My blogpost on innovation in finance, covering HFT, speed and machine learning in financial markets is up on LearnSignal blog: http://blog.learnsignal.com/?p=111. Enjoy.
Showing posts with label Financial markets. Show all posts
Showing posts with label Financial markets. Show all posts
Monday, November 3, 2014
3/11/2014: Tech & Innovation in Finance: Cyborg Algos?
My blogpost on innovation in finance, covering HFT, speed and machine learning in financial markets is up on LearnSignal blog: http://blog.learnsignal.com/?p=111. Enjoy.
Friday, June 17, 2011
18/06/2011: Two papers - Commodities Speculation and Flat Taxes
Some interesting studies worth reading released in recent weeks.
First: Lombardi, Marco J. and Van Robays, Ine, paper "Do Financial Investors Destabilize the Oil Price?" (May 20, 2011). ECB Working Paper No. 1346. Available at SSRN: http://ssrn.com/abstract=1847503
The study results "suggest that …financial activity in the futures market can signi…ficantly affect oil prices in the spot market, although only in the short run. The destabilizing …financial shock only explains about 10 percent of the total variability in oil prices, and shocks to fundamentals are clearly more important over our sample.
Indeed, looking at speci…fic in the second half of 2008 can be mainly explained by a substantial fallback in economic points in time, the gradual run-up in oil prices between 2002 and the summer of 2008 was mainly driven by a series of stronger-than-expected oil demand shocks on the back of booming economic activity, in combination with an increasingly tight oil supply from mid 2004 on. Strong demand-side growth together with stagnating supply were also the main driving factors behind the surge in oil prices in 2007-mid 2008, and the drop in oil prices activity following the …nancial crisis and the associated decline in global oil demand. Since the beginning of 2009, rising oil demand on the back of a recovering global economy also drove most of the recovery in oil prices.
However, we …find that …financial investors did cause oil prices to signifi…cantly diverge from the level justi…ed by oil supply and demand at speci…c points in time. In general, inefficient …financial activity in the futures market pushed oil prices about 15 percent above the level justi…fied by (current and expected) oil fundamentals over the period 2000-mid 2008, when the volume of crude oil derivatives traded on NYMEX quintupled. Particularly in 2007-2008, destabilizing fi…nancial shocks aggravated the volatility present in the oil market and caused oil prices to respectively over- and undershoot their fundamental values by signi…ficant amounts, although oil fundamentals clearly remain more important."
Note - emphasis above and below is my own.
Another interesting study I came across is the Blumkin, Tomer, Sadka, Efraim and Shem-Tov, Yotam, paper "Labor Migration and the Case for Flat Tax" (May 31, 2011). CESifo Working Paper Series No. 3471. Available at SSRN: http://ssrn.com/abstract=1855947
The study examines the case for a flat tax in the presence of migration threats - in other words, in the case of open labour markets. The study considers a tax competition game between two identical countries populated with individuals with two skill-levels.
"We compare between a non-linear tax regime and a flat tax system and demonstrate that in the backdrop of a high-skill migration threat (due to a reduction of the migration costs faced by high-skill individuals), the re-distributive advantage of a non-linear system over a linear (flat) one is significantly mitigated." In other words, when high skills workers are mobile across borders (as in the case of advanced economies, and especially small open economies like Ireland), progressive taxation's main benefit over flat taxes (its actual redistributive 'progressivity') is reduced significantly.
"In the presence of migration, and in sharp contrast to the autarky case, a coordinated shift to a flat system (with its entailed administrative advantages), still allowing for fiscal competition between countries (by maintaining the countries' sovereignty over the welfare state generosity), is not too welfare-reducing; and when administrative costs are taken into account, such a shift may prove to be mutually beneficial for both countries."
"... taking into account the administrative gains associated with a flat system (relative to a non-linear tax regime), even when both countries may choose a general non-linear tax regime, an equilibrium where both do set a flat system in place is likely to form." So for two systems starting from a non-flat progressive taxes base, open labour policies will lead to a flattening of the tax systems.
The authors "...also confirm the race-to the-bottom hypothesis that suggests that migration reduces the extent of redistribution." This point should be salient for Ireland. As we all know, Ireland is currently experiencing very substantial outflow of skills, especially at the higher (internationally marketable) segment of skills distribution. This means that this trend alone will tend to lead to a reduction in the redistributive effectiveness of the existent taxation system progressivity. Thus, there may be serious grounds to consider flatter (not more progressive) taxes as the means to actually mitigate the effects of lost progressivity. Some food for thought.
