Chris Dillow — Progress in economics

Financial economics. e.g., EMH and CAPM.

Stumbling and Mumbling
Progress in economics
Chris Dillow | Investors Chronicle

Ramanan — A Short Note On George Soros’ Principle Of Reflexivity

A Post Keynesian view of Soros on reflexivity.

The Case for Concerted Action
A Short Note On George Soros’ Principle Of Reflexivity
V. Ramanan

What Can We Really Know About the Future of Stock Prices? — Lynn Parramore interviews Roman Frydman

Lynn Parramore interviews Roman Frydman.

The Huffington Post
What Can We Really Know About the Future of Stock Prices?
Lynn Parramore
ht Neil Wilson

RT — People unlikely to change their mind, even when facts contradict their views - study

The research from the University of Iowa is based on previous studies indicating that people are particularly likely to stick to their original viewpoint when they’ve had to write their beliefs down– a phenomenon known as the ‘explanation effect’, which also affects future actions.
In the study, Tom Gruca, a professor of marketing at the Tippie College of Business, tried to find evidence of something called ‘confirmation bias’ – the tendency to give preference to existing information or beliefs, rather than considering alternative possibilities. He says equity analysts working on financial markets are particularly prone to this bias, with those who issue written forecasts being especially vulnerable to falling into the trap, despite having access to new data to influence them.…

Hypo-rationality?

According to Gruca, “This study shows that when all traders in a market have the same bias — in this case, confirmation bias — market prices are not efficient and do not reflect all of the information available.

“However, if some traders are not biased, then market prices efficiently reflect new, relevant information,” Gruca writes.

RT
People unlikely to change their mind, even when facts contradict their views - study

Sam Ro — In 9 Tweets, Marc Andreessen Explains How Bubbles Happen

8/Therefore Efficient Market Hypothesis is correct if for "all information" you substitute "all information, theories, noise, and bullsh*t".

Business Insider
In 9 Tweets, Marc Andreessen Explains How Bubbles Happen
Sam Ro

J. Benson Durham — Can Investors Use Momentum to Beat the U.S. Treasury Market?

More nails in the coffin of EMH. Momo rules!

Decades of research have produced a library on the “momentum” anomaly in markets. Momentum refers to the tendency for financial assets with the best prior returns to continue to produce superior results, at least for a time. Previous findings—regarding individual U.S. stocks as well as foreign shares, broad equity indexes, commodities, and currencies—contradict the common wisdom that markets are efficient. Curiously, even though the market for nominal U.S. Treasury securities is among the deepest and most liquid in the world, no one has rummaged through government bond term structures to find similar strategies that work, no matter what the future general direction of interest rates. Yet my recent staff report describes simple low-cost trading rules that produce positively skewed and sizable excess returns, merely by directing investors to construct portfolios of maturities that have had superior returns. Neither short sales nor exposure to interest rate risk is required. 

Just how does the strategy work, and what are the risks?....

FRBNY — Liberty Street Economics
Can Investors Use Momentum to Beat the U.S. Treasury Market?
J. Benson Durham | assistant vice president in the Federal Reserve Bank of New York’s Markets Group

Lars Syll — Efficient markets and rational expectations – two ideas that aren’t true

EMH and REH assume away the reason for Keynesian economics.

Lars P. Syll | Professor, Malmö University

Efficient markets and rational expectations – two ideas that aren’t true

quoting John Cassidy

Noah Smith — The hard-money people throw Gene Fama under the bus

I think where one does see evidence of prices higher than they would be otherwise is likely in equities were low borrowing rates decrease the cost of margin (leverage). Cost of margin is hugely influential in speculative markets.

Housing "bubble" reigniting? No way. Prices are still way down from their highs, a historically high percentage of purchases of existing residential RE are foreclosure or underwater related and for cash, with Wall Street and flippers big buyers in expectation of exceptional ROI on resale. Rent/purchase ratio is still reflecting the bursting of the bubble, and new housing is not exactly "on fire." There is not going to be another housing bubble in the US for years and there are still housing bubbles to pop abroad.


But it's good to see the inflationistas in retreat and throwing the EMH under the bus, too, in favor of financial instability. But is the Fed creating financial instability now? No way. The Fed is still fighting the consequences of financial instability and not all that successfully.

