25/10/2012: Cool infographic on social media use in the US Elections

Cool infographic summarizing use of social media in the US elections so far:
http://open-site.org/blog/social-media-election/

(click to enlarge or best go to the link above)

23/10/2012: Article in Expresso

A link to the Portugal's Expresso article on sovereign debt risk premia quoting me.

23/10/2012: HFT restrictions and market efficiency

In my class on Investment Theory (MSc in Finance, TCD) we've discussed the issues relating to markets efficiency, HFT and relative speeds in newsflow and trading. We are going to talk more about this subject in my course on HFT in early 2013.

Here is the latest report on the effects of the EU regulatory interference in HFT.

Quote: "European Union plans to clamp down on trading shares faster than the blink of an eye could damage market efficiency and reduce liquidity, a UK government-sponsored paper said… A report by the Foresight Project, which was sponsored by the British government and gathered evidence from 150 academics and experts from 20 countries, said plans to force minimum resting times on orders could reduce liquidity."

The Project (led by John Beddington, the UK's chief scientific advisor) has found that:

• "...some of the commonly held negative perceptions surrounding HFT are not supported by the available evidence and, indeed, that HFT may have modestly improved the functioning of markets in some respects"
• "However it is believed that policymakers are justified in being concerned about the possible effects of HFT."
• "The report found no direct evidence that HFT increased volatility, nor evidence to suggest it has led to an increase in market abuse."
• "It said that computer-based trading could have adverse side effects in some circumstances and that these risks should be addressed."

As my students would know, I am of two views on HFT:

1. HFT is a necessary activity with inherent risks (as any other activity in the market) 
2. HFT can act in contradiction to the direct real-activity nature of the financial markets, but so can other financial instruments and strategies (e.g. hedging across non-asset-related risks, e.g. using Forex markets).

23/10/2012: Signs, Indicators and Noise

From time to time in the past I used to look at CDS spreads for sovereigns. I have not done so in a while. In fact, I have not even updated my database for these in a while. Why? Because something is dodgy about the sovereign assets' market that is manipulated by the sovereigns. And here's a quote from the TF Market Advisors that sums it up well enough:

"One of the effects of the central bank policies is that many of the more obscure parts of the market that you could look to for clues or early warning signs have been eliminated. Sure these markets still exist, but the information from them is so manipulated that it is difficult to get a clear read."

1. LIBOR : "Between Fed lending programs, LTRO, and the lawsuits, I have no clue what to make of LIBOR other than it probably isn’t a whole lot of use as a sign of anything."
2. EUR/USD 3 month basis swap : "...was another useful indicator showing the relative strength of US banks versus European banks. Again with LTRO and various central bank global swap lines, this measure has become useless. With banks willing to use central bank liquidity without fear of reprisals or negative stigma, they do, and this rate hovers right around where the governments would like it to be."
3. European sovereign CDS : "has become far more difficult to interpret as all these naked bans get enforced. French CDS went from 106 on the 11th of October to 65 today, in pretty much a straight line. I have difficulty thinking of one real reason that France could have done so well – they have funded ESM, instituted some domestic policies that seem dubious at best, have had weak economic data, and are marching to the beat of their own drum in the Euro in a way that indicates willingness to take on more debt, yet they are tighter. This makes it hard to figure out what is going on in European bank CDS."
4. US Treasury Yields : "...are very difficult to figure out. The Fed owns over 35% of treasuries with maturities 5 years and longer. Almost everything you would look at and try and infer from the treasury market is skewed by that."
5. Economic data "has even come under attack. In general I don’t believe the data is manipulated, particularly not for political purposes (but there are a growing number of people who do). But I do think they try and cover up their own mistakes. Jobless claims came in at 337k or something (pre upward revision) two weeks ago. There was a lot of concern, and some very good economists spoke to the BLS and came up with the conclusion that one big state had not sent in their quarter end revisions in time. There was some confirmation of this, but then some sort of denial. Missing the deadline would be an honest mistake in my opinion, it shouldn’t happen, but I can see how it could. Then last week, we posted 388k as the number. Now we have data that looks like 369k, 342k, and 388k. Is the reality that had they properly accounted for the missing number, that the claims have been 369k, 365k, 365k? If so, we have okay but steady claims. If the actual data is correct (which I don’t think it is) then we would have seen some euphoric hiring followed by aggressive firing. I find that harder to believe."

