

2. Ringo Starr endorsed Brexit, as indeed John Cleese had earlier.

3. Krugman on the aggregate effect of the China trade shock.

4. “I have a serious reason for raising my cats gender neutral.”  That’s about Judith Butler.  There is also this part: “Once, when he [my son] was younger, I said, ‘So, how is it for you having queer parents?’ ” Butler remembers. “He said, ‘That’s not the hard part. The hard part is having two academics.’ ”

5. Profile of David Card.

6. Claudia Sahm now has a MacroMom blog.

Freedom in the World is in Decline

My thoughts on Independence Day are more muted this year than they have been in the past. In the first half of my life I saw the Berlin Wall fall and I watched as democracy, trade, and greater freedom spread around the world. There was still plenty wrong, of course, especially for a libertarian, but the world was on an upswing and it seemed like the ideas that led to the economic, political and social destruction of the first half of the twentieth century were in decline. Now, following the second Great Depression, illiberalism is on the rise much as it rose following the first Great Depression. All could yet turn out well but there is no denying that the world is no longer on an upswing.

In Freedom in the World: 2016, Freedom House reports:

The world was battered by crises that fueled xenophobic sentiment in democratic countries, undermined the economies of states dependent on the sale of natural resources, and led authoritarian regimes to crack down harder on dissent….

  • The number of countries showing a decline in freedom for the year—72—was the largest since the 10-year slide began. Just 43 countries made gains.
  • Over the past 10 years, 105 countries have seen a net decline, and only 61 have experienced a net improvement.
  • Ratings for the Middle East and North Africa region were the worst in the world in 2015, followed closely by Eurasia.
  • Over the last decade, the most significant global reversals have been in freedom of expression and the rule of law.

Freedom in the World has now declined for the 10th year in a row.

In defense of Davos, or at least its cosmopolitanism

I very much liked yesterday’s Ross Douthat piece, and I agree with most of it, and I regard him as one of the truly great columnists writing today.  Still, there was one tiny part I disagreed with, and I see the point being repeated in varying forms elsewhere, so I thought I would pull it out and add a few comments, namely:

(There is more genuine cosmopolitanism in Rudyard Kipling and T. E. Lawrence and Richard Francis Burton than in a hundred Davos sessions.)

That is Ross, do read the whole piece for context, but here are my worries.  They may be nitpicks, but actually I feel a fair amount is at stake here:

1. It seems unfair to compare Davos sessions to some rather robust, historically important, top-of-the-line explorers.  Virtually all sessions are boring, including or maybe even especially in the 19th or early 20th centuries.  How about comparing the elites of back then to the elites of today?  Then I think the Davos set would look quite good.  Or if you compare the explorers of more recent times — say Jan Morris or Louis Sarno — to the explorers of back then, still the present day looks good and possibly even considerably superior in terms of curiosity, tolerance, and a broad outlook.

Overall, I see a lot of evidence — both cross-sectional and time series — that those qualities are what economists call normal goods rather than inferior goods, or in other words those qualities rise with income.  And do we moderns not in some ways have an overall better and more accurate perspective?  Have we not read much more, learned better social science, and developed a greater facility for spotting prejudices and logical fallacies?

2. I suspect either the elites or the explorers of today are better when it comes to understanding differing perspectives of gender, neurology, sexuality, race, age (should you beat your kids?), and a variety of other dimensions.  Maybe none of these wisdoms fall exactly under the heading of the adjective “cosmopolitan,” but still they seem relevant for whether today’s elite is wiser and broader.  How many of the earlier elite were women, and embodied that set of diverse perspectives, to pose a simple comparative question?

3. I’ve never been to Davos, but I know some people who have.  They’re weird!  And I mean that in a (mostly) good way.  I am reluctant to overgeneralize about them, and I suspect they are more diverse than is often thought to be the case.  Almost by the virtue of having been invited, they are some pretty extreme outliers, consider for instance Bill Gates or Elon Musk.  I’d also like to see data on how many of them have spent serious time in say poor rural villages in less developed nations, or had other strange or diverse experiences.  The answers might surprise us.

Who amongst us knows this about CEO and billionaire Patrick Byrne of Overstock?:

“30 years ago in China I contracted Hep C.  I got a bad head wound and a ‘barefoot doctor’ they called him, sewed me up.  I’ll give you the facts, I went stage 4 last summer, seemed to have gotten through the treatment but it’s been quite harsh on me and it’s on top of a long, I’ve actually had 106 surgeries, 51 times they stopped my heart electrically, another 50 times chemically,”

Isn’t that a kind of cosmopolitanism?  And the medical treatments also have given him some pretty novel perspectives.  Patrick by the way is fluent in Mandarin and has spent years in strange and unusual parts of China, and during a time when it was far less safe and comfortable than today.

Or how about what Jeff Sachs does?  Whether or not you agree with all of his economics, it’s not easy, and I mean on both the mind and the body.  How about those Harvard MBAs who are Mormons and have done missions in exotic locales and gone door to door for two years?

