22/10/2012: Is Ireland a 'Special Case' in the Euro area periphery?

Since the disastrously vacuous summit last Thursday and Friday, there has been a barrage of 'Ireland is special' statements from Merkel and other political leaders. The alleged 'special' nature of Ireland compared to Greece, Portugal and Spain is, supposedly, reflected in Irish banks being successfully repaired and Irish fiscal crisis corrected to a stronger health position than that of the other peripheral countries.

I am not going to make a comment on the banking system's functionality in Ireland compared to other states. But on the fiscal front, let's take a look. Per IMF:

• In 2012 we expect to post a Government deficit of 8.30% of GDP against Greece's deficit of 7.52%, Portugal's 4.99% and Spain's 6.99%. We are 'special' in so far as we will have the highest deficit of all peripheral countries.
• In 2013, Ireland is forecast to post a Government deficit of 7.52% of GDP against Greece's 4.67%, Portugal's 4.48% and Spain's 5.67%. Once again, 'special' allegedly means the 'worst performing'.
• In 2012, Ireland's structural deficit would have fallen from 9.31% of potential GDP in 2010 to 6.15% - a decline of 3.16 ppt. For Greece, the same numbers are 12.12% to 4.53% - a decline of 7.59 ppt or more than double the rate of austerity than in Ireland. For Portugal, these numbers are  8.96% to 4.09% - a decline of 4.87 ppt of more than 50% deeper reduction than in Ireland. For Spain: 7.32% to 5.39% - a drop of 1.93 ppt or shallower than that for Ireland.
• In 2013 in terms of structural deficit, Ireland (5.38% of potential GDP deficit) will be worse off than Greece (-1.06% of potential GDP), Portugal (2.28%) and Spain (3.52%)

Now, run by me what is so 'special' about Ireland's fiscal adjustment case?

Can it be that we are 'lighter' than other peripherals on debt?

• 2010 Government debt in Ireland stood at 92.175% of GDP and this year it will be around 117.743% - up 25.255% of GDP. For Greece this was respectively 144.55% of GDP in 2010 and 170.731% in 2012 - a rise of 26.181%, marginally faster than that for Ireland. For Portugal, gross Government debt was 93.32% of GDP in 2010 and that rose to 119.066% in 2012, an increase of 25.746%. Again, not far from Ireland's. And for Spain, these numbers were 61.316% to 90.693% - a rise of 29.377%. So while Spain is clearly the worst performer in the class, Ireland, Greece and Portugal are not that far off from each other.

Wait, what about economic reforms and internal devaluations? Surely here Ireland, with its exports-focused economy is a 'special' case?

• In 2012, Ireland is expected to post a current account surplus of 1.813% of GDP, against deficits of between 0.148% and 2.909% for the other three peripheral countries. This, of course, is not the legacy of Irish reforms, but of the MNCs operating from here.
• However, in terms of current account dynamics, Ireland is not that special. Between 2010 and 2012, Greece will reduce its current account deficit by 4.294 ppt, Ireland will improve its external balance by 0.674 ppt, Portugal by 7.105 ppt and Spain by 2.278 ppt. So Ireland is the worst performing country of four in terms of current account dynamics, while the best performing in terms of current account balance.

Now, do run by me what can it possibly mean for Ireland to be a 'special' case compared to Greece, Portugal and Spain?

21/10/2012: Some links for Investment Analysis 2012-2013 course

For Investment Analysis class - here are some good links on CAPM and it's applications to actual strategy formation & research, and couple other topics we covered in depth:

Classic:
"The Capital Asset Pricing Model: Theory and Evidence" Eugene F. Fama and Kenneth R. French : http://papers.ssrn.com/sol3/papers.cfm?abstract_id=440920

"CAPM Over the Long-Run: 1926-2001", Andrew Ang, Joseph Chen, January 21, 2003: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=346600

"Downside Risk", Joseph Chen, Andrew Ang, Yuhang Xing, The Review of Financial Studies, Vol. 19, Issue 4, pp. 1191-1239, 2006

"Mean-Variance Investing", Andrew Ang, August 10, 2012, Columbia Business School Research Paper No. 12/49  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2131932&rec=1&srcabs=2103734&alg=1&pos=1



More related to the Spring 2013 course on HFT and Technical Models:
"A Quantitative Approach to Tactical Asset Allocation" Mebane T. Faber : http://www.mebanefaber.com/2009/02/19/a-quantitative-approach-to-tactical-asset-allocation-updated/

"The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation", Andrew Clare, James Seaton, Peter N. Smith and Stephen Thomas, 11th September 2012: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2126478

"Dynamic Portfolio Choice" Andrew Ang: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2103734

21/10/2012: Overselling & Overhyping

Here's at last a significant recognition from the Irish media that the Government should be held accountable for the claims it makes relating to 'selling' newsflow to the public.

