Predictability and correlation

Today another little note that I discovered while teaching. Warning: this will only be of any interest at all to time-series finance academics. I'll try to come back with something practical soon!

Does the predictability of stock returns from variables such as the dividend yield imply that stocks are safer in the long run? The answer would seem to be yes -- price drops mean expected return rises, bringing prices back and making stocks safer in the long run. In fact, the answer is no: it is possible to see strong predctability of returns from dividend yields, yet stocks are completely uncorrelated on their own.

I've been through three versions of showing how this paradox works. In  Asset Pricing the best I could come up with was a complex factorization of the spectral density matrix in order to derive the univariate process for returns implied by the VAR. In later Ph.D. classes, I found a way to do it more simply, by seeing that returns have to follow an ARMA(1,1), and then matching coefficients. This year, I found a way to show it even more simply and intuitively. Here goes.

Prices and Returns

Warning: this will only be interesting to academic finance people.

One of the fun things about teaching is that it forces me to look back at old ideas and refine them. Last week, I needed a problem set for my MBA class. It occurred to me, why not have them do for returns what Shiller did for dividends?

Here it is

Bubble Busters

The latest profession to be displaced by technology: Liberal pundit. 

Bubble Busters

Bubble Busters™ the App is a one-of-a-kind toolbox for progressives that provides fingertip access to numerous stats, graphs, talking points, quotes, analogies, and more to use with far-right conservatives when discussing topics ranging from health care reform to gun control to income inequality. It's everything a progressive would want all in one convenient place. Whether you are a policy expert looking for new ideas or a novice looking to understand the issues better - this is app a must have!

Larry Summers' Martin Feldstein Speech

The latest NBER Reporter has the speech Larry Summers gave at the annual NBER "summer camp" for economists. As you would expect, there are some really interesting bits, which provoked a good lunchroom discussion. To my mind it (and this blog post) gets much better toward the end.

The organizing thread is Larry's worries about long term trends in employment and income distribution, and how trends in productivity and innovation affect it. If the word did not have negative connotations, I might term the talk "neo-Luddite," the worry that this time, unlike all the others, technical change, primarily information technology, will be really bad for workers.

Ouch. "Unemployment" figures in the popular press, but it is the fraction of people actively looking for jobs. The far bigger worry among many economists is the rise in "non-employment." One in ten men, 25-50, are simply not working at all or even looking for work.

The Big Question: Is there an alternative to Obamacare?

A health policy discussion with Booth colleagues Matthew Gentzkow and Matthew Notowidigdo.


The original is here at the Booth / Capital Ideas website. The other "big ideas" videos are really good.

My views expressed here are summed up a bit more eloquently in a recent WSJ Oped, here, and a longer essay "After the ACA" available here. More on health economics and insurance, including how individual insurance can protect against preexisting conditions on my webpage here, and by clicking the "health economics" link to the right.

Two points on inequality

I've stayed out of the inequality - minimum wage business, largely because it strikes me as mostly political posturing rather than serious policy or economics.

A few small points from the blogosphere struck me as interesting enough to pass on, and indicative of that conclusion.

What's the Fed doing? One view

Torsten Slok of Deutsche Bank Research, showed me a slide deck he prepared for evaluating the US economy. Here are a few fascinating graphs. Sorry, the slide deck isn't public -- you have to pay DB for this kind of art!

Most hilariously, "forward guidance" seems to be getting harder.

Torsten also makes the case that interest rates are much below the Fed's usual "Taylor rule." Implicitly, it's supply now not "demand." The market of people who are working looks recovered, the large number of people out of the labor force is the problem, and addressing that is, at least, a deviation from usual policy.

The rest of Torsten's slide deck makes a persuasive case that strong growth may finally be just around the corner, a warning to anyone spending a lot of time on "secular stagnation" models!

No editorial here, I just thought the graphs were really interesting. Thanks to Torsten for allowing me to post them.

Alternative Lenders

I found an interesting article in the Wall Street Journal on Alternative Lenders to small businesses.  Some highlights with comments.

With Credit for Businesses Tight, Nonbank Lenders Offer Financing at a Price

When Khien Nguyen needed $180,000 to open his 13th nail salon near Philadelphia in November, he didn't go to a bank. Mr. Nguyen's credit score had dropped during the recession, so he figured a bank would put him through weeks of aggravation, then reject him.

