Myron Scholes

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pages: 364 words: 101,286

The Misbehavior of Markets by Benoit Mandelbrot

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Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John Meriwether, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, Myron Scholes, new economy, paper trading, passive investing, Paul Lévy, Paul Samuelson, Plutocrats, plutocrats, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, Vilfredo Pareto, volatility smile

Samuels, Warren J. 1974. Pareto on Policy. Amsterdam: Elsevier Scientific Publishing Co. Samuelson, Paul A. 1970. The fundamental approximation theorem of portfolio analysis in terms of means, variances and higher moments. Review of Economic Studies 37 (112) October: 537-542. Scholes, Myron S. 1995, Fisher Black. Journal of Finance 50 (5): 1359–1370. Scholes, Myron S. 1997. Autobiography. Nobel e-Museum, www.nobel.se/economics/laureates/1997/. Scholes, Myron S. 2000. Crisis and risk management. American Economic Review 90 (2): 17-21. Scholes, Myron S. 2001. Merton H. Miller: Memories of a great mentor and leader. Journal of Finance 56 (4): 1179-1182. Schoutens, Wim. 2003. Lévy Processes in Finance: Pricing Financial Derivatives. Chichester, West Surrey, UK: John Wiley & Sons Ltd. Securities and Exchange Commission. 1998.

Hence, my books often devote a portion to the contemplation of individual scientists, physical or social, and their vicissitudes. To understand why the orthodox theory of financial markets and investment is so flawed, it first helps to review it—and there is no better way than by portraying a few men of the twentieth century who stand out as especially influential, regardless of whether one agrees with them or not. They are Louis Bachelier, Harry Markowitz, William Sharpe, and the duo of Fischer Black and Myron Scholes. The first, hero of this chapter, was a maverick, a lone visionary who overcame the general apathy and occasional opprobrium of his contemporaries and doggedly pursued his unique view of the financial world. The others, appearing in the next chapter, were secure in their professions and honored by their peers; their importance was to have made the boldest strokes that completed the canvas begun by Bachelier.

Other studies have found even wilder errors. In the foreign exchange market, where $15 trillion of options were traded in 2001, one study found some dollar-yen options underpriced by 84 percent, and some Swiss franc–dollar options undervalued by 40 percent. Valuing options correctly is a high-roller game, but the rules are all messed up. As described earlier, the most widely known formula was published in 1973 by Fischer Black and Myron Scholes, and it has been known for years that it is simply wrong. It makes unrealistic assumptions. It asserts that prices vary by the bell curve; volatility does not change through the life of the option; prices do not jump; taxes and commissions do not exist; and so on. Of course, these are simplifications to make the math easier. And so easy was it that, for the first fifteen years after its discovery, it was used blindly throughout options markets; it was viewed as a kind of financial alchemy that turned everything to gold.


pages: 425 words: 122,223

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

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Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buy low sell high, capital asset pricing model, corporate raider, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, Kenneth Arrow, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, money market fund, Myron Scholes, new economy, New Journalism, Paul Samuelson, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, stochastic process, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond, zero-sum game

(Photo by Fabian Bachrach) After a notable professional career at Chicago and MIT, Fischer Black led the parade from gown to town by joining Goldman Sachs in 1984. He originally started out in science and mathematics and never had a course in economics or finance. In 1965 while working at Arthur D. Little in Boston, he met Jack Treynor and was captivated by his theories. Although not yet an academic, Black collaborated with Myron Scholes and Robert Merton in the early 1970s to develop the most widely used formula for pricing options. Fischer Black had been stuck on the options problem for “many, many months” when he started working with Myron Scholes. Scholes collaborated with Black to unlock the puzzles of option pricing. Their article on the subject was rejected at first as excessively specialized, but thanks to Merton Miller’s intervention it finally appeared just as the Chicago Board Options Exchange opened for business in 1973.

Journal of Portfolio Management (Spring), pp. 4–9. Savage, Leonard Jimmie. 1981. The Writings of Leonard Jimmie Savage–A Memorial Selection, W. Allen Wallis, ed. American Statistical Association and The Institute of Mathematical Statistics. Scheinman, William X. 1991. “All Win.” Timings, January 28. Scholes, Myron S. 1972. “The Market for Securities: Substitution versus Price Pressure and the Effects of Information on Share Prices.” Journal of Business, Vol. 44, No. 2 (April). Also in Lone and Brealey (1972). Scholes, Myron S. 1990. “In Honor of Merton H. Miller’s Contributions to Finance and Economics.” Journal of Business, Vol. 63, No. 1, Part 2 (January), pp. 81–85. Schweiger, Irving. 1967. “The Journal of Business.” The Newsletter, University of Chicago Graduate School of Business, Vol. XIV, No. 1 (Spring), pp. 14–16.

I have been unusually fortunate in having had such generous and essential assistance from the people named below. The book could never have taken shape without the participation of the people whose work it describes: Fischer Black, Eugene Fama, William Fouse, Hayne Leland, Harry Markowitz, John McQuown, Robert C. Merton, Merton Miller, Franco Modigliani, Barr Rosenberg, Mark Rubinstein, Paul Samuelson, Myron Scholes, William Sharpe, James Tobin, Jack Treynor, and James Vertin. Each of them spent long periods of time with me in interviews, and most of them engaged in voluminous correspondence and telephone conversations as well. All of them read drafts of the chapters in which their work is discussed and gave me important criticisms and suggestions that enrich virtually every page of the book. Most of them also provided their photographs.


pages: 701 words: 199,010

The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal by Ludwig B. Chincarini

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affirmative action, asset-backed security, automated trading system, bank run, banking crisis, Basel III, Bernie Madoff, Black-Scholes formula, buttonwood tree, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discounted cash flows, diversification, diversified portfolio, family office, financial innovation, financial intermediation, fixed income, Flash crash, full employment, Gini coefficient, high net worth, hindsight bias, housing crisis, implied volatility, income inequality, interest rate derivative, interest rate swap, John Meriwether, labour mobility, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low skilled workers, margin call, market design, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Northern Rock, Occupy movement, oil shock, price stability, quantitative easing, quantitative hedge fund, quantitative trading / quantitative finance, Ralph Waldo Emerson, regulatory arbitrage, Renaissance Technologies, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Sharpe ratio, short selling, sovereign wealth fund, speech recognition, statistical arbitrage, statistical model, survivorship bias, systematic trading, The Great Moderation, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond

With success came more assets. By 2007, JWMP managed roughly $3 billion in assets, most of it from fund-of-funds investors. Platinum Grove Asset Management Former LTCM principals Myron Scholes and Chi-Fu Huang, along with three former LTCM employees, Ayman Hindy, Lawrence Ng, and Tong-Sheng Sun, left to start their own hedge fund. Platinum Grove Asset Management LLC (PGAM) was located in a beautiful office in Rye Brook, New York. Its dealing room was quiet and organized, unlike the typical trading-floor chaos. PGAM was primarily a fixed-income hedge fund. It used the same variety of fixed-income strategies that LTCM had favored. Myron Scholes believed this new operation was more sound than LTCM had been, mainly because Scholes was running it.9 PGAM also made some of the same risk-management changes that JWMP used.

The third part of the book speaks about some of the same elements of crowd behavior snuck into the May 2010 Flash Crash–when Apple stock traded briefly for $100,000 per share–and on to the continuing debt saga in Europe which started with the Greek crisis. Throughout the book, I sprinkle in excerpts from my interviews with many of the people who were on the front line of the crises, including five LTCM partners: Eric Rosenfeld, Chi-Fu Huang, Hans Hufschmid, and Nobel prize winners Robert Merton and Myron Scholes. I also spoke with numerous bank authorities, like Sir Deryck Maughan, former Vice Chairman of Citibank, Andrew Crockett, former Head of the BIS, the founders and CEOs of many leading hedge funds, including Goldman Sachs Alpha fund. These are supplemented by numerous other sources–testimonies, court documents, newspaper articles and previous books on the crises–that helped me understand and explain what had happened.

Chuck Prince: CEO and Chairman of Citigroup from 2003 to 2007. Resigned in 2007 due to the poor performance of mortgage-related products. Franklin Raines: CEO of Fannie Mae from 1999 to 2004 and Vice Chairman of Fannie Mae from 1991 to 1996. Julian Robertson: Founder of the very successful hedge fund Tiger Management. Eric Rosenfeld: Principal at LTCM and JWMP. Meriwether's right-hand man. Myron Scholes: Principal at LTCM and PGAM. Winner of the 1997 Nobel prize in economics. Alan Schwartz: CEO and President of Bear Stearns during 2008. William Sharpe: Professor at Stanford University and co-inventor of the CAPM. Won the 1990 Nobel in economics for his work on asset pricing theory. Robert Shustak: CFO of LTCM. Currently CFO and COO of the hedge fund founded by Sanford Grossman, QFS. James Simons: Founder and CEO of Renaissance Technologies, one of the most successful quantitative hedge funds.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

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activist fund / activist shareholder / activist investor, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

Fixed-income arbitrage traders also perform relative-value volatility trades, in which they compare the pricing of different derivatives and go long–short based on the relative attractiveness. Finally, fixed-income arbitrageurs pursue a variety of other trades such as municipal bond spreads, emerging market bonds, the bond futures basis relative to the cash market (based on cheapest-to-deliver considerations), structured credit, and break-even inflation trading.8 14.10. INTERVIEW WITH NOBEL LAUREATE MYRON SCHOLES Myron Scholes was awarded the Nobel Prize in 1997 for his new method of determining the value of derivatives, notably the famous “Black–Scholes–Merton formula.” He has held several professorships, currently the Frank E. Buck Professor of Finance, Emeritus, at the Stanford Graduate School of Business, and has served as the chairman of Platinum Grove Asset Management, a principal and limited partner at Long-Term Capital Management, and a managing director at Salomon Brothers.

Ainslie III of Maverick Capital 108 Chapter 8 Dedicated Short Bias 115 Interview with James Chanos of Kynikos Associates 127 Chapter 9 Quantitative Equity Investing 133 Interview with Cliff Asness of AQR Capital Management 158 Part III Asset Allocation and Macro Strategies 165 Chapter 10 Introduction to Asset Allocation: The Returns to the Major Asset Classes 167 Chapter 11 Global Macro Investing 184 Interview with George Soros of Soros Fund Management 204 Chapter 12 Managed Futures: Trend-Following Investing 208 Interview with David Harding of Winton Capital Management 225 Part IV Arbitrage Strategies 231 Chapter 13 Introduction to Arbitrage Pricing and Trading 233 Chapter 14 Fixed-Income Arbitrage 241 Interview with Nobel Laureate Myron Scholes 262 Chapter 15 Convertible Bond Arbitrage 269 Interview with Ken Griffin of Citadel 286 Chapter 16 Event-Driven Investments 291 Interview with John A. Paulson of Paulson & Co. 313 References 323 Index 331 The Main Themes in Three Simple Tables OVERVIEW TABLE I. EFFICIENTLY INEFFICIENT MARKETS Market Efficiency Investment Implications Efficient Market Hypothesis: Passive investing: The idea that all prices reflect all relevant information at all times.

Quant luminary and a pioneer in the discovery of momentum investing. Global Macro Investing: George Soros: Betting on the macro developments in global bond, currency, credit, and equity markets. The macro philosopher who “broke the Bank of England.” Managed Futures Strategies: David Harding: Trend-following trades across global futures and forwards. Devised a systematic trend-detection system. Fixed-Income Arbitrage: Myron Scholes: Relative value trades across similar securities such as bonds, bond futures, and swaps. Traded on his seminal academic ideas that won the Nobel Prize. Convertible Bond Arbitrage: Ken Griffin: Buying cheap illiquid convertible bonds and hedging with stocks. Boy king who started trading from his Harvard dorm room and built a big business. Event-Driven Arbitrage: John A. Paulson: Trading on specific events such as mergers, spin-offs, or financial distress.


pages: 322 words: 77,341

I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

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asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black-Scholes formula, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, George Akerlof, greed is good, hindsight bias, housing crisis, Hyman Minsky, intangible asset, interest rate swap, invisible hand, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, laissez-faire capitalism, light touch regulation, liquidity trap, Long Term Capital Management, loss aversion, Martin Wolf, money market fund, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, negative equity, new economy, Nick Leeson, Norman Mailer, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, tulip mania, value at risk

(One of my favorites is in jazz: the moment in “A Night in Tunisia” when Charlie Parker plays a saxophone break, which is like the arrival of modernism, right there, in real time. It’s said that the first time he went off on his solo, the other musicians simply put down their instruments and stared.) The moment in finance came in 1973, with the publication of a paper in the Journal of Political Economy titled “The Pricing of Options and Corporate Liabilities,” by Fischer Black and Myron Scholes. Derivatives have a bad press at the moment, but it’s important to acknowledge their role in the long history of man’s attempt to understand, control, and make money from risk. The study of risk is a humanist project, an attempt to abolish the idea of incomprehensible fate and replace it with the rational, quantifiable study of chance.1 Once upon a time, we were the playthings of fate, and the future was unknowable; but then, starting with philosophers and mathematicians such as Pierre de Fermat, Blaise Pascal, and Christiaan Huygens, humanity began to work out ways in which the future could be measured and assessed in terms of probabilities.

As soon as the market in derivatives was professionalized at the Chicago exchange, it quickly became obvious that there was a huge potential market in the field of financial derivatives, which derived their value not from eggs or butter or wheat but from shares. The market, however, was hampered by one big thing: no one could work out how to price the derivatives. The interacting factors of time, risk, interest rates, and price volatility were so complex that they defeated mathematicians until Fischer Black and Myron Scholes published their paper in 1973, one month after the Chicago Board Options Exchange had opened for business. The revolutionary aspect of Black and Scholes’s paper was an equation enabling people to calculate the price of financial derivatives based on the value of the underlying assets. The Black-Scholes formula opened up a whole new area of derivatives trading. It was a defining moment in the mathematization of the market.

(It’s what Nick Leeson was supposed to be doing, exploiting tiny differences in the price of Nikkei 225 futures between the Osaka exchange, where trading was electronic, and the Singapore exchange, where it wasn’t. The gap in price would last only for a couple of seconds, and in that gap Barings would buy low and sell high—a guaranteed, risk-free profit.) The complexity of the mathematics involved in derivatives can’t be exaggerated. This was the reason John Meriwether, a famous bond trader, employed Myron Scholes—he of the Black-Scholes equation—and Robert Merton, the man with whom he shared the 1997 Nobel Prize in Economics, to be directors and cofounders of his new hedge fund, Long-Term Capital Management.* The idea was to use these big brains to create a highly leveraged, arbitraged, no-risk investment portfolio designed to profit no matter what happened, whether the market went up, down, or sideways or popped out for a cheese sandwich.


pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

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activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, South Sea Bubble, statistical model, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

“You know, people are getting computers and putting all this data in them,” Fama told him. “Somebody’s going to do your dissertation in an afternoon if you don’t hurry up.”20 By the time Fama finished his dissertation, in 1964, and was asked to stay on as an assistant professor, a whole crowd of quantitatively minded, computer-savvy students was beginning to make waves. The ones who were to attain the most prominence were Michael Jensen, Myron Scholes, and Richard Roll. Jensen and Scholes both enrolled in the Chicago MBA program in autumn 1962. Jensen was the son of a printer at the Minneapolis Star-Tribune, and had put himself through Macalester College by working a daily shift in a print shop. After trying and failing to get in to Harvard Business School, he got a Chicago scholarship and headed south with no real idea what was in store for him (other than a night-shift printing job at the Chicago Tribune).

Wells Fargo’s CEO wanted to give his bank’s retail customers access to the stock market free of the sales-pitch-laden, stock-by-stock approach of Wall Street brokerages. His dream shattered against the strictures of the Depression-era Glass-Steagall Act, which banned banks from getting into the brokerage business.31 But McQuown’s team had spent several years investigating the merits of an index-based mutual fund, and along the way became the nation’s chief employer of moonlighting finance professors—most of whom McQuown had met at CRSP seminars. Myron Scholes and Michael Jensen were the first hires, followed by such present and future notables as Sharpe, Burton Malkiel, Barr Rosenberg of UC–Berkeley, and Fischer Black, a computer scientist who had succeeded Treynor at Arthur D. Little. In 1971 the courts definitively closed the door to a Wells Fargo retail mutual fund. The Wells team was wondering what to do next when a recent Chicago graduate, whose family owned luggage maker Samsonite, came calling.

Two other partial solutions published by economics graduate students in the 1960s suffered from similar limitations.17 As a member of the small community of finance quants resident those days in Cambridge, Fischer Black heard of this option-pricing puzzle, and set about trying to solve it. Not surprisingly, he looked for guidance to CAPM, in which risk is a stock’s sensitivity to the fluctuations of the market and expected return is a function of that. Considered in this way, it didn’t matter what the stock’s expected return was. The return was already reflected in its price. All that mattered was volatility. Black teamed up with Myron Scholes, who had just arrived from Chicago to teach finance at MIT’s Sloan School, and the pair worked out the proof for an equation that valued an option using the price of the underlying stock, the exercise price of the option, the time until the option expired, the risk-free interest rate, and the variance of the stock. Black and Scholes figured all this out in 1969, and first presented it in public in 1970.


pages: 240 words: 60,660

Models. Behaving. Badly.: Why Confusing Illusion With Reality Can Lead to Disaster, on Wall Street and in Life by Emanuel Derman

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Albert Einstein, Asian financial crisis, Augustin-Louis Cauchy, Black-Scholes formula, British Empire, Brownian motion, capital asset pricing model, Cepheid variable, creative destruction, crony capitalism, diversified portfolio, Douglas Hofstadter, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Henri Poincaré, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, Isaac Newton, law of one price, Mikhail Gorbachev, Myron Scholes, quantitative trading / quantitative finance, random walk, Richard Feynman, Richard Feynman, riskless arbitrage, savings glut, Schrödinger's Cat, Sharpe ratio, stochastic volatility, the scientific method, washing machines reduced drudgery, yield curve

In physics the values of the fundamental constants (the gravitational constant G, the electric charge e, Planck’s constant h, the speed of light c) are apparently timeless and universal. I doubt there will ever be a universal value for the risk premium. THE EMM AND THE BLACK-SCHOLES MODEL The best model in all of economics is the Black-Scholes Model for valuing options on stocks, an ingeniously clever extension of the EMM published in 1973 by Fischer Black and Myron Scholes.a I spent my first two years at Goldman Sachs, 1986–1987, working with Fischer Black on an extension of this model to valuing options on bonds,12 and I devoted 1993–1994 to working on an extension of Black-Scholes to stocks with variable volatility. Stocks are commonplace, but a call option on a stock is more arcane, and prior to Black and Scholes no one had a plausible clue for how to value it.

As with earthquakes, it may be wiser to remember that catastrophes much more dramatic than those the random-walk model envisages occur quite often. It is better to ensure that one owns a portfolio that will not suffer too badly under disastrous scenarios than it is to try to estimate the probability of destruction. So die the dreams of financial theories. Only imperfect models remain. The movements of stock prices are more like the movements of humans than of molecules. It is irresponsible to pretend otherwise. aMyron Scholes together with Robert C. Merton, who derived a different proof of the Black-Scholes formula and developed much of the elegant mathematics associated with options pricing, received the 1997 Nobel Memorial Prize in Economics for their work on the model. Fischer Black died two years earlier. Chapter 6 Breaking The Cycle Caught in a fiendish cage • Avoiding pragmamorphism • The great financial crisis and the abandonment of principle • The point of financial models • Be sophisticatedly vulgar • Let the dirt be visible • Beware of idolatry • The modelers’ Hippocratic oath • We need free markets, but we need them to be principled • Once in a blue moon, people stop behaving mechanically “Alas” said the mouse, “the world is growing smaller every day.

See return risk: Black-Scholes Model and CAPM and deliciousness analogy with of diffusion EMM and and ethics of designing financial products financial models and futility of using financial models and herding idiosyncratic market model for money and premium price and purpose of models purpose of theory return and uncertainty and universal value for volatility and role models/exemplars Roth, Philip rules: Feynman diagrams and nature of models and for using models S&P 500: Apple stock and EMM and Salam, AbdusSchadenfreude, Scholes, Myron Schopenhauer, Arthur Schrödinger, Erwin Schwinger, Julian Science and Reflection (Heidegger) Second World War/World War II securities: definition of Law of One Price and and ranking of securities by value unified theory of valuing of See also type of security self: control of image of understanding of and why we treat ourselves differently from others will and Senate, U.S. sensations: global local sexual revolution: Habonim and Sharpe ratio Sharpe, William similarity: securities and simultaneity Six Day War sleep: Modeh and Schopenhauer views about The Sleepwalkers (Koestler) social sciences; models in Socialism sophistry soufflé recipes: assumptions and South Africa: apartheid in Collie’s hypnosis in communism in Derman’s childhood and youth in internal contradictions of models of Jews in political models that failed in space: outer, emotional vocabulary in theories of Special Theory of Relativity (Einstein) Spider-Man advertising Spinoza, Baruch: adequate causes of and body-mind relationship and definition of perfection and reality and emotions as link between mind and body emotions theory of God of as materialist and money understanding of world and views about truth of wonder definition of stand-alone electrons Standard Model Stanford Linear Accelerator Center Stark, P.


Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business process, butterfly effect, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, Chance favours the prepared mind, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical arbitrage, Steven Pinker, stochastic process, survivorship bias, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

Cardano’s martingale, Bachelier’s random walk, Samuelson’s proof, and Fama’s statistics all lead to the same place: prices must fully reflect all available information. The Efficient Markets Hypothesis didn’t appear in a vacuum, however. It was part of a new quantitative movement in financial economics, along with Harry Markowitz’s optimal portfolio theory; William Sharpe’s Capital Asset Pricing Model (which we’ll come back to in chapter 8); and Fischer Black, Myron Scholes, and Robert C. Merton’s option pricing formula. These discoveries appeared within a few years of each other, and they illuminated aspects of market behavior that had remained mysterious for centuries. Of all the discoveries in the new quantitative finance movement, however, the Efficient Markets Hypothesis was the crown jewel. These esoteric discoveries not only changed the way economists thought about financial markets, but they also made these markets much more accessible to the general public.

In 2002, Montague and Berns reviewed the neurophysiological data and located a dopamine-receiving structure in the brain that seemed to translate reward response into neural activity in a manner eerily reminiscent of the famous Black-Scholes/Merton option pricing formula.31 Th is startled scientists, since options are an important part of the derivatives market, the financial market in which complicated contracts related to the outcomes of future events are traded. Economists think so highly of the Black-Scholes/Merton model that Myron Scholes and Robert C. Merton were awarded the Nobel Prize in Economics for its discovery in 1997 (Fischer Black died two years before). The explosion of the options market is often credited to the rise of the option-pricing pocket calculator in the 1970s. Did Homo sapiens already have the neurological equivalent of an option-pricing calculator in its head? 98 • Chapter 3 I WANT IT ALL, AND I WANT IT NOW The story, however, isn’t so simple.

Meriwether would raise a record-breaking (for that time) $1 billion to start his fund, but an essential part of his strategy was to use extremely high ratios of leverage—upwards of twenty or even thirty—to magnify that initial stake even further.27 LTCM opened to great fanfare in 1994. Meriwether not only had managed to recruit the nucleus of his old group at Salomon Brothers, but also intellectual luminaries of academic finance like future Nobel laureates Robert C. Merton and Myron Scholes. The new fund was almost immediately successful, despite a newfound nervousness in the global bond market. This early success didn’t depend as much on the firm’s mathematical trading models, the general principles of which were well known by that time, but in two areas of superiority: expertise in reading those models, and the ability to acquire lower-cost financing to take advantage of the opportunities detected by those models.28 These key adaptations kept LTCM extremely profitable well into 1997, the year of the Asian financial crisis.

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

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Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business process, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

For example, options on agricultural commodities were traded regularly during the American Civil War. Early twentiethcentury financial market participants in Chicago and New York actively JWPR007-Lindsey May 7, 2007 18:27 Introduction 5 traded commodity and equity options during regular time periods, albeit off the exchange floors, and prices were reported in the papers. Like Fermat, what Fischer Black and Myron Scholes (and Robert Merton) added, was a way to determine the “fair” value of an option (subject to various caveats related to the reasonableness of the model’s assumptions). Once adopted, their solution replaced the prior ad hoc pricing approach. Fermat is not the only historical example of a scientist devising a financial innovation that today would label him as a quant. A particularly striking example is the role quants played in improving government finance practices as far back as the sixteenth century.

Today, almost any teenage nerd has more computational gear than they know what to do with. But in the 1970s, access to a machine like the PDP-1, with graphics, sound, plotting, and a supportive hacker1 culture was a rare opportunity. It was also the first of the series of accidents that eventually led me into quantitative finance. I wish could I could say that I realized the PDP-1 would allow me to use the insights of Fisher Black, Myron Scholes, and Robert Merton to become a god of the options market and buy Chicago, but those were the guys at O’Connor and Chicago Research and Trading, not me. I used the machine to simulate nuclear physics experiments for the lab that adopted me as a sophomore. They flew down to use the particle accelerators at Brookhaven National Lab to find out the meaning of life, the universe, and everything else by smashing one atomic nucleus into another.

While I may have the resume of a quant, and I can spout quant sounding sentences, when it comes to true quantness, I fall a bit short. Conjecture 1: If It Quacks Like a Quant . . . My background is quantative enough. In junior high school, I was a star of the Mathletes team. I went to Harvard, where I studied math and physics. I even had a job at the Princeton Plasma Physics Laboratory working on the Tokomak Fusion reactors. I then went to the University of Chicago for business school, where I took courses given by Myron Scholes and Merton Miller, among others. 177 JWPR007-Lindsey 178 April 30, 2007 18:1 h ow i b e cam e a quant My first indication that I wasn’t a quant came in college. While I was taking advanced math courses, one teacher wrote on my first math exam: “You have a serious misunderstanding, please see me.” The question was simple enough. It was something like: Definition: A linear operator is such that f (a + bx) = f (a) + b ∗ f (x).


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

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Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

If you’re insuring your house, some of the determinants of the policy premium are the replacement cost of the house, the length of time the policy is in effect, and the amount of the deductible. The considerations for a stock include these plus others having to do with the rise and fall of stock prices. Although the practice and theory of insurance have a long history (Lloyd’s of London dates from the late seventeenth century), it wasn’t until 1973 that a way was found to rationally assign costs to options. In that year Fischer Black and Myron Scholes published a formula that, although much refined since, is still the basic valuation tool for options of all sorts. Their work and that of Robert Merton won the Nobel prize for economics in 1997. Louis Bachelier, whom I mentioned in chapter 4, also devised a formula for options more than one hundred years ago. Bachelier’s formula was developed in connection with his famous 1900 doctoral dissertation in which he was the first to conceive of the stock market as a chance process in which price movements up and down were normally distributed.

They can short-sell, buy on margin, use various other sorts of leverage, or engage in complicated arbitrage (the near simultaneous buying and selling of the same stock, bond, commodity, or anything else, in order to profit from tiny price discrepancies). They’re called “hedge funds” because many of them try to minimize the risks of wealthy investors. Others fail to hedge their bets at all. A prime example of the latter is the collapse in 1998 of Long-Term Capital Management, a hedge fund, two of whose founding partners, Robert Merton and Myron Scholes, were the aforementioned Nobel prize winners who, together with Fischer Black, derived the celebrated formula for pricing options. Despite the presence of such seminal thinkers on the board of LTCM, the debacle roiled the world’s financial markets and, had not emergency measures been enacted, might have seriously damaged them. (Then again, there is a laissezfaire argument for letting the fund fail.)

Petersburg paradox stock-newsletter scam based on stock options and probability theory progressive taxation psychology anchoring effect availability error behind buying more stock as price drops confirmation bias counterproductive behavior endowment effect scandal cover-ups status quo bias trying to outguess the masses publicly available information. see also common knowledge accounting scandals and Efficient market hypothesis and pump and dump strategy put options. see also stock options buying/selling puts on S&P as hedge against decline of stock selling strategies for using valuation tools for pyramid schemes quarterly estimates RagingBull railroads, depression of Ramsey, Frank random events appearance of order in Efficient market hypothesis and investing with meaning vs. predictability random sequences A Random Walk Down Wall Street (Malkiel) random walk theory rate of return arithmetic mean outstripping geometric mean Beta (B) values and determining expected excess return fixed, with treasury bills IPO purchases/sales and median vs. average minimizing risk without reducing “single index model” and standard deviation and stocks vs. bonds ratio of the excess return on a portfolio reality, inability to model reforms, accounting practices regression to the mean as contrarian measure Sport Illustrated cover jinx as illustration of widespread examples of Reminiscences of a Stock Operator (Lefevre) resistance levels risks aversion, illustrated by online chatrooms diversification and graphing against expected value (Markowitz optimal portfolios) market-related and stock-related mathematics of minimizing without hurting rate of return options and rate of return and selling short and stocks vs. bonds taking unnecessary Roschach blots Ross, Sheldon roulette rules. see trading strategies rules of thumb, as time saving device rumors conclusions based on not being able to ignore when considering investments S-shaped curve, P/E ratio S&P 500, buying/selling puts Salomon Smith Barney Samuelson, Paul scaling laws. see power law scams card tricks Ponzi schemes, chain letters, and pyramid schemes sports betting scam stock-newsletter scam scandals. see accounting scandals; fraud Scholes, Myron script, sports scam secrecy complexity resulting from lack of investment strategies and Securities and Exchange Commission (SEC) charging WorldCom of inflated earnings decimalization reforms parable of common knowledge and Security Analysis (Graham and Dodd) self-fulfilling beliefs selling on the margin. see short selling sensitive dependence, nonlinear systems sequences complexity of (mathematics of) random sequences random walk theory and share price, P/E ratio. see also prices, of stocks Sharpe, William Sherra, Jesse Shiller, Robert short selling short-term investors shorting and distorting strategy Shubik, Martin Sidgmore, John Siegel, Jeremy “single index model” (Sharpe) six sigma performance Slovic, Paul Sluggish Market Hypothesis Smith, Adam socially regressive funds Spitzer, Eliot Sport Illustrated spread, making money on St.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

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Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

Speculators also came to play in derivatives markets, investing in order to profit from price movements rather than to hedge real risks. The second impetus behind the derivatives explosion came from another theoretical breakthrough. Options pricing had always been a bit finger-in-the-wind before: there was no good way to put a value on the right to buy or sell something in the future. In 1973 a trio of American academics—Fischer Black, Myron Scholes, and Robert Merton—cracked the problem of what to pay for an option. The answer they came up with, expressed as what is now known as the Black-Scholes equation, was based on a simple idea: two things that had identical outcomes ought to cost the same. The price of the option ought to be the same as whatever it cost to construct an investment portfolio that achieved the same end. The Black-Scholes formula enabled the rapid pricing of options and paved the way for explosive growth in derivatives markets.