The Irish Government has grossly oversold and mis-interpreted the June 29 EU Summit outcomes, and then subsequently opted to actively undervalue the statements made by the EU states' officials on interpretation of the summit results.

I wrote about this matter here, here, here and here.

20/10/2012: Is there a WW3 going on somewhere?

Is there a war of major proportions the US fighting somewhere?..

And may be Japan and Europe are all fighting for something pretty big too?

20/10/2012: Irish Agriculture 2009-2011 - Value Added

CSO released data for gross value added in agriculture for 2009-2011 yesterday - a set of data that reveals the final figures for the various sources of income in Irish agriculture. The good news is that in 2011 the subsidies junkies have managed (in part on foot of booming agricultural prices) to derive some net value added from their activities. The bad news is that ba far the Agricultural sector in Ireland remains unproductive.

The core figures are defined as follows:

• Net subsidies: Subsidies on products less taxes on products plus subsidies on production less taxes on production.
• GVA at basic prices = Operating surplus + Compensation of employees + Fixed capital consumption - Other subsidies less taxes on production

I have written on many occasions before that Irish agriculture is an extension of the welfare state, in so far as most of the value added in it is provided for by the subsidies. Here are the latest details:

Thus, only in the South-West did 2011 net of tax subsidies cover less than 50% of the operating surplus. In Broder, Midland and Western region, net subsidies exceeded operating surplus.

Over the last 3 years:

• Value of the total output in Livestock nationwide rose from €2,225 million in 2009 to €2,281 million in 2010 and €2,665 million in 2011 - an increase for 2009-2011 of cumulative 19.8%
• Value of the total output in Livestock Products nationwide rose from €1,148 million in 2009 to €1,591 million in 2010 and €1,887 million in 2011 - an increase for 2009-2011 of cumulative 64.3%
• Value of the total output in Crops nationwide rose from €1,377 million in 2009 to €1,523 million in 2010 and €1,751 million in 2011 - an increase for 2009-2011 of cumulative 27.1%
• Value of the Total Goods Output in Agriculture nationwide rose from €4,751 million in 2009 to €5,395 million in 2010 and €6,303 million in 2011 - an increase for 2009-2011 of cumulative 32.7%
• However, there was also a 16.9% rise in Intermediate Consumption of inputs that went into supplying the above Total Goods Output in Agriculture, which rose from €4,185 million in 2009, to €4,302 million in 2010 and €4,890 million in 2011.
• At the same time, Net Subsidies (as defined above) rose only marginally - by 0.04% cumulative, from €1,813 million in 2009declining first to €1,649 million in 2010 and rising to €1,814 million in 2011.
• As the result of this, Operating Surplus in Irish Agriculture went from €1,446 million in 2009 to €1,841 million in 2010 and to €2,395 million in 2011, posting a cumulated rate of growth for 2009-2011 of 65.7%.

All of the above means that absent net subsidies, Irish Agriculture's contribution to the economy (net of costs) would have been: a loss of €367.4 million in 2009, a gain of €192.5 million in 2010 and a gain of €581.5 million in 2011. With a sector that has managed to add - out of its own activity - just €406.6 million to the economy cumulative over last 3 years, we have a lot of policy and marketing hoopla about the value of Ireland's Agriculture.

The table below summarizes inputs and outputs in the GVA calculation for Irish Agriculture:

Even taking into the account wages paid by and to Irish farmers, the overall Agriculture's importance to the economy is (on the net) minor. Oh, and above does not account for the cost of running the Department of Agriculture and other tax-related spending that effectively is an added cost to the taxpayers.

19/10/2012: FDI: It ain't all it is claimed to be...

Quite an interesting little study out of the US worth reading (link here to an earlier version).

Christian Fons-Rosen, Sebnem Kalemli-Ozcan, Bent E. Sørensen, Carolina Villegas-Sanchez, and Vadym Volosovych just published a working paper titled "Where are the Productivity Gains from Foreign Investment? Evidence on Spillovers and Reallocation from Firms, Industries and Countries".

The paper identifies "the effect of foreign direct investment (FDI) on host economies by separating positive productivity (TFP) effects of knowledge spillovers from negative effects of competition."

"Policymakers around the world have welcomed this development and encouraged it given the perceived benefits of FDI such as technology transfer, knowledge spillovers, and better management practices. Several macro-level studies confirm these predictions by documenting a positive correlation between aggregate growth and aggregate FDI flows (see Kose, Prasad, Rogoff, and Wei (2009)). Researchers argue that this positive correlation between FDI and growth is a result of knowledge spillovers from multinationals and their foreign-owned affiliates to domestic firms in the host country."

