Cyberlibris blog

Fama - French musings

For those who enjoy Gene Fama and Ken French voices on market efficiency, be aware that they write (since December 2008) regular posts (Q&A) on kind of two-hand blog.

Interesting musings and always instructive to see how these market efficiency hard-liners continue to spread the efficiency gospel.

Have a look at what they say about the Equity Risk Premium puzzle or how they handle Nassim Taleb's Black Swan.

Here is the RSS feed to their writings.

For those who agree to disagree with Fama and French, here is a link to Bob Shiller's books available in Cyberlibris.

By the way, finance aficionados will soon be able to access this.

L'Arrogance de la Finance: comment la théorie financière a produit le krach

En janvier 2009, dans toutes les bonnes librairies et dans toutes les bonnes bibliothèques numériques, l'ouvrage écrit par Eric Briys (Co-fondateur de Cyberlibris) et Henri Bourguinat (Professeur Emérite à l'université de Bordeaux-4) et intitulé "L'Arrogance de la Finance" publié aux Editions La Découverte.

Sous-titre: Comment la théorie financière a produit le krach.

La quatrième de couverture en guise d'apéritif:

"La cause semble entendue : le krach financier d’octobre 2008 incombe aux crédits hypothécaires du marché immobilier américain, les fameux subprimes. En réalité, comme l’expliquent dans ce livre lumineux deux éminents spécialistes de la finance internationale, les racines du mal sont beaucoup plus profondes.

Mus par une sorte d’ivresse technique et une avidité pécuniaire démesurée, les professionnels des marchés ont fait de la « finance pour la finance », comme on fait de l’«art pour l’art ».

Encouragés par les économistes théoriciens de la finance, dont plusieurs prix Nobel, ils ont succombé à un véritable péché d’arrogance. En apportant leur caution scientifique aussi bien au travail des « quants » (les experts des modèles mathématiques d’ingénierie financière) qu’à celui des équipes de gestion des risques, les théoriciens ont conforté les praticiens dans le fantasme d’avoir dompté tous les risques. Or, comme le montrent les auteurs, contrairement à ses prétentions, la théorie financière est bien loin d’offrir cette garantie.

Errements des marchés, perversion du « génome théorique » de la finance et carences de la régulation ont produit une véritable dislocation du système financier. Seule une refonte profonde de celui-ci peut le guérir. Elle risque fort de se révéler longue et douloureuse pour l’« économie réelle » et ses agents, salariés et entrepreneurs."

Risk can be securitized, information may not and that means heading for trouble...

Securitization has become a panacea on financial markets.

Indeed, it is predicated on the simple idea that balance sheets are more often than not the best parking for risks. In other (shareholders) words, they are the most costly parking you can find. Hence, commercial banks with the structuring help of Wall Street firms have "shipped" assets and liabilities that were so far stored in their balance sheets to investors.

It sounds like a marvelous and lucrative never ending innovation spiral à la Merton where banks can do more business, investors have access to a wider spectrum of securities and risks are more efficiently shared.

Too good to be true: The subprime mess is a wake up call, one that calls for deep thinking.

There are some things that do not change. In October 1987, the equity market crashed and portfolio insurance was designated as the culprit. Portfolio insurance used to be considered as the solution to downside risk protection. Investors hate downside risk even more than they love upside. University of Berkeley mavericks, Hayne Leland and Mark Rubinstein (co-founders if LOR), came up with a technique that promised to replicate what a long put option does, namely pay off, when the market goes south. The "trick" was simply to use Black-Scholes-Merton option hedging argument to replicate the put option payoff. In other words, they were selling stock index futures (mechanically/dynamically) and going long T-bills (cash) when the equity market was tanking. When the market was rallying up, they did the opposite. That's why when the market crashed in October 87, LOR was accused of provoking/amplifying the downward trend. The argument is a bit odd: Mark Rubinstein rightly pointed out that nobody praised LOR when the market was going up for making the growth even stronger.

The truth is that while portfolio insurance is in effect more of car insurance than earthquake insurance type there is an important market item that it paradoxically "destroys": Information. Indeed, when lots of investors are willing to buy put options bidding the price up they signal their bearishness to the market. What portfolio insurance does is to break down a single (put) transaction into two separate transactions: stock index futures and T-bills. Information about market expectations may get distorted in the process as it is hard for the rest of the market to decipher the initial intent. Worse, as shown by Sanford Grossman and others when portfolio insurers sell mechanically to dynamically replicate the target put, people may mistakenly think that this signals bad news. Asymmetric information problems have increased and we know both from the seminal works of George Akerlof, Michael Spence and Joseph Stiglitz and casual business experience that this is a sure recipe for trouble.