Talking about the moves that have been made to make banks safer, he worries that people tend to drive four-wheel-drive vehicles faster because they have the comfort of additional safety. The automotive industry was where the young Merton intended to make his career; he studied engineering at Columbia University. But economics and finance were to claim him. Merton’s name was made in the 1970s, with work that paralleled research by two older academics, Fischer Black and Myron Scholes. Together the three men cracked the problem of how to price an option, a financial instrument that gives the buyer the right, but not the obligation, to buy or sell an underlying asset. The question of what price to pay for an option was one to which there was no rigorous answer until Black, Scholes, and Merton came along. The answer they came up with, expressed as what is now known as the Black-Scholes equation, was based on the idea that the price of the option ought to be the same as the cost of constructing a perfect hedge for the underlying asset.

., 32 Keys, Benjamin, 48 Kharroubi, Enisse, 79 Kickstarter, 172 King, Stephen, 99 Klein, David, 182 Krugman, Paul, xv Lahoud, Sal, 166 Lang, Luke, 153, 161–162 Laplanche, Renaud, 179, 184, 188, 190, 193–194, 196–197 Latency, 53 Law of large numbers, 17 Layering, 57 Left-digit bias, 46 Lehman Brothers, x, 44, 65 Lending direct, 84 marketplace, 184 payday, 200 relationship-based, 11, 151, 206–208 secured, xiv, 76 unsecured, 206 See also Loans; Peer-to-peer lending Lending Club, 172, 179–180, 182–184, 187, 189, 194–195, 197 Leonardo of Pisa (Fibonacci), 19 Lerner, Josh, 59 Lethal pandemic, risk-modeling for demographic profile, 230 exceedance-probability curve, 231–232, 232 figure 3 historical data, 228–229 infectiousness and virulence, 229–230 location of outbreak, 230–231 Leverage, 51, 70–71, 80, 186, 188 Leverage ratio, 76–77 Lewis, Michael, 57 Liber Abaci or Book of Calculation (Fibonacci), 19 LIBOR (London Interbank Offered Rate), 41 Liebman, Jeffrey, 98 Life expectancy government reaction to, 128–129 projections of, 124–127, 126 figure 2 ratio of young to older people, 127–128 Life-insurance policies, 142 Life-settlements industry, 142–143 Life table, 20 Limited liability, 212 Liquidity, 12–14, 39, 185–186 List, John, 109 The Little Book of Behavioral Investing (Montier), 156 Lo, Andrew, 113–115, 117–123 Loans low-documentation, 48–49 secured, 76 small business, 181, 216 student, 164, 166–167, 169–171, 182 syndicated, 41 Victory Loans, 28 See also Lending; Peer-to-Peer lending Logistic regression, 201 London, early fire insurance in, 16–17 London, Great Fire of, 16 London Interbank Offered Rate (LIBOR), 41 Long-Term Capital Management, 123 Longevity, betting on, 143–144 Loss aversion, 136 Lotteries, 212, 213 Low-documentation loans, 48–49 Lumni, 165, 168, 175 Lustgarten, Anders, 111 Lynn, Jeff, 160–161 Mack, John, 180 Mahwah, New Jersey, 52, 53 Marginal borrowers assessment of, 216–217 behavioral finance and, 208–214 industrialization of credit, 206 microfinance and, 203 savings schemes, 209–214 small businesses, 215–219 unsecured lending to, 206 Wonga, 203, 205, 208 Marginal borrowers (continued) ZestFinance, 199, 202, 205–206 Maritime piracy, solutions to, 151–152 Maritime trade, role of in history of finance, 3, 7–8, 14, 17, 23 Market makers, 15–16, 55 MarketInvoice, 195, 207, 217–218 Marketplace lending, 184 Markowitz, Harry, 118 Massachusetts, use of inflation-protected bonds in, 26 Massachusetts, use of social-impact bonds in, 98 Matching engine, 52 Maturity transformation, 12–13, 187–188, 193 McKinsey & Company, ix, 42 Mercator Advisory Group, 203 Merrill, Charles, 28 Merrill, Douglas, 199, 201 Merrill Lynch, 28 Merton, Robert, 31, 113–114, 123–124, 129–132, 142, 145 Mian, Atif, 204 Michigan, University of, financial survey by, 134–135 Microfinance, 203 Micropayment model, 217 Microwave technology, 53 The Million Adventure, 213–214 Minsky, Hyman, 42 Minsky moment, 42 Mississippi scheme, 36 Mitchell, Justin, 166–167 Momentum Ignition, 57 Monaco, modeling risk of earthquake in, 227 Money, history of, 4–5 Money illusion, 73–74 Money laundering, 192 Money-market funds, 43, 44 Monkeys, Yale University study of loss aversion with, 136 Montier, James, 156–157 Moody, John, 24 Moody’s, 24, 235 Moore’s law, 114 Morgan Stanley, 188 Mortgage-backed securities, 49, 233 Mortgage credit by ZIP code, study of, 204 Mortgage debt, role of in 2007–2008 crisis, 69–70 Mortgage products, unsound, 36–37 Mortgage securitization, 47 Multisystemic therapy, 96 Munnell, Alicia, 129 Naked credit-default swaps, 143 Nature Biotechnology, on drug-development megafunds, 118 “Neglected Risks, Financial Innovation and Financial Fragility” (Gennaioli, Shleifer, and Vishny), 42 Network effects, 181 New York, skyscraper craze in, 74–75 New York City, prisoner-rehabilitation program in, 108 New York Stock Exchange (NYSE), 31, 52, 53, 61, 64 New York Times, Merrill Lynch ad in, 28 Noncorrelated assets, 122 Nonprofits, growth of in United States, 105–106 Northern Rock, x NYMEX, 60 NYSE Euronext, 52 NYSE (New York Stock Exchange), 31, 52, 53, 61, 64 OECD (Organization for Economic Co-operation and Development), 128, 147 Oldfield, Sean, 67–68, 80–84 OnDeck, 216–218 One Service, 94–95, 105, 112 Operating expense ratio, 188–189 Options, 15, 124 Order-to-trade ratios, 63 Oregon, interest in income-share agreements, 172, 176 Organization for Economic Co-operation and Development (OECD), 128, 147 Overtrading, 24 Packard, Norman, 60 Pandit, Vikram, 184 Park, Sun Young, 233 Partnership mortgage, 81 Pasion, 11 Pave, 166–168, 173, 175, 182 Payday lending Consumer Financial Protection Bureau, survey on, 200 information on applicants, acquisition of, 202 underwriting of, 201 PayPal, 219 Peak child, 127 Peak risk, 228 Peer-to-peer lending advantages of, 187–189 auction system, 195 big investors in, 183 borrowers, assessment of, 197 in Britain, 181 commercial mortgages, 181 CommonBond, 182, 184, 197 consumer credit, 181 diversification, 196 explained, 180 Funding Circle, 181–182, 189, 197 investors in, 195 Lending Club, 179–180, 182–184, 187, 189, 194–195, 197 network effects, 181 ordinary savers and, 184 Prosper, 181, 187, 195 RateSetter, 181, 187, 196 Relendex, 181 risk management, 195–197 securitization, 183–184, 196 Peer-to-peer lending (continued) small business loans, 181 SoFi, 184 student loans, 182 Zopa, 181, 187, 188, 195 Pensions, cost of, 125–126 Perry, Rick, 142–143 Peterborough, England, social-impact bond pilot in, 90–92, 94–95, 104–105, 112 Petri, Tom, 172 Pharmaceuticals, decline of investment in, 114–115 Piracy Reporting Centre, International Maritime Bureau, 151 Polese, Kim, 210 Poor, Henry Varnum, 24 “Portfolio Selection” (Markowitz), 118 Prediction Company, 60–61 Preferred shares, 25 Prepaid cards, 203 Present value of cash flows, 19 Prime borrowers, 197 Prince, Chuck, 50–51, 62 Principal-agent problem, 8 Prisoner rehabilitation programs, 90–91, 94–95, 98, 108, 112 Private-equity firms, 69, 85, 91, 105, 107 Projection bias, 72–73 Property banking crises and, xiv, 69 banking mistakes involving, 75–80 behavioral biases and, 72–75 dangerous characteristics of, 70–72 fresh thinking, need for, xvii, 80 investors’ systematic errors in, 74–75 perception of as safe investment, 76, 80 Prosper, 181, 187, 195 Provisioning funds, 187 Put options, 9, 82 Quants, 19, 63, 113 QuickBooks, 218 Quote stuffing, 57 Raffray, André-François, 144 Railways, affect of on finance, 23–25 Randomized control trials (RCTs), 101 Raphoen, Christoffel, 15–16 Raphoen, Jan, 15–16 RateSetter, 181, 187, 196 RCTs (randomized control trials), 101 Ready for Zero, 210–211 Rectangularization, 125, 126 figure 2 Regulation NMS, 61 Reinhart, Carmen, 35 Reinsurance, 224 Relendex, 181 Rentes viagères, 20 Repurchase “repo” transactions, 15, 185 Research-backed obligations, 119 Reserve Primary Fund, 44 Retirement, funding for anchoring effect, 137–138 annuities, 139 auto-enrollment in pension schemes, 135 auto-escalation, 135–136 conventional funding, 127–128 decumulation, 138–139 government reaction to increased longevity, 128–129 home equity, 139–140 life expectancy, projections of, 124–127, 126 figure 2 life insurance policies, cash-surrender value of, 142 personal retirement savings, 128–129, 132–133 replacement rate, 125 reverse mortgage, 140–142 savings cues, experiment with, 137 SmartNest, 129–131 Reverse mortgages, 140–142 Risk-adjusted returns, 118 Risk appetite, 116 Risk assessment, 24, 45, 77–78, 208 Risk aversion, 116, 215 Risk-based capital, 77 Risk-based pricing model, 176 Risk management, 55, 117–118, 123, 195–197 Risk Management Solutions, 222 Risk sharing, 8, 82 Risk-transfer instrument, 226 Risk weights, 77–78 Rogoff, Kenneth, 35 “The Role of Government in Education” (Friedman), 165 Roman Empire business corporation in, 7 financial crisis in, 36 forerunners of banks in, 11 maritime insurance in, 8 Rotating Savings and Credit Associations (ROSCAs), 209–210 Roulette wheel, use of in experiment on anchoring, 138 Royal Bank of Scotland, 186 Rubio, Marco, 172 Russia, mortgage market in, 67 S-curve, in diffusion of innovations, 45 Salmon, Felix, 155 Samurai bonds, 27 Satsuma Rebellion (1877), 27 Sauter, George, 58 Save to Win, 214 Savings-and-loan crisis in US (1990s), 30 Savings cues, experiment with, 137 Scared Straight social program, 101 Scholes, Myron, 31, 123–124 Science, Technology, and Industry Scoreboard of OECD, 147 Securities and Exchange Commission (SEC), 54, 56, 57, 58, 64 Securities markets, 14 Securitization, xi, 20, 37–38, 117–122, 183–184, 196, 236 Seedrs, 160–161 Sellaband, 159 Shared equity, 80–84 Shared-equity mortgage, 84 Shepard, Chris, xii–xiii Shiller, Robert, xv–xvi, 242 Shleifer, Andrei, 42, 44 Short termism, 58 SIBs.


pages: 270 words: 73,485

Hubris: Why Economists Failed to Predict the Crisis and How to Avoid the Next One by Meghnad Desai

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3D printing, bank run, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, BRICs, British Empire, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, correlation coefficient, correlation does not imply causation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, German hyperinflation, Gunnar Myrdal, Home mortgage interest deduction, imperial preference, income inequality, inflation targeting, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, market bubble, market clearing, means of production, Mexican peso crisis / tequila crisis, mortgage debt, Myron Scholes, negative equity, Northern Rock, oil shale / tar sands, oil shock, open economy, Paul Samuelson, price stability, purchasing power parity, pushing on a string, quantitative easing, reserve currency, rising living standards, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, seigniorage, Silicon Valley, Simon Kuznets, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, women in the workforce

The year 1973 witnessed the Chicago Board of Trade open the Chicago Options Exchange to allow centralized trading in options on listed stocks. Options are contingent claims on equities. They were bets that committed an option holder to buy or sell an option by a certain date. The potential buyer was said to have a long position and the seller a short position. The pricing of options became a subject of study. In 1973, the very same year in which option trading became more regular, two economists, Fisher Black and Myron Scholes, presented an analysis which put options in a broader class of contingent assets the price of which could be determined by sophisticated probability analysis.9 (Fisher Black left his job at MIT to join Solomon Brothers. When asked what persuaded him, he replied, “They added a zero to my salary.”) Forward and futures trading had always existed. But in forward trading, the commitment to buy is unconditional.

Hayek, “Economics and Knowledge,” Economica, 4.13 (Feb. 1937): 33–54. 7.Robert Lucas, “Econometric Policy Evaluation: A Critique,” in K. Brunner and A. Metzler, eds, Carnegie-Rochester Conference Series on Public Policy, 1.1 (1976): 19–46. 8.See, for instance, Frank Smets and Raf Wouters, An Estimated Stochastic Dynamic General Equilibrium Model of the Euro Area, ECB Working Paper 171 (European Central Bank, Frankfurt, 2002). 9.Fisher Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy, 81.3 (May–June 1973): 637–54. 6 The New Globalization 1.For some historical background, see Meghnad Desai, Marx’s Revenge: The Resurgence of Capitalism and the Death of Statist Socialism (Verso, London, 2002). 2.For background on the Asian crisis see Julia Leung, The Tides of Capital: How Asia Surmounted the Crisis and Is Now Guiding World Recovery (Official Monetary and Financial Institutions Forum, London, 2015). 3.See Roger Lowenstein, When Genius Failed: Rise and Fall of Long Term Capital Management (Fourth Estate, New York, 2002). 4.J.

(i) “This Time is Different” (with Carmen Reinhardt) (i) Roosevelt, Franklin D. (i), (ii) Rothschilds (i) Roubini, Nouriel (i) Royal Charter, grants of monopoly (i) rules of competition (i) Russia (i), (ii) Russian revolution (i), (ii) saltwater economists (i), (ii) Samuelson, Paul (i), (ii), (iii), (iv) “Analytical Aspects of an Anti–Inflation Policy” (with Robert Solow) (i) Say, Jean-Baptiste (i) Say’s Law (i), (ii) scarcity value (i) Scholes, Myron (i), (ii), (iii) Schumpeter, Joseph (i), (ii), (iii), (iv) The Theory of Economic Development (i) Schwartz, Anna, A Monetary History of the United States (with Milton Friedman) (i) Scottish Enlightenment (i) Second International (i) secular stagnation (i) securitization of mortgages (i) seigniorage privilege (i) self-interest (i) self-organizing society (i) self-sufficiency (i) service sector (i), (ii) servomechanism (i) shadow banking structure (i) shares (i) Sherman Act (i) Shiller, Robert (i), (ii) shocks (i), (ii), (iii) contagion (i) debt crises (i) political (i) see also oil shock short cycles (i) short-run rate of interest (i) Silesian weavers (i) single global currency (i) skills, types needed (i), (ii) slack (i) slavery, abolition of (i) Slutsky, Eugen (i), (ii), (iii) Smith, Adam (i), (ii), (iii), (iv), (v) the founding of the political economy (i) An Inquiry into the Nature and Causes of the Wealth of Nations (i), (ii) The Theory of Moral Sentiments (i), (ii) social science, founding (i) Socialist International (i) society regulation (i) self-organizing (i) Solow, Robert (i), (ii), (iii) “Analytical Aspects of an Anti–Inflation Policy” (with Paul Samuelson) (i) sovereign debt crises (i), (ii) Soviet Union, break up (i), (ii) speculation (i) speculative motive (i), (ii) stag-deflation (i) stagflation (i), (ii), (iii) Stalin, Joseph (i) static vision (i) statistics (i) development of (i) historical research (i) usefulness (i) sterling, as reserve currency (i) stochastic calculus (i) stock market crash, London (i) stock markets bull run (i) competition (i) computer technology (i) stock prices, randomness (i) Stockholm School (i) Stop-Go cycle (i) policy (i) Summers, Larry (i) surplus value (i) sustainable recovery, sources of (i) Sutcliffe, Robert (i), (ii) sweetwater economists (i), (ii) Sweezy, Paul (i) System of Natural Liberty (i) T bills (i), (ii), (iii) tatonnement (i) tax cut, US (i) technical progress, role of (i) technological innovations author’s experiences (i) displacement effect (i), (ii) and manufacturing location (i) see also computer technology technological shocks (i) telecommunications (i) Thailand, Crisis, 1997 (i) Thatcher, Margaret (i) theories, need for validation (i) theory of economic behavior of the household (i) Thornton, Henry (i) time, role of (i) time series data (i) Tinbergen, Jan (i) Tobin, James (i) Tobin tax (i) total money supply, and prices (i) total output, heterogeneity (i) trade doctrine see under Ricardo trade-off, unemployment and inflation (i) trade surpluses, banking (i) trade unions effect on money wage (i) as harmful (i) power (i) rise of (i) strengthening (i) weakening (i) transactions motive (i) transmission mechanism (i) Troubled Assets Recovery Program (TARP) (i) true costs of production (i) Truman, Harry (i) trusts (i) Tugan-Baranowsky, Michael (i) Turkey (i) Turner, Adair, Lord (i) Two Treatises on Government (Locke) (i) uncertainty (i) underemployment equilibrium (i), (ii), (iii) undersaving (i), (ii) unearned income (i) unemployment aggregate level (i) cycles (i) effect of wages (i) explaining (i) and inflation (i) involuntary (i) and money wage (i) natural rate (i) see also Keynesian models unifying principle (i) unique static equilibrium, and moving data (i) unit labor costs (i) United Kingdom budget deficit elimination (i) deindustrialization (i) economic trajectory (i) Great Depression (i) monetarism (i) recovery strategy (i) see also Britain United Nations Industrial Development Organization (UNIDO) (i) United States budget deficit (i) deindustrialization (i) econometric modeling (i) economic trajectory (i) economic weakness, post WWI (i) fiscal boost (i) Gold Standard (i) Great Depression (i) interest rates (i) Keynesianism (i) post-World War I power (i) post-World War II (i) Progressive Movement (i) prosperity (i) recovery strategy (i) seigniorage privilege (i) tax cut (i) trade deficit (i) welfare state expansion (i) westward expansion (i) withdrawal of currency (i) see also America unorthodoxy (i) urbanization (i) US House of Representatives, Greenspan’s testimony (i) usury defining (i) laws (i) prohibition (i), (ii) utopianism (i), (ii) valuation of assets, theory of (i) of capital (i) value vs.price (i) as price (i) relative (i), (ii) value added (i) value of goods, determination (i) variable costs (i) variables (i) Vietnam War (i) visions of economy (i) vocabulary, economic (i), (ii), (iii) volition (i) wage agreements, voluntary (i) demands, post-World War I (i) downward trend (i) effect on unemployment (i) rates, and unemployment (i) restraint (i) rises (i) share: declining (i); developed and developing economies (i); rise in (i), (ii) wage/profit distinction (i) units (i), (ii) see also money wages; real wages Walras, Antoine Auguste (i) Walras, Léon (i), (ii) Walrasian model (i) wars, financing (i) wealth distribution (i) inequality of (i) indicators (i) Smith’s theory (i) weaving, mechanization (i) welfare economics (i) welfare state, levels of support (i) White, Harry (i) Wicksell, Knut (i), (ii) basis of Hayek’s theory (i) later development of ideas (i) Wicksellian boom, developing countries (i) Wicksellian cycle, combined with Kondratieff cycle (i) William III (i) women, in workforce (i) workers dependence on capitalists (i) living standards (i) migration (i) productive/unproductive (i) workforce, recruitment of women (i) World Trade Organization (WTO) (i), (ii) World War I (i) World War II, outbreak (i) yields (i) Zombie firms (i)


pages: 239 words: 69,496

The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, assortative mating, Benoit Mandelbrot, Brownian motion, capital asset pricing model, carried interest, collective bargaining, corporate governance, corporate raider, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, follow your passion, George Akerlof, Gordon Gekko, greed is good, housing crisis, income inequality, information asymmetry, Isaac Newton, Jony Ive, Kenneth Rogoff, Louis Bachelier, moral hazard, Myron Scholes, new economy, out of africa, Paul Samuelson, Pierre-Simon Laplace, principal–agent problem, Ralph Waldo Emerson, random walk, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, Steve Jobs, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, Tim Cook: Apple, transaction costs, zero-sum game

Aside from an interesting reversal of conventional wisdom, the story of Bachelier’s discovery is also the story of the two most important risk management strategies—options and diversification. Bachelier’s ability to describe the movement of stock prices mathematically as “random walks” provided the foundation for him to crudely price the option contracts that were then trading in Paris and had traded since the seventeenth century in Amsterdam. Myron Scholes and Robert Merton would win the Nobel Prize in 1997 for a pricing formula that corresponds to (and considerably improves upon) the mostly forgotten logic laid down by Bachelier. And Bachelier’s ability to describe stock prices moving about at random ultimately gave rise to portfolio theory by putting forward the notion that it was hopeless to try to beat the market—the best you could do was hold a diversified portfolio.

“An Intertemporal Capital Asset Pricing Model.” Econometrica 41 (September 1973): 867–87. Two particularly good textbooks on options are McDonald, Robert L. Derivatives Markets. Boston: Addison-Wesley, 2006; and Hull, John, Sirimon Treepongkaruna, David Colwell, Richard Heaney, and David Pitt. Fundamentals of Futures and Options Markets. New York: Pearson, 2013. Critical important early papers on options include Black, Fischer, and Myron Scholes. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy 81, no. 3 (May/June 1973): 637–54; and Merton, Robert C. “Theory of Rational Option Pricing.” Bell Journal of Economics and Management Science 4, no. 1 (Spring 1973): 141–83. An elegant treatment of these topics is provided in Merton, Robert C. Continuous-Time Finance. Cambridge: B. Blackwell, 1990. “It is a truth”: Austen, Pride and Prejudice, chapter 1.

., and Martha Parke Firestone, 118–19 marriages as mergers, 104–6 in modern America, 105–6 in Renaissance Florence, 100–101 in Thailand, 105 “Romance Without Finance” (Grimes, Little Feat), 98–99 Room with a View, A (Forster), 8, 89–91 Rothschild family, 8, 100, 104–5 Hannah Mayer and marriage, 105 James and marriage to Nicky Hilton, 106 Mayer Amschel and marriage, 104 Royal Coat of Arms of the United Kingdom, 40 Russell, Bertrand, 14 S Salmon, Felix, 130 Schjeldahl, Peter, 32, 129 Scholes, Myron, 40 Seize the Day (Bellow), 48–49 Shakespeare, William, 8, 122 Sheldon, Sidney, 96 Shenk, Joshua Wolf, 139 Shkreli, Martin, 166 Shleifer, Andrei, 77 Simpsons, The (TV show), 28 Sliding Doors (film), 13 Sloan, Alfred P., 117 Smith, Adam, 121–22 Smith, Fred, 44–45 Snow, C. P., 175–77 Socrates, 168 Stevens, Wallace, xi, 7, 32–34, 170 disorder and chaos, 33–34 insurance executive, 32–33 T talent, etymology of, 58–59, 74 “Tale of Beryn” (Chaucer), 74 Talmud, 52 Thales of Miletus, 7, 42–43, 162, 177 Tiger Moms, 95 Tolstoy, Leo, 9, 162–64 tontines, 28–30 Tontine Coffee House, 28 Tootsie Roll Industries, 78–80, 83–85 transaction cost approach to mergers, 115 Trilogy of Desire (Dreiser), 165 Trollope, Anthony, 7, 38, 175 Trump, Donald, 127, 152 Turner, Ted, 108 “Two Cultures” (Snow), 175 “Two Tramps in Mud Time” (Frost), xiii Tynan, Kenneth, 96 U Ulysses (Joyce), 91–92 V Vaillant, George, 138–39 value creation and valuation, 7, 59 accounting vs. finance, 64 alpha generation or getting paid for beta, 71–73 destruction of value, 63 discounted cash flows, 65 measuring value creation, 64–67 stewardship and, 61–63, 74 terminal values, 66–67 weighted average cost of capital, 65 value of education, 65–66 value of housing, 66 van Doetechum, Lucas, 58 (illus.), 59 van Eyck, Jan, 97 (illus.), 103 Vega, Joseph de la, 5–6, 43–44 venture capital, 73, 82 Vishny, Robert, 77 W Wall Street (film), 165, 166 Warhol, Andy, 129 Washington, George, 142–43, 145 Watson, Thomas, 138 Wealth of Nations, The (Smith), 121 Weaver, Sigourney, 97–98 Wells Fargo, 80 Wesley, John, 63 West, Kanye, 99 Wheel of Fortune (TV show), 17–18 White, Vanna, 18 Whitney Museum of Modern Art, 140 Wilder, Gene, 94 Wilson, E.


pages: 349 words: 134,041

Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives by Satyajit Das

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accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Meriwether, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative finance, random walk, regulatory arbitrage, Right to Buy, risk-adjusted returns, risk/return, Satyajit Das, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

In the 1970s, financial economists around the globe wondered: ‘What is Chicago’s view of this?’ DAS_C02.QXP 8/7/06 22 4:22 PM Page 22 Tr a d e r s , G u n s & M o n e y In Chicago, Eugene Fama and his colleagues developed the efficient markets hypothesis. Merton Miller developed theories on dividends, borrowing by companies and the effect of taxes. Against this background of febrile activity, in 1973, three academics – Fischer Black, Myron Scholes and Robert Merton – developed a model to price options. Scholes and Merton were to receive the Swedish Central Bank’s Prize for achievement in economics (often mistakenly referred to as the Nobel Prize). In Business Finance, there was a lecture on the Black–Scholes option pricing model. We had no clue what an option was and eventually, someone asked about options at a tutorial. ‘What good are options?’

If we could find an equal but opposite transaction to our client’s requirements at the very moment they deigned to trade, then we would. It just never happened that way. This meant we were left with surrogate hedges. The surrogates proved true to their name, sometimes proving imperfect. We had begun to make markets in options. In the early 1980s, Hayne Leland and Mark Rubinstein had built on the work done by Fischer Black, Myron Scholes and Robert Merton on pricing options. They had developed a way of hedging options – option replication or delta hedging. The model made assumptions about the workings of markets but the markets just hadn’t read the assumptions. I realized that these hedging models would come apart under real-world conditions, especially when things went crazy. There was no point telling anybody, however, and the margins in options were better than in other products.

The fund was formed in 1994 by a group of ex-Salomon Brothers traders led by John Meriwether. The key principals (in addition to Meriwether) included DAS_C06.QXP 8/7/06 168 4:43 PM Page 168 Tr a d e r s , G u n s & M o n e y Eric Rosenfield, Lawrence Hilibrand, William Krasker, Victor Haghani, Greg Hawkins and David Modest. LTCM principals included Nobel Prize winners Robert Merton and Myron Scholes and former regulators including ex-Federal Reserve Board Vice Chairman David Mullins. The core group had worked together in Salomon Brother’s fixed income arbitrage operations. The individuals did not fit the mould of traditional rough and tumble traders: most were highly qualified, holding PhDs in economics, finance, mathematics, science or related disciplines. The unifying element was the enigmatic Meriwether, he had hired many of the key players.


pages: 317 words: 84,400

Automate This: How Algorithms Came to Rule Our World by Christopher Steiner

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23andMe, Ada Lovelace, airport security, Al Roth, algorithmic trading, backtesting, big-box store, Black-Scholes formula, call centre, cloud computing, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, Donald Trump, Douglas Hofstadter, dumpster diving, Flash crash, Gödel, Escher, Bach, High speed trading, Howard Rheingold, index fund, Isaac Newton, John Markoff, John Maynard Keynes: technological unemployment, knowledge economy, late fees, Marc Andreessen, Mark Zuckerberg, market bubble, medical residency, money market fund, Myron Scholes, Narrative Science, PageRank, pattern recognition, Paul Graham, Pierre-Simon Laplace, prediction markets, quantitative hedge fund, Renaissance Technologies, ride hailing / ride sharing, risk tolerance, Sergey Aleynikov, side project, Silicon Valley, Skype, speech recognition, Spread Networks laid a new fibre optics cable between New York and Chicago, transaction costs, upwardly mobile, Watson beat the top human players on Jeopardy!, Y Combinator

This is phase one of an algorithmic takeover: a computer, equipped with human-composed algorithms, analyzes inputs and issues marching orders to humans. About a year after the men had put their algorithm to work, a thunderclap sounded above Wall Street. In 1973 Fischer Black and Myron Scholes, both professors at the University of Chicago, published a paper that included what would become known as the Black-Scholes formula, which told its users exactly how much an option was worth. Algorithms based on Black-Scholes would over the course of decades reshape Wall Street and bring a flock of like-minded men—mathematicians and engineers—to the front lines of the financial world. The Black-Scholes solution, quite similar to Peterffy’s, earned Myron Scholes a Nobel Prize in 1997 (Black had died in 1995). Change didn’t happen overnight. The Black-Scholes formula, a partial differential equation, was brilliant. But most traders didn’t peruse academic journals.

