Saturday, December 31, 2011

Buses are another matter

From Matt Turner:

First, two commonly suggested responses to traffic congestion—expansions of the road and public transit network—do not appear to have their desired effect:  road and public transit expansions should not be expected to reduce congestion.  Second, traffic levels do not help to predict which cities build roads. Therefore, new roads allocated to metropolitan areas on the basis of current rules are probably not built where they are most needed, which suggests that more careful reviews of highway expansion projects be required. Third, reductions in travel time caused by an average highway expansion are not sufficient to justify the expense of such an expansion. Whether or not other benefits of these expansions may justify their expense remains unresolved. In any case, expansions of the bus network are more likely to pass a cost–benefit test than expansions of the highway network

No wonder he can't understand benefit cost analysis.

In his advocacy for California High Speed Rail, Will Doig can't even get the population of California right.    He says during the century, the population will more than double from 25 million to 60 million.  Well, at the beginning of this century, the census population was around 34 million.

Of course, you can find this out in thousands of places.  He might start here--at the Census web site.  But of course, it is a lot easier just to make stuff up, which is something that rail advocates enjoy doing.  They are about as reliable as the intelligent design people--just cuddlier and not as dangerous.

Choice words from William Black (h/t Rik Osmer)

He writes:

If one had to pick one person in the private sector most responsible for causing the global financial crisis it would be Wallison.  As I explained, he is the person, who with the aid of industry funding, who has pushed the longest and the hardest for the three “de’s.”  It was the three “de’s” combined with modern executive and professional compensation that created the intensely criminogenic environments that have caused our recurrent, intensifying crises.  He complained during the build-up to the crisis that Fannie and Freddie weren’t purchasing more affordable housing loans.  He now claims that it was Fannie and Freddie’s purchase of affordable housing loans that caused the crisis.  He ignores the massive accounting control fraud epidemics and resulting crises that his policies generate.  Upon reading that Fannie and Freddie’s controlling officers purchased the loans as part of a fraud, he asserts that the suit (which refutes his claims) proves his claims.

The piece is long, but worth reading in its entirety. 

Stegman as Geithner's Advisor on Housing

The news that Michael Stegman will be taking a leave from MacArthur to advise Tim Geithner on housing is very good.  It is important for three reasons: (1) Mike has been a leading sensible voice on housing issues for at least 30 years; (2) Treasury has recognized the importance of having an in-house housing person at a senior level; (3) Mike will remind Geithner than users of housing are at least as important as those who lend for housing.

Tuesday, December 27, 2011

Jeremy Stein for Fed Governor (reprise)

Personally, I am a big fan of Stein's work. The shortest way to explain why is to list the titles of his five most cited papers:

  • Herd Behavior and Investment
  • A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets
  • Rick Management: Coordinating Investment and Financing Policies
  • Bad News Travels Slowly: Size, Analyst Coverage and the Profitability of Momentum Strategies
  • Internal Capital Markets and the Competition for Corporate Resources.

Stein has spent his career trying to figure out how capital markets really work instead of pledging fealty to models that don't work very well.  I can't think of a better intellectual qualification for a Federal Reserve Board member.

Sunday, December 25, 2011

Joe Nocera nails it

He writes:

...Peter Wallison, a resident scholar at the American Enterprise Institute, and a former member of the Financial Crisis Inquiry Commission, almost single-handedly created the myth that Fannie Mae and Freddie Mac caused the financial crisis. His partner in crime is another A.E.I. scholar, Edward Pinto, who a very long time ago was Fannie’s chief credit officer. Pinto claims that as of June 2008, 27 million “risky” mortgages had been issued — “and a lion’s share was on Fannie and Freddie’s books,” as Wallison wrote recently. Never mind that his definition of “risky” is so all-encompassing that it includes mortgages with extremely low default rates as well as those with default rates nearing 30 percent. These latter mortgages were the ones created by the unholy alliance between subprime lenders and Wall Street. Pinto’s numbers are the Big Lie’s primary data point.

Two things: First, Pinto and Wallison's definition of "subprime" is any loan that goes to a neighborhood they wouldn't live in or  to a person they wouldn't have lunch with.  According to the American Housing Survey, there were around 52 million mortgages outstanding in the US in 2009.  This means that according to Wallison and Pinto,  the median borrower is a subprime borrower.  I guess this means they think that that half of homeowners with mortgages should be renting in Potterville.

Second, Nocera should in his piece put quotes around the word "scholar."

Friday, December 23, 2011

End of year reflection

This year instead of the usual summary of the past 12 months I would like to share with all my friends and readers of this blog some beautiful music to prompt reflections on all those joyful and fun moments, accomplishments and successes, things that made us proud, personal victories…and failures, sad events and insurmountable loses we suffered. The rollercoaster of fortune and misery… Life.

What would be more appropriate than Kate Bush’s latest Snowflakes and a few pieces from George Winston’s classic album December…

Simon Johnson underlines a problem..that could point to a solution.