First: Lombardi, Marco J. and Van Robays, Ine, paper "Do Financial Investors Destabilize the Oil Price?" (May 20, 2011). ECB Working Paper No. 1346. Available at SSRN: http://ssrn.com/abstract=1847503
The study results "suggest that …financial activity in the futures market can signi…ficantly affect oil prices in the spot market, although only in the short run. The destabilizing …financial shock only explains about 10 percent of the total variability in oil prices, and shocks to fundamentals are clearly more important over our sample.
Indeed, looking at speci…fic in the second half of 2008 can be mainly explained by a substantial fallback in economic points in time, the gradual run-up in oil prices between 2002 and the summer of 2008 was mainly driven by a series of stronger-than-expected oil demand shocks on the back of booming economic activity, in combination with an increasingly tight oil supply from mid 2004 on. Strong demand-side growth together with stagnating supply were also the main driving factors behind the surge in oil prices in 2007-mid 2008, and the drop in oil prices activity following the …nancial crisis and the associated decline in global oil demand. Since the beginning of 2009, rising oil demand on the back of a recovering global economy also drove most of the recovery in oil prices.
However, we …find that …financial investors did cause oil prices to signifi…cantly diverge from the level justi…ed by oil supply and demand at speci…c points in time. In general, inefficient …financial activity in the futures market pushed oil prices about 15 percent above the level justi…fied by (current and expected) oil fundamentals over the period 2000-mid 2008, when the volume of crude oil derivatives traded on NYMEX quintupled. Particularly in 2007-2008, destabilizing fi…nancial shocks aggravated the volatility present in the oil market and caused oil prices to respectively over- and undershoot their fundamental values by signi…ficant amounts, although oil fundamentals clearly remain more important."
Note - emphasis above and below is my own.
Another interesting study I came across is the Blumkin, Tomer, Sadka, Efraim and Shem-Tov, Yotam, paper "Labor Migration and the Case for Flat Tax" (May 31, 2011). CESifo Working Paper Series No. 3471. Available at SSRN: http://ssrn.com/abstract=1855947
The study examines the case for a flat tax in the presence of migration threats - in other words, in the case of open labour markets. The study considers a tax competition game between two identical countries populated with individuals with two skill-levels.
"We compare between a non-linear tax regime and a flat tax system and demonstrate that in the backdrop of a high-skill migration threat (due to a reduction of the migration costs faced by high-skill individuals), the re-distributive advantage of a non-linear system over a linear (flat) one is significantly mitigated." In other words, when high skills workers are mobile across borders (as in the case of advanced economies, and especially small open economies like Ireland), progressive taxation's main benefit over flat taxes (its actual redistributive 'progressivity') is reduced significantly.
"In the presence of migration, and in sharp contrast to the autarky case, a coordinated shift to a flat system (with its entailed administrative advantages), still allowing for fiscal competition between countries (by maintaining the countries' sovereignty over the welfare state generosity), is not too welfare-reducing; and when administrative costs are taken into account, such a shift may prove to be mutually beneficial for both countries."
"... taking into account the administrative gains associated with a flat system (relative to a non-linear tax regime), even when both countries may choose a general non-linear tax regime, an equilibrium where both do set a flat system in place is likely to form." So for two systems starting from a non-flat progressive taxes base, open labour policies will lead to a flattening of the tax systems.
The authors "...also confirm the race-to the-bottom hypothesis that suggests that migration reduces the extent of redistribution." This point should be salient for Ireland. As we all know, Ireland is currently experiencing very substantial outflow of skills, especially at the higher (internationally marketable) segment of skills distribution. This means that this trend alone will tend to lead to a reduction in the redistributive effectiveness of the existent taxation system progressivity. Thus, there may be serious grounds to consider flatter (not more progressive) taxes as the means to actually mitigate the effects of lost progressivity. Some food for thought.
Sunday, January 17, 2010
Economics 17/01/2010: Back to the future in risk-aversion?
Are markets settling for a renewed pressure of higher risk aversion strategies?
Given the fact that the US (and generally OECD) economic conditions remain extremely weak, the markets might be signaling a reversal of the risk attitudes - overdue after the rallies of the second half of 2009. The first signals came in from the bond markets, where even sick puppies, such as Ireland, have enjoyed some bounce in recent weeks. One can argue that the Greeks are getting away with a murder, as their CDS and spreads are following much shallower dynamic than one would have expected in light of continued concerns as to the credibility of their fiscal adjustment plans.
But the real ticker for troubles potentially brewing ahead is the overall markets behavior.