In 1807, Joseph Fourier published his heat equation, which described the distribution of heat over time within a metal plate that had been warmed from one point. Fourier’s periodic function built on the work of Euler and Daniel Bernoulli to develop a series of trigonometric integrals—now called a Fourier series—that have proven incredibly handy in dozens of applications. Among those who profited from Fourier’s work were Fischer Black and Myron Scholes, who used a variation of Fourier’s heat equation to create their algorithm that would go on to reorder Wall Street and earn Scholes a Nobel Prize.21 An earlier Nobel was awarded to Herbert A. Hauptman and Jerome Karle in 1985 for their work utilizing Fourier series to model crystalline structures using X-rays.22 Fourier’s work has also proved useful in decoding music, a fact Brown picked up in a math journal in the mid-1990s.

., 154 Rolling Stones, 86 Rondo, Rajon, 143 Ross, Robert, 143–44 Roth, Al, 147–49 Rothschild, Nathan, 121–22 Royal Society, London, 59 RSB40, 143 runners, 39, 122 Russia, 69, 193 intelligence of, 136 Russian debt default of 1998, 64 Rutgers University, 144 Ryan, Lee, 79 Saint Petersburg Academy of Sciences, 69 Sam Goody, 83 Sandberg, Martin (Max Martin), 88–89 Sandholm, Tuomas: organ donor matching algorithm of, 147–51 poker algorithm of, 128–33, 147, 150 S&P 100 index, 40–41 S&P 500 index, 40–41, 51, 114–15, 218 Santa Cruz, Calif., 90, 95, 99 satellites, 60 Savage Beast, 83 Saverin, Eduardo, 199 Scholes, Myron, 23, 62, 105–6 schools, matching algorithm for, 147–48 Schubert, Franz, 98 Schwartz, Pepper, 144 science, education in, 139–40, 218–20 scientists, on Wall Street, 46, 186 Scott, Riley, 9 scripts, algorithms for writing, 76 Seattle, Wash., 192, 207 securities, 113, 114–15 mortgage-backed, 203 options on, 21 Securities and Exchange Commission (SEC), 185 semiconductors, 60, 186 sentence structure, 62 Sequoia Capital, 158 Seven Bridges of Königsberg, 69, 111 Shannon, Claude, 73–74 Shuruppak, 55 Silicon Valley, 53, 81, 90, 116, 188, 189, 215 hackers in, 8 resurgence of, 198–211, 216 Y Combinator program in, 9, 207 silver, 27 Simons, James, 179–80, 208, 219 Simpson, O.


pages: 237 words: 50,758

Obliquity: Why Our Goals Are Best Achieved Indirectly by John Kay

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Andrew Wiles, Asian financial crisis, Berlin Wall, bonus culture, British Empire, business process, Cass Sunstein, computer age, corporate raider, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, discovery of penicillin, diversification, Donald Trump, Fall of the Berlin Wall, financial innovation, Gordon Gekko, greed is good, invention of the telephone, invisible hand, Jane Jacobs, Long Term Capital Management, Louis Pasteur, market fundamentalism, Myron Scholes, Nash equilibrium, pattern recognition, Paul Samuelson, purchasing power parity, RAND corporation, regulatory arbitrage, shareholder value, Simon Singh, Steve Jobs, The Death and Life of Great American Cities, The Predators' Ball, The Wealth of Nations by Adam Smith, ultimatum game, urban planning, value at risk

To fit the world into a single model or narrative fails to acknowledge the universality of uncertainty and complexity. The reputation of financial economics has never recovered from the blow of the virtual collapse of Long-Term Capital Management, a sophisticated practitioner of the risk models outlined in chapter twelve, and the involvement of two Nobel Prize winners, Robert C. Merton and Myron Scholes. The fund built huge positions on the basis of estimated mispricings, relying on its models to control its exposures. When the Asian financial crisis blew up in 1997, the fund managers extended their positions. They believed their own models. Their failure was a precursor of the much larger failures that would follow a decade or so later. At the banks a decade later, as in Iraq, evidence and models were used to confirm what was already asserted to be true rather than to challenge the validity of prior assumptions.

randomness Rawls, John Reed, John reengineering Reengineering the Corporation (Hammer and Champy) regulatory arbitrage religion Rembrandt van Rijn Renaissance retail sector Ricks, Christopher risk management RiskMetrics Rockefeller, John D. Roosevelt, Franklin D. root method Rotella, Bob Rousseau, Jean-Jacques rules Saint-Gobain salesmen Salomon Brothers Samuelson, Paul Santa Maria del Fiore cathedral Scholes, Myron science scorecard Scottish Enlightenment Sculley, John Sears securities selfish gene September 11 attacks (2001) shareholder value share options Sieff, Israel Sierra Leone Simon, Herbert simplification Singapore Singer Smith, Adam Smith, Ed Smith, Will SmithKline soccer (English football) social contract socialism social issues socialist realism sociopaths Solon Sony Sony Walkman Soros, George Soviet Union sports Stalin, Joseph “Still Muddling, Not Yet Through” (Lindblom) Stockdale, James Stockdale Paradox stock prices Stone, Oliver successive limited comparison sudoku Sugar, Alan Sunbeam Sunstein, Cass Super Cub motorcycles superstition surgery survival sustainability Taleb, Nassim Nicholas Tankel, Stanley target goals teaching quality assessment technology see also computers teleological fallacy telephones Tellus tennis Tetlock, Philip Tet Offensive (1968) Thales of Miletus Thornton, Charles Bates “Tex” tic-tac-toe Tolstoy, Leo transnational corporations transportation Travelers Treasury, U.S.

Trend Commandments: Trading for Exceptional Returns by Michael W. Covel

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Albert Einstein, Bernie Madoff, Black Swan, commodity trading advisor, correlation coefficient, delayed gratification, diversified portfolio, en.wikipedia.org, Eugene Fama: efficient market hypothesis, family office, full employment, Lao Tzu, Long Term Capital Management, market bubble, market microstructure, Mikhail Gorbachev, moral hazard, Myron Scholes, Nick Leeson, oil shock, Ponzi scheme, prediction markets, quantitative trading / quantitative finance, random walk, Sharpe ratio, systematic trading, the scientific method, transaction costs, tulip mania, upwardly mobile, Y2K, zero-sum game

Fama who developed the Efficient-Markets Hypothesis. The premise of their hypothesis was that stock prices were always right so you could not divine the market’s future direction. It assumed that everyone was rational.2 Miller and Fama believed that perfectly rational people would never pay more or less for a financial instrument than it was actually worth. A colleague, and fervent supporter of the Efficient-Markets Hypothesis, Myron Scholes was also certain that markets could not make mistakes. He and his associate, Robert Merton, saw the finance universe as tidy and predictable. They assumed that the price of IBM would never go directly from 80 to 60 but would always stop at 79 3/4, 79 1/2, and 79 1/4 along the way.3 LTCM’s founders believed the market was a perfect normal distribution with no outliers, no fat tails, and no unexpected events.

See also trend following manipulation of monetary policy, 181-183 Marcus, Michael, 15 Longstreet, Roy, 239 market crashes, trend following during, 97-98 losers and winners market gurus, 147-148 crowd mentality, 117-120 during market crashes, 97-98 Efficient-Markets Hypothesis, 101-102 market predictors, 165-167 contradictions in predictions, 175-178 trend following versus, 194 hatred of trend following, 109-110 market price, importance of, 51-52 unexpected events, 91 market theories zero-sum game, 95 losses avoiding averaging, 79 271 fundamental analysis, 33-35 technical analysis, 35-36 markets drawdowns, 69-70 change in, 45 exit strategies, 75-76 entering, 73 what to trade, 65-67 272 Index McCain, John, 182 media, market predictions by, 177 Merton, Robert, 101 Miller, Merton, 101 origins of trend following, 221-231 Ostgaard, Stig, 221 P Paulson, John, 109 misleading information, spreading, 169-170 Pelley, Scott, 175 monetary policy, government manipulation of, 181-183 performance statistics for trend following, 15-23 money, capitalism and, 113-115 Picasso, Pablo, 88 money management, importance of, 61-62 players, types of, 205 morality of trend following, 109-110 Popoff, Peter, 166 pliability, 30 moving average, defined, 13 portfolio diversity, example of, 65-67 Mulvaney, Paul, 22 position sizing, 61-62 Munger, Charlie, 157 Prechter, Robert, 225 N–O predictions about market, 165-167 Nasdaq market crash (1973-1974), 151 net worth of trend following traders, 15 New Blueprints for Gains in Stocks and Grains (Dunnigan), 230 avoiding, 47-48 contradictions in, 175-178 trend following versus, 194 predictive technical analysis, 35 Nicklaus, Jack, 120 presidents, approval ratings based on economy, 181-182 Nikkei 225 stock index, 151 price action Obama, Barack, 182 optimism in trend following, 201-202 entering markets, 73 importance of, 51-52 profit targets, avoiding, 75-76 Index Profits in the Stock Market (Gartley), 226 Prospect Theory, 118 prudence, 30 Pujols, Albert, 138-139 Q–R quants, defined, 12 quarterly performance reports, 105-106 273 S S&P 500, defined, 13 Sack, Brian, 183 Schabacker, Richard W., 226 Schmidt, Eric, 47 Scholes, Myron, 101 scientific method in trend following, 134-135 Seidler, Howard, 20 Ramsey, Dave, 91 Seinfeld (television program), 161 Rand, Ayn, 113 selecting trading systems, 59-62 reactive technical analysis, 36 self-regulation, 124 “Reminiscences of a Stock Operator” (Lefèvre), 223 self-reliance, 30 repeatable alpha, defined, 12 Seykota, Ed, 15, 62 Rhea, Robert, 225 Shanks, Tom, 21 Ricardo, David, 223 Sharpe ratio, 137 risk assessment, 55-56 sheep mentality, 117-120 risk management, 61-62 short, defined, 12 Robbins, Anthony, 208 Simons, Jim, 135 Robertson, Pat, 166 The Simpsons (television program), 110 robustness of trend following, 85 Rogers, Jim, 23 Roosevelt, Franklin D., 114 Rosenberg, Michael, 201 rules of trend following, 201-202 Serling, Rod, 26 skill versus luck in trend following, 189-190 Smith, Vernon, 26 Social Security, 181 Sokol, David, 158 Soros, George, 189 274 Index speculation qualities of, 30 role of, 29-30 Speilberg, Steven, 208 spreading misleading information, 169-170 statistics in trend following, 137-140 Stone, Oliver, 29 story, fundamental analysis as, 33-35 Studies in Tape Reading (Wyckoff), 226 sunk costs, 118 Sunrise Capital, 5 drawdowns statistics, 70 performance statistics, 22 Technical Traders Guide to Computer Analysis of the Futures Markets (Lebeau), 60 Ten Years in Wall Street (Fowler), 224 three-phase systems, 60 Trader (documentary), 143 traders, investors versus, 29-30 trading gold, 173 trading systems, selecting, 59-62 “Trading With the Trend” (Dunnigan), 229 Transtrend, 5, 15 Trend Commandments (Covel) content of, 6 people written for, 9 trend following Swensen, David, 187 advantages of, 235-236 systematic global macro, defined, 12 compared to black box, 187 systematic trend following.

Investment: A History by Norton Reamer, Jesse Downing

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

He became quite fluent in finance as a result of this experience, and soon Bachelier found himself back in academia working under the polymath Henri Poincaré.1 He defended the first portion of his thesis, entitled “Theory of Speculation,” in March 1900. In it, he showed how to value complicated French derivatives using advanced mathematics. In fact, his approach bore some similarity to that of Fischer Black and Myron Scholes many years later. Bachelier’s work was the first use of formal models of randomness to describe and evaluate markets. In his paper, Bachelier used a form of what is called Brownian motion.2 Brownian motion was named after Robert Brown, who studied the random motions of pollen in water. Albert Einstein would describe this same phenomenon in one of his famous 1905 papers. The mathematical underpinnings of this description of randomness could be applied not only to the motions of small particles but also to the movements of markets.

He also redefined Bachelier’s equations to have the returns in lieu of the actual stock prices move in accordance with a slightly different form of Brownian motion because Bachelier’s form of Brownian motion implied that a stock could potentially have a negative price, which is not sensible, as the concept of limited liability for shareholders implies that the floor of value is zero.17 The Emergence of Investment Theory 235 Samuelson helped motivate the work on derivatives pricing with a 1965 paper on warrants and a 1969 paper with Robert Merton on the same subject—although he did, as he would later note, miss one crucial assumption that Black and Scholes were able to make in their formulation of options prices.18 Samuelson can be considered an intermediary in calling attention to the subfield of derivatives pricing, even if the cornerstone of the most famous final theory was not his own. Black-Scholes Options Pricing Formula Myron Scholes spent his graduate years at the University of Chicago, where he studied alongside Merton Miller and Eugene Fama. He went on to teach at the MIT Sloan School of Management, and during his time there he met his future collaborator in the theory of derivatives, Fischer Black. Black was a graduate of Harvard, where he had spent both his undergraduate and graduate years studying applied mathematics, and was working for Arthur D.

Dixit, “Samuelson’s Legacy,” 19–20. For the original works, see Paul A. Samuelson, “Rational Theory of Warrant Pricing,” Industrial Management Review 6, no. 2 (Spring 1965): 13–39; Paul A. Samuelson and Robert C. Merton, “A Complete Model of Warrant Pricing That Maximizes Utility,” Industrial Management Review 10, no. 2 (Winter 1969): 17–46. 7. The Emergence of Investment Theory 371 19. Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, no. 3 (May–June 1973): 637–654. 20. A. James Boness, “Elements of a Theory of Stock-Option Value,” Journal of Political Economy 72, no. 2 (April 1964): 163–175. 21. Marion A. Brach, Real Options in Practice (Hoboken, NJ: Wiley, 2003), 24. 22. Robert C. Merton, “Option Pricing When Underlying Stock Returns Are Discontinuous,” Journal of Financial Economics 3, no. 1–2 (January– March 1976): 125–144. 23.

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

But the theory of options pricing was given a big boost in the 1970s when two academic economists, Fischer Black and Myron Scholes, developed the first mathematical for12 Chapter 16 will discuss a valuable index of option volatility called VIX. 266 PART 4 Stock Fluctuations in the Short Run mula to price options. The Black-Scholes formula was an instant success. It gave traders a benchmark for valuation where previously they used only their intuition. The formula was programmed on traders’ handheld calculators and PCs around the world. Although there are conditions when the formula must be modified, empirical research has shown that the Black-Scholes formula closely approximates the price of traded options. Myron Scholes won the Nobel Prize in Economics in 1997 for his discovery.13 Buying Index Options Options are actually more basic instruments than futures or ETFs.

But for every option that gains so spectacularly in value, there are thousands of options that expire worthless. Some market professionals estimate that 85 percent of individual investors who play the options market lose money. Not only do options buyers have to be right about 13 The original article was published in 1973: Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy, vol. 81, no. 3, pp. 637–654. Fischer Black was deceased when the Nobel Prize was awarded in 1997. Myron Scholes shared the Nobel Prize with William Sharpe and Bob Merton, the latter contributing to the discovery of the formula. CHAPTER 15 The Rise of Exchange-Traded Funds, Stock Index Futures, and Options 267 the direction of the market but also their timing must be nearly perfect, and their selection of the strike price must be appropriate.

., 18n Royal Bank of Scotland, 175 Royal Dutch Petroleum, 55, 56i, 183 Royal Dutch Shell, 183 Ruane, Cunniff, and Goldfarb, 346 Russell 1000, 45, 46i Russell 2000, 45, 46i Russell 3000, 45 Russell 2000 Index, 142n Russell indexes, 342 Russian default on bonds, 88 S. A. B. de C. V., 177 Safe-haven status, 32 Samsonite fund, 351n Samsung Electronic, 177 Samuelson, Paul, 24, 35n, 207q, 292 Samuelson, William, 35n Saturday Night Massacre, 195 Saunders, Edward M., Jr., 314n SBC Communications, 58 Schering, 59i Schleifer, A., 326n Schlumberger, 59i, 61 Schlumberger, Conrad, 61 Schmitt, Dennis E., 303n Schneider, D. J., 326n Scholes, Myron, 265, 266 Schwert, G. William, 5n Sears and Roebuck, 56i, 57 Seasonal anomalies, 306–316 January effect, 306–311, 307i large monthly returns and, 311, 312i, 313i Seasonal anomalies (Cont.): September effect, 311, 313–315, 314i Sector diversification, in global market, 173–177, 174i, 175i Sectors, in S&P 500, 52–58, 53i, 55i, 56i Security Analysis (Graham and Dodd), 83, 141, 150 Self-attribution bias, 326 Sell-on-close orders, 318 Sell programs, 258 Sentiment, 333–334, 335i September effect, 311, 313–315, 314i Sequoia Fund, 346 Settlement dates, for futures, 256 Settlement procedure, for futures, 257 Shareholder value, sources of, 98–102 Sharpe, William, 140n, 266n, 345 Shefrin, Hersh, 329n, 331n Shell Oil, 55, 56i Shell Transport and Trading, 183 Shiller, Robert, 5n, 87, 91, 285, 323, 325n Short-term returns, 14 Shorting stock, 262 Shulman, David, 86 Siegel, Jeremy, 7n, 17n, 86, 88–89, 100n, 159n, 305, 354n, 363 Siemens, 177 Silk, Leonard, 218 Silverblatt, Howard, 107n, 108n Sinquefield, Rex, 84 Slatter, John, 147 Sloan, Paul, 90n, 331n Sloan, Richard, 108 Slovic, P., 326n Small-cap stocks large-cap stocks versus, 141–144, 142i trends in returns on, 142–144, 143i Smith, Edgar Lawrence, 79–81, 81n, 82, 83, 86, 201 378 Smith, Frank P., 83–84 Smith, Steven, 12n, 21n Smithers, Andrew, 117, 118 Social dynamics, 323–325 Socony Mobil Oil, 55, 56i Soliman, Mark, 108n Sony Corporation, 176 Southwest Airlines, 156 Spiders, 252 Spot market, 257 Standard & Poor’s (S&P), 37, 61 core earnings of, 107–108 Standard & Poor’s 500 Depository Receipts (SPDRs), 252 Standard & Poor’s 500 stock index, 37, 40, 47, 51–64, 342 outperformance of original S&P 500 firms and, 63–64 reaction to business cycle, 208, 20i sector allocation and, 175i sector rotation in, 52–58, 53i, 55i, 56i top-performing firms in, 58–63, 59i, 60i Standard & Poor’s (S&P) Index, 42–43 Standard & Poor’s (S&P) Index futures, 256 Standard Brands, 60i, 62 Standard Industrial Code (SIC), 52 Standard Oil of California, 55, 56i Standard Oil of Indiana, 55, 56i Standard Oil of New Jersey, 55, 56i Statman, Meir, 329n Stattman, Dennis, 150, 152n Staunton, Mike, 18, 19n, 20 Steiner, Robert, 253n Stern, Siegfried, 81 Stewart, James, 273n Stires, David, 106n Stock bubbles, 323–325 avoidance by fundamentally weighted portfolios, 355 Index Stock index funds, 361–362 Stock index futures, 253, 254i, 255–264 arbitrage and, 257–258 basics of markets for, 255–257 choosing, 262–264, 263i double and triple witching and, 260–261 fair market value of, 259 Globex trading and, 258–260 importance of, 267–268 leverage and, 261 margin and, 261 stock market crash of 1987 and, 275–276 using, 261–262 Stock indexes, 37–49 Dow Jones, 38–42 (See also Dow Jones Industrial Average [DJIA]) market averages and, 37–38 prediction of future returns using trend lines and, 41–42 return biases in, 46–47 value-weighted, 42–45 (See also Center for Research in Security Prices [CRSP] index; Nasdaq Index; Standard & Poor’s [S&P] Index) Stock Market Barometer (Hamilton), 290 Stock market crash of 1929, 4–5, 6, 269, 270i Babson’s prediction of, 78 Stock market crash of 1987, 224, 269, 270i, 271–276 causes of, 273–276 futures markets and, 273 trading on NYSE and, 272–273 Stock prices: economic growth and, 240–241 randomness of, 291–292, 293i, 294 Stocks: outperformance over bonds, 26–27 returns on (see Returns) yields on, bond yields related to, 95–97 “Stocks, Bonds, Bills, and Inflation: Year-by-Year Historical Returns (1926-74)” (Ibbotson and Sinquefield), 84–85 Stocks for the Long Run (Siegel), 86, 88–89, 305, 363 Stop-loss orders, 275 Story stocks, 158 Strike price, of options, 265 Subrahmanyam, Avandihar, 326n Summers, Lawrence H., 224n Sun Microsystems, 38, 89, 156 Supply-side effects, failure of stocks as long-term inflation hedge and, 202 Support level, 294 Surowiecki, James, 324n Survivorship bias, 18, 343, 343i Sweets Colgate-Palmolive. of America, 59i Swensen, David, 90 Switching returns, 214–215, 215i Szilagyi, Jan, 158n Taiwan Semiconductor, 177 Tax code, history of, 74–75 Tax-deferred accounts, 73–74 Taxes: capital gains (see Capital gains taxes) income (see Income taxes) increasingly favorable tax factors for equities and, 72–73 Technical analysis, 289–304 Dow’s role in, 290–291 momentum investing and, 302–303 moving averages and, 295–302 nature of, 289–290 Index Technical analysis (Cont.): randomness of stock prices and, 291–292, 293i, 294 trending markets and price reversals and, 294–295 Technology boom of 1999-2001, 320–322 Technology bubble, 167 Telecommunications services sector: in GICS, 53 global shares in, 175i, 177 Telefonica, 177 Templeton, John, 65q, 66, 161q Tennessee Coal and Iron, 47 in DJIA, 39i, 49 Terrorist attacks: market movements and, 221–223, 222i, 226 of September 11, 2001, 221–223, 222i Texaco, 54–55, 56i Texas Co., 55 Thaler, Richard, 17n, 303, 329, 331n, 332–333, 335 Thatcher Glass, 60i, 62 Theoretical high/low, 296n Theory of Investment Value (Williams), 101 Thomson Houston, 57 Time horizons, returns and, 361 Time Warner, 176 Titman, Sheridan, 302 Tobin Q, 117–119, 118i Tootsie Rolls, 64 Total, 177, 184 Total return, defined, 5 Toyoda, Sakichi, 183 Toyoda Loom Works, 183 Toyota Motor Corporation, 58, 176, 183 Trading, informed, 349–350 “Trading Is Hazardous to Your Wealth” (Barber and Odean), 325 Treasury inflation-protected securities (TIPS), 115, 361 379 Trend lines: caution regarding use to predict future returns, 41–42 in DJIA, 40–42, 41i Trends, technical analysis and, 294–295 Triple witching hour, 260–261 Triumph of the Optimists: 101 Years of Global Investment Returns (Dimson, Marsh, & Staunton), 18, 20 Tuna, Irem, 108n Tversky, Amos, 322–323, 328, 330 Twain, Mark, 305q 200-day moving-average, 295, 296–297, 298i, 299–300, 299i distribution of gains and losses and, 301–302, 301i UBS, 175 Uncertainty, 226–227 Underfunding, of defined benefit plans, 106 Unemployment rate, 242 Unilever, 47, 177 Union Carbide, 56i, 58 Union Electric Co., 48 Uniroyal, 49 United Kingdom, end of gold standard in, 9, 10i United States: annual real return in, 20 employment statistics for, 237–238 end of gold standard in, 9–10, 10i, 188–189, 192–193 global market share of, 179, 179i, 180i gold as backing for currency of, 193–194 political parties in, market movements and, 227–228, 228i–230i, 230 sector allocation and, 175i, 177 uncertainty about president in, 226–227 U.S.


pages: 381 words: 101,559

Currency Wars: The Making of the Next Gobal Crisis by James Rickards

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Asian financial crisis, bank run, Benoit Mandelbrot, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, borderless world, Bretton Woods, BRICs, British Empire, business climate, capital controls, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Fall of the Berlin Wall, family office, financial innovation, floating exchange rates, full employment, game design, German hyperinflation, Gini coefficient, global rebalancing, global reserve currency, high net worth, income inequality, interest rate derivative, John Meriwether, Kenneth Rogoff, labour mobility, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, Network effects, New Journalism, Nixon shock, offshore financial centre, oil shock, one-China policy, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, private sector deleveraging, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, Ronald Reagan, sovereign wealth fund, special drawing rights, special economic zone, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, time value of money, too big to fail, value at risk, War on Poverty, Washington Consensus, zero-sum game

From the faculties of Yale, MIT and the University of Chicago came a torrent of carefully reasoned academic papers by future Nobel Prize winners such as Harry Markowitz, Merton Miller, William Sharpe and James Tobin. Their papers, published in the 1950s and 1960s, argued that investors cannot beat the market on a consistent basis and that a diversified portfolio that broadly tracks the market will produce the best results over time. A decade later, a younger generation of academics, including Myron Scholes, Robert C. Merton (son of famed sociologist Robert K. Merton) and Fischer Black, came forward with new theories on the pricing of options, opening the door to the explosive growth of financial futures and other derivatives contracts ever since. The work of these and other scholars, accumulated over fifty years and continuing today, constitutes the branch of economic science known as financial economics.

Duncan Brown, Ted Smyth, Ron Luman and Peggy Harlow never rest in their threat assessments and forward-leaning thinking about how to counter those threats. They were kind to include me in their efforts. I owe an enormous debt incurred over many years to my legal mentors Tom Puccio, Phil Harris, Mel Immergut, Mary Whalen and Ivan Schlager. Even lawyers need lawyers and they are the best. Thank you to my economics mentors, John Makin, Greg “the Hawk” Hawkins, David Mullins, Jr., Myron Scholes and Bob Barbera. Given my heterodox theoretic approach to their field, I thank them for listening and sharing their thoughts and views. Thanks also to my market mentors, Ted Knetzger, Bill Rainer, John Meriwether, Jim McEntee, Gordon Eberts, Chris Whalen, Peter Moran and Dave “Davos” Nolan. Davos and I shorted Fannie Mae stock at $45 per share in 2005 and lost money when it went to $65. Today it trades for 39 cents.

phase transitions, in complex system Plaza Accord, 1985 Poland Pompidou, Georges Portugal price-gold-flow mechanism price-specie-flow mechanism primary dealers private enterprise prospect theory protectionism Putin, Vladimir quantitative easing (QE) Ray, Chris Reagan, Ronald real estate bubble of 2002 to 2007 recessions, U.S. 1970s to 1980s of 2001 of 2007 See also Panic of 2008 regional currency blocs Reichsbank reichsmark rent seeking rentenmark reserve currencies risk, in complex systems risk aversion Road, The (McCarthy) Rockefeller, John D., Jr. Romer, Christina D. Roosevelt, Franklin D. Rothkopf, David Rousseff, Dilma Rubin, Robert Russia Samuels, Nathaniel Samuelson, Paul San Francisco earthquake, 1906 Sarkozy, Nicolas Schacht, Hjalmar Schiff, Jacob H. Scholes, Myron Schumer, Charles E. Schwartz, Alan Second Bank of the United States September 11, 2001, terrorist attacks of Shakespeare, William Sharpe, William Shultz, George P. Slovic, Paul Smith, Adam Smithsonian Agreement social media social psychology, on economics Soros, George South Korea sovereign debt crisis of 2010, European sovereign wealth funds (SWFs) Spain special drawing rights (SDRs) stagflation state capitalism sterling crisis of 1992 devaluations and gold exchange standard Stiglitz, Joseph stimulus, Keynesian stimulus programs, Obama’s stock market crash critical state system of a of October 19, 1987 Strategic and Economic Dialogue (S&ED) Strategic Command, U.S.


pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

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Albert Einstein, asset allocation, Atul Gawande, backtesting, beat the dealer, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam, zero-sum game

The story of who lost has been told repeatedly over the years; however, because trading is a zero-sum game, 151 152 Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets exploring the winners was the real story. LTCM is a classic saga of the zero-sum game played out on a grand scale with trend followers as winners. “Trillion Dollar Bet,” a PBS special, described how LTCM came to be. In 1973, three economists—Fischer Black, Myron Scholes, and Robert Merton—discovered an elegant formula that revolutionized modern finance. This mathematical Holy Grail, the Black-Scholes Option Pricing Formula, was sparse and deceptively simple. It earned Scholes and Merton a Nobel Prize and attracted the attention of John Meriweather, the legendary bond trader of Salomon Brothers. LTCM promised to use complex mathematical models to make investors wealthy beyond their wildest dreams.