He turned instead to one of the nonbank, short-term lenders that have been gaining traction since the financial crisis. The lenders cater to small businesses, often at high cost.

Richmond Fed Interview

The Richmond Fed published a long interview with me in their Econ Focus, shorter pdf (print) version here and longer web version here. Some of the questions:

• Does the 2010 Dodd-Frank regulatory reform act meaningfully address runs on shadow banking?
• So what do you think is the most promising way to meaningfully end "too big to fail"?
• Do you think there's any reason to believe recessions following financial crises should necessarily be longer and more severe, as Carmen Reinhart and Kenneth Rogoff have famously suggested?
• Many people have asked whether the finance industry has gotten too big. How should we think about that?
• What are your thoughts on quantitative easing (QE) — the Fed's massive purchases of Treasuries and other assets to push down long-term interest rates — both on its effectiveness and on the fear that it's going to lead to hyperinflation?
• Both fiscal and monetary policies have been on extreme courses recently. What are your thoughts on how they might affect each other as they move back to normal levels?
• Switching gears to finance specifically, what do you think are some of the big unanswered questions for research?
• You wrote an op-ed on an "alternative maximum tax." What’s the idea there?
• Can transfers really help the bottom half of the income distribution?
• Which economists have influenced you the most?

You'll have to click to the interview for answers!

Thanks to Aaron Steelman, Lisa Kenney and especially  Renee Haltom, who helped a lot with the editing. I'm a lot less coherent in person!

Making fun of people's names?

Paul Krugman is now reduced to making fun of my name.

I was alerted to the fact that we were living in a Dark Age of macroeconomics when the same cockroach put in an appearance at the University of Chicago.

Oh how clever. I haven't heard that one since about, hmm, first grade, circa 1965. (Follow the link if you're not sure who he's talking about.)

Paul continues

Now, some people get all upset by this terminology. Why can’t I be serious and respectful? Well, the answer is that we’re not having a serious conversation

No, the royal "we" are not.

I suppose I should read this as a welcome sign of desperation; that Krugman, having run out of ideas, and unwilling to read the interesting "serious conversation" regarding stimulus that the rest of us are having in the academic literature (say, my own recent modest contribution), is reduced to endlessly flogging the old "Say's law" calumny and now this.

Here are Krugman's similarly profound thoughts about Narayana Kocherlakota's name.

Healthcare tidbits

Tidbits that came in following my WSJ oped last week

1. I heard from a lot of people in the burgeoning market for cash only transparent service. Maybe the internet will undercut the current non-competitive system! Some nice links:

http://selfpaypatient.com/ A blog devoted to self-pay patients and doctors.The first post is cool -- why passing laws to force price transparency won't work.

http://www.amazon.com/The-Self-Pay-Patient-Affordable-Healthcare-ebook/dp/B00HBUPLFG/ The e book. Haven't read, looks interesting.

http://surgerycenterofoklahoma.tumblr.com/ Dr. Keith Smith, of Surgery Center of Oklahoma, who I wrote about last week, has a nice tumblr.

 www.regencyhealthnyc.com.  An interesting direct cash pay pricing surgical clinic

2. The "last embassy" blog points out a curious feature of Obamacare: you need a credit card or bank account -- plus internet connection -- to sign up. That's a bit of a problem for poor uninsured people supposedly the beneficiaries of this system. I do sense a bit of a disconnect between the people who designed Obamacare, and the intended beneficiaries -- who don't have a computer, high speed broadband, strong internet skills, credit card and bank account, and who shop (like all of us) by word of mouth. ("They have no computers? Let them use their ipads" a modern Marie Antoinette might say)
http://thelastembassy.blogspot.com/2013/05/the-aca-and-unbankable-or-steve-miller_22.html

3. Cato's Michael Cannon produced an extraordinary comprehensive listing of Adminstration executive orders on Obamacare. I salute Michael's patience to slog through this. Get to the excellent last two paragraphs.
http://www.forbes.com/sites/michaelcannon/2013/12/27/as-predicted-obamacare-plunges-into-utter-chaos/

4. Media. I did a few interviews following the WSJ oped

Fox
http://video.foxbusiness.com/v/2976885479001/the-steps-to-fixing-obamacare/

CNBC's Kudlow report
http://video.cnbc.com/gallery/?play=1&video=3000231610

Not very enlightening, really.