Here is one interesting chart:
Given the fact that the US (and generally OECD) economic conditions remain extremely weak, the markets might be signaling a reversal of the risk attitudes - overdue after the rallies of the second half of 2009. The first signals came in from the bond markets, where even sick puppies, such as Ireland, have enjoyed some bounce in recent weeks. One can argue that the Greeks are getting away with a murder, as their CDS and spreads are following much shallower dynamic than one would have expected in light of continued concerns as to the credibility of their fiscal adjustment plans.
But the real ticker for troubles potentially brewing ahead is the overall markets behavior.
Here is one interesting chart:
For last week: TIPS up, bonds up, everything else - down. Not exactly a confidence game. And this is compounded by the January effect not playing out this year so far.
Now, VIX:
Now, not yet as pronounced as on level performance for the markets themselves, but note MCAD cross over and reduced divergence in the last 5 trading days, teamed up with S&P negative movement. Both suggest that VIX downward trend might be breaking.
Irish data is yet to show a clear trend/pattern or resistance breaks -
IFIN is pointing to a gently rising momentum in volatility, ISEQ broader index shows a gentle decline. Plus the highest frequency data I do have relates to daily close prices. But, of course, there are lags relative to the US markets, so something to watch here.
Wednesday, April 22, 2009
Daily Economics 22/04/09: IMF's GFSR
IMF's Global Financial Stability Report (available here) is a lengthy read worthy of attention, both for its finance world-view and a diplomatically correct version of the 'Office' comedy. Subtle language turns tell more of a story of IMF's desperation from looking at APIIGS' incompetent macroeconomic management than the direct phrases. That said, there is little in the report, aside from two tests of financial contagion, that is either new or forward-looking.
"The United States, United Kingdom, and Ireland face some of the largest potential costs of financial stabilization given the scale of mortgage defaults."
Emphasis on the word 'mortgage' is mine, of course, added precisely because the IMF concern has not been, to date, echoed by many Irish economists or banks. In fact, all Irish banks currently assume that mortgage defaults will not happen. Instead, policymakers (via NAMA and debt issuance), bankers (via impairment charges and recapitalization funding) and economists (via RTE / Irish Times opinion pages) have been preoccupied with 'toxic' assets (development loans). Poor households have largely been left out of the 'They deserve help too' circle. The Government actually is so confident that mortgage defaults will not be a problem, that it is taxing households into the recession. As I have noted before, this presents a problem - should inflationary pressures rise, interest rates will regain upward momentum and Ireland will be plunged into a mortgages implosion.
How costly are Lenihan's commitments?
Moving on, two illustrations from the IMF report are worth putting together: First, the sheer size of the so-called 'costless' (Brian Lenihan's grasp of economics), guarantees written by Ireland Inc on our banks:
Second, the real-world cost of these guarantees...
I've identified this link between the throwaway promises Irish Government has been issuing since September and the cost of our debt before. It is nice to see IMF finally saying the same: "Figure 1.37 highlights that the spread on the issues guaranteed by sovereigns perceived as less capable of backing their guarantee is wider than for those that are deemed well able to stand behind their promises, such as the United States and France."
But here is another proof of the link between Brian Lenihan's guarantees and the cost of these to you and me:
Note the coincident timing: September 2008, and spreads on Government debt shooting through the roof to reach banks bonds spreads and trending from there on side-by-side to Anglo's Nationalization (another spike), then to recapitalization (a slight decline)...
Go long, not short...
The IMF advises the Governments to switch debt issuance to longer term maturities. Exactly the opposite is the strategy adopted by the Irish Government that has launched increasing quantities of new 3-9mo bonds into the markets. "...Authorities should take the opportunity of the currently low level of real long-term yields to lengthen the maturity of issuance where possible to reduce their refinancing risk," says the IMF, implying in simple terms that you shouldn't really pile on short term debt at the time of a prolonged crisis.
For all its faults, even the IMF knows that you can't run the country on the back of credit card debt. But Brian, Brian & Mary wouldn't have a clue, would they? All their experience relates to managing a cash cow for the public sector unions that is our public purse.
Shock scenarios
More interesting stuff is in the IMF's modeling of financial shocks: Scenario 1 (pure credit shock with no fire sale of assets - more like a situation in the US in recent months) v Scenario 2(credit shock with fire sale of assets - a more relevant case scenario for the likes of AIB). Here are the results of the latter test:
In scenario 2, Australia shows 7 double-digit responses to shocks to other countries' financial systems, Austria, Italy, Portugal, Sweden & UK 6; Canada, Japan, Spain & US 5; France 8; Belgium, Germany & Ireland 9; The Netherlands 12; Switzerland 13. This hardly supports an assertion that we are driven by external markets crises in our own financial sector to any exceptional degree. Yes, we are less exposed than Switzerland and the Netherlands, but we are way more exposed than the many other countries.