He writes:

Santa Claus came early this year for four former executives of Washington Mutual, which failed in 2008. The executives reached a settlement with the FDIC, which sued them for taking huge financial risks while “knowing that the real estate market was in a ‘bubble.’ ” The FDIC had sought to recover $900 million, but the executives have just settled for $64 million, almost all of which will be paid by their insurers; their out-of-pockets costs are estimated at just $400,000.
To be sure, the executives lost their jobs and now must drop claims for additional compensation. But, according to the FDIC, the four still earned more than $95 million from January 2005 through September 2008. This is what happens when financial executives are compensated for “return on equity” unadjusted for risk. The executives get the upside when things go well; when the downside risks materialize, they lose nothing (or close to it).
Just thinking aloud here, but if bank executives were compensated based on return on assets (i.e., the returns to both debt and equity), rather than return on equity, a lot of the misaligned incentives in their pay packages would go away.  Among other things, it would discourage races to the bottom.

Why Fannie and Freddie will likely last

I was talking with SF Chronicle columnist Kathleen Pender yesterday, and she shared a trenchant observation:  now that Congress has figured out a way to use the GSEs to raise revenue (via raising G-fees), it will always have an incentive to keep them.  Specifically, Congress has now tied itself to the GSEs, because it will take awhile for increased G-fees to repay the cost of the payroll tax cut.

Thursday, December 22, 2011

Merry Merry

I can't believe Christmas is almost here!!!

{our Christmas tree...  my mom has given me an ornament every year of my life
& now I have a treefull!  ...thanks ma!}

.....And I swear I'm not 200 years old.. I've also been given many others & bought some myself over the years ;)

 We finished up the work year with a condo installation today and are now totally ready to veg.   Tomorrow is our last-minute shopping day & I'm also hoping for some downtime reading & cuddling by the tree (if at all possible) before the holiday rush of parties.   I'm off for the night, but: a very merry holiday - whichever it is you're celebrating!!- to you & yours!!!
Big hug.

xoxo, Lauren

If you'd like help creating a home you absolutely love, contact me about our design services.

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The Higgs Boson -- and the value of money

What does the (tentatively discovered) Higgs Boson have to do with finance? Nothing. At least nothing obvious. Still, it's a fascinating topic with grand sweeping themes. I've written an essay on it for Bloomberg Views, which will appear later tonight or tomorrow. I'll add the link when it does.

The interesting thing to me about the Higgs Boson, and the associated Higgs field (the boson is an elementary excitation of this field), is the intellectual or conceptual history of the idea. It seems crazy to think that as the universe cooled (very shortly after the big bang) a new field, the Higgs field, suddenly appeared, filling all space, and giving particles mass in proportion to how strongly they interact with that field. It would be a crazy idea if it were just a proposal pulled out of thin air. But the history is that Higgs' work (and the work of many others at the same time, the early 1960s) had very strong stimulation from the BCS theory of superconductivity of ordinary metals, which appeared in 1957.

That theory explained how superconductivity originates through the emergence below a critical temperature of a condensate of paired electrons (hence, bosons) which acts as an extremely sensitive electromagnetic medium. Try to impose a magnetic field inside a superconductor (by bringing a magnet close, for example) and this condensate or field will respond by stirring up currents which act precisely to cancel the field inside the superconductor. This is the essence of superconductivity -- its appearance changes physics inside the superconductor in such a way that electromagnetic fields cannot propagate. In quantum terms (from quantum electrodynamics), this is equivalent to saying that the photon -- the carrier of the electromagnetic fields -- comes to have a mass. It does so because it interacts very strongly with the condensate.

This idea from superconductivity is pretty much identical to the Higgs mechanism for giving the W and Z particles (the carriers of the weak force) mass. This is what I think is fascinating. The Higgs prediction arose not so much from complex mathematics, but from the use of analogy and metaphor -- I wonder if the universe is in some ways like a superconductor? If we're living in a superconductor (not for ordinary electrical charge, but for a different kind of charge of the electroweak field), then it's easy to understand why the W and Z particles have big masses (more than 100 times the mass of the proton). They're just like photons traveling inside an ordinary superconductor -- inside an ordinary metal, lead or tin or aluminum, cooled down to low temperatures.

I think it's fitting that physics theory so celebrated for bewildering mathematics and abstraction beyond ordinary imagination actually has its roots in the understanding of grubby things like magnets and metals. That's where the essential ideas were born and found their initial value.

Having said that none of this has anything to do with finance, however, I should mention a fascinating proposal from 2000 by Per Bak, Simon Nørrelykke and Martin Shubik, which draws a very close analogy between the process which determines the value of money and any Higgs-like mechanism. They made the observation that the absolute value of money is essentially undetermined:
The value of money represents a “continuous symmetry”. If, at some point, the value of money was globally redefined by a certain factor, this would have no consequences whatsoever. Thus, in order to arrive at a specific value of money, the continuous symmetry must be broken.
In other words, a loaf of bread could be worth $1, $10, or $100 -- it doesn't matter. But here and now in the real world it does have one specific value. The symmetry is broken.

This idea of continuous symmetry is something that arises frequently in physics. And it is indeed the breaking of a continuous symmetry that underlies the onset of superconductivity. The mathematics of field theory shows that, anytime a continuous symmetry is broken (so that some variables comes to take on one specific value), there appears in the theory a new dynamical mode -- a so-called Goldstone Mode -- corresponding to fluctuations along the direction of the continuous symmetry. This isn't quite the appearance of mass -- that takes another step in the mathematics, but this Goldstone business is a part of the Higgs mechanism.