Note, I wrote about US jobless claims figure here.

There is a major problem, folks. While we can debate the numbers left, right and center, what is clear is that the current environment (political, monetary and policy) is becoming less and less transparent. The market signals are being distorted (willingly and via the law of unintended consequences) and this does not bode well for the future. 

22/10/2012: Financial Crises: Borrowers Pain, Creditors Gain

A very interesting paper on the effects of the financial crises on imbalance of power (and thus the imbalance of the incidence of costs) between the borrowers and the lenders. The paper is a serious reality check for Irish policymakers in the context of the 'reforms' of the Personal Insolvency laws currently being proposed. In fact, the Irish proposed 'reforms' actually tragically replicate the very worst implications of the study summarized below.

"Resolving Debt Overhang: Political Constraints in the Aftermath of Financial Crises" by Atif R. Mian, Amir Sufi, and Francesco Trebbi (NBER Working Paper No. 17831, February 2012 http://www.nber.org/papers/w17831) shows that "debtors bear the brunt of a decline in asset prices associated with financial crises and policies aimed at partial debt relief may be warranted to boost growth in the midst of crises. Drawing on the US experience during the Great Recession of 2008-09 and historical evidence in a large panel of countries, [the study explores] why the political system may fail to deliver such policies. [The authors] find that during the Great Recession creditors were able to use the political system more effectively to protect their interests through bailouts. More generally we show that politically countries become more polarized and fractionalized following financial crises. This results in legislative stalemate, making it less likely that crises lead to meaningful macroeconomic reforms."

Mortgage recourse:

"The higher level of recourse and tougher rules for declaring bankruptcy are likely to prevent borrowers from declaring default. As a result, debtors in European countries are more likely to absorb financial shocks internally than declare default. …We investigate this …by comparing the change in default rates across Europe and the United States during the 2007 to 2009 global housing crisis. Since the bankruptcy regime is relatively more lax in the United States, one would expect a larger increase in default rates." Controlling for rates of decline in house prices and the level of indebtedness of the borrowing households (LTVs at origination) the authors test explicitly data for US, U.K., Spain, France and Ireland from 2007 to 2009 using data from the European Mortgage Federation. 

Figure 1 

"The change in default rate (red bar) for USA between 2007 and 2009 is 5.9 percentage points. While the default rate level in 2007 is not shown in Figure 1, it is quite low and similar across the five countries (0.4%, 1.2%, 0.7%, 1.9%, and 2.1% for France, Ireland, Spain, the United Kingdom and the United States, respectively). …All European countries in Figure 1 have high recourse and tough bankruptcy laws relative to the United States. The very large increase in default rates for the US is consistent with the notion that lower level of recourse and easier bankruptcy legislation helps indebted borrowers declare default. …A collective look at the three housing market variables in Figure 1 shows that the United States experienced the highest increase in default rates by far, despite some of the European countries experiencing very similar (if not stronger) decline in house price (e.g. Ireland) and having similar housing leverage (Ireland and the United Kingdom)."

  

The Political Response to Financial Crises and Debt Overhang:

                                                

"The 2007-2009 US financial crisis provides an interesting case study to examine the political tug of war between debtors and creditors. …[In the US], housing assets were the main asset for low net worth individuals, and their housing positions were quite levered. As a result, the collapse in house prices disproportionately affected low net worth individuals. Mian, Rao, and Sufi (2011) show that at the 10th percentile of the county-level house price distribution, house prices dropped by 40 to 60% depending on the house price index used. This decline would completely wipe out the entire net worth of the median household in lowest quintile of the net worth distribution. CoreLogic reports that 25% of mortgages are underwater; for the low net worth individuals in the US, this effectively means that their total net worth is negative." 