Fama, two scholars at the University of Chicago, launched what became known as the Efficient Market Hypothesis: “The premise of the hypothesis is that stock prices are always right; therefore, no one can divine the market’s future direction, which in turn, must be ‘random.’ For prices to be right, of course, the people who set them must be both rational and well informed.”27 In other words, Miller and Fama believed that perfectly rational people would never pay more or less than any financial instrument was actually worth. A fervent supporter of the Efficient Markets Hypothesis, Myron Scholes was certain that markets could not make mistakes. His associate, Robert Merton, took it a step further with his continuous-time finance theory, which essentially wrapped the finance universe into a supposed tidy ball.28 Chapter 4 • Big Events, Crashes, and Panics 153 Merton’s markets were as smooth as well brewed java, in which prices would flow like cream. He assumed…that the price of a share of IBM would never plunge directly from 80 to 60 but would always stop at 79 3/4, 79 1/2, and 79 1/4 along the way.29 If LTCM’s universe was supposed to be “in a tidy ball,” it might have been because where Merton and Scholes pioneered their theories, academic life was tidy.

Philip Anderson, a Nobel Prize Recipient in Physics, sees the dangers that come from thinking in terms of normal distributions: “Much of the real world is controlled as much by the ‘tails’ of distributions as by means or averages: by the exceptional, not the mean; by the catastrophe, not the steady drip; by the very rich, not the ‘middle class.’ We need to free ourselves from ‘average’ thinking.”45 Breaking out from average thinking results in hitting home runs (trend followers) instead of attempting and failing to slap those supposed sure-fire singles (LTCM). A footnote: Myron Scholes went on to form a new fund called Platinum Grove after LTCM’s demise. With Scholes as Chairman, Platinum Grove lost $600 million dollars during 2007–2008 during the credit market meltdown. How many funds does this particular financial genius have to blow up before the genius tag should be taken away? Event #4: Asian Contagion The Asian crisis of 1997, also referred to as the Asian Contagion, was yet another big event where trend followers won.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

Brandon Adams, Gustavo Bamberger, Bill Benter, John Bogle, Rick Bookstaber, Reuven Brenner, Eugene Christiansen, Emanuel Derman, Art Duquette, Dylan Evans, Doyne Farmer, Justin Fox, Kenneth French, Lisa Goldberg, James Grosjean, Ian Hacking, Michael Heneberry, Carey Hobbs, Craig Howe, James McManus, Michael Maubossin, Nick Maughan, Perry Mehrling, Robert Merton, Joe Nocera, John O’Brien, Deborah Pastor, Scott Patterson, William Poundstone, Kevin Rosema, Myron Scholes, James Stoner, Nassim Taleb, Edward Thorp, Whitney Tilson, James Ward, Paul Wilmott, and Bruce Zastera were particularly helpful. The title comes from my daughter, Aviva Pastor. Tiffany Charbonier, Bill Falloon, Stacey Fischkelta, Meg Freeborn, Sharon Polese, and other folks at John Wiley & Sons provided essential feedback and support. Muhammad Cohen edited every word I wrote, and I rarely overrode his corrections.

From the banks of the Charles—that is, for academics far away from the action who were not betting personally—there was nothing obvious in the reported numbers coming out of Wall Street to demonstrate the change. But from the banks of the Hudson—that is, for people on Wall Street making quantitative bets—you couldn’t miss it. Smile One example is option smile and skew. Fischer Black, along with Myron Scholes and Robert Merton, had come up with an option pricing model in 1973 that was widely used on Wall Street. (Ed Thorp had developed a very similar model six years earlier, but he didn’t publish it; he used it to make money.) Practitioners noticed that options on unusual events—say, that the stock market would rise or fall more than 20 percent over a month—tended to have higher prices than the model results.

I am reporting back about what works and what doesn’t. I leave it to others more qualified than I am to make these observations formal and precise. Thorp, Black, Scholes, and Merton Finance started to diverge from statistics in the decade around 1970. We could start with Ed Thorp’s first development and use of an option pricing model in the 1960s, or the publication of Fischer Black’s and Myron Scholes’s famous 1973 paper, “The Pricing of Options and Corporate Liabilities,” or the publication of Robert Merton’s paper, “Theory of Rational Option Pricing,” the same year. Popular finance books usually describe the Black-Scholes option pricing model as horrendously complex and requiring advanced mathematics. That’s silly. The basic idea is simple. Some of the technical details in proving it are complicated, and the formula itself looks a bit intimidating compared to, say, 2 + 2 = 4, but that’s no reason to ignore the insight.


pages: 289 words: 113,211

A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber

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affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, intangible asset, Jeff Bezos, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, William Langewiesche, yield curve, zero-coupon bond, zero-sum game

If the portfolio declines in value, the hedge is increased, so that finally, if the portfolio value falls well below the floor price, the portfolio is completely hedged. Thus the portfolio is hedged when it needs it and is free to take market exposure when there is a buffer between its value and the floor value. Because the hedge increases and decreases over time, it is called a dynamic hedge. The hedging method of portfolio insurance is based on the theoretical work of Fischer Black, Robert Merton, and Myron Scholes. Their work is encapsulated in the Black-Scholes formula, which makes it possible to set a price on an option. No other formula in economics has had as much impact on the world of finance. Merton and Scholes both received the Nobel Prize for it. (Fischer Black had died a few years before the award was made.) The theory and mathematics behind it were readily embraced by the academic community.

LTCM TAKES UBS TO THE CLEANERS With the UBS traders so active in generating huge losses, it was only a matter of time before the senior management of UBS took up the sport, this time under the tutelage of none other than LTCM, which offered to provide the company with insight into its trading and risk management practices. 118 ccc_demon_097-124_ch06.qxd 7/13/07 2:43 PM Page 119 LT C M R I D E S THE LEVERAGE CYCLE TO HELL The partners in LTCM not only ran a highly levered fund for their investors; they doubled up on that leverage by borrowing money themselves to put into the fund. Hilibrand borrowed $24 million from Credit Lyonnais; Hans Hufschmid, formerly the head of foreign exchange trading at Salomon and a more recent addition to the LTCM partnership, personally borrowed $14 million, and a few others with either less wherewithal or more prudence borrowed less. Myron Scholes, a Nobel laureate and latecomer into the LTCM hedge fund partnership, championed another approach to pile leverage onto their positions: a warrant that would pay off as the fund increased while limiting the partners’ liability if the fund value dropped. They shopped the warrant to Merrill Lynch and to Chase, and both firms demurred. Spurred on by the prospects of further riches—and in the case of the warrant, apparently tax-advantaged riches—the warrant was an ongoing imperative for the partners.

But, like the coarse response mechanism of the cockroach, when faced with the inevitable march of events that we cannot even contemplate, simpler financial instruments and less leverage will create a market that is more robust and survivable. 260 ccc_demon_261-270_notes.qxd 2/13/07 1:47 PM Page 261 NOTES CHAPTER 1 Introduction 1. The problem of increasing market risk in the face of reduced economic risk, and its implications for greater endogenous risk in the financial markets, is presented in detail in Horace W. Brock, “The Transformation of Risk: Main Street versus Wall Street,” May 2002 Profile Report, Strategic Economic Decisions, Inc. CHAPTER 2 The Demons of ’87 1. Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, no. 3 (May/June 1973). Robert C. Merton, “Theory of Rational Option Pricing,” Bell Journal of Economics and Management Science 4 (Spring 1973); reprinted as Chapter 8 in his book, Continuous-Time Finance (Malden, MA: Blackwell Publishing, 1992). What is most remarkable about the Black-Scholes formula is that there is no need to know the expected course of the security price on which the option is based, the preferences of investors, or economic conditions, all things that are subjective and hard to predict.


pages: 543 words: 147,357

Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

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Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, liberal capitalism, light touch regulation, Long Term Capital Management, Louis Pasteur, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, Mikhail Gorbachev, millennium bug, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, Plutocrats, plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, working poor, zero-sum game, éminence grise

In December 1997 JP Morgan succeeded in securitising $10 billion of its existing portfolio of loans in a so-called BISTRO (broad index secured trust offering) deal and thus reducing the amount of capital it had to hold from $800 million to just $160 million. In the markets the joke was that the acronym actually stood for ‘BIS Total Rip Off’, in honour of the BIS (Bank of International Settlements), whose rules had been so easily avoided. Yet alarm bells should have been ringing. The following year, the Long Term Capital Management (LTCM) hedge fund very nearly collapsed when an investment strategy built on the mathematical models of Myron Scholes and Robert Merton (who had won the Nobel Prize for economics for his theories on how to price options) went spectacularly wrong. LTCM had anticipated the crisis in the Russian bond market as part of the fallout from the Asian crisis; but it had been unable to predict the behaviour of other assets. To meet their margin calls on Russian debt, investors had sold bonds in more liquid markets, including Danish mortgage bonds, despite their excellent value – something which the LTCM’s model had overlooked.32 The Federal Reserve required Wall Street’s finest to stump up some $3.6 billion to save the hedge fund, which had almost $125 billion in borrowings.

If this is true then, as mentioned earlier, financial data will correspond to the law of large numbers and follow the same rules that dictate the distribution of, say, tall, average and short people, dice rolls and flips of a coin. There will be a bell curve in which 95 per cent of the population is captured in two standard deviations away from the mean. (Technically known as a normal or Gaussian distribution after Carl Friedrich Gauss, who introduced the idea.) Myron Scholes and Fisher Black hypothesised back in 1973 that not just the spread of the prices of financial assets but, crucially, their volatility corresponded to the bell curve. This meant the price of a derivative, depending on the underlying value of financial assets, would tend to sit plumb middle of the volatility range. The financial institution that traded in derivatives should therefore buy or sell depending on how much the price had deviated from the mean volatility.

Worse, once the system began to creak, there was a snowball effect on asset prices, collateral and confidence: liquidation by one firm put downward pressure on the assets held by numerous other firms, triggering a series of fire sales, an unravelling that ensured the so-called once-in-a-thousand-years event would arrive much sooner.35 Part of the problem was the ideological belief that financial markets were efficient. The likes of Myron Scholes were on a mission to prove the superiority of free markets and to make their own fortunes. Paying as little tax as possible was one component of their formula. In 2005 Scholes was a director of LTCM when the firm was implicated in a lawsuit accusing it of devising false accounting losses of over $100 million and tax ‘savings’ of some $40 million. But even he thought that his methodology was applied in too slapdash a fashion.


pages: 478 words: 126,416

Other People's Money: Masters of the Universe or Servants of the People? by John Kay

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, call centre, capital asset pricing model, Capital in the Twenty-First Century by Thomas Piketty, cognitive dissonance, corporate governance, Credit Default Swap, cross-subsidies, dematerialisation, diversification, diversified portfolio, Edward Lloyd's coffeehouse, Elon Musk, Eugene Fama: efficient market hypothesis, eurozone crisis, financial innovation, financial intermediation, financial thriller, fixed income, Flash crash, forward guidance, Fractional reserve banking, full employment, George Akerlof, German hyperinflation, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, income inequality, index fund, inflation targeting, information asymmetry, intangible asset, interest rate derivative, interest rate swap, invention of the wheel, Irish property bubble, Isaac Newton, John Meriwether, light touch regulation, London Whale, Long Term Capital Management, loose coupling, low cost carrier, M-Pesa, market design, millennium bug, mittelstand, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nick Leeson, Northern Rock, obamacare, Occupy movement, offshore financial centre, oil shock, passive investing, Paul Samuelson, peer-to-peer lending, performance metric, Peter Thiel, Piper Alpha, Ponzi scheme, price mechanism, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, random walk, regulatory arbitrage, Renaissance Technologies, rent control, Richard Feynman, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, Schrödinger's Cat, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, sovereign wealth fund, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, Steve Wozniak, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tobin tax, too big to fail, transaction costs, tulip mania, Upton Sinclair, Vanguard fund, Washington Consensus, We are the 99%, Yom Kippur War

The idea was to apply the same type of contract to foreign exchange and subsequently to other financial instruments. Butter and eggs would soon be left behind. This was the beginning of the development of markets in derivative securities. It is not a coincidence that the University of Chicago was then and is today a leading centre of the study of financial economics. In the following year two members of its faculty – Fischer Black and Myron Scholes – would publish a seminal paper on the valuation of derivatives.5 Much of the growth of the financial sector in the three decades that followed would be the direct and indirect consequence of the growth of derivative markets. Futures were not the only kind of derivative. An option gave you the right, but not the obligation, to buy or sell – you could use an option to insure yourself against a rise, or a fall, in price.

They include the Markowitz model of portfolio allocation (to which Greenspan referred) and the Black–Scholes model (the derivative pricing model to which he alluded). The key components of academic financial theory, however, are the ‘efficient market hypothesis’ (EMH), for which Eugene Fama won the Nobel Prize in 2013, and the Capital Asset Pricing Model (CAPM), for which William Sharpe won the Nobel Prize in 1990. Sharpe shared that prize with Markowitz, and Myron Scholes received a Nobel Prize in 1997, just before the famous blow-up of Long-Term Capital Management, in which Scholes was a partner; Black had died in 1995. All of these financial economists have affiliations to the University of Chicago. EMH asserts that all available information about securities is ‘in the price’. Interest rates are expected to rise, Procter and Gamble owns many powerful brands, the Chinese economy is growing rapidly: these factors are fully reflected in the current level of long-term interest rates, the Procter & Gamble stock price and the exchange rate between the dollar and the renminbi.

Rather obviously, for example, the price of a derivative based on a stock will follow the price of the stock itself. Arbitrage involves taking matched positions – buying one security, selling another, when the price differential moves outside its normal range. Such arbitrage strategies were widely used by Long-Term Capital Management, the hedge fund that collapsed spectacularly in 1998. LTCM, best known for its association with the two Nobel Prize-winning economists Robert Merton and Myron Scholes, was founded by John Meriwether, who had headed the trading operations of Salomon Bros in the 1980s (those described by Michael Lewis in his book Liar’s Poker) which pioneered the explosive growth of FICC trading. The fund was largely staffed by his former colleagues, and insiders often described it as ‘Salomon North’. In the end, the LTCM trades were settled profitably by the investment banks which had taken them over: a telling illustration of Keynes’s (possibly apocryphal) dictum that ‘markets can remain irrational for longer than you can stay solvent’.4 More recently, the mathematical analysis of trading patterns has enabled some algorithmic traders to make returns from minute movements in the prices of securities.


pages: 265 words: 74,000

The Numerati by Stephen Baker

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Berlin Wall, Black Swan, business process, call centre, correlation does not imply causation, Drosophila, full employment, illegal immigration, index card, Isaac Newton, job automation, job satisfaction, McMansion, Myron Scholes, natural language processing, PageRank, personalized medicine, recommendation engine, RFID, Silicon Valley, Skype, statistical model, Watson beat the top human players on Jeopardy!

Say it rains in Tucson from zero to six times per month, and you listen to the weather report, which has been right 19 of the past 20 days, only three times a week. One of your three jackets is suede. What are the chances it'll get drenched tomorrow? Imagine that same question with one thousand variables, and you've stepped into the stochastic world. A generation ago, a crew of math whizzes led by Myron Scholes and Fischer Black focused their mastery of probability on finance, where they calculated risk and put prices on it. This led to a panoply of new financial products, from options to hedging strategies. It was a math revolution on Wall Street. The mathematicians were replacing hunches, wholesale, with science. Takriti says that by the time he reached IBM, many of the same math tools were being refitted for other industries.

See Medications Privacy not a concern in animal testing, [>] concerns about loss of, [>], [>], [>]–[>], [>] as issue in Europe, [>] people's voluntary lifting of, [>]–[>], [>] personal details as violating, [>] and phones, [>], [>]–[>], [>]–[>] policies regarding shoppers', [>] protections for, [>]–[>], [>]–[>], [>]–[>], [>]–[>] of workers, [>]–[>], [>] Probability, [>]–[>], [>], [>], [>] Probst, Katharina, [>] Proxies, [>], [>]–[>], [>] Psychology, [>], [>], [>] Pulleyblank, William, [>] Quantification, [>] See also Mathematical models Quants, [>], [>] Raghavan, Prabhakar, [>]–[>], [>], [>] Remy, Martin, [>] Republican Party, [>], [>]–[>], [>], [>], [>]–[>], [>] "Resourcefuls" tribe, [>], [>] Retail store data, [>]–[>], [>], [>], [>], [>], [>] See also Advertisers RFID technology, [>] "Right Clicks" tribe, [>]–[>], [>]–[>], [>], [>], [>] Romantic-movie lovers, i—[>], [>]–[>], [>], [>] Root, Mabel, [>] Rosenberger, Larry, [>] Rove, Karl, [>], [>] Sandia National Labs (New Mexico), [>]–[>] Schatz, James, [>], [>], [>]–[>], [>], [>] Scholes, Myron, [>] The Sea, the Sea (Murdoch), [>] Search engine optimization (SEO), [>] Second Life (virtual world), [>] Sensors in animals, [>]–[>] medical, [>], [>]–[>], [>]–[>], [>], [>], [>] SEO (search engine optimization), [>] Serotonin, [>], [>] [>]-Hour Task Force, [>] Shakespeare, William, [>], [>], [>] Shoppers (consumers) averaging of, [>] bloggers as, [>]–[>], [>] choices available to, [>]—ii, [>], [>] data collected about, [>], [>], [>], [>], [>]–[>], [>], [>], [>], [>]–[>], [>], [>]–[>], [>], [>], [>], [>] lists of, [>], [>], [>]–[>], [>] targeting of individual, by advertisers, [>], [>], [>]–[>], [>], [>], [>], [>] See also Advertisers; Credit Sifry, David, [>]–[>] Silverstein, Craig, [>]–[>] Simplex algorithms, [>]–[>] Simplex triangle, [>]–[>] Singapore, [>], [>] Small Blue search engine, [>] "Smart bombs" (medical), [>] "Smart carts," [>]–[>], [>], [>]–[>] Smith, J.


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Crapshoot Investing: How Tech-Savvy Traders and Clueless Regulators Turned the Stock Market Into a Casino by Jim McTague

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algorithmic trading, automated trading system, Bernie Madoff, Bernie Sanders, Bretton Woods, buttonwood tree, computerized trading, corporate raider, creative destruction, credit crunch, Credit Default Swap, financial innovation, fixed income, Flash crash, High speed trading, housing crisis, index arbitrage, locking in a profit, Long Term Capital Management, margin call, market bubble, market fragmentation, market fundamentalism, Myron Scholes, naked short selling, pattern recognition, Ponzi scheme, quantitative trading / quantitative finance, Renaissance Technologies, Ronald Reagan, Sergey Aleynikov, short selling, Small Order Execution System, statistical arbitrage, technology bubble, transaction costs, Vanguard fund, Y2K

Quants in the late 1990s and early 2000s learned the hard way what should have been fairly obvious—the longer one’s time horizon, the more difficult it is to predict the future. Any meteorologist or political prognosticator could have told them that. It was this eureka moment that ushered in the era of what is now known as HFT. Previously, the Quants had chosen investments with durations of months or even years. LTCM had Nobel Prize laureates Myron Scholes and Robert C. Merton on its team. The hedge fund made a highly leveraged, long-term bet on the direction of interest rates. That bet went haywire about a year after it was made when Russia unexpectedly defaulted on its sovereign bonds. They might have done better of they had called the fund Short-Term Capital Management. Likewise, dozens of hedge funds swallowed huge losses when the mortgage markets blew up in 2007.

See CFTC; SEC researching stocks, recommendations for, 233-234 retail market, wholesale market versus, 171-174 retail trades, monopoly by brokerage houses, 31-32 retirement savings, recommendations for, 230 Reuters, 195 revenue generated from volume, 165-166 RGM (HFT company), 151 “Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market” (Vega), 98 Ritholtz, Barry, 234 Robinette, Robbie, 151 Rowen, Harvey A., 106, 116 Rubin, Robert, 98-100 Rueckert, Cleveland, 180 Rumsfeld, Donald, 114 S S&P 500, volatility, 2 S&P 500 E-Mini futures contracts in Flash Crash, 68-69 Safian, Ken, 158 Salmon, Felix, 211-212 Saluzzi, Joseph, 11-25, 44-45, 61 Sanders, Bernie, 100-101 Sarbanes, Paul, 100 Sarbanes-Oxley Act, 100 Schapiro, Mary, 43, 52-61, 86, 97-103, 183, 188, 198, 209-210, 214, 226 Scholes, Myron, 159 Schultz, Paul, 139 Schumer, Chuck, 43-44, 56, 172, 187 Schwab, Charles, 120 Schwed, Fred, 105 Schwert, G. William, 179-180 SEC (Securities and Exchange Commission) Arnuk and Saluzzi’s finding discussed with, 44-45 Congressional pressure on, 47-59 Division of Risk, Strategy and Financial Innovation, formation of, 97 on erosion of investor confidence, 208-210 Flash Crash report, 213-227 immediate reaction to Flash Crash, 82 investigation of Flash Crash, 183-185, 189-191 consolidated tape delays, 199-205 ethics issues, 193-198 quick fix rules after Flash Crash, 85-87, 90 tracking mechanism, need for, 64 Securities Act Amendments of 1975, 113-122 Securities Investor Protection Corporation (SIPC), 62, 109, 115 self-regulation, 120 Senate.


pages: 297 words: 77,362

The Nature of Technology by W. Brian Arthur

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Andrew Wiles, business process, cognitive dissonance, computer age, creative destruction, double helix, endogenous growth, Geoffrey West, Santa Fe Institute, haute cuisine, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kevin Kelly, knowledge economy, locking in a profit, Mars Rover, means of production, Myron Scholes, railway mania, Silicon Valley, Simon Singh, sorting algorithm, speech recognition, technological singularity, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions

If the price was higher than $8.40 the farmer could sell on the market; if the price was lower he could exercise the option, thus locking in a profit at the cost of purchasing the option contract. The value of the contract “derived” from the actual market value—hence it was called a derivative. In the 1960s, putting a proper price on derivatives contracts was an unsolved problem. Among brokers it was something of a black art, which meant that neither investors nor banks in practice could use these with confidence. But in 1973 the economists Fischer Black and Myron Scholes solved the mathematical problem of pricing options, and this established a standard the industry could rely on. Shortly after that, the Chicago Board of Trade created an Options Exchange, and the market for derivatives took off. We cannot quite say here that derivatives trading “adopted” computation. That would trivialize what happened. Serious derivatives trading was made possible by computation.

., 49 programming of, 51–54, 56 replication of, 52 philosophy, 4, 14, 61, 97, 158, 170 photography, 66, 80–81 photonics, 69, 83 physics, 38, 202 atomic, 10, 24, 80, 114–15, 160 puzzles of, 47–50 quantum, 159 pilots, 72–73, 92 Pirsig, Robert, 216 Pittsburgh, University of, 9 Planck, Max, 57 planets, 47–49, 50, 65, 67 orbiting of, 47, 63 plastic injection molding, 25, 156 poetry, 32, 78, 79 Polak, Wolfgang, 182–83 politics, 61, 212 polymerase chain reaction, 123 Pont de Normandie, 31 potassium-argon dating, 46 pottery firing, 22, 171 power, 51, 52, 71, 73, 171, 200 see also energy; specific power sources Pratt & Whitney, 40, 93 JT9D jet engine, 93–94 pressure-measuring devices, 50, 52 printing press, 10, 75 products, 71, 210 barter and exchange of, 55 distribution and transport of, 81–84, 192, 193, 194 domination of markets by, 2, 152 prices and availability of, 152, 154, 177, 179, 192, 202 see also markets propulsion systems, 52, 108, 111–12, 120 proteins, 53, 147, 148, 208 psychology, 36, 97, 107, 212 purposed systems, 54–56, 105–6, 138, 142, 192–93 quantum phenomena, 57, 59, 66, 69 quantum theory, 123, 159, 161 quartz crystals, 49 “Question Concerning Technology, The” (Heidegger), 213–14 Quicksort computer algorithm, 17, 98 radar, 15, 17, 18, 22, 33, 39, 41, 49, 55, 56, 70, 72, 73–74, 113–14, 132, 135, 184 radiation: black-body, 57 electromagnetic, 59, 121 radio, 7, 15, 18, 74, 75, 184 components of, 30, 50, 167–68 signals processed by, 30, 33, 49, 50, 122, 167–68, 171 radiocarbon dating, 45 radiolabeling, 70 railroads, 14, 75, 107, 147, 149–50, 152, 153, 155, 192 locomotives for, 17, 145–47 Randall, John, 113–14, 122 random events, 2 raw materials, 19, 24–25 recursiveness, 37–39, 42, 46, 91, 113 resonant cavities, 113–14, 122 Ribet, Kenneth, 129 Ricardo, David, 202 Rickover, Hyman, 104 riveting machines, 29 rivets, 33 robotics, 9 rocket technology, 113, 175 roller bearings, 28 Röntgen, Wilhelm Conrad, 57 Rosati, Robert, 94 Rosenberg, Nathan, 14, 101 Santa Fe Institute, Stanislaw Ulam Memorial Lectures, 4 satellites, 41, 206 Savery, Thomas, 176 Scholes, Myron, 154 Schumpeter, Joseph, 6, 19–20, 90, 107, 180, 185, 199, 200, 202 Schwandbach bridge, 99–100 science, 7, 14 application of, 1, 27, 57–58, 60–61, 91, 162–63, 171 beauty of, 64 definitions of, 64 experiment and insight in, 57–64 Greek thought-based, 64 invention in, 126–29 investment in, 162, 170 modern, 57–58, 61–63 technology and, 29, 59–65 theoretical, 141–42 see also specific scientific disciplines science fiction, 74–75, 207, 215–16 seismic analysis, 75 semiconductors, 71 sensing systems, 52, 72–74, 150 sewer systems, 150 Shannon, Claude, 125 Shimura, Goro, 128 ships: evolution of, 16 navigation of, 25 sailing, 16, 177 see also specific ships silicon, 9, 71, 179 Silicon Valley, 28, 151, 162 Simon, Herbert, 36 “smart” systems, 12, 207, 215 Smith, Adam, 37, 202 society, 106 ideas and culture of, 10, 16, 88 influence of technology on, 4, 6, 10–12, 13 primitive, 21 sociology, 4, 6, 14, 16, 21, 106 software, 31, 50, 56, 79 Solvay process, 177 space, 47–50, 74–75, 175 see also planets; stars species, 17, 18, 31, 66, 89 evolution of, 13, 16, 107, 127–28, 188, 204 interrelatedness of, 13, 14, 32 origin of, 14, 127–28 spectroscopy, 50, 61, 80 Stanford University, 3, 162 staphylococci bacteria, 119 Starkweather, Gary, 117–18 stars, 47–50 light spectra of, 48–49, 50 oscillation of, 47–50 Star Wars, 215–16 steam engines, 10, 14, 16, 29, 73, 75, 87, 109, 147, 156, 174, 176 steam technology, 21, 74, 159 steel, 10 basic oxygen processing of, 42 open-hearth processing of, 24 see also Bessemer process stemcell regeneration, 11 Stockton and Darlington Express, 147 stoves, 10 street cars, 21 structural deepening, 3, 131–43, 163 superchargers, 140 surveying methods, 25, 30, 88 Sutter, Joseph, 92 symphonies, 54, 55, 56 systems theory, 170 tailrace, 33 Taniyama, Yutaka, 128 Tatara Bridge, 91 techniques, 5, 6, 27, 65, 169, 212 laboratory, 6, 37 modern, 57–58 refinement of, 48 sophisticated, 10 see also specific techniques technium, 28 technologies, 1–7 abstract vs. particular view of, 31–32, 39, 170 adoption, use, and diffusion of, 2, 4, 6, 9, 11–12, 13, 17, 59, 89, 152–53 assemblies and subassemblies of, 2, 3, 24, 28, 32–40, 43, 50, 53, 87, 90–94, 116, 134–35, 136–37, 139, 169, 172, 204 beauty of, 5, 78–79 changing or switching elements of, 15, 24, 29, 36, 42, 81, 87–88, 132–34, 138, 209 collapse and replacement of, 147, 177, 180, 181, 185, 192, 195 collective, 28–29, 69–85, 88, 167–89, 205 combinations of, 2–3, 15–26, 29, 32–43, 46, 51–52, 81, 89, 91, 107, 167–89 competition of, 2, 117, 138–39, 149, 159–63 complexity and sophistication of, 10, 21, 28, 34, 46, 132, 135, 159, 168 components of, 14, 18–19, 21, 23–25, 28, 29–43, 50, 54, 63, 66, 69, 70, 72–73, 79–80, 87, 96–98, 130, 133–34, 157, 169, 181, 204 conflicting definitions of, 5, 27 constraints within, 35 conventional vs. non-conventional, 55–56 core mechanism of, 51, 176–78 creation of, 2–3, 6, 12, 14, 15, 19, 21, 23, 26, 27, 43, 57, 66, 87, 90, 98–99, 106–30 current shift in character of, 24–26, 209–11 definitions of, 1, 5, 27–30, 38, 50–51, 53, 54, 60, 203 design of, 4, 12, 13, 17, 36, 39, 50, 91–95, 99–100 emergence of the world from, 4, 10, 11, 12, 171–72 evolution of, 1–6, 12–26, 29, 43, 64–70, 87–90, 105–43, 145–65, 167–89, 191–202, 203, 204–5 familiar, 6, 46 fear of, 215–16 feedback from, 2, 91, 103–4, 161 hidden, 98, 216 hierarchy of, 37–41, 92 higher vs. lower levels in, 42 history of, 4, 6, 13, 16, 75 hope in, 11, 28, 215 humanity and, 216 improvement and modification of, 2, 3, 4, 15, 16, 17, 24, 29, 36, 42, 73, 81, 87–88, 89–90, 93, 131–43, 146, 160–61, 185, 196 increasing returns and, 2 individual, 29, 70–71, 75, 78, 85, 87, 107–43, 145, 153, 163, 203 inside view of, 14–15, 18–19, 24, 87–88 interrelatedness of, 2–3, 14, 15–26, 29, 32–43 literature of, 3–4, 6, 13 lock-in and adaptive stretch of, 103, 138–41 magic and wonder of, 7, 9–10, 52 maintenance of, 175 manual, 73, 74 mature, 138, 149–50, 165, 177 mechanics and methods of, 3, 12, 18, 19, 21–24, 27–28, 30–31, 51, 55, 90, 172–89, 207–8 medieval, 10 as metabolism, 52–53, 189 miniature, 23, 24, 71 modern, 10, 12, 21, 22, 25, 65, 207, 213 nature and essence of, 4, 12, 13, 43, 50–54, 56, 87 nonphysical, 55–56 nontechnology-like, 54–56 novel, 2, 5, 6, 15, 17–19, 20, 21, 22, 23, 24, 29, 66, 105, 106–30, 143, 145, 163–64, 168, 193, 196, 203–4 opportunity niches for, 170, 174–76, 177–79, 180–81, 183, 187, 195, 199 organization and structure of, 1, 2, 14, 17, 22–23, 32–43 outside view of, 51, 87 overall theory lacking on, 4, 12–15, 21 partitioning of, 36–37, 54 phenomena, as products of, 3, 22, 24, 29, 43, 45–67, 69, 77, 85, 88, 122, 123, 124, 125, 133, 141, 145, 146, 157, 160, 162, 163, 170, 171–172, 177, 186, 188–189, 200, 201, 203, 204, 205, 215 primitive, 16, 21, 22, 171, 176, 180–81 principles and logic of, 4, 5–6, 12–15, 23–24, 25–26, 29, 32, 33, 46, 49, 55, 87 problems posed by, 11–12, 176, 197–201, 204 production and distribution of, 175 promises and threats of, 6, 9, 12 purposes and functions of, 17, 24–25, 28–31, 37–39, 40–41, 43, 54, 71, 88–89 questions about, 1–3, 9–12, 15, 43, 59–60, 107–8 radical novelty in, 17–18, 19, 107–11 real-world, 38, 41–42, 47, 50 recursive patterns of, 3, 37, 38–43, 46, 91, 110, 113, 129–30, 135, 204 revolutions in, 65, 149, 157 self-creation of, 2–3, 21, 24, 59, 167–170, 188 signature of, 55 simple, 30, 33, 36, 47, 185 skepticism and suspicion of, 7, 8, 11–12 specialized, 171–72 study of, 14–15, 18–19 supply and demand of, 172, 174–76, 196–98 support, 175–76 terminology of, 4–5 testing and analysis of, 36, 93, 112, 117, 118, 120, 131 theory of, 2, 4, 13, 14, 16, 21, 23, 25, 107, 109, 172, 203 versions of, 17, 18, 88, 89, 92–93, 95, 100, 105, 131–34, 145, 161 tectonic plates, 11 telecommunications, 150–51, 171, 206 telegraphy, 59, 60, 74, 162 telephones, 42, 59, 98 telescopes, 47, 48, 61, 64 textile technology, 65, 139, 159, 171, 192, 193, 196, 197 theater-of-war systems, 39–42 theorems, 128–129 thermodynamics, 171 thermoluminescence dating, 46 tire industry, 162 toilets, 10 tools, 20, 46, 171 Townes, Charles, 80, 115, 118, 123 trade, 160–61, 192 derivatives, 154–55, 209 foreign, 19 see also economy; markets; products trade unions, 105–6, 197 transformers, 33, 59 transistors, 69, 174, 179 transmission networks, 79 transportation, 21, 85, 200 container, 83–84 horse, 82, 147, 180 see also aircraft; automobiles; ships tree-ring dating, 45 tricycles, 73 triode vacuum tube, 168 trucks, 46, 75, 99 trust, 55 Truxal, John G., 60 turbines, 19, 33, 34, 52, 65, 93, 103–4, 115, 134–35, 168 turbojets, 22, 108–9, 137 Tyndall, John, 119 typesetting, 76 Usher, Abbott Payson, 20 vacuums, 83 vacuum tubes, 59, 146, 150, 167–68, 169, 179 Varela, Francisco, 2, 170 variation and selection, 17, 18, 127, 128, 132, 188 Vaughan, Diane, 139–40 Venturi, Robert, 212–13 Verne, Jules, 74–75 vertebrates, 32 Vincenti, Walter, 15 von Ohain, Hans, 20, 111–12 watchmaking, 36, 38 water, 67, 171 flow of, 33, 147, 176 heavy (D2O), 104 light (H2O), 104–5 storage of, 29, 33 Waterloo, Battle of, 125 waterwheels, 10, 73, 147, 177 Watson, James, 58, 61 Watt, James, 109, 156 wavelength division multiplexer, 28 waves, 22, 33, 40, 80, 122, 146, 168, 171 WD-40, 93 wealth, 10, 11, 71, 197, 210, 214 weapons, 171 Westinghouse, 104 wheels, 46, 66, 73 whisky, 43 Whittle, Frank, 20, 111, 113, 115–16, 136–37 Wideröe, Rolf, 114–15, 121 Wiles, Andrew, 128–29 Williams, Michael, 126 wood, 45, 57 World War I, 119, 202 World War II, 36–37, 73, 75, 113 Wright brothers, 120 Wright Brothers’ Flyer, 96, 132 Xenopus laevis frog, 148 xerography, 33, 108, 117–18 Xerox, 117 X-rays, 57, 61, 122, 171 ABOUT THE AUTHOR W.