I'll try to return to this paper again. It offers a seemingly plausible dynamical model for how a value of money can emerge in an economy, and also why it should be subject to strong inherent fluctuations (because of the Goldstone mode). None of this comes out of equilibrium theory, nor should one expect it to as money is an inherently dynamical thing -- we use it as a tool to manage activities through time, selling our services today to buy food next week, for example.

Wednesday, December 21, 2011

Why to worry about Chinese house prices.

Getting good data from China is problematic, but it is pretty clear house prices there are falling (see here, here and here).  At first blush, this shouldn't cause too much worry, because the Chinese use far less leverage to buy houses than Americans, and so the probability of being upside down there remains pretty low.

The problem, however, is that municipalities in China have lots of debt.  The actual amount is controversial, but the fact that it is a lot is not.  Chinese municipalities service debt using land sales.  So if property values fall a lot.....

Blogger Secret Santa: Who are you???!!

This year I'm in a Secret Santa exchange with some blogger friends -arranged by Stefanie of Brooklyn Limestone- and I have NO IDEA who my {AWESOME} Secret Santa is!!!

Here is the list of possible culprits:

My Santa seems to know me so well!!  (Or maybe I'm really obvious to figure out????  hahaha)  But, really, when my first package arrived I was thrilled.  She's the best.  It was an itunes gift card (yipeeeeeeee-  I love to dance in the kitchen - or anywhere- to new music) and the most adorable little box of GREEN notecards.:

They'll stay in my kitchen where I'm always scrounging around for a piece of paper for grocery lists or notes.   (It's so funny but I can't believe how having this little box of pretty note paper has made life easier for me...  I know it should be common sense to keep paper in the kitchen but I never wanted to because I never had any that was pretty enough to keep out.  All the rest always felt like clutter.  So no more running around through the house looking for scrap paper to make lists for me!!)

Anyway, I was all happy thinking that was it.  But THEN, another package arrived.  ( !!! ) I tore open the package like a six year-old....  (getting gifts in the mail is awesome.) It was a beautiful Stella & Dot box...

{I'm using stella & dot as a clue...  I know some of those Santa culprits above are stella & dot ladies so I'm narrowing down my guessing pool.}

And this is what was inside:

{Seriously Santa???  You are amazing!!!  I LOVE YOU!!}

How did she know??!!  It's perfect and with green being my favorite color, I am going to wear this baby all the time.  (It is more green in person than in the pic if that didn't make sense ;)  It's so beautiful and (maybe it's the pregnancy hormones) but it made me a teensy bit teary.  Santa, thank you for being so generous & thoughtful. 

So...  now that you have seen the list of Secret Santas,  any guesses as to who sent me my package?  Also, I sent a little Santa package myself over to one of those Santas...  You can click these posts below to see the other gifts & make guesses.  If you follow the link to Brooklyn Limestone, you can also enter a contest with your guesses.  Have fun & I would really love some help as to who you think sent me mine so be sure to enter a guess in the comments section!! :)

Thank you again to my Secret Santa.

xoxo, Lauren

If you'd like help creating a home you absolutely love, contact me about our design services.

Monday, December 19, 2011

The Holiday Whirlwind

I guess it probably seems like this every year, but this year seems extremely whirlwindish in terms of the holidays coming up quickly. 
At work, our past month (or 2) has been jam-packed with client installations & presentations and it has floooown: 

{mid-installation day in a living room}

{a dining room}

{sneakity peek of the adjoining living room}

{a master bedrom}

{a sliver of a family room}

{the neighboring breafast room with kids' art gallery}

{an almost-finished master bedroom...  will be sure to post a new pic with artwork, styling & new bedding}

...And there are a few more that I just can't post quite yet... but it's been ca-razy.  (And thank God for my assistant, Meghan.)

At home though, we've tried to take it easy and we've been leaving our weekends fairly open so we have time with each other.  I've been coming out of the first-trimester pregnancy coma and am almost halfway there till baby arrives.  (NOT that I'm wishing this time away...  I know this is the probably the easiest my life is going to be for a loooooong time ;)  But we've been slowly adding Christmas around our house.  One of my favorite simple ways to make the house feel festive is to put hack cut white poinsettias & place them in containers around the house:

{I mentioned last year that I'd seen it in an old Better Homes & Gardens article & it really is sooo fast & pretty.  It's the perfect 1-minute centerpiece.}

We also strung up COLORED LIGHTS outside our house.  I know, I know.  But the kids love them...  And I sort of do too.  (shhhhhhhh ;)

I'm extremely behind on Christmas shopping, as always.

..And...  we celebrated Justin's 2nd birthday last night with my parents & grandparents.   
 I can't believe how big my baby got!! 