"It is in this context that Mian, Sufi and Trebbi (2010a), henceforth MST, document the political economy of two major bailout bills that were passed in the US Congress in 2008. The first of these bills, the American Housing Rescue and Foreclosure Prevention Act (AHRFPA), provided up to $300 billion in Federal Housing Administration insurance for renegotiated mortgages, which translated into using public funds to provide debtor relief… At the same time, creditors--i.e., the shareholders and debt-holders of large financial institutions--pushed a second bill which was closely tied to protecting their own interests [the $700 billion Emergency Economic Stabilization Act (EESA) which eventually led to TARP]…"

"While both debtors and creditors were effective in passing legislation in their favor, there were two important differences in the magnitude of their effectiveness. First, the debtor friendly bill provided fewer resources ($300 billion versus $700 billion) than the creditor friendly legislation… [despite the fact that] debtors faced substantially larger losses …than creditors in the face of the US housing crisis. Second, while the creditor friendly EESA bill was fully implemented and executed, the housing legislation was a miserable failure. As of December 2008, there were only 312 applications for relief under the program and the secretary of Housing and Urban Development was highly critical of the program. … When Obama Administration …implemented the Home Affordability Modification Program under AHRFPA, their initial goal was to help 3 to 4 million homeowners with loan modifications. In July, 2011 President Obama admitted that HAMP program has “probably been the area that's been most stubborn to us trying to solve the problem.”" 

"It is worth noting that one of the main reasons for the ineffectiveness of the HAMP program has been the lack of cooperation from creditors. The initial legislation made creditor cooperation completely voluntary, thereby enabling many creditors to opt out of the program despite qualifying borrowers. In fact, as Representative Barney Frank noted, banks actually helped formulate the program in the summer of 2008."

Need I remind you that in Ireland's reform bill to alter the draconian personal insolvency laws currently on the books, the banks not only have an option of voluntary participation, but an actual veto on resolution mechanism deployed.

"Cross-country evidence on financial crises and change in creditor rights The seminal work of La Porta et al (1998), followed by Djankov et al. (2007), introduced cross-country index of “creditor rights” from 1978 to 2002. The index captures the rights of secured lenders under a country’s legal system. A country has stronger creditor rights if: 

1.  there are restrictions for a debtor to file for reorganization [In the case of Ireland's Insolvency Law reform, this factor is actually made worse than in the current legislation since the reform law is going to force debtors to undergo a period of compulsory arrangements dictated solely by the banks before they can file for bankruptcy]; 
2. creditors are able to seize collateral in bankruptcy automatically without any “asset freeze” [again, my reading of Ireland's 'reform' proposals suggests automatic seizure of assets once bankruptcy is granted]; 
3. secured creditors are paid first [as is the case in Ireland]; and 
4. control shifts away from management as soon as bankruptcy is declared.  

"Overall, while creditor rights promote the origination of more credit, a financial crisis that results from excessive debt tends to reduce creditor rights. These results highlight a fundamental tension between the benefits of stronger creditor rights ex-ante and the debt overhang costs associated with giving creditor too much power in the financial crisis state of the world. Ex-post relaxation of creditor rights is not the norm after a financial crisis. …More specifically, we show that financial crises are systematically followed by political polarization and that this may result in gridlock and anemic reform. …Financial crises polarize debtors and creditors in society. On the one hand, debtors are weakened by a fall in the value of assets they hold. On the other hand, creditors become more sensitive to write-offs during bad times …and possibly more reluctant to converge onto a renegotiated platform because of their increased reliance on the satisfaction of the original terms of agreement."

22/10/2012: Income Tax in Ireland: a snapshot

Another tax chart (source here) on effective income & social security taxes in various countries:

And so where's Ireland in this? I took KPMG tax calculator for 2012 and... for a person on $100,000 (depending on which exchange rate you take - spot or 3mo average), Ireland scores:

• Self-employed person, single, no children effective tax rate of 40%
• PAYE effective tax rate of 37.5-37.75%
• Average for a single earner tax rate of 38.42%

See for yourselves where that places Ireland.

More on this in forthcoming Village Magazine issue.

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.