Muhammad Yunus was born in a Chittagong Muslim village into a family of nine children, circa 1940.  Later “From 1969 to 1972, Yunus was assistant professor of economics at Middle Tennessee State University in Murfreesboro.”  Isn’t that a pretty incredible diversity of life experience?

Thomas Friedman, a classic exemplar of the globalist mindset and whipping boy for many, in fact spent serious time in Beirut covering the civil war, and doing original reporting in situations of very real danger, winning Pulitzers and a National Book Award for the quality of his work.  During one later four-year period, he traveled over 500,000 miles.  Nicholas Kristof is another good example of someone who really “gets out there,” in his case often in Africa but not only.

If you are curious, here’s a basic list of Davos attendees.   Note also that the very real increase in segregation by income in America — mostly a bad development and which Ross mentions — seems to be centered around the upper middle class, not the Davos set, as the very wealthy and the elites always have lived somewhat apart.

Overall I think Ross and many others are somewhat underrating Davos.  I do understand that Davos attendees may, as a whole, suffer from excess hubris, excess complacency, or be excessively fond of technocracy.  And the fact that many (by no means all) of them have not suffered very much does limit some of their perspectives.  But are they not in fact actually about as cosmopolitan as we might hope for?

Addendum: Rob Howse offers some useful remarks, and also notes the connection of the “genuine cosmopolitan” idea — a tricky concept — to Leo Strauss.  Here is his closing bit:

Is it so that the cosmopolitans Douthat despises merely retreat into comfortable and familiar neighborhoods in global cities?…[many are] working in a combat zone with Medicins sans frontiers; or persisting as a foreign correspondent in a country where journalists’ lives are threatened; or setting up a truth commission to heal wounds in a conflict-ridden nation; or soldiering as a social entrepreneur to empower women’s small business in an African village; or confronting traditional community leaders about female genital mutilation.  These are all quintessentially cosmopolitan roles, which involve real risks, real sacrifice, and often wrenching encounters with otherness.

I agree with Ross’s description that the Davos set is very often “liberal Christianity without Christ.”  But maybe that’s the most cosmopolitan philosophy going these days.  The bigger question of course is, given slow economic growth and institutional rigidification, how much that really helps us.

The rhetoric of Andrea Leadsom

She is in the running to lead the Conservative Party and be the next PM.  Here are her words on Theresa May, the front runner and heavy favorite, under whom she may well end up serving as a Cabinet member:

She’s a superb candidate.  A brilliant Home Secretary and a seriously intelligent and principled person.

And on Michael Gove, her more direct rival for the number two slot for a possible run-off against May:

Michael is an incredibly decent person.  I don’t buy all this talk of treachery and evil.

Here is some of the talk of treachery and evil, based on the notion that Gove stabbed Boris Johnson, ostensibly the previous front-runner to be PM, in the back.

The Telegraph article, an interview with Leadsom, is in the paper edition titled “I like to think I have the qualities of Lady Thatcher.”

Here are some critical remarks about Andrea Leadsom.

Sunday assorted links

1. Obama at night (NYT).

2. MIE experiment: “Who would go to a restaurant to eat Frosted Flakes—and pay $6, maybe even $8 for it? What if the bowl was topped with a sprinkle of lemon zest, toasted pistachios and fresh thyme, and was singularly delicious?”  New York will soon find out.

3. One dad’s story on confirmation and availability bias.

4. Why are NBA stars paid more than NFL stars?

5. “In 2013, there were 166 black-owned radio stations and 68 black-owned radio companies, compared with 250 stations and 146 companies in 1995…” Black media companies are now fighting for survival (NYT).  I would say the returns to scale have been going up in the sector, though at much smaller levels the returns to scale are down, witness “Black Twitter.”  This is perhaps another example of the hollowing out of the middle.

6. The magical thinking of pro-Brexit conservatives.  And put the referendum aside, constituency-by-constituency, most of the support is for Leave.  Sobering.  And here is an excellent John Kay piece: “As one student of Scottish politics, explaining the UK Independence party’s lack of traction north of the border, put it to me two years ago: “People in Scotland who are disgruntled and suspicious of foreigners [the English] already have a party they can vote for.””

Paul Krugman on Brexit and falling investment

I think there is a pretty simple story here.  Brexit increases uncertainty, both in the mean-preserving sense, and in the “very bad outcomes are now more likely” sense, and that lowers investment.  That in turns shifts back the aggregate demand and aggregate supply curves, and a recession may result.  Less than a year ago, MIT economist Olivier Blanchard published a major paper on capital inflows being expansionary, and now of course we are seeing the reverse.  Toss in some negative wealth effects for further transmission.  I was at an event in The City a few days ago where the anecdotal data about postponed or cancelled deals seemed pretty overwhelming, and this is consistent with what one reads in the papers as well, not to mention with basic economic theory.  It is true of course that we don’t know how large these effects will be, but the more purely British measures of equity value are still down quite a bit.