{This is a picture of him just after triumphantly annoucing to the table "I'm two!"}

Above, that's his Pop Pop/ my step dad Tom  is making sure he doesn't dive off :)

We celebrated with a caramel cake sent to us by our friends at John Rosselli in Georgetown.  My mom topped it with rice krispy treat snowmen- oh my:

{As you can see, it's tough to have to blow out two whole candles.}
My little sister, "Auntie Morgan," is on the left holding Christian.
Anyway, I hope you're enjoying your own whirlwind.  I've realized that life never really does seem to slow down so you have to make your own moments to savor.  We've been trying ourselves & I hope you've gotten some in at your house too!!

xoxo, Lauren

If you'd like help creating a home you absolutely love, contact me about our design services.

Sunday, December 18, 2011

End of year clearance

One of well hidden gems on is a Thematic Reports Series page which contains a number of free PDF publications for download. Thematic Reports downloads page was developed as an experiment to test user sign-up and file download functionality. It might as well be put to some good use now allowing controlled access to a collection of PDF maps and data files from So, I have just added to the list several PDF maps of postal areas covering capital cities of Australia. These maps show Census 2006 version of boundaries – still relevant for use with official ABS statistics, until the latest Census data is released (sometime in July 2012).

[Persons speaking Vietnamese at home, as proportion of all persons. Source: ABS]

Map of landfill and recycle sites

Geoscience Australia has just released a new dataset mapping locations of waste transfer stations, landfill sites and recycling facilities across Australia. The database identifies 1,700 locations and provides links to the Australian Waste Industries biannual landfill surveys, which allows users to access detailed, site specific information for a range of policy issues as well as environmental and research work. Information is distributed under Creative Commons licence in PDF, KML and Access Database format.

Saturday, December 17, 2011

It is possible to hold the following two views at the same time

(1) The executives for Fannie Mae and Freddie Mac should be held to account for their contributions to the crisis; and

(2) Compared with banks, shadow and otherwise, Fannie and Freddie were pikers in their contributions to the crisis.

Thursday, December 15, 2011

Why don't economists have more influence in the White House?

I was talking to someone who was an official in the adminstration about this.  The person told me the problem is, in part, that economists have poor social skills.  Maybe as part of grad school there should be a one credit charm school elective.

Wednesday, December 14, 2011

A Sign of the Times

Every now and then, I venture out to go shopping at mainstream chain clothing stores.  Although I find it onerous, there are certain things I can't get at thrift stores.  For example, I can never find nice jeans.

The last time I set foot in these stores was about two years ago.  It was tough to find pants my size at that time-- many stores simply didn't sell pants with a 30 inch waist.  This year, it was even harder, since some of the stores that formerly carried 30W pants no longer did.  I managed to find my usual 30W 30L size in two stores, but I had a bizarre experience in both cases.   I put them on, and they were falling off my waist.  Since my waist size hasn't changed in two years, and my old 30W 30L pants of the same brand still fit the same as they did when I bought them two years ago, I have to conclude that both stores have changed their definition of "30 inches".  My new size is 28W 30L, which is tough to find these days.
Read more »

More Motorbike Digitally Painted Ink Sketches

Here are the last of 2011s motorbike sketches that have received the digital treatment.

Rudge TT Rep style 250cc

1911 Humber 3.5hp 500cc
1923 BSA Model E 770cc V Twin

There are a few car sketches left to receive this treatment and then I'll need to find some more subjects to skribble.

The House in My Head

I always have a dream house or "future" house in my head.  I keep a file with floorplans that I've drawn of it and exterior & interior inspiration pics.  I always find myself thinking about what would make a house perfect for me & my family.  I think about it more frequently sometimes than others.  When I lived in my parents' basement with my husband & our first baby a couple of years ago (to recover financially from buying a townhome at the height of the market & selling almost at the low) I used to think about it so much my heart would literally ache.  (Honestly I thought about ANY house at that time, but my dream house got me excited.)  This was a bit what it looked like:  (from Cottage Living)

But after we moved into our 70s bilevel fixer-upper, my idea of our dream house started to change.  (Don't get me wrong, I'm in looooove with the house above, but it's not where the house in my head is at anymore.)  I started to appreciate & crave a more modern feeling for my dream house yet I still wanted the charm of an older house.  I love the walls of windows in our house now, and wish they were even bigger.  I know that I now want glass walls leading straight outdoors all over my future house.  Even though my 70s house is architecturally uninteresting, I started to appreciate its "plain box" qualities & have reimagined how I might have something similar in a new home one day:  

{Our "box" before we moved in.... It feels like we're almost outside or in a tree house.}

I also love the easy living of its floorplan.  All of our main rooms are on one level and our addittional spaces like family room, office & guest room are all on the lower level.  I love this one-floor living and definitely want to keep this easy way of living in our new place.  (In our townhouse I used to leave piles of things at the top and bottom of all the stairs to go up & down...  I used to feel like keeping the house neat was a series of moving things up and down the stairs.)  My husband, who used to be super-traditional is now craving something simple & modern.  (more than me!)  He loves the Cullens' house from Twilight.  (I made him watch it ;)

Every once in a while my husband & I will read a book that makes us think about architecture & we talk about what we want in a house & how we can make our own house better.  When we read Bobby McAlpine's The Home Within Us I really started to think of architecture a bit differently.  I started realizing that it didn't have to be something we'd seen before & that we could one day make something that was really "us."  The thatched roof idea is one I can't shake.

