Category Archives: The Real World

Are markets efficient? Let the two Nobel Economics Laureates debate!

Two Nobel laureates in economics from University of Chicago, Eugene Fama (2013) and Richard Thaler (2017) debate the efficient market hypothesis. This debate is required viewing for anyone with even a remote interest in finance!  (spoiler alert – virtually all derivatives pricing models covered in Finance 4366 assume that the underlying asset follows a random walk, which corresponds to the so-called “weak form” of Fama’s efficient market hypothesis)…

Eugene F. Fama and Richard H. Thaler discuss whether markets are prone to bubbles.

Extra Credit opportunity: Cyber Day Panel Discussion

Here is a very worthwhile extra credit opportunity for Finance 4366. You may earn extra credit by attending and reporting on the Cyber Day Panel Discussion described below.  In order to receive extra credit for this presentation, you must submit (via email sent to a 1-2 page executive summary of what you learn from this panel discussion. The executive summary is due by no later than 5 p.m. on Monday, October 9th.  This extra credit will replace your lowest quiz grade in Finance 4366 (assuming the extra credit grade is higher).

Important empirical evidence on hedge fund performance…

An ongoing debate in finance is whether “active” investment strategies can outperform “passive” strategies. The empirical evidence in favor of passive strategies which appears in studies published by peer-reviewed scientific journals is overwhelming. For example, in studies of mutual fund performance, passive strategies almost always blow away active strategies. Similarly, the empirical evidence on frequency of trading by “retail” customers is that on average, portfolio performance is inversely related to trading frequency; i.e., the more people trade, the worse they do. Even hedge funds chronically underperform passive investment strategies. For example, the authors of a 2011 Journal of Financial Economics (JFE) article entitled “Higher risk, lower returns: What hedge fund investors really earn” find that hedge fund returns are on the magnitude of 3% to 7% lower than corresponding buy-and-hold fund returns, reliably lower than the return on the Standard & Poor’s (S&P) 500 index, and only marginally higher than the riskless rate of interest.

Notwithstanding the growing popularity of critiques of the efficient market hypothesis (e.g., see “The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street” by Justin Fox), the growing body of scientific evidence which corroborates efficient market theory is very impressive indeed!

Paul Samuelson’s Secret (on the origin of hedge funds)…

In a 2011 article, economics columnist David Warsh provides a fascinating narrative (see “Paul Samuelson’s Secret” for the PDF version) concerning the late MIT economist and Nobel Laureate Paul Samuelson’s involvement in one of the earliest and most influential hedge funds ever, Commodities Corp. Along the way, Mr. Warsh also manages to provide a rich conceptual framework and intellectual history for understanding how important developments in finance theory which were largely pioneered by the likes of Professors Samuelson and Fama (e.g., the notion that financial markets are informationally efficient which in turn implies that stock prices follow a random walk) have influenced the evolution over time of financial markets and institutions. Mr. Warsh also liberally references Sebastian Mallaby’s book entitled “More Money Than God: Hedge Funds and the Making of a New Elite”, which he refers to as a “…very interesting book about the origins and recent history of the hedge fund industry”.

Mexico Earthquakes Test Plan for Investors to Absorb Government Disaster Costs

More on the role of catastrophe (cat) bonds and related derivatives in helping public as well as private entities in insuring natural disasters. See also and for more on cat bonds.

Investors recently bought a catastrophe bond designed to minimize the financial hit to the Mexican government from earthquakes. They could now be on the hook for as much as $150 million after two major quakes struck the country in quick succession.

Ed Thorp, the Man Who Beat the Dealer and the Market (extra credit opportunity)

Here is an extra credit opportunity for Finance 4366. You may earn extra credit by listening to and reporting on the 1 hour, 40 minute podcast hosted by Barry Ritholtz’s Masters of Business podcast (link provided below) entitled “Ed Thorp, the Man Who Beat the Dealer and the Market”.  In order to receive extra credit for this assignment, you must submit (via email sent to a 1-2 page executive summary of what you learned from this podcast; it is due by no later than 5 p.m. on Monday, September 18.  This extra credit assignment will replace your lowest quiz grade in Finance 4366 (assuming the extra credit grade is higher).
Bloomberg View columnist Barry Ritholtz interviews Ed Thorp, one of the most storied people in finance. A math professor at MIT and UC Ivine, Thorp figured out how to beat Las Vegas at blackjack and baccarat, created statistical arbitrage, and ran a hedge fund that not only beat the market by a wide margin, but never had a losing quarter. He is the author of several books, including “Beat the Dealer” and “Beat the Market”; his latest book is “A Man for All Markets.” Thorp tells Ritholtz that the secret to beating the market is having an edge that’s specific, definable and mathematical. If you don’t, you should be in index funds instead. This interview aired on Bloomberg Radio.

How government policy exacerbates hurricanes like Harvey

Here’s the (very timely) cover story of the latest issue of The Economist. Quoting from the article, “Underpricing (of flood insurance) encourages the building of new houses and discourages existing owners from renovating or moving out. According to the Federal Emergency Management Agency, houses that repeatedly flood account for 1% of NFIP’s properties but 25-30% of its claims. Five states, Texas among them, have more than 10,000 such households and, nationwide, their number has been going up by around 5,000 each year. Insurance is meant to provide a signal about risk; in this case, it stifles it.”

As if global warming were not enough of a threat, poor planning and unwise subsidies make floods worse.

On the Economics of Price Gouging

This is an oldie (from 2007) but goody – on the economics of price gouging in the wake of a hurricane. The principles discussed are timeless and well worth pondering!

Mike Munger of Duke University recounts the harrowing (and fascinating) experience of being in the path of a hurricane and the economic forces that were set in motion as a result. One of the most important is the import of urgent supplies when thousands of people are without electricity. Should prices be allowed to rise freely or should the government restrict prices? Listen in as Munger and EconTalk host Russ Roberts discuss the human side of economics after a catastrophe.