pages: 291 words: 81,703

Average Is Over: Powering America Beyond the Age of the Great Stagnation by Tyler Cowen

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Amazon Mechanical Turk, Black Swan, brain emulation, Brownian motion, Cass Sunstein, choice architecture, complexity theory, computer age, computer vision, computerized trading, cosmological constant, crowdsourcing, dark matter, David Brooks, David Ricardo: comparative advantage, deliberate practice, Drosophila, en.wikipedia.org, endowment effect, epigenetics, Erik Brynjolfsson, eurozone crisis, experimental economics, Flynn Effect, Freestyle chess, full employment, future of work, game design, income inequality, industrial robot, informal economy, Isaac Newton, John Markoff, Khan Academy, labor-force participation, Loebner Prize, low skilled workers, manufacturing employment, Mark Zuckerberg, meta analysis, meta-analysis, microcredit, Myron Scholes, Narrative Science, Netflix Prize, Nicholas Carr, pattern recognition, Peter Thiel, randomized controlled trial, Ray Kurzweil, reshoring, Richard Florida, Richard Thaler, Ronald Reagan, Silicon Valley, Skype, statistical model, stem cell, Steve Jobs, Turing test, Tyler Cowen: Great Stagnation, upwardly mobile, Yogi Berra

Those are qualities that will serve well the workers of the future. Larry Kaufman, who developed the evaluation function for the Rybka program, and who is the mastermind of the Komodo program, graduated from MIT with an undergraduate degree in economics in 1968. He went to work on Wall Street as a broker and soon started developing his own form of options-pricing theory, working independently of Fischer Black and Myron Scholes; Scholes later won a Nobel Prize for that contribution. Kaufman’s theory was based on ideas of Brownian motion and the logistic function, the latter of which he took from formulas for calculating chess ratings. In the 1970s he made money by applying his options-pricing work through a trading firm and stopped when the profits went away, and he has since dedicated his life to chess and computer chess, including his work on Rybka and Komodo.

See also demographic trends Poundstone, William, 35 Poverty Action Lab, 222 Preuss, David, 188 prices and automation, 112–13 and convenience vs privacy, 15 and economy theory, 222 and education, 181–83, 197 and employment, 53 and foreign competition, 163, 165–66, 175 housing and real estate, 5, 240, 242–45, 247 and internet businesses, 69 and physician ratings, 122, 124 “price factor equalization,” 163 and tax policy, 234 and wealth inequality, 253 Princeton University, 193 privacy issues, 15 privatization, 235 prodigies, 188, 216 productivity of workers, 4, 25, 57–58, 165, 169 programming skills, 48, 188 progressive taxation, 256–57 protectionism, 175–76 psychology, 105 public services, 241 Putallaz, Martha, 188 quality assessment, 119–25 quantum mechanics, 205, 211–15 Rajlich, Vasik, 79–80, 81, 104, 107 Rand, Ayn, 240–41 rating systems, 119–25, 126–27 rationality, 100, 103 rationing of health care, 249–50 Reagan, Ronald, 235 Reality Is Broken (McGonigal), 187 recessions, 38, 54–59 Regan, Ken, 101–4, 106–7, 109, 120, 126, 149–50 regulatory issues and computer diagnosis, 128–29 and education standards, 90 and inscrutability of science, 217 and machine intelligence, 16–17, 224 and man-machine collaborations, 128–29 and reporting standards, 129–30 religion, 197, 210–11 The Rent Is Too Damn High (Yglesias), 240 rents, 63, 236, 239–40 reporting standards, 129–30 Republican Party, 256–57 research assistants, 27–28 research teams, 207 “reshoring,” 177 residential segregation, 247–48 resources ownership, 20 retirees, 51, 173–75, 191, 232, 242 retraining, 202 Ricardo, David, 6 Ripley, Amanda, 200 risk and risk-aversion, 75–76, 106, 129 robots and the arts, 146 and chess, 115–16 and complex environments, 116 and labor trends, 177 and manufacturing, 7–8 and marketing, 22 and popular culture, 5 and vision systems, 116 Rosette (computer program), 139–40 Rowling, J. K., 234 Russia, 20 Rybka (chess program) and computer chess matches, 72 and evaluation of chess play, 203, 224–25 and Freestyle chess, 47 and human collaboration, 135, 168 and human intuition, 114–15 and performance evaluation, 104 power of, 68 and training human chess players, 102, 106–7, 120, 124, 192–93 Santa Cruz, California, 9–10 Scholes, Myron, 203 Schwarzenegger, Arnold, 134 science, engineering, and math majors (STEM), 21, 22, 27 scientific research and bureaucracy, 210 economics, 221–28 and impossible problems, 211–17 increasing complexity of, 205–6 machine science, 217–20 specialization in, 206–11, 219 screening systems, 121 searching skills, 151–55 Second Life, 145 self-awareness programs, 135 self-education, 188–94, 202 self-employment, 59–63 self-scrutiny, 14 self-service, 113, 118 service sector, 22, 62, 169 Shannon, Claude, 68–69 shanty towns, 245–46 Shogun (game), 135 short-run spending hypothesis, 53–54 Shredder (chess program), 78, 81–82, 105 Sicily, 174–75 Simon, Herbert, 75–76 simulation, 200, 210 “singularity” hypothesis, 137–38 Siri, 7, 17, 72, 119, 121, 149 Siu, Henry, 55 sketches, 146, 147 “Skynet,” 134 Skype, 146 “slackers,” 51, 246 smart phones, 92, 152 Smith, Adam, 28–29, 215 Smith, Vaughan, 26 Snow, Peter, 187 social contract and the fiscal crunch, 231–51 and inequality, 229–31 and political trends, 251–59 social interactions, 12–13, 73, 142 social networks, 188, 209–10, 223 social safety net, 231 social sciences, 224, 227 Social Security, 233, 234–35, 237, 247 social unrest, 253–55, 257 South Korea, 8 Southeast Asia, 171 Soviet Union, 168, 189, 252 Spain, 173–74 Spark (chess program), 70–72, 155–56 specialization in the sciences, 206–11, 219 spelling bees, 187–88 Spence, Michael, 176 spending trends, 54 standardization, 126–31 Stanford University, 193 state budgets, 237 stem-cell research, 17 Stephen, Zackary, 78 stock trading, 74 Stockfish (chess program), 68, 70–72, 155–56 string theory, 212–14 structural unemployment, 37, 55 Sunstein, Cass, 105 supermarkets, 118 supply and demand, 234 support service, 169 Sweden, 161 Switzerland, 161 Tang, Hangwi, 89 taxes and tax policy and the fiscal crunch, 232–34, 236 and political trends, 254, 256, 258 progressive taxation, 256–57 “tax incidence,” 234 TCEC Stage 2a (chess tournament), 156 Tea Party Movement, 251, 256 teaching schools, 196 team-orientation, 28, 36, 207 technical support, 111–13 Technique 2011, 140, 142–43 technological progress, 133 The Terminator (1984), 134 Texas, 239, 241, 247 textile mills, 8 Thaler, Richard, 105 Thatcher, Margaret, 235 theory development, 221–22, 223, 225–26 therapy, online, 145 Thoresen, Martin, 155–56 threshold earners, 202 Thrun, Sebastian, 189, 191 time management, 81 Toiletgate, 149–50 Topalov, Vaselin, 149 tourism, 174, 175 transparency in business, 130 Transportation Safety Administration (TSA), 10 Trefler, Daniel, 164 TripAdvisor, 16 Turing, Alan, 68–69, 141, 143–44 Turing test, 83, 139–51 “tutor kings,” 200–201 Twitter, 154 underemployment, 50, 164 unemployment and freelancing, 59–63 gender disparity in, 31 and geographic trends, 172 and the Great Recession, 54–59 and immigration, 163–71 and in-flow rate, 58 and intelligent machines, 45–50 labor force participation rate, 46 recent trends, 50–54 structural, 37 unskilled labor, 19, 56 US Air Force, 20–21 US Congress, 255 US military, 57 US Supreme Court, 238 USA Memory Championships, 152 utopian visions, 136 Vancouver, British Columbia, 241 Venezuela, 171 Vidal, Gore, 257 video games, 185–88 Virginia Tech, 183–84 virtual schools, 181 vision systems (robotic), 116 visual arts, 146, 147 voice recognition, 119 Vonnegut, Kurt, 126, 247–48 wages and the fiscal crunch, 236 and freelancing, 59–60 and gender, 52–53 and geographic trends, 171–73 and immigration, 163–71 impact of intelligent machines, 136 wages (cont.)


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

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activist fund / activist shareholder / activist investor, Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, centralized clearinghouse, clean water, computerized trading, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, fixed income, Flash crash, income inequality, index fund, information asymmetry, invisible hand, Kenneth Arrow, light touch regulation, London Whale, Long Term Capital Management, moral hazard, Myron Scholes, Northern Rock, passive investing, performance metric, Ponzi scheme, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

The adjustments to the shape of the curve were many, but the fundamental assumption, that the variability of the outcomes was predictable, was largely unchallenged. 19. International Monetary Fund, “IMF Performance in the Run-up to the Financial and Economic Crisis: IMF Surveillance in 2004–07” (International Monetary Fund, Independent Evaluation Office, January 10, 2011), http://www.ieo-imf.org/ieo/pages/NewsLinks107.aspx. 20. Myron Scholes and Robert Merton were both directors of Long-Term Capital Management. Wikipedia.org/wiki/Long_Term_Capital_Management. 21. John Maynard Keynes, General Theory of Employment Interest and Money (Snowball Publishing, 2012), bk. 5, chap. 21. 22. Friedrich von Hayek, “The Pretense of Knowledge,” Nobel Prize acceptance speech, 1974, http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1974/hayek-lecture.html. 23.

See also Pension funds Revenue sharing, 31 Risk: categorization of loans and, 129, 175, 212–13 diversification and, 21–22, 44–45, 240–41n35, 242–43n57 fiduciary duty and, 140 financial industry and reduction of, 17 gaps in managing, 171–74 insurers and, 22 modeling, 12–13, 39–44, 161–65, 240n27 uncertainty and, 172, 261n35 Rock Center for Corporate Governance, Stanford University, 82–83 Rothschild, Victor, 17 Rotman School of Management, 100 Royal Society of the Arts, 243n57, 255n12 Rule of law, 184 Rumsfeld, Donald, 172 Russia, social media and demands for finance industry transparency in, 115–16 S&P 1500, 67 S&P 500, 45–46, 49, 51 Safety, banks and, 20, 22, 211, 212, 216 Sarbanes-Oxley Act (US), 10 Save Darfur Coalition, 120 Savers. See Citizen investors/savers Schmidt, Breno, 102 Scholes, Myron, 260n20 Schwartz, Barry, 52 Scott, Andrew, 171 SEC (Securities and Exchange Commission), 52, 88, 91, 107, 204, 257n32, 265n14, 266n27 SHARE. See Shareholder Association for Research and Education (SHARE) Share price, 66, 71, 148 ShareAction, 89, 111, 121, 225 Sharegate, 90–91 Shareholder activism, agency capitalism and, 76 Shareholder Association for Research and Education (SHARE), 121 Shareholder resolutions, mutual fund votes on, 102 Shareowners: board of directors and, 18 rollback of powers, 11 Short volatility strategies, 239n25 “The Short Long” (Haldane), 66 Short-term buying and selling, 150–51 Short-termism, 8, 10, 63–66, 68, 71, 148, 228.


pages: 353 words: 81,436

Buying Time: The Delayed Crisis of Democratic Capitalism by Wolfgang Streeck

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activist fund / activist shareholder / activist investor, banking crisis, basic income, Bretton Woods, capital controls, Carmen Reinhart, central bank independence, collective bargaining, corporate governance, creative destruction, David Graeber, deindustrialization, Deng Xiaoping, Eugene Fama: efficient market hypothesis, financial deregulation, financial repression, fixed income, full employment, Gini coefficient, Growth in a Time of Debt, income inequality, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour market flexibility, labour mobility, late capitalism, liberal capitalism, means of production, moral hazard, Myron Scholes, Occupy movement, open borders, open economy, Plutonomy: Buying Luxury, Explaining Global Imbalances, profit maximization, risk tolerance, shareholder value, too big to fail, union organizing, winner-take-all economy, Wolfgang Streeck

Lin, ‘Income Dynamics, Economic Rents and the Financialization of the US Economy’, American Sociological Review, vol. 76/4, 2011, pp. 538–59. 71 Fig. 1.8 shows four countries where the compensation effect was especially marked. It is worth noting that Sweden too (along with other Scandinavian countries) belongs in this group. 72 Among the main names here are Eugene Fama (father of the ‘efficient market hypothesis’), Merton H. Miller (co-founder of the Modigliani-Miller theorem), Harry Markowitz, Robert Merton, Myron Scholes and Fischer Black. Most have taught at the University of Chicago and appear on the list of winners of the so-called Nobel Prize in economics, awarded by the Swedish central bank (Riksbank). 73 This became clear in summer 2012, during the discussions on an EU ‘rescue package’ for Spanish banks. Of course, the dual nature of money as private property and public institution goes back a long way (G.

See also executive pay rights, 1.1, 1.2, 1.3, 2.1, 2.2, 2.3, 2.4n76, 3.1 risk propensity, 1.1, 2.1n40, 2.2 Romney, Mitt, 3.1n50, 3.2 Rosenfeld, Jake Rösler, Philipp Rubinstein, David Sallusti, Alessandro Sarkozy, Nicolas, 3.1, 3.2, 4.1n6 Sarrazin, Thilo: Europa braucht den Euro nicht savings, 1.1, 2.1, 2.2n59, 3.1 Scandinavia, 1.1, 1.2, 1.3, 2.1. See also Denmark; Sweden Schäfer, Armin Schäuble, Wolfgang, 2.1n71, 4.1 Schiller, Karl, 1.1, 1.2 Schmidt, Helmut Scholes, Myron schooling Schröder, Gerhard, 2.1, 2.2n37, 3.1 Schumpeter, Joseph, 1.1, 1.2n50, 2.1, 2.2 ‘self-regulated markets’, 1.1, 1.2, 1.3 ‘shareholder value’, 1.1, 2.1 Shonfield, Andrew: Modern Capitalism Sicily, 3.1, 3.2, 3.3n72, 3.4 Slovakia social class. See class social democracy, 1.1, 2.1, 2.2, 3.1, 3.2, 3.3; demise/elimination, 3.4, 3.5; post – World War II, 1.2n55, 2.3, 4.1n26 Social Democratic Party of Germany (SPD), 1.1, 2.1n37, 3.1n76 socialism, 1.1, 2.1n25, 3.1; France; Hayek view; Schumpeter and Weber view, 1.2, 2.2.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Bayesian statistics, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, naked short selling, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

Yet, only if such options contracts were standardized and if a model could be developed for the pricing of options as there had been a decade earlier for securities could the options market be successful and the derivative become an efficient and effective instrument for hedging risk. The CBOT could take care of the first precedent. The team of Fischer Black and Myron Scholes would take care of the second. The young boy wonder Myron Scholes had arrived at the Sloan School at MIT in 1968, with his freshly minted PhD from the Univesity of Chicago in hand. He was strong mathematically, but he was also brilliant with computing, which made him as invaluable for the MIT faculty as he had been for the Chicago faculty. He had teamed up with Merton Miller at Chicago and had also worked with Miller’s famous collaborator, the great mind Franco Modigliani, who had, very early on, championed large-scale computer modeling of the macroeconomy.

As Jon Corzine, his former Goldman Sachs colleague and former Governor of New Jersey and Senator of the USA, and most recently as the CEO when the investment bank MF Global failed spectacularly, remembered: “Fischer Black was simply the best. Giants without arrogance are rare.”4 Myron Scholes While Fischer Black was a man of few, carefully chosen words, and had a soft-spoken nature, he nonetheless stood tall, both physically and intellectually, especially on the practitioner side of finance. However, while it was he who generated the differential equation which Myron Scholes would help solve, Scholes’ contribution to the equation, and especially its intuition, should not be underestimated. Scholes remained immersed in research and teaching at MIT until Stanford University successfully attracted him to California in 1981.

They live together in Pasadena, California. Scholes has two daughters, Anne and Sara. One story left to be told There remains one significant story left to be told in Myron Scholes’ life. Before the saga of Long Term Capital Management can be told, we must first describe the life, times, and theories of one final great mind in pricing theory. This page intentionally left blank Part IV Robert Merton Our last great mind in pricing theory is appropriate for a number of reasons. First, he shares an American pioneer pedigree that is common among the great quant minds in this volume. Second, he worked closely with Fischer Black and Myron Scholes to bring their idea to fruition, and then took their ideas still further. Third, he was part of the intellectual hub that had shifted from Chicago toward Cambridge, Massachusetts, but often with the same cast of characters.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

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Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, negative equity, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, value at risk, Washington Consensus, Yom Kippur War

It would happen only once in four million years of trading.78 This was the planet imagined by some of the most brilliant financial economists of modern times. Perhaps it is not altogether surprising that it turned out to look like Greenwich, Connecticut, one of the blandest places on Earth. In 1993 two mathematical geniuses came to Greenwich with a big idea. Working closely with Fisher Black of Goldman Sachs, Stanford’s Myron Scholes had developed a revolutionary new theory of pricing options. Now he and a third economist, Harvard Business School’s Robert Merton, hoped to turn the so-called Black-Scholes model into a money-making machine. The starting point of their work as academics was the long-established financial instrument known as an option contract, which (as we saw in Chapter 4) works like this. If a particular stock is worth, say, $100 today and I believe that it may be worth more in the future, say, in a year’s time, $200, it would be nice to have the option to buy it at that future date for, say, $150.

Short term, it was still dear old Planet Earth, inhabited by emotional human beings, capable of flipping suddenly from greed to fear. When losses began to mount, many participants simply withdrew from the market, leaving LTCM with a largely illiquid portfolio of assets that couldn’t be sold at any price. Moreover, this was an ever more integrated Planet Earth, in which a default in Russia could cause volatility to spike all over the world. ‘Maybe the error of Long Term’, mused Myron Scholes in an interview, ‘was . . . that of not realizing that the world is becoming more and more global over time.’ Meriwether echoed this view: ‘The nature of the world had changed, and we hadn’t recognized it.’98 In particular, because many other firms had begun trying to copy Long-Term’s strategies, when things went wrong it was not just the Long-Term portfolio that was hit; it was as if an entire super-portfolio was haemorrhaging.99 There was a herd-like stampede for the exits, with senior managers at the big banks insisting that positions be closed down at any price.

Santiago (Chile) 218 Santo Tomás, Domingo de 23 Sassetti, Francesco 46 Saving, Thomas R. 221 savings: against future surprises 229 discouraged by taxes 211 gluts 293 international comparisons 333-5 need for banks 56 pre-modern societies 184 property purchase as 229 savings - cont. see also savings banks savings banks 56 and bonds 100 British 56 Savings & Loan (S&L) associations (‘thrifts’) 247-9 regulatory environment of 254 Savonarola, Girolamo 47 Savoy, Victor Amadeus II, Duke of 138 Scholes, Myron 320-23 Schumpeter, Joseph 348-9 Schwartz, Anna 161 science 342. see also technological innovation scope issues 346 Scotland 138. see also Glasgow Scottish Ministers’ Widows Fund 193-6 Scottish Widows 196 Scott, Sir Walter 195-7 Scruggs, Richard F. (‘Dickie’) 180-82 sea levels 224 securitas 185 securities: new types 74 see also asset-backed securities; assets; securitization Securities Act 314n.


pages: 435 words: 127,403

Panderer to Power by Frederick Sheehan

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Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, British Empire, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, inflation targeting, interest rate swap, inventory management, Isaac Newton, John Meriwether, Long Term Capital Management, margin call, market bubble, McMansion, Menlo Park, money market fund, mortgage debt, Myron Scholes, new economy, Norman Mailer, Northern Rock, oil shock, Paul Samuelson, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, rolodex, Ronald Reagan, Sand Hill Road, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War, zero-sum game

General Accounting Office, LongTerm Capital Management: Regulators Need to Focus Greater Attention on Systemic Risk, GAO/GGD-00-3, October 29, 1999, p. 15, quoted in Martin Mayer, The Fed: The Inside Story of How the World’s Most Powerful Financial Institution Drives the Markets (New York: Free Press, 2001), p. 267. 4 Alan Greenspan, “Our Banking History,” speech at the Annual Meeting and Conference of the Conference of State Bank Supervisors, Nashville, Tennessee, May 2, 1998. 5 Citicorp was renamed Citigroup Inc. after it merged with Travelers Group in 1998. Those Daffy Nobels There had been plenty of warnings that not much had changed since the derivative failures in 1994. Ignorance was essential to derivative operations. We need look no further than LongTerm Capital Management and two of its employees, Robert Merton and Myron Scholes. The pair received the Nobel Prize in economic sciences in 1997 “for a new method to determine the value of derivatives.” Upon receiving his award in Stockholm, Myron Scholes “singled out two companies—General Electric and Enron—as having the ability to outcompete existing financial firms. He noted, ‘Financial products are becoming so specialized that, for the most part, it would be prohibitively expensive to trade them in organized markets.’ According to Scholes, Enron’s trading of unregulated over-the-counter energy derivatives was a new model that someday would replace the organized [and regulated] securities exchanges.”6 Enron’s specialized derivatives left the company bankrupt in 2001, and General Electric’s financial ventures led it to government life support by 2008.