I recently read Ayn Rand's Fountainhead and it really got me excited about our "dream house" again so I decided to hit the drawing board with all of the ideas that had been floating around in my head, unformed, for the past year or so.  I haven't quite finished working out the floorplan but the main living areas are all on the first floor and the back of the house U-shaped and almost all steel floor-to-celing glass windows & doors opening to the yard.   I want the front of the house to have a crazily-pitched roof that swings low onto the front door & windows & I want more privacy in the front than in the back.   And I want the look of a thatched roof:

{We did a little research on thatched roofs & probably will never be able to have one.  They're hard to insure (due to perceived risk of fire) and expensive if you live in an area where they're not done.}  But I'm open to other materials that I can get a similar look from.  I want that old, natural & quaint feeling but mixed with a modern & seamless edge. 

{Bobby McAlpine's first home built by his firm...  I can't get over it or its roof.  I think maybe it's slate & even though it's not thatched, it has the feeling I'm after.  I wonder if you can encourage moss to grow on your slate roof without it hurting anything??  ****  UPDATE:  Greg Tankersley of McAlpine Tankersley Architecture let me know that the roof is actually handsplit cedar shingle, and yes, moss does grow on it!!  Thanks so much Greg!! }

Like I mentioned before, I want the back of my house to be almost completely open so it will definitely be a challenge to mix these two styles without making a total mess.

{love this feeling - oh my goodness!!!!}

I want it to feel as if you're almost outside when you're inside.

I know these two styles are totally different but I think "where there's a will there's a way" and I have a LOT of time to figure it out before we can actually have a dream home anyway. ;)

... The windows in most of these modern homes are mostly glass without the interruption of the steel...

But I'm thinking I like the charm of the paned windows and I'd like a sort of modern conservatory-feeling...

{crazy over the steel windows & doors in Jill Brinson Sharp's home}

It's one detail (of many) I'm still thinking on...  I don't know if we'd feel caged with an entire back wall in them or if it could work for what I want.  I came across this house when searching for inspiration images:

I'd never seen anything like it & am definitely intrigued.  It's not what I'm looking to do but I think it's really interesting in how it combined what reminds me of a barn with a glass contemporary house. 

I was floored when I came across this thatched-roof house:

{image via}

...It is so close to what I want in style.  The back is all open just like I'd envisioned and it even has a thatched roof!!  The feeling I'm after is a different though.  (This is so pretty & fresh & white & modern-feeling whereas I want a more textured, natural, aged feeling.  If you look to the right where you see a more private space with smaller windows... I like that a lot.  I definitely want some "cozy" & private spaces towards the front of the house.)

And finally, I came across this old house which combines my windows with the thatched crazy-sloped roof & this embodies a bit more of the feeling I'm after:

{I would probably want it a little more seamless -without the diagonal bars  btwen the roof & windows- but I think it shows how the glass walls can actually work beautifully with a low roofline.}

Anyway, by the time we're actually able to build this house, I'm sure it will have changed considerably, but for now, I'm really excited about getting this house in my head all figured out.  (Or as figured out as it would need to be before getting an architect involved ;)   I'm always happiest when I have a dream.

What about you:  Do you have a house in your head or a dream house that you think of?  (And if you've written a post on yours, be sure to link to it in the comments section!! :)

xoxo, Lauren

If you'd like help creating a home you absolutely love, contact me about our design services.

ps- I found all of these images on pinterest & listed original sources where I had them.

AND... I wrote this entire post yesterday (which took hours) & when I hit "Publish" on blogger, the WHOLE THING DELETED....  ahhhhh!!!!! :)

Tuesday, December 13, 2011

a little more on power laws

I wanted to respond to several insightful comments on my recent post on power laws in finance. And, after that, pose a question on the economics/finance history of financial time series that I hope someone out there might be able to help me with.

First, comments:

ivansml said...
Why exactly is power-law distribution for asset returns inconsistent with EMH? It is trivial to write "standard" economic model where returns have fat tails, e.g. if we assume that stochastic process for dividends / firm profits has fat tails. That of course may not be very satisfactory explanation, but it still shows that EMH != normal distribution. In fact, Fama wrote about non-gaussian returns back in 1960's (and Mandelbrot before him), so the idea is not exactly new. The work you describe here is certainly useful and interesting, but pure patterns in data (or "stylized facts", as economists would call them) by themselves are not enough - we need some theory to make sense of them, and it would be interesting to hear more about contributions from econophysics in that area.
James Picerno said...
It's also worth pointing out that EMH, as I understand it, doesn't assume or dismiss that returns follow some specific distribution. Rather, EMH simply posits that prices reflect known information. For many years, analysts presumed that EMH implies a random distribution, but the empirical record says otherwise. But the random walk isn't a condition of EMH. Andrew Lo of MIT has discussed this point at length. The market may or may not be efficient, but it's not conditional on random price fluctuations. Separately, ivansmi makes a good point about models. You need a model to reject EMH. But that only brings you so far. Let's say we have a model of asset pricing that rejects EMH. Then the question is whether EMH or the model is wrong? That requires another model. In short, it's ultimately impossible to reject or accept EMH, unless of course you completely trust a given model. But that brings us back to square one. Welcome to economics.
I actually agree with these statements. Let me try to clarify. In my post I said, referring to the fat tails in returns and 1/t decay of volatility correlations, that  "None of these patterns can be explained by anything in the standard economic theories of markets (the EMH etc)." The key word is of course "explained."