Unfortunately, as the authors point out, "there is no direct causal evidence at the firm-level supporting this view for a large set of countries. Available evidence lacks external validity and the existing findings vary to a great extent between developed countries and emerging markets depending on the focus of the particular study".

The point raised is that "Any finding of a positive relation between foreign owner- ship and domestic productivity can be an artifact of (a) foreigners investing in productive firms in productive sectors and (b) exit of low productivity domestic firms following foreign investment. Establishing a causal effect of FDI on productivity (directly on foreign owned firms and indirectly via spillovers on domestic firms) is challenging: to identify such an effect, firm and sector specific selection effects must be accounted for, as well as the possibility of dynamic effects through the exit of weak domestic firms."

"The second difficulty in the quest for identification arises from the simultaneity problem. Foreign investment may be correlated over time with higher productivity of affiliates, or higher productivity of domestic firms with whom they interact; however, dynamic patterns might be driven simultaneously by time varying factors other than foreign ownership."

To control for the above, the study uses "a unique new firm/establishment-level data set covering the last decade for a large set of countries (60 countries) with information on economic activity, ownership stake, type, sector, and country of origin of foreign investors."

Top of the line conclusion is that:
"Controlling for foreigners potentially selecting themselves into productive firms and sectors, we show that the positive effect of FDI on the host economy’s aggregate productivity is a myth.
-- Foreigners invest in high productivity firms and sectors, but do not increase productivity of the acquired firms nor enhance the productivity of the average domestic firm.
-- In emerging markets, we find that the productivity of acquired firms increases but the effect is too small to significantly affect the aggregate economy.
-- For domestic firms, a higher level of foreign investment in the same sector of operation leads to strong negative competition effects in both developed and emerging countries.
-- In developed countries, we find evidence of positive spillovers through knowledge transfers only for domestic firms with high initial productivity levels operating within the same broad sector as the multinational investor but in a different sub-sector.
-- Our results confirm the predictions of the new new trade and FDI literature, in that more productive firms select themselves into exporting and FDI activities."

Oops!

More damning:
"Our preliminary results show that foreign owned firms/multinational affiliates are more productive … in developed countries; however, …this effect in developed countries is solely driven by future fundamentals (growth potential); i.e., growing firms becoming foreign-owned."

Double Oops!

Next:
"We find evidence of positive spillovers from foreign activity only when we look at a finer sectoral classification where the domestic firms are not direct competitors of the foreign firms and where domestic firms are at the top of the productivity distribution." Now, let's face it, folks, in MNCs-dominated sectors, Irish firms are not exactly a shining example of being at the top of the productivity distribution (except perhaps in ICT services, but most certainly not in pharma or medical devices or financial services). Which means that by and large we should not expect significant spillovers from the MNCs to Irish firms.


PS: Sadly, the study was not able to incorporate data from Ireland, because - to use polite authors' expression - Ireland belongs to a group of countries with 'Problematic Data Coverage' (aka dodgy data) for Manufacturing firms 2002-2007.

19/10/2012: Tail Risk and Basic Investment Markets Models

For Investment Theory course: some additional slides on the topic of tail risks and applicability of the models we covered in class (note: these are just supplementary readings, so no exam-focused material):

Here are few of my slides from the 2009-2010 Advanced Quantitative Portfolio Management course. You can enlarge each slide by clicking on it.

18/10/2012: ARMs - compounded effects of austerity and banks deleveraging

As the Irish banks are hiking ARMs, it is worth reminding us as to why this is a bad news for Irish economy:

Now, here's the Catch22.

1. Irish banks funding costs are joined at a hip with the Sovereign funding costs, thus reducing these costs will require reducing Sovereign costs, which in turn means taking in more taxes and cutting back more Government spending.
2. The former part of (1) means that households on the ARMs will be bearing all of the burden of the high funding costs for the banks.
3. The latter part of (2) means that households on the ARMs are going to experience, alongside all other economic agents, the cost of Government deleveraging.

(2) + (3) means that in our 'fairness-concerned' society, ARMs holders will be paying twice the rate of the fiscal adjustment that any other group of agents.

Good luck, Michael Noonan, bankrupting the ARMs.

18/10/2012: Summit/Dinner+Dinner Commencing

With the start of the 2-day summit (cross-out: series of dinners) at the EU, here's what JPM research team we should expect from the meetings:

In brief: expect nothing much... With that, may I wish good 'news hunting' for the army of media folks besieging EU buildings...

14/10/2012: Shadow Economy

An interesting chart based on OECD data:

The above captures data for 2010 latest so we can expect the 'Latest' metric to come up as the crisis and rising tax burdens continue to push more and more activity into the Black Economy. Still, at ca 15% of GDP in Shadow economy, the problem of extra-legal economy is non-negligible. Another point to make is that since Shadow economy does not apply to the MNCs activities, Ireland figure should be adjusted for GNP/GDP gap. Which would put us right at Sweden's level. Performing the same for mid-1990s figure implies that Ireland's Shadow economy has declined over the period covered by lower percentage points than any other economy (save Austria's, US' and Germany's - where Shadow economy share rose).