Sadly enough, the same holds true with securitization as witnessed by the subprime mess. Bad loans have been securitized. As a result the shareholders of the originating banks do not bear the consequences, good or bad, of their loan activity anymore. They have no incentive anymore to monitor these loans that get "diluted" in securitization vehicles. Hence while risks seem to have been more efficiently cut into pieces and shared the overall situation has worsened drastically because asymmetric information problems are now more toxic (1). Asymmetric information is a market killer and we end up collectively harvesting what others have planted.

Not convinced. Well, think of what microfinance does. It does exactly the opposite: It reduces information asymmetries by putting monitoring and safety devices in the micro-lending process: Lend only to women, in a village where everybody knows each other, make the borrowers collectively liable when one of them defaults etc... This is why it is successful.

So, next time innovation in the form of sophisticated securitization knocks at your door, ask yourself whether information and incentives have been reduced or not before joining the bandwagon. If portfolio insurance and the subprime can teach us one thing or two, it is precisely this.



(1) Not to mention the fact that it becomes very hard, almost impossible, to restructure the (securitized) loans when disaster strikes.

From the best minds of finance, marketing, economics....

What if you were to find in one place, in one go? :

• Deborah J. Macinnis ,Professor of Marketing at the Marshall School of Business, USC,
  

• Joanna Shepherd, Professor of Law, Emory Law School,
  

• Martin Gaynor, E.J. Barone Professor of Economics and Health Policy, Northwestern University,
  

• Jack Meyer, Professor of Economics, Michigan State University,
  

• Narayan Naik, Professor of Finance, London Business School,
  

• Dominique Hanssens, Bud Knapp Professor of Marketing, UCLA,

• Yakov Amihud, Ira Leon Rennert Professor of Entrepreneurial Finance,

• Howard Kunreuther, Cecilia Yen Koo Professor of Decision Sciences and Business and Public Policy, The Wharton School,

• Aswath Damodaran, Professor of Finance, New York University,

• Robert C. Merton, John and Natty McArthur University Professor, Harvard Business School,

• John H. Cochrane, Myron S. Scholes Professor of Finance, University of Chicago,

• Rajnish Mehra, Professor of Finance, University of California, Santa Barbara,

• Donald Kuratko, The Jack M. Gill Chair of Entrepreneurship, Indiana University,

and many more....

The contributions of these bright academic spirits are available online full-text in Cyberlibris Academia thanks to Cyberlibris partnership with Now Publishers. Just type the name of the authors in Cyberlibris search box or, even better, just type Now Publishers in the search box and you'll get immediate access to 46 magnificent pieces of work.

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Who said academic conversation was boring!: Vox Academia is live!

We said we would do it. We've done it. Vox Academia is live! Vox Academia is the place for academic chronicles.

It is the place for starting academic conversations and, indeed, from what I've seen already these conversations are far from boring!

So, join Vox Academia and let's have a buoyant worldwide academic conversation!

Stiglitz's Crusade: Rescuing Hostages from International Capital Markets

Here is an interesting video of Nobel Laureate Joseph Stiglitz. Stiglitz is well-known for his contribution to the microeconomics of information, adverse selection and moral hazard.

After having been a World Bank official and receiving the Nobel distinction he embarked on a crusade against international finance and the big players thereof.

According to him, Argentina (and Brazil for that matter) was cursed. Indeed, financial markets decided that Argentina was risky despite the fact its debt to GDP ratio was no worse than most European countries. No matter what Argentina would do right, its fate was carved in stone from outside: Thumbs down as if international financial markets were a large Roman crowd asking for the wounded gladiator's death.

Frankly, I find it hard to swallow. I fail to get the full picture. As always the devil lies in the details. It was a time when Stiglitz had a passion for details (see his insurance and banking papers). It seems that this time is over and leads him to gross oversimplification which is sad for a man of his stature and responsibility.

I leave you the task of judging:

Stiglitz Explains International Finance
Uploaded by madmundo

Marchés financiers, globalisation et croissance

Les marchés financiers ont souvent mauvaise presse. C'est bien dommage et souvent infondé. Au risque de paraître paradoxal, on peut dire que nous ne souffrons pas d'une hypertrophie de marchés financiers. Bien au contraire! L'économie mondiale pâtit d'un nombre insuffisant de marchés financiers, insuffisance qui nuit à la croissance économique.

Croissance et richesse sont les deux versions du même Saint Graal. Ce Graal économique est aussi difficile à cerner que celui de la Geste Arthurienne. Sa quête a mobilisé les talents d’économistes, d’historiens, de sociologues, d’anthropologues. Pourtant, la brûlante question posée par David S. Landes : «Pourquoi sommes-nous si riches et pourquoi sont-ils si pauvres?» reste sans réponse convaincante. Les inégalités de richesse sur la planète restent criantes. L’économiste Péruvien Hernando De Soto a récemment suggéré que le vrai problème n’était pas l’absence de capital dans les pays pauvres mais bien plutôt l’absence de droits de propriété sur ce capital dûment définis et applicables. Dans les pays pauvres, le capital, quel qu’il soit, est mort et le reste.