Noahpinion
The hard-money people throw Gene Fama under the bus

Noah Smith

Lars P. Syll — Blog Bernanke’s hubris

Lucas and Bernanke disastrously wrong — Minsky and Keen presciently right.

Lars P. Syll's Blog
Bernanke’s hubris
Lars P. Syll | Professor of Social Studies and Associate Professor of Economics, Malmo University

Antoine Reverchon — The Dogmas of the Market Economy under Critical Scrutiny

About Beyond Mechanical Markets: Asset Price Swings, Risk, and the Role of the State by Roman Frydman and Michael D. Goldberg and what the authors call "imperfect knowledge economics."

INET Blog
The Dogmas of the Market Economy under Critical Scrutiny
Antoine Reverchon (translated from French), Le Monde

PDF of the epilogue here.

From the epilogue:

Keynes ... shared Knight’s profound doubts concerning the usefulness of standard probability theory for understanding change in individual decisionmaking and market outcomes: we “cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist” .... The importance that Keynes attached to the role of uncertainty concerning both outcomes and probabilities played a key role in his analysis of financial markets and their influence on the broader economy, particularly investment.

But

Hayek’s admonition was directed at the post- (1945) Keynesian econometric models, which grew out of the purported formalization of Keynes’s ideas and were estimated by statistical methods on the basis of historical data. Around the time of Hayek’s Nobel lecture, the applicability of these models for policy analysis had come under severe criticism, either for portraying market participants’ forecasting behavior with mechanical rules, which did not take into account contemplated changes in policy, or for disregarding such behavior’s eff ects on aggregate outcomes altogether.

While unnamed, the most prominent author of "the post- (1945) Keynesian econometric models" was Paul Samuelson, who integrated some Keynesian principles with neoclassical general equilibrium.

Hayek fared no better.

Rational Expectations models, which were becoming highly influential at the time, were proposed by their advocates as a way to remedy this fl aw in Keynesian econometric models. But the Rational Expectations models were as mechanical as their Keynesian predecessors.

Because their portrayal of individuals' forecasting behavior is woefully inadequate, Rational Expectations models were unsuitable for analyzing how market participants would respond to the contemplated changes in economic policy. Remarkably (given that they were developed by Hayek's successors at the University of Chicago), these models were, moreover, fully predetermined, and thus perpetuated "the pretense of exact knowledge" that Hayek criticized so scathingly in his Nobel lecture.

Behavioral economics, often credited with overturning this did nothing of the sort, since it carried over previous assumptions.

Faith that better fully predetermined models hold the key to
adequately predicting all future changes and their consequences is
puzzling not only with respect to adherents of the Rational Expectations Hypothesis. When behavioral economists, who uncovered
many important empirical failures of Rational Expectations models,
formalized their insights, they followed their conventional predecessors by doing so with fully predetermined models

The authors then outline their approach as qualitative and contingent.

Imperfect Knowledge Economics stakes out an intermediate position between erratic animal spirits and the contemporary presumption that change and its consequences can be adequately prespecifi ed with mechanical rules. In contrast to the contemporary approach, the mathematical models of Imperfect Knowledge Economics explore the possibility that change and its consequences can be portrayed with qualitative and contingent conditions. h ese conditions are context-dependent, and as discussed in Chapter 9, the qualitative regularities that they formalize become manifest—or cease to be relevant—at moments that no one can fully predict.

Imperfect Knowledge Economics therefore does not adopt the extreme view, often associated with Knight, that uncertainty is so radical as to preclude economists from saying anything useful and empirically relevant about how market outcomes unfold over time. Indeed, departing from the position of Knight and Keynes, we make nonstandard use of probabilistic formalism.

This approach facilitates the formalization of qualitative conditions that make up Imperfect Knowledge Economics models and the mathematical derivation of their qualitative and contingent implications. However, Imperfect Knowledge Economics recognizes the importance of early modern arguments that market participants (and economists) have access to only imperfect knowledge of the causal factors that may be useful for understanding outcomes.

Andrew Lainton — The Cost (that is Price) of Speculation – Going Beyond The Minsky ‘Ponzi’ Model

How do you make speculation endogenous to economic theory?
Further how do you make the full suite of potential profit making activities, speculation, hedging, arbitrage and investment endogenous?