5. Hilarious tidbit. I know, it's hard to clean up websites.

http://www.whitehouse.gov/realitycheck/3

What to do when Obamacare unravels

Wall Street Journal Oped December 26 2013.

The unraveling of the Affordable Care Act presents a historic opportunity for change. Its proponents call it "settled law," but as Prohibition taught us, not even a constitutional amendment is settled law—if it is dysfunctional enough, and if Americans can see a clear alternative.

Source: David Gothard, Wall Street Journal

This fall's website fiasco and policy cancellations are only the beginning. Next spring the individual mandate is likely to unravel when we see how sick the people are who signed up on exchanges, and if our government really is going to penalize voters for not buying health insurance. The employer mandate and "accountable care organizations" will take their turns in the news. There will be scandals. There will be fraud. This will go on for years.

Yet opponents should not sit back and revel in dysfunction. The Affordable Care Act was enacted in response to genuine problems. Without a clear alternative, we will simply patch more, subsidize more, and ignore frauds and scandals, as we do in Medicare and other programs.

There is an alternative. A much freer market in health care and health insurance can work, can deliver high quality, technically innovative care at much lower cost, and solve the pathologies of the pre-existing system.

Why English Majors (and their editors) Should Take an Economics Class

To avoid writing silly articles, as appeared in the Sunday New York Times under the title "Triumph of the English Major." Gerald Howard, a book editor in New York City writes of an early experience:

I had the idea that we should reissue two early novels by the fine writer Alice Adams...

So there I was in our C.F.O.’s office with a P. & L. that just eked out a 7 percent return. He looked at that piece of paper dubiously....Then, with that wry and sad expression with which financial people have regarded liberal arts people since at least the invention of movable type and perhaps even written language, he signed off on my shortfallen P. & L. and said to me, “You know, we could make more money by just putting this advance into a certificate of deposit.”

I knew he was right...C.D.’s were paying 10 percent per annum or more....

However, as I went back to my office I experienced an instance of what the French call “stair wit.” I thought, wait a minute, I am putting that $7,500 to work. It’s an investment. The chain of activity I am putting in motion will give work to printers and shippers. It will provide bookstores (there were still bookstores) with tangible goods to sell at a profit. The revenue from those sales will help to pay my salary, my colleagues’ salaries, even our C.F.O.’s salary. Alice Adams will have some thousands of dollars in her pocket — maybe to invest in a C.D. All this and a few thousand people fewer than I put down on the P. & L. (I’d lied, of course) will have bought and enjoyed two excellent novels that deserved to be in print.

Whereas if we’d just put that money in the hands of a bank, they would just ... well, I was pretty hazy on what a bank would actually do with that money, but my general sense was that it would sit there in a vault microbially propagating itself and what good would that do anybody? Economically I was putting my shoulder — or Penguin’s shoulder — to the wheel! I came away with the conviction that I wasn’t useless anymore.

This makes a good quiz question for an undergraduate micro class. Make it an essay question, for the English majors. "What's wrong with this story?"

Hope for healthcare?

"Can this Man Save Health care?" is another nice article about Dr. Keith Smith, founder of the Surgery Center of Oklahoma (SCO) in Oklahoma City. (Previous blog post here.)  He is trying the audacious, running a low-price hospital with prices posted on the web -- the Southwest Airlines of hospitals that I've been hoping for.

Williamson on the economics blogosphere

Steve Williamson has an insightful set of posts, Minneapolis Redux, and Journalists Looking for a Fight. They are tangentially on the Minneapolis Fed affair, but really about the coverage of the affair and deeply thoughtful about how the economics blogosphere is evolving.

Reporters at the Minneapolis Star-Tribune, the Financial Times, the Wall Street Journal, and other outlets were fair, I think. They talked to the people involved, and covered the story the way good reporters should. What went on in the economics blogosphere I think is revealing of what this medium can and cannot do. In many cases, bloggers dived into the story and did what they do best. They made stuff up, or repeated things that have become "blog truths" - basically fiction that, when repeated often enough, somehow becomes truthy. 

So, this runs from the outrageous to the comical, covering all points in between....