(Herbert Greenspan), 9–10 Reed, John, 114–115 Rees, Albert, 42 Regan, Donald, 79, 82, 92 Resolution Trust Corporation (RTC), 89 Restructuring of debt, 291 Reuss, Henry, 65 Riegle, Donald, 85 Risk management, by banks, 184–186 Rivlin, Alice, 348 RJR Nabisco, 116–117 Roach, Stephen, 49–50 Robertson, Julian, 223, 228–229 Rockefeller, Happy, 74 Rockefeller, Laurence, 75 Rohatyn, Felix, 75, 138 Röpke, Wilhelm, 145 Rosenberg, David, 358 Rostenkowski, Dan, 110 Roth, Emory, 352 Rowan, Hobart, 67 Royal Society for the Arts, 200 RTC (Resolution Trust Corporation), 89 Rubin, Robert, 136, 143, 276, 277, 300, 322–323, 354 Rubinstein, Mark, 103–104, 109, 110 Russell, Richard, 345–347 Russia, 172 Rutgers University, 37 S Salinger, Pierre, 75 Salmon, Jean, 45 Salomon Brothers, 183 Salomon Smith Barney, 233 Salon.com, 342 Samuelson, Paul, 26 San Remo apartments (New York City), 352–353, 356 Santomero, Anthony, 259 Sarkozy, Nicolas, 341 Sasser, Jim, 98–99 Savings, personal, 364 in 1999, 258 Bernanke’s perspective on, 310 in early 1990s, 253 proposed tax on, 288 and recession of 1990s, 126 Savings and loans (S&Ls), 86, 88–93 (See also Lincoln Savings and Loan Association) Scholes, Myron, 183, 187 Schoolsnet.com, 221 Schultz, George, 42 Schultze, Charles, 61, 66, 230n.11 Schumer, Chuck, 219 Schwartz, Anna, 344 Schwartzman, Stephen, 311–312, 320–322 Sears, Roebuck and Company, 99, 100 SEC (Securities and Exchange Commission), 87 Securities and Exchange Commission (SEC), 87 Seiders, David, 280 Seidman, L. William, 55, 55n.33, 85, 88–91 Semiconductors, 207, 242 September 11, 2001, terrorist attacks, 245–249 740 Park Avenue, 322, 357 Shanghai Stock Exchange, 327 Sharkey, Thomas F., 91 Shulman, David, 133 Shultz, George, 42 Sichel, Daniel, 159 Silk, Leonard, 61–62 Simon, William, 56 Skadden Arps, Slate, Meagher & Flom, 116 Slichter, Sumner, 24 S&Ls (see Savings and loans) Smith, Greg, 248 Soccernet, 222 Social security, 84, 147, 149, 154 Social Security Commission, 146 Solow, Robert, 137 Soros, George, 131 S&P 500 Index, 169 and 1987 stock market crash, 111–112 in 1991, 128 in 1995, 139, 141 in 1996, 141 in 1997, 141, 278 in 1998, 188, 278 futures contract on, 110n..5, 111–112 Spielberg, Steven, 353 Sprinkel, Beryl, 42, 60 Stagflation, 52 Standards of living, investment and, 350–352 Statistical espionage, 4 Statisticalitis, 40 Stein, Herbert, 61, 227n.1 Steinberg, Jonathan, 322 Steinberg, Saul, 35, 88–90, 117, 322 Steinhardt, Michael, 38 Stempel, Robert, 127 Stern, Gary, 194 Stern, Robert A.M., 356 Stevenson, Richard W., 164 Stiglitz, Joseph, 143, 342 Stock market: 1950 to 1966 rise in, 4 in 1970s, 43 1987 crash, 103–104, 110–115 1990s bubble in, 145, 155, 160–164, 169–178, 191–210, 285–287 and 1990s recession, 127 in 1995, 133 in 1998, 187–188 in 2000, 215–216, 219, 221, 224–225, 229 in 2001, 237–238, 246, 248 as driver of the economy, 175 Greenspan’s predictions about, 105–106 and “irrational exuberance,” 105 (See also Nasdaq; S&P 500 Index) Stock market analysts (see also Wall Street analysts under “Alan Greenspan”), 177–178, 193, 195, 198–204, 209, 218, 232, 239, 243–244, 284 Stock options, 318 Stock-option cashout plans, 72 Strauss-Kahn, Dominique, 341 Subprime lending market, 1990s, 164–166, 274 Subprime mortgages, 296, 328–331, 340, 357 Summers, Lawrence “Larry,” 143, 276–277, 323, 361 Sun Microsystems, 207 Sunny Isles Beach, Florida, 295 Supply-side economics, 68–69, 96 “Sweeping” assets from retail checking accounts, 134–135 Swope, Gerard, 364–365 Sulzberger, Arthur Ochs, 74 Sunday Times (London), 342 Sydney Morning Herald (Australia), 347 Synthetic CDOs, 313 T TACA International, 164 Technology, 196, 200–201, 241 “Technology and the Economy” (Alan Greenspan), 218 Technology industry, 207 and 2000 slowdown, 234, 235 in 2001, 237 profit losses in, 219 and Y2K scare, 216 Television, stock market and, 248–249 Terra Holdings LLC, 356 Terrorist attacks of 2001, 245–247 Tett, Gillian, 313 Texas Instruments, 207 Thomas, Allen, 74 Thomas, Barbara, 74 Thrifts (see Savings and loans) Time magazine, 35, 42, 43, 45, 55–56, 60–61, 70, 96, 101, 289 Townsend, William, 3, 15–16, 353 TownsendGreenspan & Co., 3, 5, 6, 16, 17, 19, 25, 27, 73, 74, 102 Trans-World Financial, 93 Travelers, 275 Treasury Department, 20, 56, 132, 247, 296 Treasury securities (see U.S.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

In addition to the random walk model of stock prices, the period between 1950 and 1970 saw the development of the mean-variance approach to portfolio diversification, which Harry Markowitz, another Chicago economist, pioneered; the capital asset pricing model, which a number of different scholars developed independently of one another; and the Black-Scholes option pricing formula, which Fischer Black, an applied mathematician from Harvard, and Myron Scholes, a finance Ph.D. from Chicago, developed. Some of the mathematics used in these theories is pretty befuddling, which helps explain why there are so many physicists and mathematicians working on Wall Street, but the basic ideas underpinning them aren’t so difficult. Many of them originated with Bachelier and his coin-tossing view of finance. Imagine tracking the daily movements in a stock over a year, or two years, and plotting them on a bar chart.

A year later, the misplaced bets of a single derivatives trader, Nick Leeson, brought down the venerable Barings Bank. In 1998, the giant (and unregulated) hedge fund Long-Term Capital Management, which was a big player in many derivatives markets, had to be propped up and then wound down by a consortium of Wall Street banks, with the Fed playing a coordinating role. The demise of Long-Term Capital, which had two economics Nobel winners as partners—Robert Merton and Myron Scholes—demonstrated the limitations of counterparty regulation. When the secretive firm opened its books to its Wall Street lenders and counterparties, many of them were astonished to discover that its leverage ratio was close to thirty to one, and that its derivatives exposures totaled about $1.4 trillion. The lesson was clear: in a world of hidden information, there is often no way for financial firms to know what risks their counterparties have taken on—be they hedge funds, banks, investment banks, or subsidiaries of industrial companies such as GE Capital.

Paul’s Cathedral (London) Salomon Brothers Salomon Smith Barney Salzburg, University of Samsung Group Samuelson, Paul San Francisco Chronicle Sante Fe Railroad Sargent, Thomas Saunders, Anthony Savage, Jimmy Saving Capitalism from the Capitalists (Rajan and Zingales) Savings & Loan (S&L) industry, collapse of Scharfstein, David Schlesinger, Karl Schlick, Moritz Scholes, Myron Schumpeter, Joseph Schwartz, Alan Schwartz, Anna J. Schweitzer, Albert Science Scott, Andrew Scott, Hal Scottish Enlightenment Seale, Bobby Securities and Exchange Commission (SEC) Securities Industry and Financial Markets Association Seidman, L. William Sen, Amartya Senate, U.S. Banking Committee Senior, Nassau September 11, 2001, terrorist attacks (9/11) shadow banking system Shakespeare, William Shearson Lehman Sherman Antitrust Act (1890) Shiller, Robert Shin, Hyun Song Shleifer, Andrei Shmelev, Nikolai Shultz, George Simons, Henry Sinai, Todd 60 Minutes Skidelsky, Robert Smith, Adam on banking death of divison of labor described by on duties of government Greenspan influenced by Hayek and legacy of invisible hand metaphor of moral philosophy of public goods addressed by Smith, Debbie Smith, Vernon Smoot-Hawley Tariff Act (1930) Socialism (Mises) Socialist Party Social Security Société Générale Solomon, Amit Solow, Robert Sonnenschein, Hugo Soros, George Soros Fund Mangement South Africa Southern California, University of Southern Pacific Railroad South Korea South Sea bubble Soviet Union collapse of Ministry of Light Industry Spain Spamann, Holger special-purpose vehicles (SPVs) speculative bubbles, see bubbles Spence, Michael Sperry Lease Finance Corporation spillovers Spitzer, Eliot Sputnik I Sraffa, Piero stability, illusion of Stabilizing an Unstable Economy (Minsky) Stack, Brian E.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

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Alvin Roth, bank run, banking crisis, barriers to entry, Bernie Madoff, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, income inequality, information asymmetry, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

The accumulation through time of these small price changes amounts to a result that is not random but that instead provides discovery of true economic value—a value that is highly useful in the allocation of economic resources and in generating our livelihoods. The discovery of a mathematical law to describe the price of a stock option in terms of the price of the underlying stock (as exempli ed by the famous mathematical formula derived by Fischer Black and Myron Scholes) is an example of a conservation law in finance.4 The option price is driven by exactly the same shocks as a ect the price of the underlying stock, but with a nonlinear transformation of e ect, a transformation that is at rst challenging to comprehend but that, upon su cient re ection, seems almost obvious. The same kind of conservation laws can be found throughout the eld of financial derivatives pricing.

Journal of Political Economy 112(6):1269–95. Berle, Adolf A., and Gardiner C. Means. 1932. The Modern Corporation and Private Property. New York: Commerce Clearing House. Bernasek, Anna. 2010. The Economics of Integrity. New York: HarperCollins. Bhagwati, Jagdish, and T. N. Srinivasan. 1994. India’s Economic Reforms. Delhi: Ministry of Finance. Black, Fischer. 1986. “Noise.” Journal of Finance 41(3):529–43. Black, Fischer, and Myron Scholes. 1973. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy 81(3):637–54. Blank, Rebecca M., and Michael S. Barr, eds. 2009. Insu cient Funds: Savings, Assets, Credit and Banking among Low-Income Households. New York: Russell Sage Foundation. Bloom, Paul. 2004. Descartes’ Baby: How the Science of Child Development Explains What Makes Us Human. New York: Basic Books.

See executive compensation; rewards salespeople, financial, 80, 85, 97, 235 Samuelson, Paul A., 185 Sarkozy, Nicolas, 2 Saverin, Eduardo, 49 Save the Children, 200 savings: encouraging, 214; lottery-linked, 177; rates of, 153–54; retirement, 214 savings banks, 44 SBA. See Small Business Administration Scarf, Herbert, 69, 131 Schneider, Daniel, 177 Schoar, Antoinette, 31 Schoenberg, Arnold, 136 Scholes, Myron, 132 Schultz, Wolfram, 59, 60, 139–40 Schumpeter, Joseph A., 122 Schwed, Fred, Jr., 79, 161–62 science. See brain; physics scientists, 188, 190 Securities and Exchange Commission (SEC), 60, 87, 88, 96, 98, 99 securities regulations, 35–36, 46, 80, 96–97, 161. See also regulation, financial securitized debt, 43, 52–55. See also mortgage securities Seghers, Conrad, 35 self-esteem, 139, 159, 163, 224, 234, 237 self-regulatory organizations, 36, 80, 94, 95, 96–97, 101–2 sensation seeking, 140, 141–42 Šerys, Rosalia, 174 shadow banking system, 42–43 Shakers, 120 Shapley, Lloyd S., 69, 73 Sharpe, William, 34, 81 Sharpe ratio, 34, 35 Shefrin, Hersch, 78, 80 Shiller, George, 174 Shiller, Robert J., 2, 166, 172, 178, 180, 185–86, 193, 195 Shubik, Martin, 116 Simmons, Joseph P., 161 Simonov, Andrei, 28 Singapore, Central Provident Fund, 214 Singh, Manmohan, 3 SIVs.


pages: 385 words: 128,358

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

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Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, buy low sell high, capital controls, central bank independence, Chance favours the prepared mind, commoditize, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, diversification, diversified portfolio, family office, fixed income, glass ceiling, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, John Meriwether, Long Term Capital Management, margin call, market bubble, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shale / tar sands, oil shock, out of africa, paper trading, Paul Samuelson, Peter Thiel, price anchoring, purchasing power parity, reserve currency, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, yield curve, zero-coupon bond, zero-sum game

For one, the arbitragefocused fund drifted into global macro trades and its subsequent unwind had ramifications for global macro markets.Two, it offers insights into what can go wrong at a hedge fund, as well as shed light on such important issues as liquidity, risk management, and correlations. And three, almost every interviewee in this book mentions LTCM. LTCM was started in 1994 by infamous Salomon Brothers proprietary trader John Meriwether, who hired an all-star cast of financial minds including former Fed vice chairman David Mullins and Nobel Prize winners Robert Merton and Myron Scholes (pioneers in option pricing theory and methodology). LTCM started with $1.3 billion in assets from a who’s who list of investors and initially focused on fixed income arbitrage opportunities (which had become more attractive as spreads widened after the bond market rout of 1994). The original core strategy was to bet on the convergence of the spread between “off-the-run” and “on-the-run” bonds, as well as other relative value and arbitrage opportunities, primarily in fixed income.

I don’t feel I have to be at the start of every move anymore. I work off this matrix that I developed 25 years ago based on the flows of money. Money is always going somewhere no matter what, so I just have to stay attuned. But I am more patient in letting THE FLOOR TRADER 207 moves develop before I get in. As I’ve gotten older, my patience has improved. Do you express your views through options? I don’t, but I have a funny story about that. Myron Scholes is on the board of the CME and we went out to dinner one night. I had a couple of drinks in me already and said to him,“Myron, options are for pussies.” Everybody at the table was laughing because here was this idiot floor trader telling a Nobel Prize winner that options are for pussies. But he replied, “I’m not disagreeing with you. Options are slow to pick up a trend because the beginning of a trend is always a grind.

See also Arbitrage Risk aversion, 107, 115 Risk capital, 24 Risk curve, 328 Risk-free rate, 196, 342 Risk management strategies, 7–8, 25, 32, 50, 53–54, 61–62, 131, 137–138, 172, 192, 204, 206, 213–214, 285, 293–294, 333–334 Risk premium, 55 Risk/reward analysis, 98, 110–111, 126, 296 Risk-to-return ratio, 62 Robertson, Julian, xi, 8, 10, 21, 23, 27–28, 245–247, 277 Roditi, Nick, 269, 278 Rogers, Jim, 8, 210, 217–221, 223–239, 269–271, 278 Rogers International Commodity Index, 218 Rubin, Robert, 32, 245 Rumors, 249, 268 Russia/Russian rubles, 22–23, 49–50, 64–65, 203–204, 211, 237–238, 277, 280, 283, 286, 289, 290 Russian crisis 1998, 10, 21–23, 26, 54, 64, 80, 292–294, 299–300, 310 Russian Equity Index, 65 Russian stock market index (RTSI$), 22 INDEX S&P 500 index, 27–28, 193, 212–213, 217, 273–274, 282 Safe harbor, 205 Salomon Brothers, 24 Samuelson, Paul, 9 Scholes, Myron, 24, 207 Secular trends, 234 Sell-offs, 20, 118, 175, 295, 302 SemperMacro, 71, 72 Seykota, Ed, 9 Sharpe ratio, 62, 342–343 Short-dated volatility, 55 Short positions, xii, 58. See also specific traders Short selling, 272–274, 282, 330 Short stocks, 29 Short-term trading, 69 Siberia, 261 Sidelsky, Robert, 5–6 Silver, 206, 230 Singapore, 63 Site visits, 261 Siva-Jothy, Christian, 31, 72–101 Slower Fool Theory, 204–205 Small caps, 177, 219 Soros, George, xi, xiv, 8, 10, 12, 14–16, 20, 23, 27–30, 32, 206, 209, 233, 238, 246, 268–269, 273–279, 282–283 Soros Fund Management, 12, 15, 20, 27, 29, 31, 33, 93, 269–270, 273–274, 278–279 South America, 82.


pages: 317 words: 106,130

The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

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asset allocation, backtesting, Bernie Madoff, Black Swan, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index fund, interest rate swap, invisible hand, market microstructure, merger arbitrage, moral hazard, Myron Scholes, passive investing, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve, zero-sum game

Arbitrage relationships in capital and A Brief History of Asset Allocation 11 corporate markets were explored during the 1930s (forward interest rates implied in yield curve models)10 and in the 1950s (corporate dividend policy and debt policy). Similarly, cost of carry arbitrage models had long been the focal point of pricing in most futures based research. In the early 1970s Fischer Black and Myron Scholes (1973) and Merton (1973) developed a simple-to-use option pricing model based in part on arbitrage relationships between investment vehicles. Soon after, fundamental arbitrage between the relative prices of a put option (the right to sell) and a call option (the right to buy) formed a process to become known as the Put-Call Parity Model, which provided a means to explain easily the various ways options can be used to modify the underlying risk characteristics of existing portfolios.

See Modern Portfolio Theory (MPT) MSCI Emerging Markets, 257, 258 Multi-asset allocation, 70–71, 133 performance, 148, 153, 158 principal concerns, 167 Multi-factor model, 41, 42, 43, 44, 50–54 Multi-factor regression model, 51 Multivariate linear regression, 198 Mutual funds, 129 NAREIT Domestic Real Estate Index, 179 NASDAQ, 250, 251 NCREIF National Property Index (NPI), 173, 175 Non-linear payoffs, 197 Old Portfolio Theory (OPT), 3 Operational risk, 197 Opportunity cost risk, 210 Optimization models, 92–98, 200 Options, 11, 197 and return distribution, 27 and risk management, 206 trading, 12 Option theory, 10–11, 231, 238, 246 Order, definition of, 242–245 Oversight, 243–244 Parameter estimation error, 25 Peer group creation, 126–132 Performance alpha, 46–47 Performance attribution, 34 Performance evaluation, conditional, 53–54 Political risk, 197 Portfolio insurance strategy, 92, 107 Portfolio management: active versus passive, 46–47 convexity of returns, 49–50 market segment weightings, 70–71 performance comparison between aggressive and conservative, 72–73 risk based, 66 Portfolio returns: differences in aggressive and conservative management, 86–87 ranked by BarCap US Aggregate, 83 ranked by S&P 500, 81 weightings, 84–85 Portfolio risk, 11, 30–34 Portfolios: bootstrapped or resampled, 94 measuring exposure, 198 model, 102 quantitative construction models, 93 rebalancing, 15, 107, 201 return volatility, 99 292 Portfolios (Continued) risk based, 106 risk decomposition of, 202–203 tactical asset, 106 Portfolio weights, 94 Price risk, 33, 219 Private equity, 61, 65, 118, 148–153 benchmarks, 170–173, 174, 275 performance of indices, 171 return and risk performance, 151–153 returns ranked by S&P 500, 154, 172 sources of return, 151 Probability, 2, 20 Product development, 15–16 Pro forma performance, 167, 169 Protected investment strategy, 107 Pure security, 62 Purity, style, 126–132 Put-Call Parity Model, 11 Put option, 11 Put protected investment strategy, 107 Quantitative model, 102–103 Rate of return: annualized S&P 500, 93 excess break-even rate, 43–44 and risk, 197–198 Real estate, 61, 65, 129, 153–160, 176 benchmarks, 173–179, 274 comparison benchmark performance, 157 correlation with S&P 500 indices, 178, 181 international and FTSE returns, 177 prices, 155–156 return and risk performance, 156–158 sources of return, 155–156 Real estate investment companies (REITs), 155 Reallocation strategy, 103 Reasonable man theory, 60 Rebalancing, 15, 107, 201 Regression coefficients, 52 Regression model, 51, 52 Regulations, governmental, 127, 197, 244–245, 247–248 REITs (real estate investment companies), 155, 157–158, 179 Replication-based indices, 122–126, 223 Reporting bias, 192 INDEX Return and risk: of asset classes through business cycles, 251–270 characteristics of alternative investments, 61–62 characteristics of indices, 169 commodities, 162–163 differences among similar asset class benchmarks, 167–194 hedge funds, 140–143 historical attributes and strategy allocation, 66–70 historical comparisons, 71–74 managed futures, 146–148 models post-1980, 11–13 multi-factor estimation, 50–54 performance results, 66 predictability of, 95–96 private equity, 151–153 real estate, 156–158 sources in alternative investments, 134–166 and strategic asset allocation, 99 Return estimation models, 50–54 Return generating models, 46 Return intervals, 36 Returns: benchmark, 136 CISDM hedge funds, 145 commodities, 160–162 hedge funds, 139–140 and managed futures, 146 and performance of investment managers, 215 real estate, 155–156 Return to risk, 2, 18, 19 Return volatility, 61, 99 Risk, 1–2 absolute, 65 and alternative investments, 134–166 assessment, 28–30 aversion, 98, 100, 133 budgeting and asset allocation, 195–211 decomposition, 34, 202–203 determinants, 23 and expected return, 230 factor weightings, 54–55 individual vs. portfolio, 69 and liabilities, 96 management of (See Risk management) 293 Index measurements of, 20–38, 96–97 measures of exposure, 63 qualitative, 63 and rate of return, 197–198 tolerance, 89, 117–119 and tracking error, 97–98 what it is, 22–24 Risk factor sensitivity analysis, 34 Risk-free assets, 4 Risk hedge ratio, 204 Riskless rate of interest, 7 Risk management, 1–2, 3, 11, 107, 214, 247 benefits of reduction, 74 goal of, 199 models, 247 multi-factor approach to, 195–200 using futures, 203–206 using options, 206 and volatility, 200–202 Risk premia, 7, 214 Robertson, Julian, 222 Rogers International Commodity Index (RICI), 182 Roll returns, 166 Rosenberg, Barr, 10 Russell Growth, 120, 207, 251 volatility, 254, 255, 256, 257 Salomon Brothers Bond Indices, 168 Sample selection, 38 Satellite allocation, 110–133 Scholes, Myron, 11 Securities: fixed income, 12, 24, 63, 65, 272 investable, 123 pure, 62 Securities and Exchange Commission (SEC), 229 Securitization, 155 Security market line, 6 Seed capital, 153 Selection bias, 192 Semi-standard deviation, 97 Semi-variance, 30 Sensitivity, market, 74–82, 82–84, 89 Sharpe Ratio, 18, 26–28, 37, 43 Skewness, 29, 62, 97, 223 Slope of the yield curve, 101 Small minus big (SMB) factor, 45 Smoothing, 28, 175 S&P 500, 36, 37, 185 annualized rate of return, 93, 168 annualized standard deviation, 93 benchmark returns, 79, 138 CISDM CTA indices, 150 commodity benchmarks, 165 correlations with real estate indices, 175, 178, 181 correlation with Barclays Capital U.S.


pages: 369 words: 94,588

The Enigma of Capital: And the Crises of Capitalism by David Harvey

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accounting loophole / creative accounting, anti-communist, Asian financial crisis, bank run, banking crisis, Bernie Madoff, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business climate, call centre, capital controls, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, deskilling, equal pay for equal work, European colonialism, failed state, financial innovation, Frank Gehry, full employment, global reserve currency, Google Earth, Guggenheim Bilbao, Gunnar Myrdal, illegal immigration, indoor plumbing, interest rate swap, invention of the steam engine, Jane Jacobs, joint-stock company, Joseph Schumpeter, Just-in-time delivery, land reform, liquidity trap, Long Term Capital Management, market bubble, means of production, megacity, microcredit, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Northern Rock, oil shale / tar sands, peak oil, Pearl River Delta, place-making, Ponzi scheme, precariat, reserve currency, Ronald Reagan, sharing economy, Silicon Valley, special drawing rights, special economic zone, statistical arbitrage, structural adjustment programs, the built environment, the market place, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, Thorstein Veblen, too big to fail, trickle-down economics, urban renewal, urban sprawl, white flight, women in the workforce

Innovations were ad hoc and private, corresponding more to the activities of the ‘bricoleur’ than of the systematiser. This was the way to avoid the regulator and free the market. The traders were by the mid-1990s often highly trained mathematicians and physicists (many arriving with doctorates in those fields straight from MIT) who delighted in the complex modelling of financial markets along lines pioneered back in 1972 when Fischer Black, Myron Scholes and Robert Merton (who later became infamous for their role in the Long-term Capital Management crash and bail-out in 1998) wrote out a mathematical formula for which they earned a Nobel Prize in Economics on how to value an option. The trading identified and exploited inefficiencies in markets and spread risks but, given its entirely new patterns, this permitted manipulations galore that were extremely difficult to regulate or even to spot because they were buried in the intricate ‘black box’ mathematics of computerised over-the-counter trading programs.

