Twofish's Blog

November 2, 2007

Conspiracy theory fodder

Filed under: china, finance, quantitative finance — twofish @ 1:46 am 

One other bit of data is that I was at the Chinese Financial Association conference over the weekend in which Chinese mutual managers were actively trying to recruit Wall Street professionals to come back home and manage portfolios. In the short run, there is a huge demand for all sorts of people to manage QDII transactions. In the long run, one fund mentioned that they were looking for people with experience investing in emerging markets.

The other thing that I got from the conference was how close the cooperation is between Hong Kong and mainland markets. One of the medium term goals of the PRC government seems to be to have Hong Kong displace Tokyo as the center for finance in the “third time zone” as well as to tap into the financial expertise that exists there. One interesting part of this is that one of the goals of Hong Kong appears to be to become a center for Islamic finance which ties into a lot of the themes in this post.

About currency revaluation….. There was a mid-level official from the PRC who gave a talk. He didn’t answer any questions about currency valuation directly, but he did say to read Hu Jintao’s remarks at the party congress in the original Chinese, and that “interesting things are about to happen.”

It was also curious to hear a talk from someone that worked in the Treasury during the mid-1990’s and to hear first hand what they said happened and the relevance to China. Far from trying to destroy East Asian economies, that person said that Treasury and the IMF were trying hard to pump money into the southeast Asia during the crisis, but they were just overwhelmed by the scale of the capital flows.

The final thing about the conference was that it would have been a playground for conspiracy theorists. You had people from the Council of Foreign Relations, Wall Street bankers, ex-officials from the US Treasury Department, officials from the Chinese government, and the heads of some of the Chinese mutual funds all in one room. One point that the PRC official made was that he travelled all the way from China to give a twenty minute talk because the people in the audience, who were a sample of Chinese people who work in Wall Street finance were the precisely people who are going to be making the big decisions in the future.

Yes there is a vast conspiracy. I’ve seen it. I’m actually part of it. Care to join in?

October 4, 2007

Should Chinese Banks Acquire Banks Abroad?

Filed under: china, finance, quantitative finance — twofish @ 8:29 am

This is really interesting because this calls into question one of the basic assumptions of corporate finance which is that the well being of the company is measured by its share price. If an insolvent risky Chinese bank were to buy a solvent one, it would seem obvious to me that this would be “good” for the company, not withstanding the drop in share price.

Along these lines, it would seem therefore that incentive structures that encourage management to increase share prices may simply cause them to accquire more risk at the expense of long term corporate stability, which nicely explains dot-coms…..

By TwofishOpen in a new window – Wed, 03 Oct 2007 15:18:33 GMT

Thinking out loud….

1) How does this apply to minority shareholders?

2) How does this apply to *solvent* banks? Most banks are highly leveraged structures that are always skating on the thin ice of insolvency.

3) How does this apply to a situation in which a person has a given utility function? The regulator has a different loss profile than the shareholder, but the regulator also has a different utility function.

4) How does this apply to different shareholders with different utility functions?

I have to think through this, but I wouldn’t be surprised if the result is that unregulated banks are inherently unstable and that banks need to be highly regulated to function.

By TwofishOpen in a new window – Wed, 03 Oct 2007 15:26:07 GMT

Something that really bothers me about the option framework. In a Black-Scholes world, volatility only affects the price of an option, it shouldn’t affect the price of the stock. It will affect the *return* of a stock, but that shouldn’t change the price of the stock.

Now since we have empirical evidence that it does, then the conclusion is that we are not living in a Black-Scholes world. This opens up the question of what world we are living in. I have a feeling that there are two effects here

1) people are investing not based on the current value of the stock but rather on the expected future value of the stock

2) people have non-linear utility functions, and if you have a non-linear utility function (i.e. you don’t care if the stock falls but you really care if it rises or vice versa) then volatility does under the picture. One bit of thinking that I have is that when people buy an option, they are actually hedging against their own personal utility function, which explains why people buy and sell options.

There is some cool work by Robert Jarrow on how options behave in the middle of an asset price bubble. This line of thought also explains why and how assets are misallocated in a bubble. In Black-Scholes world, everything can be reduced to risk-neutral prices and so there isn’t any incentive to buy risky stocks over treasuries. In a bubble, we are no longer living in a world in which Black-Scholes or Miller-Modigliani apply.

The question is:

1) How do you make cash money from these insights?