The table below (it is the same table that was reported by me in December 2008) shows that we have the second highest (after Luxembourg) ratio of Bonds, Equities and Banks Assets to GDP in the world - a whooping 900%!
Furthermore, Table 23 provides some amazing evidence: Banks Capital to Assets in Ireland stood at only 4.1% in 2008, down from the high of 5.2% in 2003. Only Belgium and The Netherlands have managed to get lower ratio in 2008. Irish Central Bank actually provided these figures to the IMF and yet the CB has managed to do precious nothing to correct the steadily deteriorating capital ratios throughout 2003-2008 period. This, presumably is why we pay our CB Governor a higher salary than the one awarded to his boss, the ECB Chief.
So the 'comedy' part now being played in Dublin has a simple scenario that IMF, with its diplomatic mission, will not reveal to us, but that is visible to a naked eye though the prism of the IMF report:
"The United States, United Kingdom, and Ireland face some of the largest potential costs of financial stabilization given the scale of mortgage defaults."
Emphasis on the word 'mortgage' is mine, of course, added precisely because the IMF concern has not been, to date, echoed by many Irish economists or banks. In fact, all Irish banks currently assume that mortgage defaults will not happen. Instead, policymakers (via NAMA and debt issuance), bankers (via impairment charges and recapitalization funding) and economists (via RTE / Irish Times opinion pages) have been preoccupied with 'toxic' assets (development loans). Poor households have largely been left out of the 'They deserve help too' circle. The Government actually is so confident that mortgage defaults will not be a problem, that it is taxing households into the recession. As I have noted before, this presents a problem - should inflationary pressures rise, interest rates will regain upward momentum and Ireland will be plunged into a mortgages implosion.
How costly are Lenihan's commitments?
Moving on, two illustrations from the IMF report are worth putting together: First, the sheer size of the so-called 'costless' (Brian Lenihan's grasp of economics), guarantees written by Ireland Inc on our banks:
Second, the real-world cost of these guarantees...
I've identified this link between the throwaway promises Irish Government has been issuing since September and the cost of our debt before. It is nice to see IMF finally saying the same: "Figure 1.37 highlights that the spread on the issues guaranteed by sovereigns perceived as less capable of backing their guarantee is wider than for those that are deemed well able to stand behind their promises, such as the United States and France."
But here is another proof of the link between Brian Lenihan's guarantees and the cost of these to you and me:
Note the coincident timing: September 2008, and spreads on Government debt shooting through the roof to reach banks bonds spreads and trending from there on side-by-side to Anglo's Nationalization (another spike), then to recapitalization (a slight decline)...Go long, not short...
The IMF advises the Governments to switch debt issuance to longer term maturities. Exactly the opposite is the strategy adopted by the Irish Government that has launched increasing quantities of new 3-9mo bonds into the markets. "...Authorities should take the opportunity of the currently low level of real long-term yields to lengthen the maturity of issuance where possible to reduce their refinancing risk," says the IMF, implying in simple terms that you shouldn't really pile on short term debt at the time of a prolonged crisis.
For all its faults, even the IMF knows that you can't run the country on the back of credit card debt. But Brian, Brian & Mary wouldn't have a clue, would they? All their experience relates to managing a cash cow for the public sector unions that is our public purse.
Shock scenarios
More interesting stuff is in the IMF's modeling of financial shocks: Scenario 1 (pure credit shock with no fire sale of assets - more like a situation in the US in recent months) v Scenario 2(credit shock with fire sale of assets - a more relevant case scenario for the likes of AIB). Here are the results of the latter test:
In scenario 2, Australia shows 7 double-digit responses to shocks to other countries' financial systems, Austria, Italy, Portugal, Sweden & UK 6; Canada, Japan, Spain & US 5; France 8; Belgium, Germany & Ireland 9; The Netherlands 12; Switzerland 13. This hardly supports an assertion that we are driven by external markets crises in our own financial sector to any exceptional degree. Yes, we are less exposed than Switzerland and the Netherlands, but we are way more exposed than the many other countries.The table below (it is the same table that was reported by me in December 2008) shows that we have the second highest (after Luxembourg) ratio of Bonds, Equities and Banks Assets to GDP in the world - a whooping 900%!
Furthermore, Table 23 provides some amazing evidence: Banks Capital to Assets in Ireland stood at only 4.1% in 2008, down from the high of 5.2% in 2003. Only Belgium and The Netherlands have managed to get lower ratio in 2008. Irish Central Bank actually provided these figures to the IMF and yet the CB has managed to do precious nothing to correct the steadily deteriorating capital ratios throughout 2003-2008 period. This, presumably is why we pay our CB Governor a higher salary than the one awarded to his boss, the ECB Chief.