The EMH has so much flexibility and is so loosely linked to real data that it is indeed consistent with these observations, as Ivansml (Mark) and James rightly point out. I think it is probably consistent with any conceivable time series of prices. But "being consistent with" isn't a very strong claim, especially if the consistency comes from making further subsidiary assumptions about how these fat tails might come from fluctuations in fundamental values. This seems like a "just so" story (even if the idea that fluctuations in fundamental values could have fat tails is not at all preposterous).

The point I wanted to make is that nothing (that I know of) in traditional economics/finance (i.e. coming out of the EMH paradigm) gives a natural and convincing explanation of these statistical regularities. Such an explanation would start from simple well accepted facts about the behaviour of individuals, firms, etc., market structures and so on, and then demonstrate how -- because of certain logical consequences following from these facts and their interactions -- we should actually expect to find just these kinds of power laws, with the same exponents, etc., and in many different markets. Reading such an explanation, you would say "Oh, now I see where it comes from and how it works!"

To illustrate some possibilities, one class of proposed explanations sees large market movements as having inherently collective origins, i.e. as reflecting large avalanches of trading behaviour coming out of the interactions of market participants. Early models in this class include the famous Santa Fe Institute Stock Market model developed in the mid 1990s. This nice historical summary by Blake LeBaron explores the motivations of this early agent-based model, the first of which was to include a focus on the interactions among market participants, and so go beyond the usual simplifying assumptions of standard theories which assume interactions can be ignored. As LeBaron notes, this work began in part...
... from a desire to understand the impact of agent interactions and group learning dynamics in a financial setting. While agent-based markets have many goals, I see their first scientific use as a tool for understanding the dynamics in relatively traditional economic models. It is these models for which economists often invoke the heroic assumption of convergence to rational expectations equilibrium where agents’ beliefs and behavior have converged to a self-consistent world view. Obviously, this would be a nice place to get to, but the dynamics of this journey are rarely spelled out. Given that financial markets appear to thrive on diverse opinions and behavior, a first level test of rational expectations from a heterogeneous learning perspective was always needed.   
I'm going to write posts on this kind of work soon looking in much more detail. This early model has been greatly extended and had many diverse offspring; a more recent review by LeBaron gives an updated view. In many such models one finds the natural emergence of power law distributions for returns, and also long-term correlations in volatility. These appear to be linked to various kinds of interactions between participants. Essentially, the market is an ecology of interacting trading strategies, and it has naturally rich dynamics as new strategies invade and old strategies, which had been successful, fall into disuse. The market never settles into an equilibrium, but has continuous ongoing fluctuations.

Now, these various models haven't yet explained anything, but they do pose potentially explanatory mechanisms, which need to be tested in detail. Just because these mechanisms CAN produce the right numbers doesn't mean this is really how it works in markets. Indeed, some physicists and economists working together have proposed a very different kind of explanation for the power law with exponent 3 for the (cumulative) distribution of returns which links it to the known power law distribution of the wealth of investors (and hence the size of the trades they can make). This model sees large movements as arising in the large actions of very wealthy market participants. However, this is more than merely attributing the effect to unknown fat tails in fundamentals, as would be the case with EMH based explanations. It starts with empirical observations of tail behaviour in several market quantities and argues that these together imply what we see for market returns.

There are more models and proposed explanations, and I hope to get into all this in some detail soon. But I hope this explains a little why I don't find the EMH based ideas very interesting. Being consistent with these statistical regularities is not as interesting as suggesting clear paths by which they arise.

Of course, I might make one other point too, and maybe this is, deep down, what I find most empty about the EMH paradigm. It essentially assumes away any dynamics in the market. Fundamentals get changed by external forces and the theory supposes that this great complex mass of heterogenous humanity which is the market responds instantaneously to find the new equilibrium which incorporates all information correctly. So, it treats the non-market part of the world -- the weather, politics, business, technology and so on -- as a rich thing with potentially complicated dynamics. Then it treats the market as a really simply dynamical thing which just gets driven in slave fashion by the outside. This to me seems perversely unnatural and impossible to take seriously. But it is indeed very difficult to rule out with hard data. The idea can always be contorted to remain consistent with observations.

Finally, another valuable comment:
David K. Waltz said...
In one of Taleeb's books, didn't he make mention that something cannot be proven true, only disproven? I think it was the whole swan thing - if you have an appropriate sample and count 100% white swans does not prove there are ONLY white swans, while a sample that has a black one proves that there are not ONLY white swans.
Again, I agree completely. This is a basic point about science. We don't ever prove a theory, only disprove it. And the best science works by trying to find data to disprove a hypothesis, not by trying to prove it.