Krugman is usually an exponent of the “don’t make things too complicated” approach, but here in this blog post he wants to…make things too complicated:

Second, doesn’t this argument imply a later investment boom once the uncertainty is resolved in either direction? That is, once Prime Minster Farage and President Le Pen have engineered the demise of the EU, there’s no reason to wait, and all the pent-up investment comes roaring back, right? But I haven’t heard anyone arguing that the contractionary effect of Brexit will be followed by a compensating boom once things settle down.

Third, doesn’t this argument suggest essentially the same effects from any policy negotiation whose end result isn’t known? Why don’t we say that the possibilities of TPP or TTIP are contractionary, because firms have an incentive to postpone investment decisions until they know whether these agreements actually happen? Somehow, though I’ve never heard anyone argue for the depressing effects of pending trade liberalization.

It is true investment might bounce back if Brexit were essentially undone, but that is hardly an argument for Brexit.  The UK economy is about 85 percent services, those are currently “passported” into the rest of the EU, and it is very very hard to negotiate a new free trade agreement for services in anything like a timely manner, even when passions are not inflamed and there are no considerations of punishing other possible EU-defecting countries.  So if you read someone writing “…after Brexit, the UK will face an average tariff rate of only xxx…” that is a sign they are not thinking hard enough about how trade agreements for services really work.

(Note also the subtle point that when financial and business services are being sold, the difference between “FDI falling” and “trade and exports falling” is quite a subtle one.  Most of all, the traders of these services are investing in ongoing relationships.  The decline of trade and the decline of investment are two ways of talking about the same contractionary process, it is not as if FDI falls, the exchange rate falls, and then trade then rises to pick up the slack, at least not in the UK-EU context.  What is happening is that a negative shock to both trade and investment is coming up front, and then the British pound falls; the second-order response to that currency decline won’t undo the initial problem.)

On whether the same macroeconomic logic applies to other trade agreements, many investors may be playing “wait and see” before doing more FDI in say Vietnam.  But still the very prospect of TPP in the meantime should not be lowering the chance of such investment in Vietnam because TPP represents some chance of a positive-sum advance.  The potential loser is more plausibly China, and one does read about this effect.  Investors may be less likely to set up plants in China because they are waiting on news about the options in lower-cost Vietnam.  Of course given the relative sizes of China and Vietnam, this is unlikely to be a very large effect, but it does exist and it is already discussed.  In contrast to that example, the EU is by far the biggest trading and FDI partner for the United Kingdom, and the prospective trade change is negative-sum rather than positive-sum.

What is most striking about Krugman’s post is how many Krugmanisms are completely absent from it.  I mean recent Krugmanisms, this isn’t some kind of 1990s nostalgia (not today at least).  Here are a few Krugmanisms which appear to be missing in action:

1. The EU is quite indecisive, it just kicks the can down the road and doesn’t resolve much uncertainty.  Why not expect the same when dealing with the uncertainty from Brexit?

2. Just apply the AD-AS model quite simply, and follow it where it leads you.

3. How about increasing returns to scale?  A lot of the UK exports to the EU are finance and business services, both areas which are plausibly based on clustering and scale economies.  An initial whack to a clustered IRS sector can have quite significant long-run consequences, even if some or maybe even all of the initial penalty is reversed.  This is part of what Krugman won a Nobel Prize for, admittedly I am hearkening back to the 90s and indeed 80s here but Krugman has cited this argument many times much more recently.  This is also another reason why higher trade won’t make up for the investment shortfall, because the investment shortfall stifles the prospects for future high value-added trade.

4. The gravity equation.  The pound has depreciated, but the EU is the UK’s natural trading partner, for reasons of distance, and the UK is unlikely to make up the difference by exporting more to the rest of the world.  Export adjustment from currency depreciation won’t in general neutralize the impact of investment-destroying and EU-trade-destroying policy changes.

5. What about the multiplier?  Isn’t the multiplier HUUGE in economies at the zero bound?  And isn’t that the UK?  And Cameron already has announced, plausibly in my view, that the UK won’t be meeting its forthcoming revenue targets.  Won’t that result in a form of additional austerity sooner or later?  With yet further multiplier-based negative macroeconomic consequences?

Where is the multiplier?  I want my Paul Krugman back!

Going broader lens here, and moving away from Krugman, what I notice is many of the less academic Keynesians becoming less and less comfortable making arguments about deficient or contracting investment.  C + I + G + X is ever so slowly morphing into C + G + X, at least in popular discourse.  That is odd, because Keynes himself was most concerned with the instability of investment.  It seems that these days however to worry about investment is to sympathize with capitalists, and perhaps to even wish to keep more resources in their hands.

I want my investment back!  It is no accident that Keynes’s solution was to nationalize investment, not to redistribute away from capital per se.  But nationalizing investment isn’t very popular these days, and so the vitality of capitalism and capitalists once again becomes — or should become — an important issue.