2) How do you structure the rules so that you maximize social welfare? We’ve been talking about the national balance sheet. There is probably an equivalent concept of the national utility function.

Those two questions are linked. You would be structure the rules so that in making cash money people engage in behaviors that maximize social welfare.

June 6, 2007

An idea about Chinese corporate bond markets

Filed under: china, quantitative finance — twofish @ 4:40 am

Just a thought….

Instead of replicating Western markets in which corporations generally issue bonds directly on the market, it would seem to make sense for mainland China to issue corporate-backed securities which are modelled after mortgage backed securities.  The advantage of issuing corporate-backed securities rather than individual corporate bonds is that then you don’t have to issue credit ratings off of individual corporations but rather can do statistical measures off of baskets of corporations.  You also can start creating mid-risk/mid-return securities with minimal changes to the current banking and finance structure.

Just a thought….

May 7, 2007

Returning to New York City

Filed under: new york city, quantitative finance — twofish @ 4:32 am

Back in New York City after travelling from MIT via FungWah Bus.  I’ve been rather quiet about what has happened to me over the last month, and that’s because adjusting to a new life is difficult and stressful (although it’s mostly fun difficult and fun stressful).  The other thing is that the rules about what I can say and what I can’t have changed a bit, and while I’m figuring out what the new rules are, I’d like to stay on the quiet side about my work.  Once things settle down a bit more, I’ll talk more.

One of the things that struck me as I saw Manhattan from the Triborough Bridge this morning is how the City has an entirely different character on bright, beautiful days like today than it does on rainy days or at nights.  Most of the previous times that I’ve gone back to NYC it was on an airport shuttle from JFK or transferring from the Newark PATH train at Penn Station in the middle of the night, and the City has an omnious overwhelming feel.  Something similar akin to the movie Blade Runner.  When it rains, there is a sad grey pale over the City.  Today was one of the first times I’ve entered the City in mid-day in good weather, and from a distance the buildings of Manhattan appear in light pastel colors, mostly blue, and the City was beautiful and optimistic.  It’s been said that Superman’s Metropolis is New York in the day, and Batman’s Gotham is New York after dark, and this is rather accurate for how drastically the mood of the City changes.

When I was growing up in the 1970’s, New York City was in the depth of financial crisis, and the talk there was about “urban decay” and “suburban flight.” Before my latest series of trips here, the last time I came was in 1989 which was right before the urban renaissance.  I suppose some of the fear that I had in coming here was related to these childhood and college associations.

One curious thing is that how the internet has actually caused more centralization in some cities.  Because the world is flat, industries that require a lot of close social interaction, like finance, tend to attract people from across the world.  The internet has made it easier to transmit information, but easy transmission of information has also made it easier and more efficient to transport people and physical objects, and this
causes some centralization rather than decentralization.

April 26, 2007

Popping open the parachute

Filed under: Career, quantitative finance — twofish @ 3:34 pm

Last week I left my previous employer.  It feels like jumping out of an airplane (with more than a little push).  It’s not a bad feeling actually.  Scary mostly, but not unpleasant scary.

It’s hard to describe my current status.  Technically, I’m unemployed and “out of a job.”  The curious thing is that I don’t feel as if I am unemployed or “out of a job” since I’ve been as busy, and perhaps even more so than when I was employed.  To quote a useful expression, my job is now to get a job, and that involves calling people, writing resumes, preparing for interviews, reading back and forth, travelling.  A lot of stuff which means that I have much less time for blogging.

 I don’t want to talk too much about the last days of my employer right now.  Someday, but it’s too soon to talk about it.  However, looking over the last several years, I made a series of strategic decisions which seem to be paying off right now in a big way.

The first big strategic decision was to leave the employer before my last employer.  This was a good decision because at the time, I had the chance to continue on albeit with relocation, and I decided to jump ship.  This is good because I’ve been “between jobs” before.  I know what to do, what not to do.  I’m finding in particular that resume writing is *much* easier to do the second time around.

The other big major strategic decision that I made was to put too much of my identity into my new employer or the software I was writing.  This meant that in leaving my employer there was much less emotional trauma than when I left Halliburton, and *MUCH* less trauma than when I left MIT.  One thing that shows this is how little time it took to clean out my desk.  I got notice at 2:30 that my employment was at an end.  By 2:45, I had packed up my office and left the building.  There wasn’t really anything in there that was personal.  Only my personal laptop which I unplugged and carried with me to my car.  This was in contrast to when I left Halliburton when there were boxes and boxes of stuff.

