Worth reading

[Bylo Selhi]

Too Much Capital [Efficient Frontier, Nov05]

I, for one, do not despair our low-return world. Who in their right mind would trade the standard of living today, at almost any point on the map, for that of fifty or a hundred years ago? Who would prefer to deal with the horrors of the widespread rural poverty of 1900 or the specter of Hitler and Stalin in the 1940s than with jihadi terrorism or identity theft? The price we pay for this sanguine state of affairs is derisory expected returns. An agreeable piper indeed, and one well worth paying.

[Norbert Schlenker]

Perhaps too esoteric for most, but Fitch has released a study comparing high yield bond default rates between US large and mid caps.

U.S. default rates for mid-cap companies were found to be less volatile and lower in high default periods than those of large-cap companies, according to a new study conducted by Fitch's Credit Market Research group in collaboration with Dr. Edward Altman, Director of New York University's Credit and Debt Markets Research.

As the number of high yield and distressed debt investors grows and the size of these markets approaches $1 trillion, the number of strategies employed by these investors also multiplies. A strategy that has become increasingly popular in recent years is the investment focus on mid-cap companies. The new study looks at the default behavior of mid- and large-cap companies during stress and nonstress periods and examines the volatility of default and loss rates for the two categories over a credit cycle.

The study covers a five-year sample period, 2000-2004, which includes two high default years, two average default years, and one relatively low default year and finds that while the average default rate of large-cap companies is only slightly greater than that of mid-caps in the sample, the rate differences are sensitive to whether the overall annual default rate on high yield bonds is relatively low or high.

In high default periods, e.g. 2001-2002, default rates of large-cap companies are significantly greater than those of mid-caps. In addition, when default rates are low overall, mid-cap companies appear to have higher default rates. The overall volatility of default rates was found to be greater for large-cap companies.

One of the key ingredients of any investment strategy, especially in terms of its risk and return attributes, is the expected default rate on the underlying portfolio securities.

'The study offers empirical evidence that smaller speculative grade companies may be less risky than larger companies during high stress periods and more risky during benign periods' said Mariarosa Verde, Managing Director, Fitch Credit Market Research.

Press Release

You'll have to register to read the actual report.

[Shakespeare]

'The study offers empirical evidence that smaller speculative grade companies may be less risky than larger companies during high stress periods and more risky during benign periods'

The bigger they are the harder they fall?

[Norbert Schlenker]

Yet another case where hundreds of hours of hard academic work with rigorous statistical controls can be summarized in one line of thousand year old folk wisdom.

[Norbert Schlenker]

Protecting the Pocket

How and when to involve children in estate planning

The Case for Self Help

From the Bloomberg Wealth Manager site. It's worth a look about once a month.

[Shakespeare]

I'm going to put this column here because it's a hilarious read. But don't read it while drinking coffee.

Traders, booze and The Amazing Kreskin: Together no more

[peter]

IHT: Funds: Active management wins out - in cycles.

Research paper here.

[George$]

This website seems to have some very interesting reading links
Scholarly Observations and Reviews

[Gus]

Here's an interesting article on research done by a French oil geologist on biases and means when a group of experts makes a prediction. If you liked James Surowiecki's the Wisdom of Crowds, you'll like this.

The geologist looked at the predictions of a number of French film critics who tried to guess how many people would buy cinema tickets in the first day of a film's release. The confidence intervals (means plus error bars) of the critics guesses was wrong 80% of the time, but, overall, the mean of their guesses was very close to the mean of the observed numbers. This provides a nice analogy for how markets work. Passive investors will find grist for their mills here, naturally.

A complete PowerPoint of the presentation is available for download.

[Bylo Selhi]

On Milton Friedman's Birthday, We Get the Present: Him

If we have a free society today, if we have avoided anything close to another Great Depression, if we have prosperity and fairly stable prices, we owe much of it to Milton Friedman. If we have a free market economy that will yet pull us through our many travails and will be the beacon of hope to the whole world, if we still have a majority of the economy not in the hands of the state, much of the credit goes to Milton Friedman. It is not a stretch to say that when great buildings of Manhattan have vanished, intelligent people will still find inspiration in the works of Milton Friedman. He will be in a pantheon of economists along with Adam Smith, David Ricardo and John Stuart Mill.

[Norbert Schlenker]

Milevsky's latest working paper

[Brix]

Dean Baker cheerfully outlines the case for global free trade in professional services:

How much money is at stake here? The U.S. has more than 700,000 doctors with an average pay (net of malpractice insurance) of more than $200,000 a year. In Europe, average pay is close to $100,000 a year. If we just got our doctors pay down to European levels, then we save more than $70 billion a year. We do even better if we could get doctors at wages comparable to what is paid in developing countries. There are over a million lawyers, average pay @$100,000. Who knows how low lawyers’ salaries would fall in a free market.

In the world of unlicensed professionals, inhabited by people like economists, we are still far from the Wal-Mart CD player scenario. (At this point, the economists are yelling about all the foreign born economists in their department. Turn in your license to do economics and read on.) Economics departments can and do hire foreign economists. They must certify to the government that there were no economists with the proper skills available who were citizens or green card holders. In effect, this allows foreign economists to compete on quality, not price. (A prominent World Bank economist once said in this context, that all the best economists he knew were born in India. If there was genuine free trade, all the mediocre economists would also be born in India.)