.: Limits to Growth 72 meat-based diets 73, 74 Medicare 28–9, 224 Mellon, Andrew 11, 98 mercantilism 206 merchant capitalists 40 mergers 49, 50 forced 261 Merrill Lynch 12 Merton, Robert 100 methane gas 73 Mexico debt crisis (1982) 10, 19 northern Miexico’s proximity to the US market 36 peso rescue 261 privatisation of telecommunications 29 and remittances 38 standard of living 10 Mexico City 243 microcredit schemes 145–6 microeconomics 237 microenterprises 145–6 microfinance schemes 145–6 Middle East, and oil issue 77, 170, 210 militarisation 170 ‘military-industrial complex’ 91 minorities: colonisation of urban neighbourhoods 247, 248 Mitterrand, François 198 modelling of markets 262 modernism 171 monarchy 249 monetarism 237 monetisation 244 money centralised money power 49–50, 52 a form of social power 43, 44 limitlessness of 43, 47 loss of confidence in the symbols/quality of money 114 universality of 106 monoculture 186 Monopolies Commission 52 monopolisation 43, 68, 95, 113, 116, 221 Monsanto 186 Montreal Protocol (1989) 76, 187 Morgan Stanley 19 Morishima, Michio 70 Morris, William 160 mortgages annual rate of change in US mortgage debt 7 mortgage finance for housing 170 mortgage-backed bonds futures 262 mortgage-backed securities 4, 262 secondary mortgage market 173, 174 securitisation of local 42 securitisation of mortgage debt 85 subprime 49, 174 Moses, Robert 169, 171, 177 MST (Brazil) 257 multiculturalism 131, 176, 231, 238, 258 Mumbai, India anti-Muslim riots (early 1990s) 247 redevelopment 178–9 municipal budgets 5 Museum of Modern Art, New York 21 Myrdal, Gunnar 196 N Nandigram, West Bengal 180 Napoleon III, Emperor 167, 168 national debt 48 National Economic Council (US) 11, 236 national-origin quotas 14 nationalisation 2, 4, 8, 224 nationalism 55–6, 143, 194, 204 NATO 203 natural gas 188 ‘natural limits’ 47 natural resources 30, 71 natural scarcity 72, 73, 78, 80, 83, 84, 121 nature and capital 88 ‘first nature’ 184 relation to 121, 122 ‘the revenge of nature’ 185 ‘second nature’ 184, 185, 187 as a social product 188 neocolonialism 208, 212 neoliberal counter-revolution 113 neoliberalism 10, 11, 19, 66, 131, 132, 141, 172, 175, 197, 208, 218, 224, 225, 233, 237, 243, 255 Nepal: communist rule in 226 Nevada, foreclosure wave in 1 New Deal 71 ‘new economy’ (1990s) 97 New Labour 45, 255 ‘new urbanism’ movement 175 New York City 11 September 2001 attacks 41 fiscal crisis (1975) 10, 172, 261 investment banks 19, 28 New York metropolitan region 169, 196 Nicaragua 189 Niger delta 251 non-governmental organisations (NGOs) 35, 253–4 non-interventionism 10 North Africa, French import of labour from 14 North America, settlement in 145 North American Free Trade Association (NAFTA) 200 Northern Ireland emergency 247 Northern Rock 2 Norway: Nordic cris (1992) 8 nuclear power 188 O Obama, Barack 11, 27, 34, 210 Obama administration 78, 121 O’Connor, Jim 77, 78 offshoring 131 Ogoni people 251 oil cheap 76–7 differential rent on oil wells 83 futures 83, 84 a non-renewable resource 82 ‘peak oil’ 38, 73, 78, 79, 80 prices 77–8, 80, 82–3, 261 and raw materials prices 6 rents 83 United States and 76–7, 79, 121, 170, 210, 261 OPEC (Organisation of Oil-Producing Countries) 83, 84 options markets currency 262 equity values 262 unregulated 99, 100 Orange County, California bankruptcy 100, 261 Organisation for Economic Cooperation and Development (OECD) 51 organisational change 98, 101 organisational forms 47, 101, 121, 127, 134, 238 Ottoman Empire 194 ‘over the counter’ trading 24, 25 overaccumulation crises 45 ozone hole 74 ozone layer 187 P Pakistan: US involvement 210 Palley, Thomas 236 Paris ‘the city of light’ 168 epicentre of 1968 confrontations 177, 243 Haussmann’s rebuilding of 49, 167–8, 169, 171, 176 municipal budget crashes (1868) 54 Paris Commune (1871) 168, 171, 176, 225, 243, 244 Partnoy, Frank: Ubfectious Greed 25 patents 221 patent laws 95 patriarchy 104 pensions pension funds 4, 5, 245 reneging on obligations 49 Péreire brothers 49, 54, 98, 174 pesticides 185, 186, 187 petty bourgeois 56 pharmaceutical sector 129, 245 philanthropy 44 Philippines: excessive urban development 8 Phillips, Kevin 206 Pinochet, General Augusto 15, 64 plant 58 Poland, lending to 19 political parties, radical 255–6 politics capitalist 76 class 62 co-revolutionary 241 commodified 219 depoliticised 219 energy 77 identity 131 labour organizing 255 left 255 transformative 207 pollution air 77 oceanic 74 rights 21 ‘Ponts et Chaussées’ organisation 92 Ponzi schemes 21, 114, 245, 246 pop music 245–6 Pope, Alexander 156 population growth 59, 72, 74, 121, 167 and capital accumulation 144–7 populism 55–6 portfolio insurance 262 poverty and capitalism 72 criminalisation and incarceration of the poor 15 feminisation of 15, 258 ‘Great Society’ anti-poverty programmes 32 Prague 243 prices commodity 37, 73 energy 78 food grain 79–80 land 8, 9, 182–3 oil 8, 28, 37–8, 77–8, 80, 82–3, 261 property 4, 182–3 raw material 37 reserve price 81–2 rising 73 share 7 primitive accumulation 58, 63–4, 108, 249 private consortia 50 private equity groups 50 private property and radical egalitarianism 233, 234 see also property markets; property rights; property values privatisation 10, 28, 29, 49, 251, 256, 257 pro-natal policies 59 production expansion of 112, 113 inadequate means of 47 investment in 114 liberating the concept 87 low-profit 29 offshore 16 production of urbanisation 87 reorganisation and relocation of 33 revolutionising of 89 surplus 45 technologies 101 productivity agreements 14, 60, 96 agricultural 119 cotton industry 67 gains 88, 89 Japan and West Germany 33 rising 96, 186 products development 95 innovation 95 new lines 94, 95 niches 94 profit squeeze 65, 66, 116 profitability constrains 30 falling 94, 131 of the financial sector 51 and wages 60 profits easy 15 excess 81, 90 falling 29, 72, 94, 116, 117 privatising 10 rates 70, 94, 101 realisation of 108 proletarianisation 60, 62 property markets crash in US and UK (1973–75) 8, 171–2, 261 overextension in 85 property market-led Nordic and Japanese bank crises 261 property-led crises (2007–10) 10, 261 real estate bubble 261 recession in UK (after 1987) 261 property rights 69, 81–2, 90, 122, 179, 198, 233, 244, 245 Property Share Price Index (UK) 7 property values 171, 181, 197, 248 prostitution 15 protectionism 31, 33, 43, 211 punctuated equilibrium theory of natural evolution 130 Putin, Vladimir 29, 80 Q Q’ing dynasty 194 quotas 16 R R&D (research and development) 92, 95–6 race issues 104 racism 61, 258 radical egalitarianism 230–34 railroads 42, 49, 191 Railwan, rise of (1970s) 35 rare earth metals 188 raw materials 6, 16, 37, 58, 77, 101, 113, 140, 144, 234 RBS 20 Reagan, Ronald 15, 64, 131, 141 Reagan-Thatcher counter revolution (early 1980s) 71 Reagan administration 1, 19 Reagan recession (1980–82) 60, 261 Real Estate Investment Trusts (US) 7 recession 1970s 171–2 language of 27 Reagan (1980–82) 60, 261 Red Brigade 254 reforestation 184 refrigeration 74 reinvestment 43, 45, 66–7, 110–12, 116 religious fundamentalism 203 religious issues 104 remittances 38, 140, 147 rentiers 40 rents differential rent 81, 82, 83 on intellectual property rights 221 land 182 monetisation of 48, 109 monopoly 51, 81–2, 83 oil 83 on patents 221 rising 181 reproduction schemas 70 Republican Party (US) 11, 141 reserve price 81 resource values 234 Ricardo, David 72, 94 risks, socialising 10 robbery 44 Robinson, Joan 238 robotisation 14, 136 Rockefeller, John D. 98 Rockefeller brothers 131 Rockefeller foundation 44, 186 Roman Empire 194 Roosevelt, Franklin D. 71 Rothschild family 98, 163 Royal Society 91, 156 royalties 40 Rubin, Robert 98 ‘rule of experts’ 99, 100–101 Russia bankruptcy (1998) 246, 261 capital flight crisis 261 defaults on its debt (1998) 6 oil and natural gas flow to Ukraine 68 oil production 6 oligarchs 29 see also Soviet Union S Saddam Hussein 210 Saint-Simon, Claude Henri de Rouvroy, Comte de 49 Saint-Simonians 87, 168 Salomon Brothers 24 Samuelson, Robert 235, 239 Sandino, Augusto 189 Sanford, Charles 98 satellites 156 savings 140 Scholes, Myron 100 Schumer, Charles 11 Schumpeter, Joseph 46 Seattle battle of (1999) 38, 227 general strike (1918) 243 software development in 195 Second World War 32, 168–70, 214 sectarianism 252 securitisation 17, 36, 42 Sejong, South Korea 124–6 service industries 41 sexism 61 sexual preferences issues 104, 131, 176 Shanghai Commune (1967) 243 shark hunting 73, 76 Shell Oil 79, 251 Shenzhen, China 36 shop floor organisers (shop stewards) 103 Silicon Valley 162, 195, 216 Singapore follows Japanese model 92 industrialisation 68 rise of (1970s) 35 slavery 144 domestic 15 slums 16, 151–2, 176, 178–9 small operators, dispossession of 50 Smith, Adam 90, 164 The Wealth of Nations 35 social democracy 255 ‘social democratic’ consensus (1960s) 64 social inequality 224 social relations 101, 102, 104, 105, 119, 121, 122, 123, 126, 127, 135–9, 152, 240 loss of 246 social security 224 social services 256 social struggles 193 social welfarism 255 socialism 136, 223, 228, 242, 249 compared with communism 224 solidarity economy 151, 254 Soros, George 44, 98, 221 Soros foundation 44 South Korea Asian Currency Crisis 261 excessive urban development 8 falling exports 6 follows Japanese model 92 rise of (1970s) 35 south-east Asia: crash of 1997–8 6, 8, 49, 246 Soviet Union in alliance with US against fascism 169 break-up of 208, 217, 227 collapse of communism 16 collectivisation of agriculture 250 ‘space race’ (1960s and 1970s) 156 see also Russia space domination of 156–8, 207 fixed spaces 190 ‘space race’ (1960s and 1970s) 156 Spain property-led crisis (2007–10) 5–6, 261 unemployment 6 spatial monopoly 164–5 special drawing rights 32, 34 special economic zones 36 special investment vehicles 36, 262 special purpose entities 262 speculation 52–3 speculative binges 52 speed-up 41, 42 stagflation 113 stagnation 116 Stalin, Joseph 136, 250 Standard Oil 98 state formation 196, 197, 202 state-corporate nexus 204 ‘space race’ (1960s and 1970s) 156 state-finance nexus 204, 205, 237, 256 blind belief in its corrective powers 55 ‘central nervous system’ for capital accumulation 54 characteristics of a feudal institution 55 and the current crisis 118 defined 48 failure of 56–7 forms of 55 fusion of state and financial powers 115 innovation in 85 international version of 51 overwhelmed by centralised credit power 52 pressure on 54 radical reconstruction of 131 role of 51 and state-corporate research nexus 97 suburbanisation 171 tilts to favour particular interests 56 statistical arbitrage strategies 262 steam engine, invention of 78, 89 Stiglitz, Joseph 45 stimulus packages 261 stock markets crash (1929) 211, 217 crashes (2001–02) 261 massive liquidity injections (1987) 236, 261 Stockton, California 2 ’structural adjustment’ programmes vii, 19, 261 subcontracting 131 subprime loans 1 subprime mortgage crisis 2 substance abuse 151 suburbanisation 73, 74, 76–7, 106–7, 169, 170, 171, 181 Summers, Larry 11, 44–5, 236 supermarket chains 50 supply-side theory 237 surveillance 92, 204 swaps credit 21 Credit Default 24, 262 currency 262 equity index 262 interest rate 24, 262 Sweden banking system crash (1992) 8, 45 Nordic crisis 8 Yugoslav immigrants 14 Sweezey, Paul 52, 113 ‘switching crises’ 93 systematic ‘moral hazard’ 10 systemic risks vii T Taipei: computer chips and household technologies in 195 Taiwan falling exports 6 follows Japanese model 92 takeovers 49 Taliban 226 tariffs 16 taxation 244 favouring the rich 45 inheritance 44 progressive 44 and the state 48, 145 strong tax base 149 tax rebates 107 tax revenues 40 weak tax base 150 ‘Teamsters for Turtles’ logo 55 technological dynamism 134 technologies change/innovation/new 33, 34, 63, 67, 70, 96–7, 98, 101, 103, 121, 127, 134, 188, 193, 221, 249 electronic 131–2 ‘green’ 188, 221 inappropriate 47 labour fights new technologies 60 labour-saving 14–15, 60, 116 ‘rule of experts’ 99, 100–101 technological comparative edge 95 transport 62 tectonic movements 75 territorial associations 193–4, 195, 196 territorial logic 204–5 Thailand Asian Currency Crisis 261 excessive urban development 8 Thatcher, Margaret, Baroness 15, 38, 64, 131, 197, 255 Thatcherites 224 ‘Third Italy’, Bologna 162, 195 time-space compression 158 time-space configurations 190 Toys ‘R’ Us 17 trade barriers to 16 collapses in foreign trade (2007–10) 261 fall in global international trade 6 increase in volume of trading 262 trade wars 211 trade unions 63 productivity agreements 60 and US auto industry 56 trafficking human 44 illegal 43 training 59 transport costs 164 innovations 42, 93 systems 16, 67 technology 62 Treasury Bill futures 262 Treasury bond futures 262 Treasury instruments 262 TRIPS agreement 245 Tronti, Mario 102 Trotskyists 253, 255 Tucuman uprising (1969) 243 Turin: communal ‘houses of the people’ 243 Turin Workers Councils 243 U UBS 20 Ukraine, Russian oil and natural gas flow to 68 ultraviolet radiation 187 UN Declaration of Human Rights 234 UN development report (1996) 110 Un-American Activities Committee hearings 169 underconsumptionist traditions 116 unemployment 131, 150 benefits 60 creation of 15 in the European Union 140 job losses 93 lay-offs 60 mass 6, 66, 261 rising 15, 37, 113 and technological change 14, 60, 93 in US 5, 6, 60, 168, 215, 261 unionisation 103, 107 United Fruit Company 189 United Kingdom economy in serious difficulty 5 forced to nationalise Northern Rock 2 property market crash 261 real average earnings 13 train network 28 United Nations 31, 208 United States agricultural subsidies 79 in alliance with Soviet Union against fascism 169 anti-trust legislation 52 auto industry 56 blockbusting neighbourhoods 248 booming but debt-filled consumer markets 141 and capital surplus absorption 31–2 competition in labour markets 61 constraints to excessive concentration of money power 44–5 consumerism 109 conumer debt service ratio 18 cross-border leasing with Germany 142–3 debt 158, 206 debt bubble 18 fiscal crises of federal, state and local governments 261 health care 28–9 heavy losses in derivatives 261 home ownership 3 housing foreclosure crises 1–2, 4, 38, 166 industries dependent on trade seriously hit 141 interventionism in Iraq and Afghanistan 210 investment bankers rescued 261 investment failures in real estate 261 lack of belief in theory of evolution 129 land speculation scheme 187–8 oil issue 76–7, 79, 80, 121, 170, 210, 261 population growth 146 proletarianisation 60 property-led crisis (2007–10) 261 pursuit of science and technology 129 radical anti-authoritarianism 199 Reagan Recession 261 rescue of financial institutions 261 research universities 95 the reversing origins of US corporate profits (1950–2004) 22 the right to the city movement 257 ‘right to work’ states 65 savings and loan crisis (1984–92) 8 secondary mortgage market 173 ‘space race’ (1960s and 1970s) 156 suburbs 106–7, 149–50, 170 train network 28 unemployment 5, 6, 60, 168, 215, 261 unrestricted capitalist development 113 value of US stocks and homes, as a percentage of GDP 22 and Vietnam War 171 wages 13, 62 welfare provision 141 ‘urban crisis’ (1960s) 170 urban ‘heat islands’ 77 urban imagineering 193 urban social movements 180 urbanisation 74, 85, 87, 119, 131, 137, 166, 167, 172–3, 174, 240, 243 US Congress 5, 169, 187–8 US Declaration of Independence 199 US National Intelligence Council 34–5 US Senate 79 US Supreme Court 179 US Treasury and Goldman Sachs 11 rescue of Continental Illinois Bank 261 V Vanderbilt family 98 Vatican 44 Veblen, Thorstein 181–2 Venezuela 256 oil production 6 Vietnam War 32, 171 Volcker, Paul 2, 236 Volcker interest rate shock 261 W wage goods 70, 107, 112, 162 wages and living standards 89 a living wage 63 national minimum wage 63 rates 13, 14, 59–64, 66, 109 real 107 repression 12, 16, 21, 107, 110, 118, 131, 172 stagnation 15 wage bargaining 63 Wal-Mart 17, 29, 64, 89 Wall Street, New York 35, 162, 200, 219, 220 banking institutions 11 bonuses 2 ‘Party of Wall Street’ 11, 20, 200 ‘War on Terror’ 34, 92 warfare 202, 204 Wasserstein, Bruce 98 waste disposal 143 Watt, James 89 wealth accumulation by capitalist class interests 12 centralisation of 10 declining 131 flow of 35 wealth transfer 109–10 weather systems 153–4 Weather Underground 254 Weill, Sandy 98 Welch, Jack 98 Westphalia, Treaty of (1648) 91 Whitehead, Alfred North 75 Wilson, Harold 56 wind turbines 188 women domestic slavery 15 mobilisation of 59, 60 prostitution 15 rights 176, 251, 258 wages 62 workers’ collectives 234 working hours 59 World Bank 36, 51, 69, 192, 200, 251 ‘Fifty Years is Enough’ campaign 55 predicts negative growth in the global economy 6 World Bank Development Report (2009) 26 World Trade Organisation (WTO) 200, 227 agreements 69 street protests against (Seattle, 1999) 55 TRIPS agreement 245 and US agricultural subsidies 79 WorldCom 8, 100, 261 worldwide web 42 Wriston, Walter 19 X X-rays 99 Y Yugoslavia dissolution of 208 ethnic cleansings 247 Z Zapatista revolutionary movement 207, 226, 252 Zola, Émile 53 The Belly of Paris 168 The Ladies’ Paradise 168


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

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activist fund / activist shareholder / activist investor, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

Another reason prices can diverge from fundamentals for a considerable period is that arbitrage, whereby investors simultaneously buy and sell identical or similar financial instruments which are temporarily mis-priced and thus bring prices back into line, is rarely free of risk. This was amply demonstrated by the near-collapse in 1998 of Long-Term Capital Management, a hedge fund run by former Salomon Brothers trader John Meriwether, which counted two distinguished finance academics, Robert Merton and Myron Scholes, on its strength. LTCM used complex mathematical models to exploit minute divergences in the relative value of different bonds. It was betting on the idea that the valuations would inevitably converge by buying the underpriced security and selling the overpriced security in the hope of making a small margin on the trade when convergence took place. Because the margins were thin, the hedge fund borrowed heavily to take very big trading positions in order to magnify profits.

Chilton 1 railway mania (Britain 1840s) 1 Rajan, Raghuram 1, 2, 3, 4 Rand, Ayn 1, 2 Raphael 1 Reading, Brian 1, 2, 3, 4 Reagan, Ronald 1, 2, 3, 4, 5 Reformation 1, 2 regulators 1 regulatory arbitrage 1 Renaissance 1, 2, 3 Republic (Plato) 1, 2 retail banking 1 Reynolds, Joshua 1, 2 Ricardo, David 1 Richelieu, Cardinal 1 Ring of the Nibelung (Wagner) 1, 2, 3 Ritblat, John 1 Roaring Twenties 1, 2 robber barons 1, 2, 3 Robinson Crusoe (Daniel Defoe) 1 Rockefeller, John D. 1, 2 rogue traders 1 Rolls-Royce 1 Roman republic 1 Roosevelt, Franklin 1 Rosenberg, Harold 1 Roseveare, Henry 1 Roubini, Nouriel 1 Rousseau, Jean-Jacques 1, 2 de Rouvroy, Claude-Henri 1 Royal Exchange (London) 1 Rubens, Peter Paul 1, 2 rural exodus 1 Ruskin, John 1, 2, 3 Saatchi, Maurice 1, 2 Samuelson, Paul 1 Sandel, Michael 1 sarakin banks (Japan) 1 Sarkozy, Nicolas 1 Sassoon, Donald 1 Satyricon (Petronius) 1 Savage, Richard 1, 2 Schama, Simon 1, 2 Schiller, Friedrich 1 Scholes, Myron 1 Schopenhauer 1 Schuman, Robert 1 Schumpeter, Joseph 1, 2, 3, 4, 5, 6, 7 Schwed, Fred 1, 2 second industrial revolution (1920s) 1 Sen, Amartya 1 separation of powers 1 Shakespeare 1, 2, 3, 4, 5, 6 shareholder activists 1 shareholder value 1 shareholders 1 Shaw, George Bernard 1 Sherman Antitrust Act (US 1890) 1 Shiller, Robert 1, 2, 3, 4 Shleifer, Andrei 1 short selling 1, 2 Siemens 1 von Siemens, Werner 1 Sinclair, Upton 1 Skidelsky, Robert 1, 2 Smith, Adam 1, 2, 3, 4, 5, 6, 7, 8 Smith, Sidney 1 Smithers, Andrew 1, 2 Smollett, Tobias 1 social democratic model 1, 2 Société Générale 1 Socrates 1 Solon 1 Sombart, Werner 1, 2 Soros, George 1, 2 Sotheby’s 1 South Sea Bubble 1, 2, 3, 4, 5, 6, 7 sovereign debt 1 sovereign debt crisis (2009) 1 Spain 1, 2, 3, 4, 5, 6 speculation 1 Spenser, Edmund 1 Stabilising an Unstable Economy (Hyman Minsky) 1 Steed, Wickham 1 Stephenson, George 1 Stevens, Wallace 1 Streeck, Wolfgang 1 subprime mortgages 1, 2, 3, 4 Sutter, John 1 Sutton, Willie 1 swarf 1 Sweden 1 Swift, Jonathan 1, 2, 3 Tale of Two Cities (Charles Dickens) 1 Taleb, Nassim Nicholas 1, 2 Talleyrand, Charles Maurice de 1 Taoism 1 tax farming 1 tax havens 1 tax revolts 1 taxation 1 Taylor, John 1 Tea Party movement 1 Tennyson, Alfred 1 Thaler, Richard 1 Thatcher, Margaret 1, 2, 3, 4, 5, 6 Theory of Moral Sentiments (Adam Smith) 1 ‘thingism’ 1 Thomas Aquinas 1, 2 Thompson, E.


pages: 394 words: 85,734

The Global Minotaur by Yanis Varoufakis, Paul Mason

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active measures, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, business climate, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, correlation coefficient, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, declining real wages, deindustrialization, endogenous growth, eurozone crisis, financial innovation, first-past-the-post, full employment, Hyman Minsky, industrial robot, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, light touch regulation, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market fundamentalism, Mexican peso crisis / tequila crisis, money market fund, mortgage debt, Myron Scholes, negative equity, new economy, Northern Rock, paper trading, Paul Samuelson, planetary scale, post-oil, price stability, quantitative easing, reserve currency, rising living standards, Ronald Reagan, special economic zone, Steve Jobs, structural adjustment programs, systematic trading, too big to fail, trickle-down economics, urban renewal, War on Poverty, Yom Kippur War

So when the meltdown began in precisely those locations (the US, Britain, Ireland, the housing market and Wall Street), they could not help but feel vindicated. While the Europeans’ sense of vindication was dealt a savage blow by the ensuing euro crisis, Asians can afford a large dose of smugness. Indeed, in much of Asia the Crash of 2008 and its aftermath are referred to as the ‘North Atlantic Crisis’. 5. Toxic theory In 1997, the Nobel Prize for Economics went to Robert Merton and Myron Scholes for developing ‘a pioneering formula for the valuation of stock options’. ‘Their methodology’, trumpeted the awarding committee’s press release, ‘has paved the way for economic valuations in many areas. It has also generated new types of financial instruments and facilitated more efficient risk management in society.’ If only the hapless Nobel committee had known that, in a few short months, the much-lauded ‘pioneering formula’ would cause a spectacular multi-billion-dollar debacle, the collapse of a major hedge fund (the infamous LTCM, in which Merton and Scholes had invested all their kudos) and, naturally, a bail-out by the reliably obliging US taxpayers.

., New Frontier social programmes, 83, 84 Keynes, John Maynard: Bretton Woods conference, 59, 60, 62, 109; General Theory, 37; ICU proposal, 60, 66, 90, 109, 254, 255; influence on New Dealers, 81; on investment decisions, 48; on liquidity, 160–1; trade imbalances, 62–6 Keynsianism, 157 Kim Il Sung, 77 Kissinger, Henry, 94, 98, 106 Kohl, Helmut, 201 Korea, 91, 191, 192 Korean War, 77, 86 labour: as a commodity, 28; costs, 104–5, 104, 105, 106, 137; hired, 31, 45, 46, 53, 64; scarcity of, 34–5; value of, 50–2 labour markets, 12, 202 Labour Party (British), 69 labourers, 32 land: as a commodity, 28; enclosure, 64 Landesbanken, 203 Latin America: effect of China on, 215, 218; European banks’ exposure to, 203; financial crisis, 190 see also specific countries lead, prices, 96 Lebensraum, 67 Left-Right divide, 167 Lehman Brothers, 150, 152–3 leverage, 121–2 leveraging, 37 Liberal Democratic Party (Japan), 187 liberation movements, 79, 107 LIBOR (London Interbank Offered Rate), 148 liquidity traps, 157, 190 Lloyds TSB, 153, 156 loans: and CDOs, 7–8, 129–31; defaults on, 37 London School of Economics, 4, 66 Long-Term Capital Management (LTCM) hedge fund collapse, 13 LTCM (Long-Term Capital Management) hedge fund collapse, 2, 13 Luxembourg, support for Dexia, 154 Maastricht Treaty, 199–200, 202 MacArthur, Douglas, 70–1, 76, 77 machines, and humans, 50–2 Malaysia, 91, 191 Mao, Chairman, 76, 86, 91 Maresca, John, 106–7 Marjolin, Robert, 73 Marshall, George, 72 Marshall Plan, 71–4 Marx, Karl: and capitalism, 17–18, 19, 34; Das Kapital, 49; on history, 178 Marxism, 181, 182 Matrix, The (film), 50–2 MBIA, 149, 150 McCarthy, Senator Joseph, 73 mercantilism, in Germany, 251 merchant class, 27–8 Merkel, Angela, 158, 206 Merrill Lynch, 149, 153, 157 Merton, Robert, 13 Mexico: effect of China on, 214; peso crisis, 190 Middle East, oil, 69 MIE (military-industrial establishment), 82–3 migration, Crash of 2008, 3 military-industrial complex mechanism, 65, 81, 182 Ministry for International Trade and Industry (Japan), 78 Ministry of Finance (Japan), 187 Minotaur legend, 24–5, 25 Minsky, Hyman, 37 money markets, 45–6, 53, 153 moneylenders, 31, 32 mortgage backed securities (MBS) 232, 233, 234 NAFTA (North American Free Trade Agreement), 214 National Bureau of Economic Research (US), 157 National Economic Council (US), 3 national income see GDP National Security Council (US), 94 National Security Study Memorandum 200 (US), 106 nationalization: Anglo Irish Bank, 158; Bradford and Bingley, 154; Fortis, 153; Geithner–Summers Plan, 179; General Motors, 160; Icelandic banks, 154, 155; Northern Rock, 151 NATO (North Atlantic Treaty Organization), 76, 253 negative engineering, 110 negative equity 234 neoliberalism, 139, 142; and greed, 10 New Century Financial, 147 New Deal: beginnings, 45; Bretton Woods conference, 57–9; China, 76; Global Plan, 67–71, 68; Japan, 77; President Kennedy, 84; support for the Deutschmark, 74; transfer union, 65 New Dealers: corporate power, 81; criticism of European colonizers, 79 ‘new economy’, 5–6 New York stock exchange, 40, 158 Nietzsche, Friedrich, 19 Nixon, Richard, 94, 95–6 Nobel Prize for Economics, 13 North American Free Trade Agreement (NAFTA), 214 North Atlantic Treaty Organization (NATO), 76 North Korea see Korea Northern Rock, 148, 151 Obama administration, 164, 178 Obama, Barack, 158, 159, 169, 180, 230, 231 OECD (Organisation for Economic Co-operation and Development), 73 OEEC (Organisation for European Economic Co-operation), 73, 74 oil: global consumption, 160; imports, 102–3; prices, 96, 97–9 OPEC (Organization of the Petroleum Exporting Countries), 96, 97 paradox of success, 249 parallax challenge, 20–1 Paulson, Henry, 152, 154, 170 Paulson Plan, 154, 173 Penn Bank, 40 Pentagon, the, 73 Plaza Accord (1985), 188, 192, 213 Pompidou, Georges, 94, 95–6 pound sterling, devaluing, 93 poverty: capitalism as a supposed cure for, 41–2; in China, 162; reduction in the US, 84; reports on global, 125 predatory governance, 181 prey–predator dynamic, 33–5 prices, flexible, 40–1 private money, 147, 177; Geithner–Summers Plan, 178; toxic, 132–3, 136, 179 privatization, of surpluses, 29 probability, estimating, 13–14 production: cars, 70, 103, 116, 157–8; coal, 73, 75; costs, 96, 104; cuts in, 41; in Japan, 185–6; processes, 30, 31, 64; steel, 70, 75 production–distribution cycle, 54 property see real estate prophecy paradox, 46, 47, 53 psychology, mass, 14 public debt crisis, 205 quantitative easing, 164, 231–6 railway bubbles, 40 Rational Expectations Hypothesis (REH), 15–16 RBS (Royal Bank of Scotland), 6, 151, 156; takeover of ABN-Amro, 119–20 Reagan, Ronald, 10, 99, 133–5, 182–3 Real Business Cycle Theory (RBCT), 15, 16–17 real estate, bubbles, 8–9, 188, 190, 192–3 reason, deferring to expectation, 47 recession predictions, 152 recessions, US, 40, 157 recycling mechanisms, 200 regulation, of banking system, 10, 122 relabelling, 14 religion, organized, 27 renminbi (RMB), 213, 214, 217, 218, 253 rentiers, 165, 187, 188 representative agents, 140 Reserve Bank of Australia, 148 reserve currency status, 101–2 risk: capitalists and, 31; riskless, 5, 6–9, 14 Roach, Stephen, 145 Robbins, Lionel, 66 Roosevelt, Franklin D., 165; attitude towards Britain, 69; and bank regulation, 10; New Deal, 45, 58–9 Roosevelt, Theodore (‘Teddy’), 180 Royal Bank of Scotland (RBS), 6, 151, 156; takeover of ABN-Amro, 119–20 Rudd, Kevin, 212 Russia, financial crisis, 190 Saudi Arabia, oil prices, 98 Scandinavia, Gold Standard, 44 Scholes, Myron, 13 Schopenhauer, Arthur, 19 Schuman, Robert, 75 Schumpter, Joseph, 34 Second World War, 45, 55–6; aftermath, 87–8; effect on the US, 57–8 seeds, commodification of, 163 shares, in privatized companies, 137, 138 silver, prices, 96 simulated markets, 170 simulated prices, 170 Singapore, 91 single currencies, ICU, 60–1 slave trade, 28 SMEs (small and medium-sized enterprises), 186 social welfare, 12 solidarity (asabiyyah), 33–4 South East Asia, 91; financial crisis, 190, 191–5, 213; industrialization, 86, 87 South Korea see Korea sovereign debt crisis, 205 Soviet Union: Africa, 79; disintegration, 201; Marshall Plan, 72–3; Marxism, 181, 182; relations with the US, 71 SPV (Special Purpose Vehicle), 174 see also EFSF stagflation, 97 stagnation, 37 Stalin, Joseph, 72–3 steel production, in Germany, 70 Strauss-Kahn, Dominique, 60, 254, 255 Summers, Larry, 230 strikes, 40 sub-prime mortgages, 2, 5, 6, 130–1, 147, 149, 151, 166 success, paradox of, 33–5, 53 Suez Canal trauma, 69 Suharto, President of Indonesia, 97 Summers, Larry, 3, 132, 170, 173, 180 see also Geithner–Summers Plan supply and demand, 11 surpluses: under capitalism, 31–2; currency unions, 61; under feudalism, 30; generation in the EU, 196; manufacturing, 30; origin of, 26–7; privatization of, 29; recycling mechanisms, 64–5, 109–10 Sweden, Crash of 2008, 155 Sweezy, Paul, 73 Switzerland: Crash of 2008, 155; UBS, 148–9, 151 systemic failure, Crash of 2008, 17–19 Taiwan, 191, 192 Tea Party (US), 162, 230, 231, 281 technology, and globalization, 28 Thailand, 91 Thatcher, Margaret, 117–18, 136–7 Third World: Crash of 2008, 162; debt crisis, 108, 219; interest rate rises, 108; mineral wealth, 106; production of goods for Walmart, 125 tiger economies, 87 see also South East Asia Tillman Act (1907), 180 time, and economic models, 139–40 Time Warner, 117 tin, prices, 96 toxic theory, 13–17, 115, 133–9, 139–42 trade: balance of, 61, 62, 64–5; deficits (US), 111, 243; global, 27, 90; surpluses, 158 trades unions, 124, 137, 202 transfer unions, New Deal, 65 Treasury Bills (US), 7 Treaty of Rome, 237 Treaty of Versailles, 237 Treaty of Westphalia, 237 trickle-down, 115, 135 trickle-up, 135 Truman Doctrine, 71, 71–2, 77 Truman, Harry, 73 tsunami, effects of, 194 UBS, 148–9, 151 Ukraine, and the Crash of 2008, 156 UN Security Council, 253 unemployment: Britain, 160; Global Plan, 96–7; rate of, 14; US, 152, 158, 164 United States see US Unocal, 106 US economy, twin deficits, 22–3, 25 US government, and South East Asia, 192 US Mortgage Bankers Association, 161 US Supreme Court, 180 US Treasury, 153–4, 156, 157, 159; aftermath of the Crash of 2008, 160; Geithner–Summers Plan, 171–2, 173; bonds, 227 US Treasury Bills, 109 US (United States): aftermath of the Crash of 2008, 161–2; assets owned by foreign state institutions, 216; attitude towards oil price rises, 97–8; China, 213–14; corporate bond purchases, 228; as a creditor nation, 57; domestic policies during the Global Plan, 82–5; economy at present, 184; economy praised, 113–14; effects of the Crash of 2008, 2, 183; foreign-owned assets, 225; Greek Civil War, 71; labour costs, 105; Plaza Accord, 188; profit rates, 106; proposed invasion of Afghanistan, 106–7; role in the ECSC, 75; South East Asia, 192 value, costing, 50–1 VAT, reduced, 156 Venezuela, oil prices, 97 Vietnamese War, 86, 91–2 vital spaces, 192, 195, 196 Volcker, Paul: 2009 address to Wall Street, 122; demand for dollars, 102; and gold convertibility, 94; interest rate rises, 99; replaced by Greenspan, 10; warning of the Crash of 2008, 144–5; on the world economy, 22, 100–1, 139 Volcker Rule, 180–1 Wachowski, Larry and Andy, 50 wage share, 34–5 wages: British workers, 137; Japanese workers, 185; productivity, 104; prophecy paradox, 48; US workers, 124, 161 Wal-Mart: The High Cost of Low Price (documentary, Greenwald), 125–6 Wall Street: Anglo-Celtic model, 12; Crash of 2008, 11–12, 152; current importance, 251; Geithner–Summers Plan, 178; global profits, 23; misplaced confidence in, 41; private money, 136; profiting from sub-prime mortgages, 131; takeovers and mergers, 115–17, 115, 118–19; toxic theory, 15 Wallace, Harry, 72–3 Walmart, 115, 123–7, 126; current importance, 251 War of the Currents, 39 Washington Mutual, 153 weapons of mass destruction, 27 West Germany: labour costs, 105; Plaza Accord, 188 Westinghouse, George, 39 White, Harry Dexter, 59, 70, 109 Wikileaks, 212 wool, as a global commodity, 28 working class: in Britain, 136; development of, 28 working conditions, at Walmart, 124–5 World Bank, 253; origins, 59; recession prediction, 149; and South East Asia, 192 World Trade Organization, 78, 215 written word, 27 yen, value against dollar, 96, 188, 193–4 Yom Kippur War, 96 zombie banks, 190–1


pages: 353 words: 88,376

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

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Albert Einstein, asset allocation, asset-backed security, Brownian motion, business process, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, fixed income, implied volatility, index fund, intangible asset, interest rate swap, inventory management, London Interbank Offered Rate, margin call, market fundamentalism, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option’s strike price, and the time to the option’s expiration. Also known as the Black-Scholes-Merton Model. Investopedia explains Black Scholes Model The Black Scholes Model is one of the most important concepts in modern financial theory. It was developed in 1973 by Fisher Black, Robert Merton, and Myron Scholes and is used widely today and regarded as one of the best formulas for determining option prices. Related Terms: • Exercise • Standard Deviation • Strike Price • Option • Stock Option 24 The Investopedia Guide to Wall Speak Blue-Chip Stock What Does Blue-Chip Stock Mean? The stock of a well-established and financially sound company that has demonstrated an ability to pay dividends in both good and bad times.