His own posts here set a high standard for looking up, checking, and linking to the things he's talking about. Hopefully the market test will induce us all to better blogging.

What if we got the sign wrong on monetary policy?

I've been following with interest the rumblings of economists playing with an amazing idea -- what if we have the sign wrong on monetary policy? Could it be that raising the interest rate raises inflation, and not the other way around?

Most recently, Steve Williamson plays with this idea towards the end of a recent provocative blog post.   Most of Steve's post is about the Phillips curve, but he concludes

If the Fed actually wants to increase the inflation rate over the medium term, the short-term nominal interest rate has to go up.

Three Nobel Lectures, and the Rhetoric of Finance

It was my great pleasure -- and honor -- to attend this year's Nobel prize ceremonies. It started with the Nobel prize lectures, which I found very thought provoking.

Shiller 

I'll work backwards, as it was thinking about Bob Shiller's talk that taught me the biggest lesson. Preview: this will start pretty negative, but I learn a big lesson by the end. Hang in there, Shiller fans.

Calomiris and Haber on the politics of bank regulation

Foreign Affairs has a very nice article "Why Banking Systems Succeed -- And Fail: The Politics Behind Financial Institutions" by Charles Calomiris and Stephen Haber.

This is a healthy tonic for all us economists who seem to specialize in clever complex advice for the benevolent monarch sort of policy. It's a good reminder of just how counterproductive our bank regulation is for economic ends, and how it serves well political ends.

They cover English vs. Scottish banking, US vs. Canada, and the roots of the dysfunctional US system that crashed in 2008. They are light on the current situation, but it isn't hard to see the same groups feeding at the public trough before receiving tribute now.

Public choice often seems depressing, as if ideas don't matter at all. But they do, and the last few paragraphs are thoughtful.

Within a democracy, effective reforms in banking require more than good ideas or brief windows of opportunity. What is crucial is persistent popular support for good ideas.

It does no good to assume that all the alternative feasible political bargains have already been considered and rejected.As George Bernard Shaw wrote, “The reasonable man adapts himself to the world: the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.” Meaningful banking reform in a democracy depends on informed and stubborn unreasonableness.

"Informed and stubborn unreasonableness." I like that a lot better than "tilting at windmills!"

Chris Demuth on Obamacare

Source: Weekly Standard

I found a nice Obamacare essay by Chris Demuth, "The Silence of the Liberals: Obamacare is Inimical to Their Values Too," in the Weekly Standard.

The point: Liberals ought to join in the project of constructing a market-based alternative to Obamacare.  We do, in fact, have the same goals, and the question is simple cause-and-effect of what policies will actually produce those goals.

A few highlights with comments (but read the whole thing). We start with a quick reminder of the unfolding train wreck:

Obamacare will never achieve its promise of affordable health care for all paid for with improved efficiencies in health insurance and medical care. ...the program improves “access” mainly by herding millions of people and firms into insurance they do not want or need. A great many will simply refuse, having little to fear for the time being, with the result that government expenditures will be far higher than projected. It is equally clear that the variety and quality of medical care will be seriously restricted for all concerned.

"Liberals" may not care about expenditures, but surely ought to worry on the last point.

The charge "you have no alternative" is false:

...many prominent Republicans and conservatives​...[and libertarians]...​have come forward with specific proposals for expanding affordable health care more than Obamacare does, while eliminating its many harmful and unworkable features. 

This is an important point. The alternatives will advance "liberal" values, and give people of modest means better care at lower cost than Obamacare. They "go further and aim higher."  This is not the usual narrative of "people need" government help vs. stingy budget hawks. This is about a better way to achieve the same goals-- and more.

Hansen Nobel Spanish Translation

Spanish translation of my blog post on Lars Hansen's Nobel Prize

El premio Nobel de Lars Hansen (traducción al español de Pedro Cervera)

Lars ha realizado tal cantidad de investigación pionera y profunda, que ni siquiera puedo comenzar a enumerar la lista completa sin comentar que sólo entiendo una parte de ella.

Escribí capítulos enteros de mi libro de texto “Valoración de activos” basándome tan sólo en uno de los documentos de Hansen. Lars escribe para el futuro y normalmente tardamos diez años o más en entender lo que ha hecho y su verdadera importancia....

(para el resto, haga clic aquí (pdf))