Dans cet article, nous proposons une explication complémentaire à celle de De Soto : la fracture du partage des risques («the risk-sharing divide»). Le destin de trop nombreuses populations, de trop nombreuses entreprises, de trop nombreux pays demeure dicté par un immense jeu de hasard, particulièrement dans les pays défavorisés qui ont souvent la particularité d’être sous-diversifiés. Ce jeu de dupes est perpétué, entretenu par les louvoiements de nombreuses élites gouvernantes, tant dans les pays développés que sous-développés, qui privent trop souvent les individus, les collectivités, les entreprises des libertés financières les plus élémentaires. Ceci engendre des inégalités injustifiables et inacceptables. Ces inégalités empêchent les individus d’accumuler du capital. Ils en sont contraints à «vivre au jour le jour»

Contrairement à ce que l’on entend trop souvent aujourd’hui, priorité doit être donnée à la libération des forces financières. De nouveaux modes de partage des risques doivent être promus. Dans l’acception habituelle, les marchés financiers garantissent l’ouverture (« Openness »). L’ouverture ne suffit pas. Nous avons besoin de ce que nous appelons dans cet article «d’excentricité responsable». En d’autre s termes, il est impératif que les talents (initiative individuelle, entrepreneuriale) puissent se marier au capital sous ses formes les plus créatives (fonds propres, dettes, titres hybrides, dérivés, titrisation etc…) et que chacun des deux éléments de ce mariage soient tenus de rendre des comptes – privés et publics (justice, police etc.. ) à l’autre partie à tout moment.

Voici les liens vers la version française Haiti.doc et la version anglaise Haiti2.doc de l'article mentionné ci-dessus.

Les vues exprimées dans cet article sont similaires à celles développées par Frédéric S. Mishkin dans son dernier ouvrage "The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems to Get Rich."

What they knew about finance in Genoa in 1298

It is a striking fact that finance academics are not very interested in history and that history academics seem to have a fairly restrictive view of finance.

This is sad: The two fields have much to learn from each other. My co-author, Didier Joos de ter Beerst, and myself have been fascinated by a contract that was signed in 1298 in Genoa between Benedetto Zaccaria, a powerful merchant and admiral, and two Genoese financiers, Enrico Suppa and Baliano Grillo.

To the point that we have conducted an in-depth research about this contract (Didier was able to get a copy of the original version). This contract is a masterpiece of strategy and financial engineering and a great source of inspiration for economists, finance and history scholars.

After months of reading, struggling with the contract, going into intense discussions, we wrote a paper that has already been presented in several conferences. Lastly, Didier presented the paper at the XIVth International Economic History Congress in Helsinki.

If finance, options, derivative and structured products are your pet topics, if you have an interest in insurance and banking; if you are keen on history, especially medieval history, we think you will enjoy this paper.

The latest French version forthcoming in Revue du Financier is here: article_zaccaria.pdf

The current English version (IEHCPAPERBRIYSJOOS.pdf) is fairly long (worth it ;-) but still at the rough draft stage (with typos, sorry!)) We include a shorter (IEHC.ppt). A French version will be published soon.

We'd be delighted to receive your comments!

Finance Vox

A new blog is born! I have started a new blog in French: Finance Vox. This is a blog that will be based upon my teaching at the University of French West Indies. As a matter of fact it is more than that. This is a blog where I am going to share my passion for finance and, indeed, convince you that finance is real fun!

Here is an abstract of my first Finance Vox post. Welcome and enjoy!

Masters of Finance: Markowitz, Sharpe, Samuelson and Merton

The American Finance Association has taken a long awaited initiative entitled The Masters of Finance. In the Association own words:

"In 2004, The American Finance Association Board approved a project to record aspects of the History of Finance. Stephen Buser was appointed Historian with the mission to produce video interviews with important contributors to financial economic knowledge. Links to streaming videos of edited versions of interviews with Harry Markowitz, William Sharpe, Paul Samuelson and Robert Merton are posted below. Transcripts of the full texts of these interviews will be available in due course. Additional interviews with other seminal scholars in the field are planned."

I watched Markowitz and Samuelson and did learn a lot. Next time I teach my class at the University of the French West Indies, these videos are goig to be part of my class blog and, indeed, compulsory watching :-)

I hope the AFA will soon provide RSS feeds so that we can subscribe to its numerous resources. I hope also that AFA will give more and more emphasis to history. Indeed, my view is that finance scholars ought to study history more: They'll learn a lot about all the (financial) things people knew how to do in the past!