I assume David is referring to my discussion of the empirical cubic power law for market returns. This is indeed a tentative stylized fact which seems to hold with appreciable accuracy in many markets, but there may well be markets in which it doesn't hold (or periods in which the exponent changes). Finding such deviations  would be very interesting as it might offer further clues as to the mechanism behind this phenomenon.

NOW, for the question I wanted to pose. I've been doing some research on the history of finance, and there's something I can't quite understand. Here's the problem:

1. Mandelbrot in the early 1960s showed that market returns had fat tails; he conjectured that they fit the so-called Stable Paretian (now called Stable Levy) distributions which have power law tails. These have the nice property (like the Gaussian) that the composition of the returns for longer intervals, built up from component Stable Paretian distributions, also has the same form. The market looks the same at different time scales.
2. However, Mandelbrot noted in that same paper a shortcoming of his proposal. You can't think of returns as being independent and identically distributed (i.i.d.) over different time intervals because the volatility clusters -- high volatility predicts more to follow, and vice versa. We don't just have an i.i.d. process.
3. Lots of people documented volatility clustering over the next few decades, and in the 1980s Robert Engle and others introduced ARCH/GARCH and all that -- simple time series models able to reproduce the realistic properties of financial times, including volatility clustering.
4. But today I found several papers from the 1990s (and later) still discussing the Stable Paretian distribution as a plausible model for financial time series.

My question is simply -- why was anyone even 20 years ago still writing about the Stable Paretian distribution when the reality of volatility clustering was so well known? My understanding is that this distribution was proposed as a way to save the i.i.d. property (by showing that such a process can still create market fluctuations having similar character on all time scales). But volatility clustering is enough on its own to rule out any i.i.d. process.

Of course, the Stable Paretian business has by now been completely ruled out by empirical work establishing the value of the exponent for returns, which is too large to be consistent with such distributions. I just can't see why it wasn't relegated to the history books long before.

The only possibility, it just dawns on me, is that people may have thought that some minor variation of the original Mandelbrot view might work best. That is, let the distribution over any interval be Stable Paretian, but let the parameters vary a little from one moment to the next. You give up the i.i.d. but might still get some kind of nice stability properties as short intervals get put together into longer ones. You could put Mandelbrot's distribution into ARCH/GARCH rather than the Gaussian. But this is only a guess. Does anyone know?

VicRoads traffic alerts map

Last week VicRoads announced the launch of Road Closures and Traffic Alerts application. Media release issued by the Victorian Minister for Roads, The Hon Terry Mulder MP, provided background information on the project. In particular, Road Closures and Traffic Alerts is a $924,000 initiative to provide real-time information about detours and traffic incidents, such as crashes and breakdowns, as well as road conditions during emergencies. VicRoads will update information as it receives it from its own staff and agencies such as Victoria Police, Country Fire Authority or local government.

The map-based application is accessible online and can be viewed on web-enabled mobile phones. Alerts will also be published via Twitter (but unfortunately there was no mention of RSS version).

Built with Google Map API, the application offers very familiar user interface and very simple, clean design. The list of published incidents is optimised to show only minimum detail (ie. street name, location and type of the incident) and full information is only displayed in pop-up windows on the map. Sections of closed roads, as well as available detours, are marked on the map with blue lines (visible on closer zoom), adding to clarity of presented information. The only limitation is that data is not refreshed automatically and requires manual reload to show the latest incidents.

“The website will be invaluable to road users, media and other emergency service organisations as it provides a real-time picture of incidents occurring on the roads,” Mr Mulder said. “This will help people plan their journeys in advance and help them avoid major road hazards.”

Related Post:
NSW traffic conditions map

Friday, December 9, 2011

60 Minutes Report on the Flavorist Industry

A reader sent me a link to a recent CBS documentary titled "Tweaking Tastes and Creating Cravings", reported by Morley Safer.

Safer describes the "flavorist" industry, entirely dedicated to crafting irresistible odors for the purpose of selling processed and restaurant food.  They focused on the company Givaudin.  Dr. David Kessler, author of The End of Overeating, makes an appearance near the end.

Here are a few notable quotes:

Read more »

Bungalow Dining Room: Before & After

A client of mine purchased an adorable bungalow in a great neighborhood around here & I have been so excited about her project.  We're just finishing up the main level.  She's young & single and has a really great style: relaxed & fresh yet cozy with a tiny vintage-rustic edge.  After talking with her about what she was looking for & pouring over inspiration images, we decided on a mix of woods & aged finished with fresh, happy turquoisey-blues.

{The gorgeous paisley is by Raoul Textiles available through John Rosselli}

We installed the dining room & final rouches in the other rooms earlier this week so I wanted to share a couple quick {unstyled} shots of the dining room.  My camera battery died on installation day (boo hoo!!!) but I will definitely be back to share more & pics of the other spaces.  My client entertains frequently & I can't wait for her have some guests over to enjoy the finished dining room!  Here it is a few days after she moved in.  (You can spy moving boxes)--

...And here it is now:

The artwork is a set of 3 oversized prints (out of 16 total) made out of an antique children's game where the kids could mix and match the landscapes to create different stories.  It's hard to see in this photo but the landscapes line up and we chose a tree, a mountain and a crumbling old building flanked by a super tall pair of alabaster lamps.  The curtains (which are sadly so hard to see in this pic!!) are in a Raoul Textiles linen paisley and I want them. 