By endogenous I mean a variable that is determined alongside other variables rather than outside the economic model.

The reasoning in this post comes was prompted in part from speculation by Steve Keen on to what extent the speculative drive is a necessary component of capitalism even though it is destabilising, partly from some dissatisfaction with the Minsky ‘Ponzi’ model of asset speculation, which has been too easily dismissed by neoclassicals as somehow individuals not behaving ‘rationally’. The model here is a generalisation of our earlier model of default risk in banking and insurance across all sectors.

Decisions, Decisions, Decisions
The Cost (that is Price) of Speculation – Going Beyond The Minsky ‘Ponzi’ Model
Andrew Lainton

John Carney — The Secret to SAC's Returns May Be Weirdness

What could make stock arbitrage too costly for certain stocks? Probably the most common thing would be weirdness. When a stock is very weird, when its price doesn't correlate very well with other assets, it becomes costly to develop hedges against positions taken in it. The technical term for this is "idiosyncratic volatility." When a stock behaves as if the rest of the market didn't really exist this means that risk adverse investors will not be willing to exercise efficiency creating pressure on the stock.

A paper published in the Financial Analysts Journal in 2009 explored this strategy. "When is Stock-Picking Likely to be Successful? Evidence from Mutual Funds" found that mutual fund managers exhibit "stock-picking ability for stocks with high idiosyncratic volatility but not for stocks with low idiosyncratic volatility."

****
Another way to take advantage of idiosyncrasy would be to have the skill to develop cheaper hedges. That is, if other traders are avoiding a stock because they cannot figure out how to hedge their exposure, the ability to hedge would create an edge.....

CNBC NetNet
The Secret to SAC's Returns May Be Weirdness
John Carney | Senior Editor

Why financial markets tend toward efficiency. There's money to be made in locating inefficiencies.

Chris Dillow objects

...herein lies my real gripe with pieces like Suzanne's. They help to give non-economists the wholly false impression that economics is dull, ideological and useless. It's not.

Read it at Stumbling and Mumbling
"Economics" & Rationality

by Chris Dillow

I would agree that economics is not "dull, ideological and useless," and that there is good economics and bad economics. However, there is lot of policy prescription being justified in terms of bad economics, a good deal of it seems to be based on rather rigid ideological assumptions, even in the face of evidence that seems to be disconfirmatory.

George Soros on Hayek

GS: "Friedrich Hayek is generally regarded as the apostle of a brand of economics which holds that the market will assure the optimal allocation of resources — as long as the government doesn’t interfere. It is a formalized and mathematical theory, whose two main pillars are the efficient market hypothesis and the theory of rational expectations.

"This is usually called the Chicago School, and it dominates the teaching of economics in the United States. I call it market fundamentalism.

"I have an alternative interpretation — diametrically opposed to the efficient market hypothesis and rational expectations. It is built on the twin pillars of fallibility and reflexivity.

"I firmly believe these principles are in accordance with Hayek’s ideas.

"But we can’t both be right. If I am right, market fundamentalism is wrong. That means I must be able to show some inconsistency in Hayek’s ideas, which is what I propose to do."

Read the rest, Why I agree with (some of) Hayek, at Politico.

This is an eloquent and well argued presentation that George Soros made at the Cato Institute, a Libertarian bastion. I have followed this line of thought since Soros began elaborating it some time ago, and I am in accord with it on philosophical and cognitive grounds. Hayek was a good thinker, too, but his animosity for Communism made him a bit irrational, as Soros observes.

Trader's Crucible Slays the IGBC Bogeyman

Chapter 2: In Which the Traders Crucible slays the Intertemporal Government Budget Constraint, and Mr. Rowe demonstrates his Worth

"If the violations of the no Ponzi criteria are not observable for the most liquid and transparent possible market in any economy, then the EMH must be wrong. No EMH in the market for money has devastating consequences.

"It’s at this point where I raise the head of the IGBC and proclaim the dragon slain. Either you believe the inflation rate as the only way to tell if people believe the IGBC is holding, or go back to believing in crystal balls telling the future. If you insist on a strong belief in magic, then I hand over the head of the EMH."

TC mounts a clever argument in the form of a dilemma — either the Intertemporal Government Budget Constraint (IGBC) or or the Efficient Market Hypothesis (EMH), but not both.