The other thing that made this much less traumatic was that I defined my “job” as something much broader than the 40 hours that I spent at “work.”  I saw myself and still see myself as a “junior faculty person” with a work week of between 60-80 hours.  This made it trival to cope with losing a job, since it was like losing a source of grant funding.  Annoying, but not a big deal in the grand scheme of things.

More to come….

March 22, 2007

China’s aging workers

Filed under: china, finance, quantitative finance — twofish @ 8:08 am

It’s interesting how the NYT moves from crisis to crisis, and has just discovered that China has a huge pension liability problem and an issue with a rapidly aging population.  It’s also interesting that the article doesn’t mention at all, the ***real*** big problem which is coming up.

The problem of China’s aging workers is something that people elsewhere have been thinking about for, I don’t know, the last twenty years.  The second that China started the one child policy, thirty years ago, people have been doing demographic projections, so this really isn’t a new problem.

And then there are the usual “we don’t know what to do, and the government is doomed”  slant, whereas the whole point of Chinese financial restructuring in the last ten years has been to deal with this problem.

I don’t think that it is going to be an insurmountable problem. China has vast pools of savings. The pension hole is about $1.5 trillion, but China has $1.2 trillion in foreign exchange reserves and that number is growing. Also, China has very low productivity, unlike Japan, Chinese workers can produce more by moving from farm to factory.

What really somewhat annoys me is all of the economists that have been saying that China saves too much, should consume more, and switch from a capital-intensive system to a labor-intensive system, and that it is unhealthy for China to be saving 40% of GDP, and that China should spend like there is no tomorrow like Americans do.

But wait!!!! Suddenly there is this realization that hundreds of millions of people are going to retire over the next decade. Oh my goodness, we are doomed. Well maybe it wasn’t just a bad idea that Chinese have been saving like crazy for the last twenty years, unlike these short-sighted economist, the average Chinese peasant realizes that they are going to grow old, and they want to do something about it, and unlike the US government, the Chinese government has been spending the last decade coming up with effective ways of dealing with the aging population.

I’m not too worried about China, since when China grows old they are going to start withdrawing the trillions of dollars that they have invested in the United States. What worries me is what will happen in the United States when that starts happening, and it’s interesting that the New York Times article doesn’t mention the implications of that.  China is pumping $200 billion into the US economy each year because China doesn’t have the financial system to handle all of the retiree money, but the United States does.  At some point this outflow will become an inflow, both as China develops its financial system so that it can invest the money without a “round trip” into the United States, and as retirees retire.

It will be interesting to see what happens.  China will be in good shape because people have been planning for that moment for a long time.  The United States on the other hand……  There is this interesting paragraph…

Most troubling to financial experts, the government has used payroll taxes paid by the current generation of workers, who in theory are paying into their individual retirement accounts, to pay pensions for the previous generation.

Troubling.  Yes.  In the case of China, it’s less bad because workers in 2020 will likely be much more productive than workers today, and having a “pay as you go” system will push some of this productivity into the aging population.  Chinese save money today.  This goes into a factory that increases the wealth of workers there.  Some of this wealth goes into a payroll tax which funds pension.  It works as long as there is this pool of extra productivity.

Now if you don’t have this pool of productive then if you use a “pay as you go” method of financing Social Security, you are asking for problems…. Especially if your economy is dependent on funding from another country that is saving for its retirees…..

Oh wait……

February 2, 2007

The term for the day is…. Listed open-end fund

Filed under: china, quantitative finance — twofish @ 8:14 am

These are open-end funds that are traded on a stock exchange.  The curious thing is that they don’t seem to exist in the United States, and seem to be unique to mainland China.  My guess right now is that they don’t exist in the United States because open-end funds can and do sell direct to the consumer, and there is no need to go through an exchange.  By contrast, the mutual fund industry is not yet developed in China, so the LOF’s are a way for mutual funds to “piggy back” on top of the infrastructure that exists in the stock market.  The other things that LOF and ETF does is that I think is gives the Shenzhen Stock Exchange something useful to do.  My sense is that the major corporate stock listings are going to be in Shanghai, whereas Shenzhen is going to borrow a page from what the American Stock Exchange did and become a niche player in exchange traded funds.

The scary thing about the pace of change in Chinese markets is how fast everything is.