The host chairs are slipcovered in a  robin's egg linen and I love their lines.  I'll be sure to share close-ups eventually, but the vintage-styled spindled side chairs are in black with oatmeal linen seats.  The reclaimed wood parsons table is custom by one of our favorite companies -The Lorimer Workshop - and its finish is incredible.  (If you're looking to for the perfect table, I can't recommend them enough.  The owner, David Ellison, is so helpful & knowledgable & you will end up with an amazing piece. Check it out here.)  The sideboard in the background is a painstaking reproduction & it has the most incredible rat-tail hinges.   (by Sarried Ltd.)

Everything is simple & functional and I know my client will serve up some amazing gourmet meals in here.  (She loves to cook & could write a blog on entertaining/ creative meals & drinks:)  I can't thank my client enough for such a fun & rewarding project.   (I don't want it to be over!! ;)

I'm off for the day but have a great weekend & good luck if you're braving the stores for Christmas shopping!!  I am going to try to get a fire going this weekend!

xoxo, Lauren

If you'd like help creating a home you absolutely love, contact me about our design services.

Prosecuting Wall St.

By way of Simolean Sense:
The following is a script of "Prosecuting Wall Street" (CBS) which aired on Dec. 4, 2011. Steve Kroft is correspondent, James Jacoby, producer.

It's been three years since the financial crisis crippled the American economy, and much to the consternation of the general public and the demonstrators on Wall Street, there has not been a single prosecution of a high-ranking Wall Street executive or major financial firm even though fraud and financial misrepresentations played a significant role in the meltdown. We wanted to know why, so nine months ago we began looking for cases that might have prosecutorial merit. Tonight you'll hear about two of them. We begin with a woman named Eileen Foster, a senior executive at Countrywide Financial, one of the epicenters of the crisis.

Steve Kroft: Do you believe that there are people at Countrywide who belong behind bars?

Eileen Foster: Yes.

Kroft: Do you want to give me their names?

Foster: No.

Kroft: Would you give their names to a grand jury if you were asked?

Foster: Yes.

But Eileen Foster has never been asked - and never spoken to the Justice Department - even though she was Countrywide's executive vice president in charge of fraud investigations...
See the video and transcript here.

Thursday, December 8, 2011

Wednesday, December 7, 2011

Who would pay a 73 percent income tax? Not necessarily the rich.

A paper which is receiving considerable attention (see here, here and here) is Diamond and Saez's Journal of Economic Perspectives piece on optimal marginal tax rates.  They put the rate at 73 percent, and declare it an optimum because it would maximize revenue that could then be used for other things.  In particular, they argue that the utility lost to the rich would be much less than the utility gained by lower income people via government programs.  I do believe that many government programs leave people better off, but I am skeptical about whether the optimal size of government is that which is supported by a revenue maximizing income tax.

In any event, one aspect of the paper bothers me: if one searches for the word "incidence," it is not found.  Incidence reflects who really bears the burden of a tax.  If one taxes a person or a business, they might absorb it, or they might pass it on to someone else.

The formula for the incidence of a tax on those who demand a taxed good is (Supply Elasticity)/(Supply Elasticity - Demand Elasticity).  (I apologize for not having elegant formulas--I don't know how to paste them into Blogger).  Because demand curves are generally downward sloping, demand elasticity has a negative sign, so in a sense, the incidence reflects how relatively elastic supply is relative to the sum of the absolute values of the elasticities of demand and supply.

Now let's think about supply elasticity at the revenue maximizing point.  It is exactly one, in that the reduction in labor offered exactly offsets any increase in the rate.  To illustrate, let us just assume for a moment that demand elasticity is -1.  Then half the incidence of the tax is on the supplier of labor or capital (a.k.a. the rich) and half the incidence is on the demander.  This means that the burden on the rich person is 36.5 percent, not 73 percent.

What we do know is that as tax rates fall, the supply elasticity of the wealthy falls.  Why?  Because we know at lower tax rates, raising rates raises revenue-the supply response to an increase in taxes is smaller.  Let's assume that at a 50 percent marginal tax rate, the elasticity of labor supply for the rich is .25.  Now the incidence on demanders is .25/1.25, or 20 percent of the tax burden; it is 80 percent on the rich.  hence with a 50 percent tax rate, the effective tax on the rich is 40 percent, or higher than it would be with a 73 percent rate!

These arguments all depend on assumed elasticity parameters, and so it is important to estimate them as best as possible.  I should also note that I am all for raising taxes, including on myself, to pay for the many government services that I do support.  Somedays I think that if I could change the tax code, I would just raise my own taxes by ten percent and then have policy that assured that everyone with income greater than mine would pay an effective tax rate no lower than mine.

Digitally Painted Ink Sketches Part 2

Here's the next round of digitally painted ink sketches.
Mostly bikes this time with a Model T thrown in for good measure.

Trojan Gearless Cycle Outboard
1904 500cc Peugeot
1923 Harley Davidson JD
1908 FN 4 Cylinder 500cc
1919 Blackburne
1924 Ford Model T