13/10/2012: China's Property Bubble

Some interesting insights into China's economy dependency on property markets from the ECB Monthly Bulletin (link: http://www.ecb.int/pub/pdf/mobu/mb201210en.pdf). Italics are mine:

"Housing investment has been an increasingly important source of growth for China in recent years". Most notably:

• Real estate investment accounts for about 25% of total fixed asset investment, with the latter having driven 50% of GDP growth since 2006. So overall, over 12% of China's economic expansion is now due to property boom directly. Associated activities, e.g. construction, construction materials, banking services and planning & development services probably means that good 17-20% of the overall growth in China since 2006 has been due to the real estate investment boom.
• "In terms of its share in GDP, real estate investment rose from 10% in 2006 to 16% in 2011".
• "Construction and real estate services together employ over 10% of the workforce and contribute to 13% of total added value". 
• "Real estate investment also has strong linkages to other industries such as machinery and equipment".

"House prices in China have risen sharply in recent years and are high compared with incomes'. 'High'? Judge for yourselves:

• Average price per sqm of housing "across a sample of 35 large and mid-sized Chinese cities nearly tripled between 1999 and 2011, although this average masks great disparities." 
• "The price of a 100m2 house expressed in multiples of the annual disposable income of an average family of 3.3 persons also varies widely, from 4.4 times yearly income in peripheral cities (Hohhot, Inner Mongolia), to close to 16 in large, booming cities such as Beijing and Shenzhen (see Chart A)."

• "On average, the ratio fell between 1999 and 2011 as disposable income rose faster than the square metre price (11% compared with 9% annually – see the red dotted line in Chart B). However, when one considers the increase in the size of the average house, a different picture begins to emerge. Over recent years, living space has increased from an average of 19.4 m2 per capita in 1999 to 32.7 m2 in 2011,  while the average household size has decreased from 3.6 persons to 3.1, implying that the average house has grown from 70 m2 to 101 m2. As a result, the price of the average house (expressed in multiples of income) rose from 6.4 in 1999 to 8.6 in 2011 (see the blue line in Chart B)." 

13/10/2012: ECB study on fiscal (non)sustainability in OECD 1970-2010

An interesting study (ECB Working paper NO 1465 / AUGUST 2012) titled "REVISITING FISCAL SUSTAINABILITY: PANEL COINTEGRATION AND STRUCTURAL BREAKS IN OECD COUNTRIES" by António Afonso and João Tovar Jalles (link http://ssrn.com/abstract_id=2128484 ) attempts to identify if "fiscal imbalances in a number of OECD countries need to be curtailed before they become economically unsustainable, leading to insolvency situations". The study covered 18 OECD countries over the 1970-2010 period. Italics are mine, throughout.

Per authors: "In our empirical approach we perform a systematic analysis of the stationarity properties of the first-differenced stock of government debt as well as, on the one hand, the relation between government revenues and expenditures and, on the other hand, the relation between primary balances and debt. These approaches provide us with an indirect test on the solvency of public finances in these countries. We conduct this analysis on a country-by-country basis, …as well as for the country panel as a whole."

The study results show that "the first-differenced debt series for most countries is non-stationarity suggesting that the solvency condition would not be satisfied".

In addition, the authors find "the existence of one cointegrating relationship in only 6 countries between revenues and expenditures. However, the overall test results allow the rejection of the cointegration hypothesis in both relationships under scrutiny. In other words, government expenditures, in half of the countries, exhibited a higher growth rate than government revenues, challenging therefore the hypothesis of fiscal sustainability."

"... the cointegrating coefficients for the revenues-expenditures relationship are positive (but less than one) and statistically significant, meaning that for each percentage point of GDP increase in public expenditures, revenues increase by less than one percentage point of GDP."

In terms of causality, the study finds "...stronger effects running from revenues to expenditures and most countries are not able to generate the revenues required to finance the planned expenditures. We find Granger-causality from government debt to the primary balance, which can be seen as evidence of the existence of a Ricardian regime."

Finally, "panel data results corroborate time-series findings, and even though we find that long-run causality seems to run from lagged debt to the primary balance, on average the marginal long-run impact is zero."

Core conclusion: "All in all, we cannot say that fiscal policy has been sustainable for most countries in our sample."

In effect, there has been systemic, long term overspending by the states incapable of backing expenditure hikes with revenues. Living beyond their means is a long-term thing in the sample and is a prevalent modus operandi for the majority of the states over the period of 40 years.