Statistical arbitrage and wavelets

Filed under: finance, quantitative finance — twofish @ 8:06 am

I noticed that the hot new skill right now seems to be high frequency statistical arbitrage.  I think that the interest in statistical arbritrage is very closely related to the fact that the New York Stock Exchange is going over to a hybrid system of electronic trading, and one way of thinking about statistical arbritrage is that what you are doing is programming a computer to do what a human being used to do (i.e. recognize short term patterns and profit from them).

The one curious thing is that wavelets and information theory ought to be useful in doing stat arb, but I haven’t seen any references to either being used.  One problem that I’m seeing is that wavelets and information theory assume a continuous field or a regular discrete mesh, and when you are dealing with high frequency data, you are getting irregular inputs, and at that point one finds oneself at the cutting edge of applied mathematics.

December 23, 2006

Why quantitative finance is important for a quantitative theory of Austrian economics

Filed under: austrian economics, quantitative finance — twofish @ 4:46 am

The reason that derivative markets and quantitative finance is important in developing a quantitative theory of Austrian economics is that you end up with observable quantities, which allow for hypothesis testing.

December 18, 2006

Status report – Passion and economics / Poetry and programming

Filed under: austrian economics, economics, quantitative finance, quantlib — twofish @ 5:11 am

Did a lot of reading this weekend  on papers detail with incomplete markets and utility based pricing.

I didn’t realize how the concept of “incomplete markets” was so tightly mixed in with neo-classical economics.  The basic problem with neo-classical economics when applied to derivatives pricing is that neo-classical economics assumes equilibrium states and in an equilibrium state there is no need for a market.  I think I can “go Austrian” and assume that you have a lot of actors with different utility functions.  One immediate consequence of this is that the trading volume of Shanghai warrants should be a function of the price volatility.  If the price is constant then everything moves to equilibrium, but if the price starts changing, then people will start trading derivatives back and forth.

All this connects with my earlier posts about passion and emotion.  Neoclassical economics assumes rationality on the part of people participating in a market, whereas Austrian economics by focusing on the individual allows for passion and emotion.  Passion can be almost defined as an irrational willingness to decrease individual utility, which breaks the assumptions of neoclassical economics.

This creates a duality which I think is apt

neo-classical economics <-> Austrian economics

Plato <-> Aristole

Song Learning Neo-Confucianism <-> Han Learning / Evidential school

Chu Xi <-> Dai Zhen

Part of the reason I distrust neoclassical economics is that I’ve worked in a corporation.  You just are not going to be able to convince me that corporations are rational profit maximizers.

I need to read more about Veblen.  I think I can describe my economic views about the Chinese economy as Austrian institutionalism.  You begin with the Austrian view of individual choice as the basis for an economy.  You then look at how these choices influence and are influenced by economic institutions.  Then and only then, you see how these economic institutions behave give certain economic inputs.  The problem with applying neo-classical economics to China is that they assume that a certain institutional structure already exists, and it doesn’t.

Anyway, I now have a testable prediction which is that the volume of warrant trades on Shanghai is a function of the daily shift in prices.  This will be one of the things that I want to graph once my system comes back up.  Right now things are broken because python 2.5 is out and not all of the packages have been upgraded.  I looks like to integrate vtk, quantlib, and python will take a lot of thinking.

The other thing I want to do is to review some of the papers on the Malliavin calculus.  The problem with the Malliavin calculus is that it should be a calculus.  There should be a canned set of rules that will let you apply it to a derivatives pricing situation.  Something like Feymann rules.

OK now that I seem rational, do I have permission to go a little nuts?

Maybe not now….  But…..  There is a “craziness quotient” that I have to keep aware of.  If I start looking to crazy people tend to get scared and turn off.  So before I go crazy, I have to wear the nice suit, and look “normal.”  See I can talk about economics and program C++, so I must not be too insane, and then once I “fake normal” *then* I can take off the mask and let people know how cracked I really am.

The problem is that I’m getting a little tired of the mask.  Businesses just want the C++ programmer and the nice quantitative models.  What they don’t realize is that programming and model building is a creative, artistic process, and you just have to put up with a bit of insanity to get the good stuff.

Writing good code is a lot like writing poetry.  In fact it *is* writing poetry.  When you code something, you are trying to strip the process to its creative essence, you are using odd rules of meter and rhyming (each open brace in C++ must be followed by a close brace), and making interesting allusions in the form of library calls.

The problem with the code at work that I’ve written in the last two or three weeks is that my heart just isn’t in it.  Yes the code works, but it is not particularly elegant or graceful or beautiful.  I’m just too upset about my work environment to write poetry about it.

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