So the 'comedy' part now being played in Dublin has a simple scenario that IMF, with its diplomatic mission, will not reveal to us, but that is visible to a naked eye though the prism of the IMF report:
- Incompetent state regulators (CBFSAI and more) get golden parachutes for damaging the financial services sector and the economy;
- Incompetent and greedy politicos are shielding their unions', banks' and developers' cronies from risk and pain caused by (1);
- The ordinary people and businesses of Ireland are paying for (1) and (2).
Monday, March 2, 2009
A sight of carnage: US
DJIA has fallen past the psychologically important 7,000 marker to trade at 6,763.29 at the time of writing this - well below its previous 52-week intraday low of 6,952.06. As it stands, the Dow is now at the levels last seen in April 1997. The chart below illustrates.
The drivers for the latest slide are clearly the renewed pressure on financials and the fact that the Obama Honeymoon is over - the markets are now turning sceptical about the new administration's ability to push the economy out of a depression spiral. Concerns are mounting as to the inflationary effects of the current policies amidst a general conviction that there will be no upside to economic growth. The traditional partisan Democrat policies are now being seen as setting the stage for a return to the dark ages of Jimmy Carter in the near future.
The graph below (courtesy of Calculated Risk) illustrates:
Notice that although the downgrades are much steeper today than in the 1970s, the trajectory of the most current downgrades (slope) is virtually identical to the 1973-1974 crisis. A fellow in the US investment community (thanks for the question HM) just asked me how this can happen, given oil is scrapping the bottom of the barrel in price terms while inflation is yet to rear its ugly face - the opposite of the stagflationary 1970s scenario. Here is an explanation.
The fiscal stimulus package unveiled by Obama is designed to increase inflation-inducing public spending by unprecedented amounts. At the same time, personal income is rising again, while propensity to consume is improving. These are the driving forces of the renewed inflation that can appear just as suddenly as deflation set in late last year.
On the other hand, today's energy in he economy is no longer oil. Instead it is credit and cash. Both are in short supply and near peak level of prices. The oil price is largely irrelevant lagging indicator of global demand, not of the productive capacity of economy. The flow of credit is the latter and not the former.
So the Obama-styled Carterism is going to manifest itself in higher inflation down the road and falling or stagnant real output, as price of the modern 'energy' - credit and money - is going to remain high.
Then again, the US has had it easy so far, compared to Ireland... Chart above illustrates.
May be Mr Cowen can bring some Irish bonds as a gift to the White House for the Paddy's Day? Cheaper than shamrocks and equally symbolically useless.
P.S. There is an excellent summary of the US Economic Conditions for February 2009 at Calculated Risk site (here).
The drivers for the latest slide are clearly the renewed pressure on financials and the fact that the Obama Honeymoon is over - the markets are now turning sceptical about the new administration's ability to push the economy out of a depression spiral. Concerns are mounting as to the inflationary effects of the current policies amidst a general conviction that there will be no upside to economic growth. The traditional partisan Democrat policies are now being seen as setting the stage for a return to the dark ages of Jimmy Carter in the near future.The graph below (courtesy of Calculated Risk) illustrates:
Notice that although the downgrades are much steeper today than in the 1970s, the trajectory of the most current downgrades (slope) is virtually identical to the 1973-1974 crisis. A fellow in the US investment community (thanks for the question HM) just asked me how this can happen, given oil is scrapping the bottom of the barrel in price terms while inflation is yet to rear its ugly face - the opposite of the stagflationary 1970s scenario. Here is an explanation.The fiscal stimulus package unveiled by Obama is designed to increase inflation-inducing public spending by unprecedented amounts. At the same time, personal income is rising again, while propensity to consume is improving. These are the driving forces of the renewed inflation that can appear just as suddenly as deflation set in late last year.
On the other hand, today's energy in he economy is no longer oil. Instead it is credit and cash. Both are in short supply and near peak level of prices. The oil price is largely irrelevant lagging indicator of global demand, not of the productive capacity of economy. The flow of credit is the latter and not the former.
So the Obama-styled Carterism is going to manifest itself in higher inflation down the road and falling or stagnant real output, as price of the modern 'energy' - credit and money - is going to remain high.
Then again, the US has had it easy so far, compared to Ireland... Chart above illustrates.May be Mr Cowen can bring some Irish bonds as a gift to the White House for the Paddy's Day? Cheaper than shamrocks and equally symbolically useless.
P.S. There is an excellent summary of the US Economic Conditions for February 2009 at Calculated Risk site (here).
Subscribe to:
Posts (Atom)