[Taggart]

A few American financial books that may be worth reading. I've read the first two on the list, and they were great. Most of the others I've heard good things about.

http://www.signonsandiego.com/news/busi ... 1lynn.html

[Brix]

The indefatigably lucid John Norstad has posted a new essay at his Finance Page site: "Mean Reversion, Forecasting and Market Timing."

It includes a rather seductively familiar-looking graph of 1000 coin flips (heads, up one unit; tails, down one):

Note that the ending value 24 is well above the expected ending value of 0. In this simulation, by chance, 512 of the flips came up heads, and 488 of them came up tails, which is 24 more heads than tails. Also note that large up and down swings are quite common in the graph. We can even see a clear "bubble" early on in the simulation. There's a major "bull" market in heads where the graph rises quickly from below 0 to about 24, followed by a "crash" where the graph value quickly declines back down to about 9. Then the market appears to move "sideways" for a long time, followed by another major "bull" market right before the end of the simulation. [emphasis added]

There's much more on the illusions that lead us to try timing the market can appear persuasive, including 'common sense' assumptions about RTM, and widespread, endemic addiction to ex-post analysis.

In conclusion, he assigns the reader two problems:

Consider the following two statements:

A. We know that the average P/E ratio over the last 75 years is about 14. We can use historical market data to test strategies that buy stocks when the P/E ratio is below 14 and sell them when it is above 14. The strategies work very nicely and beat the market by a healthy margin in these tests. Therefore market timing works, and the same strategies will continue to work in the future.

B. Today, the P/E ratio is well above 14. Therefore, future stock market returns will be well below average.

Problem 1 (easy): What's wrong with these seductive arguments?

Problem 2 (hard - extra-credit ): Examine the 10,000 books, articles and papers that have been published promoting a bewildering variety of market forecasting and timing systems. Count up how many of them used in-sample means or otherwise used in-sample data to calibrate their models in the back-tests of their forecasting equations and timing strategies.

[Taggart]

Secrets Of Success: If you want to coin it, start reading

By Jonathan Davis

Published: 17 December 2005

This seems a good moment to provide my annual list of the most interesting and instructive books about investment, for those who fancy some rewarding (though not so light) reading over Christmas.

As it happens, 2005 has produced at least three outstandingly good offerings from the publishers, and a number of other useful titles. Not for the first time however, the best of the crop come from the other side of the Atlantic.

LINK

[Norbert Schlenker]

A very brief golden Chanukah present from William Bernstein

Plus a terrific set of slides (warning: BIG PDF) from a Clifford Asness presentation in May 2005. Starts on page 229, with some interesting stuff preceding it too.

[Brix]

a terrific set of slides (warning: BIG PDF) from a Clifford Asness presentation in May 2005. Starts on page 229

More nutritious than delicious, but really excellent. Thanks.

[peter]

Global macroeconomic outlook for 2006 from Morgan Stanley: http://www.morganstanley.com/GEFdata/digests/20051216-fri.html.

[Taggart]

A few more words about business

Edmonton Journal

Ray Turchansky, Freelance

Published: Friday, December 30, 2005

LINK

One Canadian book I would recommend that's not on his list, is "Why Swim With The Sharks?" - An unconventional guide to early retirement, by Diana Salomaa & Henry Dembicki.

[Bylo Selhi]

Dunno if this has been posted here before but a good source of stimulating reading on a wide variety of economic, financial and political issues and opinions is available at Project Syndicate.

Project Syndicate is an international association of quality newspapers devoted to:
* bringing distinguished voices from across the world to local audiences everywhere;
* strengthening the independence of printed media in transition and developing countries;
* upgrading their journalistic, editorial, and business capacities.

Project Syndicate currently consists of 258 newspapers in 114 countries, with a total circulation of 39,541,478 copies. Its activities fall into two broad categories:
* disseminating the highest quality commentaries and analysis to its member papers;
* fostering institutional links among member papers;

Project Syndicate is a not-for-profit institution. Financial contributions from member papers in developed countries support the services provided free by Project Syndicate to members in less advanced economies. Additional support comes from the Open Society Institute, Politiken Foundation and Die Zeit Ebelin und Gerd Bucerius Foundation.

[Norbert Schlenker]

An author's name in a G&M article leads via google to this interesting paper on herding behaviour in investors.

What's been picked up in the press is the finding that psychologists appear to be better investors than physicists. Physicists get measured as the most "rational" but rationality only matters when other market participants are rational, whereas psychologists appear to be very good at detecting bullshit.

[Bylo Selhi]

whereas psychologists appear to be very good at detecting bullshit.

Perhaps because they're so accomplished at creating it

[George$]

What's been picked up in the press is the finding that psychologists appear to be better investors than physicists. Physicists get measured as the most "rational" but rationality only matters when other market participants are rational, whereas psychologists appear to be very good at detecting bullshit.

C'mon Norm. You can't allow Norbert to post such slurs without a comeback.

[NormR]

What's been picked up in the press is the finding that psychologists appear to be better investors than physicists. Physicists get measured as the most "rational" but rationality only matters when other market participants are rational, whereas psychologists appear to be very good at detecting bullshit.

C'mon Norm. You can't allow Norbert to post such slurs without a comeback.

Now now, as an experimentalist, I'm not in the habit of erasing data points.

[gyrfalcon]

...
What's been picked up in the press is the finding that psychologists appear to be better investors than physicists. ...

Sorry, but no ego = no identity:

Posted: Tue Dec 06, 2005 10:26 am:

" ... Another thing that I think about, likely more than your avg male, is human thought patterns & such. ..."

gyr.