See Required minimum distribution (RMD) ROA. See Return on assets (ROA) ROE. See Return on equity (ROE) ROI. See Return on investment (ROI) RONA. See Return on net assets (RONA) ROS. See Return on sales (ROS) Roth IRA, 137-138, 261, 302 RSI. See Relative strength index (RSI) R-squared, 9, 261-262 Run rate, 262 Sale(s), 199, 210-211, 257, 270. See also Revenue; Short (short position) Sales charge. See Load fund Scholes, Myron, 23 Scrip issue. See Stock split SEC. See Securities and Exchange Commission (SEC) Secondary market, 263-264, 282 Secondary offering, 264-265 Securities and Exchange Commission (SEC), 1, 148, 193-194, 237-238, 265, 323 Securitization, 265-266 Security, 266. See also specific topics regarding bonds, derivatives or stocks Security market line (SML), 37, 266-267 Self-regulatory organization (SRO), 104, 194-195, 218 Sell.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, John Meriwether, joint-stock company, Kenneth Rogoff, labour market flexibility, light touch regulation, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, negative equity, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce, zero-sum game

Making a huge bet, particularly on illiquid assets, is thus a very perilous pastime. The collapse of Long-Term Capital Management in 1998 was a classic example of this. LTCM was a hedge fund led by a bond trader called John Meriwether who had worked at Salomon Brothers, then one of Wall Street’s leading firms. He hired a stellar team, including two Nobel prize-winning economists, Robert Merton and Myron Scholes. LTCM pursued a strategy called arbitrage, buying assets that looked artificially cheap and selling short (betting on a falling price) similar assets that looked expensive. A classic example was in the US Treasury bond market. Investors were keen to own the latest issue of the thirty-year bond because of its liquidity. They were less keen to own last year’s issue, that is, a bond expected to mature in twenty-nine years.

leverage leveraged buyout Lewis, Michael Liberal Democrat party (UK) Liberal Party (UK) life expectancy life-cycle theory Little Dorrit lire Live 8 concert Lloyd George, David Lombard Odier Lombard Street Research London School of Economics Long Term Capital Management longevity Louis XIV, King of France Louis XV, King of France Louvre accord Lucas, Robert Lucullus, Roman general Luxembourg Macaulay, Thomas McCarthy, Cormac Macdonald, James MacDonald, Ramsay McKinsey McNamara, Robert Madoff, Bernie Malthusian trap Mandelson, Peter Marais, Matthieu Marco Polo Mares, Arnaud Marks & Spencer Marshall, George Marshall Aid Marshalsea Prison Mauro, Paolo May, Sir George means/media of exchange Medicaid Medicare Mellon, Andrew mercantilism Merchant of Venice, The Meriwether, John Merkel, Angela Merton, Robert Mexico Mill, John Stuart Milne-Bailey, Walter Minsky, Hyman Mises, Ludwig von Mississippi Project Mitterrand, Francois Mobutu, Joseph Mongols monetarism monetary policy monetary targets money markets money supply Moody’s Moore’s Law moral hazard Morgan Stanley Morgenthau, Henry Morrison, Herbert mortgages mortgage-backed bonds Multilateral Debt Relief Initiative Napier, Russell Napoleon, emperor of France Napoleonic Wars Nasser, president of Egypt National Association of Home Builders National Association of Realtors National Association of Security Dealers Netherlands New Century New Hampshire New Jersey Newton, Sir Isaac New York Times New Zealand Nixon, Richard Norman, Montagu North Carolina Northern Ireland Northern Rock North Korea North Rhine Westphalia, Germany Norway Obama, Barack odious debt Odysseus OECD d’Orléans, duc Ottoman Empire output gap Overstone, Lord overvalued currency owner-equivalent rent Papandreou, George paper money paradox of thrift Paris club Passfield, Lord (Sidney Webb) Paulson, Hank pawnbroking pension age pension funds pensions Pepin the Short Perot, Ross Perry, Rick Persians Peter Pan Philip II, King of Spain Philip IV, King of France PIGS countries PIMCO Plaza accord Poland Ponzi, Charles Ponzi scheme population growth populism portfolio insurance Portugal pound Prasad, Eswar precious metals Price-earnings ratio primary surplus Prince, Chuck principal-agent problem printing money private equity property market protectionism Protestant work ethic public choice theory public-sector workers purchasing power parity pyramid schemes Quaintance, Lee quantitative easing (QE) Quincy, Josiah railway mania Rajan, Raghuram Rand, Ayn Reagan, Ronald real bills theory real interest rates Record, Neil Reformation, the Reichsbank Reichsmark Reid, Jim Reinhart, Carmen renminbi Rentenmark rentiers reparations Republican Party reserve currency retail price index retirement revaluation Revolutionary War Ridley, Matt Roberts, Russell Rogoff, Kenneth Romanovs Roosevelt, Franklin D. Rubin, Robert Rueff, Jacques Rumsfeld, Donald Russia Sack, Alexander St Augustine Saint-Simon, duc de Salamis (city) Santelli, Rick Sarkozy, Nicholas Saudi Arabia savings savings glut Sbrancia, Belen Schacht, Hjalmar Scholes, Myron shale gas Second Bank of the United States Second World War Securities and Exchange Commission seignorage Shakespeare, William share options Shiller, Robert short-selling silver Singapore Sloan, Alfred Smith, Adam Smith, Fred Smithers & Co Smithsonian agreement Snowden, Philip Socialist Party of Greece social security Société Générale solidus Solon of Athens Soros, George sound money South Africa South Korea South Sea bubble sovereign debt crisis Soviet Union Spain special drawing right speculation, speculators Stability and Growth pact stagnation Standard & Poor’s sterling Stewart, Jimmy Stiglitz, Joseph stock markets stop-go cycle store of value Strauss-Kahn, Dominque Strong, Benjamin sub-prime lending Suez canal crisis Suharto, President of Indonesia Sumerians supply-side reforms Supreme Court (US) Sutton, Willie Sweden Swiss franc Swiss National Bank Switzerland Sylla, Richard Taiwan Taleb, Nassim Nicholas taxpayers Taylor, John tea party (US) Temin, Peter Thackeray, William Makepeace Thailand Thatcher, Margaret third world debt crisis Tiernan, Tommy Times Square, New York tobacco as currency treasury bills treasury bonds Treaty of Versailles trente glorieuses Triana, Pablo Triffin, Robert Triffin dilemma ‘trilemma’ of currency policy Truck Act True Finn party Truman, Harry S tulip mania Turkey Turner, Adair Twain, Mark unit of account usury value-at-risk (VAR) Vanguard Vanity Fair Venice Vietnam War vigilantes, bond market Viniar, David Volcker, Paul Voltaire Wagner, Adolph Wall Street Wall Street Crash of 1929 Wal-Mart wampum Warburton, Peter Warren, George Washington consensus Weatherstone, Dennis Weimar inflation Weimar Republic Weinberg, Sidney West Germany whales’ teeth White, Harry Dexter William of Orange Wilson, Harold Wirtschaftswunder Wizard of Oz, The Wolf, Martin Women Empowering Women Woodward, Bob Woolley, Paul World Bank Wriston, Walter Xinhua agency Yale University yen yield on debt yield on shares Zambia zero interest rates Zimbabwe Zoellick, Robert Philip Coggan is the Buttonwood columnist of the Economist.


pages: 471 words: 97,152

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

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affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, Plutocrats, plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

We have but to look back ten years to find another similar event. Here again, in the nick of time, the Fed came to the rescue. The institution at risk was not an investment bank but rather a hedge fund. In 1994 an offshoot financial group from Salomon Brothers opened a hedge fund, which they called Long Term Capital Management (LTCM). They would arbitrage risks according to the financial theories of Myron Scholes and Robert Merton—who would, three years later, share the Nobel Prize in economics for “a new method to determine the value of derivatives.” Because of the impeccable reputation of its advisers, not only was LTCM able to assemble $1.25 billion in capital, it was also given, unthinkingly, carte blanche to borrow from Wall Street’s leading banking houses. The partners in LTCM were at first just as successful as their initial prospectus suggested they would be.

., 178n4, 183n8, 190n14 Saulnier, Raymond, 113 Save More Tomorrow, 121, 125 saving, 6, 116–30, 174, 190–92n1–26; cues for, 119–20, 128, 130; deviation from standard economics of, 122–25; framing of, 119–21, 122, 191n4; long-term consequences of, 116–18; mental accounts and, 120–21, 192n25; national impact of, 125–28, 129–30; variability of, 118–22 savings and loan (S&L) crisis, 30–33, 93, 172; cost of, 31, 86; deregulation and, 30 Sbordone, Argia, 179n9 Schank, Roger C., 51, 183n2 Schellhammer, Melanie, 181n9 Schmeidler, David, 194n32 Schnyder, Ulrich, 181n9 Scholes, Myron, 84 Schultze, Charles L., 189n1 Schumpeter, Joseph A., 62, 184n9 Schwartz, Anna Jacobson, 61, 186n7 Schwarz, Christopher, 182n23 securities, 27–29 Securities Act of 1933, 39 Securities and Exchange Commission, 33, 147 Securities Exchange Act of 1934, 39 securitized loans, 87, 90, 170 selfish behavior, 22–23 Senate Committee on Banking, Housing, and Urban Affairs, 83 Sender, Henry, 188n17 Seuss, Dr.


pages: 298 words: 95,668

Milton Friedman: A Biography by Lanny Ebenstein

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affirmative action, banking crisis, Berlin Wall, Bretton Woods, Deng Xiaoping, Fall of the Berlin Wall, fiat currency, floating exchange rates, Francis Fukuyama: the end of history, full employment, Hernando de Soto, hiring and firing, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Arrow, labour market flexibility, Lao Tzu, liquidity trap, means of production, Mont Pelerin Society, Myron Scholes, Pareto efficiency, Paul Samuelson, Ponzi scheme, price stability, rent control, road to serfdom, Robert Bork, Ronald Coase, Ronald Reagan, school choice, school vouchers, secular stagnation, Simon Kuznets, stem cell, The Chicago School, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Thorstein Veblen, zero-sum game

—but the exposure of my confusion next to Friedman’s quickness and clarity. He would engage a particular student in a dialogue, and once engaged no escape . . . was possible. Exit lines like “Well, I’ll have to think about it” were no use: “Let’s think about it now,” Friedman would say.18 Other Nobel laureates in economics to date who were students at Chicago when Friedman taught there include Harry Markowitz, who received the prize in 1990; Myron Scholes, who received it in 1997; and James Heckman, who received it in 2000. Friedman recalls his approach to students on their dissertations: “When I was advising doctoral students about their theses, they would come in and say . . . a lot’s been done on . . . [a] subject. There is no subject on which there isn’t more to be done.”19 In 1953 correspondence, he reveals a good understanding of deficiencies in the dissertation approach: “When the student turns to his thesis, he is largely thrown on his own....

Friedman Foundation, 228, 229 Milton Friedman Prize for Advancing Liberty, 236 minimum wage, 64, 170–72 Mints, Lloyd, 22–23, 54, 62, 115, 162 Mises, Ludwig von, 139, 142, 144, 218, 221, 206 Mitchell, Wesley Clair, 2, 17, 20, 26, 38–39, 49, 57, 85, 113 Modigliani, Franco, 155, 157 monetary theory and policy, 23–24, 38, 86–90, 107–110, 156, 162–63 during the Great Contraction, 118–28 MF on, 87–88, 148, 170, 212, 232–33 MF’s influence on, 73–74, 238 MF’s teaching of, 86, 105 money supply and, 115–28 monetary velocity, 23–24, 110, 161 money supply, 160–61, 168, 171, 211, 213, 218 decline in, 18, 113, 119–22 Mont Pelerin Society, 132, 136, 148, 164–66, 215–16, 219 Morgenthau, Henry, 42–43 Moynihan, Daniel Patrick, 171 Mundell, Robert, 90 NAIRU (nonaccelerating inflation rate of unemployment), 161 Nash, George, 166 National Bureau of Economic Research, 2, 16, 17, 26, 27, 36, 37–38, 135, 232 national parks, 172, 173 Nef, John, 23, 54 New Deal, 33–35, 39, 114, 118, 125–26, 135, 187 New Economics, 180 Newman, Peter, 74 Neils Bohr Institute of Physics, 56 Niskanen, David, 235 Nixon, Richard, 17, 73, 174, 179–80, 185–89, 198, 206, 207, 232 Nobel laureates in economics: Arrow, Kenneth, 26, 56 Becker, Gary, 88 Buchanan, James, 87 Coase, Ronald, 167 Heckman, James, 91 Kuznets, Simon, 39 Lucas, Robert, 91 Markowitz, Harry, 91 Modigliani, Franco, 155 Samuelson, Paul, 21 Scholes, Myron, 91 Solow, Robert, 57 Stigler, George, 33, 48 Tobin, James, 158 Friedman, Milton, 190–93, 210 Nobel laureates from University of Chicago, 19, 55 Nobel laureates from English-speaking countries, 210 Nobel prize, competition for, 163 Nordhaus, William, 156–57 output, government control of, 171–72 Palgrave, Sir Robert Harry Inglis, 3 Patinkin, Don, 67, 70, 162–64 Perlman, Mark, 158, 164 Philadelphia Society, 165–66 Phillips curve, 100, 160 Phillips, A.


pages: 831 words: 98,409

SUPERHUBS: How the Financial Elite and Their Networks Rule Our World by Sandra Navidi

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activist fund / activist shareholder / activist investor, assortative mating, bank run, barriers to entry, Bernie Sanders, Black Swan, Bretton Woods, butterfly effect, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, commoditize, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversification, East Village, Elon Musk, eurozone crisis, family office, financial repression, Gini coefficient, glass ceiling, Goldman Sachs: Vampire Squid, Google bus, Gordon Gekko, haute cuisine, high net worth, hindsight bias, income inequality, index fund, intangible asset, Jaron Lanier, John Meriwether, Kenneth Arrow, Kenneth Rogoff, knowledge economy, London Whale, Long Term Capital Management, Mark Zuckerberg, mass immigration, McMansion, mittelstand, money market fund, Myron Scholes, NetJets, Network effects, offshore financial centre, old-boy network, Parag Khanna, Paul Samuelson, peer-to-peer, performance metric, Peter Thiel, Plutocrats, plutocrats, Ponzi scheme, quantitative easing, Renaissance Technologies, rent-seeking, reserve currency, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, rolodex, Satyajit Das, shareholder value, Silicon Valley, sovereign wealth fund, Stephen Hawking, Steve Jobs, The Future of Employment, The Predators' Ball, too big to fail, women in the workforce, young professional

As outlined in Roger Lowenstein’s book When the Genius Failed, Meriwether began his career at Salomon Brothers, where he had made a name for himself as the head of the enormously profitable bond arbitrage group.1 In the course of a trading scandal that implicated his subordinates, though not him, he resigned. Motivated by a desire to vindicate himself, he set out for bigger and better things and in 1994 created a hedge fund that invested on the basis of global economic trends. With his stellar reputation, two highly regarded Nobel laureates—Myron Scholes and Robert Merton—on his team, and wide-ranging contacts, he went on an aggressive global marketing tour, selling the fund as a low-risk market outperformer. LTCM’s investments were based on complex computer formulae that hardly anyone fully understood but which Meriwether and his team believed to be infallible. Investors flocked to the fund, eager to join the ride and associate themselves with a circle of managers uniformly considered to be simply ingenious.

., 90, 123 Rockefeller Plaza, 109 Rogoff, Kenneth, 36, 107 Romney, Mitt, 193 Roosevelt, Franklin, 34 Rosen, Aby, 124 Rosen, Sherwin, 85–86 Ross, Wilbur, 92, 144, 199 Rothschilds, 79 Roubini, Nouriel, 229 as superhub, 11 as thought leader, 47–49 charm of, 103 Dominique Strauss-Kahn and, 193–194 general references to, 34, 39, 109 Jamie Dimon and, 56 Larry Summers and, 184 networks as viewed by, 48 at Soros’ eightieth birthday party, 27 Roubini Global Economics, 109 Royal Dutch Shell, 142 Rubin, Robert, 182 as superhub, 169 as U.S. treasury secretary, 84, 168 at Bildersberg conference, 121 capital network of, 170 at Citigroup, 167 Council on Foreign Relations participation by, 105, 168, 170 education of, 166 at Goldman Sachs, 170 Hamilton Project, 169 Larry Summers and, 168, 186, 189 on National Economic Council, 166 personality of, 169, 186 power of, 166 in private sector, 167 revolving door phenomenon and, 165–170 thought constructs by, 63 Vikram Pandit and, 139, 204 “Rubinomics,” 167 Rules, 221–222, 225 Rumors, 41 Rüschlikon, 122 Rushkoff, Douglas, 8, 220 Russia, 144, 208, 219 Russian Direct Investment Fund, 194 Russian Federation, 115 Rwanda, 171, 192 Ryan, Michelle, 154 S SAC Capital, 88 Sachs, Jeffrey, 107 Sadikoglu, Kahraman, 120 Sales skills, 59, 62 Salomon Brothers, 208 SALT. See SkyBridge Alternatives Conference Samuelson, Paul, 185 Sandberg, Sheryl, 153, 155, 157 Sanford C. Bernstein, 150 Sarkozy, Nicolas, 24, 159, 177–178 Saudi Arabia, 205 Savarona, 120 Savings banks, 37 Scaramucci, Anthony, 23, 53 Scarsdale Equities, 109 Schatzalp Hotel, 115 Schmidt, Eric, 40, 114 Scholes, Myron, 208 Schumer, Chuck, 27 Schwab, Klaus background on, 93–96 Christine Lagarde and, 158 common good and, 225 at Davos, 116 digital technology and, 99 education of, 96 network power of, 95, 101 stakeholder principle of, 63 World Economic Forum and, 25, 93–96, 101. See also World Economic Forum Schwarzman, Steve background on, 59–62 Blackstone Group, xxvii, 27, 30, 53, 60–61, 79, 88, 109, 204 at charity events, 129 earnings by, 88 education of, 61 general references to, xxvii, 4, 9, 76, 109, 192 at Milken Institute conference, 192 net worth of, 88, 123 partnerships by, 79 philanthropy by, 82 power lunches by, 124 residences of, 89–92 in think tanks, 106 Schwarzman Scholars program, 103 Scotland, 212 Scowcroft, Brent, 45 Seagram Building, 124–125 SEC.


pages: 403 words: 111,119

Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist by Kate Raworth

3D printing, Asian financial crisis, bank run, basic income, battle of ideas, Berlin Wall, bitcoin, blockchain, Branko Milanovic, Bretton Woods, Buckminster Fuller, call centre, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, choice architecture, clean water, cognitive bias, collapse of Lehman Brothers, complexity theory, creative destruction, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, dematerialisation, Douglas Engelbart, Douglas Engelbart, en.wikipedia.org, energy transition, Erik Brynjolfsson, ethereum blockchain, Eugene Fama: efficient market hypothesis, experimental economics, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, Financial Instability Hypothesis, full employment, global supply chain, global village, Henri Poincaré, hiring and firing, Howard Zinn, Hyman Minsky, income inequality, Intergovernmental Panel on Climate Change (IPCC), invention of writing, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, land value tax, Landlord’s Game, loss aversion, low skilled workers, M-Pesa, Mahatma Gandhi, market fundamentalism, Martin Wolf, means of production, megacity, mobile money, Mont Pelerin Society, Myron Scholes, neoliberal agenda, Network effects, Occupy movement, off grid, offshore financial centre, oil shale / tar sands, out of africa, Paul Samuelson, peer-to-peer, planetary scale, price mechanism, quantitative easing, randomized controlled trial, Richard Thaler, Ronald Reagan, Second Machine Age, secular stagnation, shareholder value, sharing economy, Silicon Valley, Simon Kuznets, smart cities, smart meter, South Sea Bubble, statistical model, Steve Ballmer, The Chicago School, The Great Moderation, the map is not the territory, the market place, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, Torches of Freedom, trickle-down economics, ultimatum game, universal basic income, Upton Sinclair, Vilfredo Pareto, wikimedia commons

‘By encouraging us to expect the worst in others, it brings out the worst in us: dreading the role of the chump, we are often loath to heed our nobler instincts.’15 That’s a clear caution to all students of economics. But rational economic man’s influence on our behaviour goes far beyond the classroom. A striking example was uncovered at the Chicago Board Options Exchange (CBOE) which opened in 1973 and became one of the most important financial derivatives exchanges in the world. In the same year that the Exchange opened for trading, two influential economists, Fischer Black and Myron Scholes, published what came to be known as the Black–Scholes model, which used publicly available market data to calculate the expected price of options traded in the market. At first the formula’s predictions deviated widely – by 30% to 40% – from actual market prices at the CBOE. But within a few years – and with no alterations to the model – its predicted prices differed by a mere 2% on average from actual market prices.

., 6 micro-businesses, 9, 173, 178 microeconomics, 132–4 microgrids, 187–8 Micronesia, 153 Microsoft, 231 middle class, 6, 46, 58 middle-income countries, 90, 164, 168, 173, 180, 226, 254 migration, 82, 89–90, 166, 195, 199, 236, 266, 286 Milanovic, Branko, 171 Mill, John Stuart, 33–4, 73, 97, 250, 251, 283, 284, 288 Millo, Yuval, 101 minimum wage, 82, 88, 176 Minsky, Hyman, 87, 146 Mises, Ludwig von, 66 mission zero, 217 mobile banking, 199–200 mobile phones, 222 Model T revolution, 277–8 Moldova, 199 Mombasa, Kenya, 185–6 Mona Lisa (da Vinci), 94 money creation, 87, 164, 177, 182–8, 205 MONIAC (Monetary National Income Analogue Computer), 64–5, 75, 142, 262 Monoculture (Michaels), 6 Monopoly, 149 Mont Pelerin Society, 67, 93 Moral Consequences of Economic Growth, The (Friedman), 258 moral vacancy, 41 Morgan, Mary, 99 Morogoro, Tanzania, 121 Moyo, Dambisa, 258 Muirhead, Sam, 230, 231 MultiCapital Scorecard, 241 Murphy, David, 264 Murphy, Richard, 185 musical tastes, 110 Myriad Genetics, 196 N national basic income, 177 Native Americans, 115, 116, 282 natural capital, 7, 116, 269 Natural Economic Order, The (Gessel), 274 Nedbank, 216 negative externalities, 213 negative interest rates, 275–6 neoclassical economics, 134, 135 neoliberalism, 7, 62–3, 67–70, 81, 83, 84, 88, 93, 143, 170, 176 Nepal, 181, 199 Nestlé, 217 Netherlands, 211, 235, 224, 226, 238, 277 networks, 110–11, 117, 118, 123, 124–6, 174–6 neuroscience, 12–13 New Deal, 37 New Economics Foundation, 278, 283 New Year’s Day, 124 New York, United States, 9, 41, 55 Newlight Technologies, 224, 226, 293 Newton, Isaac, 13, 15–17, 32–3, 95, 97, 129, 131, 135–7, 142, 145, 162 Nicaragua, 196 Nigeria, 164 nitrogen, 49, 52, 212–13, 216, 218, 221, 226, 298 ‘no pain, no gain’, 163, 167, 173, 204, 209 Nobel Prize, 6–7, 43, 83, 101, 167 Norway, 281 nudging, 112, 113, 114, 123–6 O Obama, Barack, 41, 92 Oberlin, Ohio, 239, 240–41 Occupy movement, 40, 91 ocean acidification, 45, 46, 52, 155, 242, 298 Ohio, United States, 190, 239 Okun, Arthur, 37 onwards and upwards, 53 Open Building Institute, 196 Open Source Circular Economy (OSCE), 229–32 open systems, 74 open-source design, 158, 196–8, 265 open-source licensing, 204 Organisation for Economic Co-operation and Development (OECD), 38, 210, 255–6, 258 Origin of Species, The (Darwin), 14 Ormerod, Paul, 110, 111 Orr, David, 239 Ostrom, Elinor, 83, 84, 158, 160, 181–2 Ostry, Jonathan, 173 OSVehicle, 231 overseas development assistance (ODA), 198–200 ownership of wealth, 177–82 Oxfam, 9, 44 Oxford University, 1, 36 ozone layer, 9, 50, 115 P Pachamama, 54, 55 Pakistan, 124 Pareto, Vilfredo, 165–6, 175 Paris, France, 290 Park 20|20, Netherlands, 224, 226 Parker Brothers, 149 Patagonia, 56 patents, 195–6, 197, 204 patient capital, 235 Paypal, 192 Pearce, Joshua, 197, 203–4 peer-to-peer networks, 187, 192, 198, 203, 292 People’s QE, 184–5 Perseus, 244 Persia, 13 Peru, 2, 105–6 Phillips, Adam, 283 Phillips, William ‘Bill’, 64–6, 75, 142, 262 phosphorus, 49, 52, 212–13, 218, 298 Physiocrats, 73 Pickett, Kate, 171 pictures, 12–25 Piketty, Thomas, 169 Playfair, William, 16 Poincaré, Henri, 109, 127–8 Polanyi, Karl, 82, 272 political economy, 33–4, 42 political funding, 91–2, 171–2 political voice, 43, 45, 51–2, 77, 117 pollution, 29, 45, 52, 85, 143, 155, 206–17, 226, 238, 242, 254, 298 population, 5, 46, 57, 155, 199, 250, 252, 254 Portugal, 211 post-growth society, 250 poverty, 5, 9, 37, 41, 50, 88, 118, 148, 151 emotional, 283 and inequality, 164–5, 168–9, 178 and overseas development assistance (ODA), 198–200 and taxation, 277 power, 91–92 pre-analytic vision, 21–2 prescription medicines, 123 price-takers, 132 prices, 81, 118–23, 131, 160 Principles of Economics (Mankiw), 34 Principles of Economics (Marshall), 17, 98 Principles of Political Economy (Mill), 288 ProComposto, 226 Propaganda (Bernays), 107 public relations, 107, 281 public spending v. investment, 276 public–private patents, 195 Putnam, Robert, 76–7 Q quantitative easing (QE), 184–5 Quebec, 281 Quesnay, François, 16, 73 R Rabot, Ghent, 236 Rancière, Romain, 172 rating and review systems, 105 rational economic man, 94–103, 109, 111, 112, 126, 282 Reagan, Ronald, 67 reciprocity, 103–6, 117, 118, 123 reflexivity of markets, 144 reinforcing feedback loops, 138–41, 148, 250, 271 relative decoupling, 259 renewable energy biomass energy, 118, 221 and circular economy, 221, 224, 226, 235, 238–9, 274 and commons, 83, 85, 185, 187–8, 192, 203, 264 geothermal energy, 221 and green growth, 257, 260, 263, 264, 267 hydropower, 118, 260, 263 pricing, 118 solar energy, see solar energy wave energy, 221 wind energy, 75, 118, 196, 202–3, 221, 233, 239, 260, 263 rentier sector, 180, 183, 184 reregulation, 82, 87, 269 resource flows, 175 resource-intensive lifestyles, 46 Rethinking Economics, 289 Reynebeau, Guy, 237 Ricardo, David, 67, 68, 73, 89, 250 Richardson, Katherine, 53 Rifkin, Jeremy, 83, 264–5 Rise and Fall of the Great Powers, The (Kennedy), 279 risk, 112, 113–14 Robbins, Lionel, 34 Robinson, James, 86 Robinson, Joan, 142 robots, 191–5, 237, 258, 278 Rockefeller Foundation, 135 Rockford, Illinois, 179–80 Rockström, Johan, 48, 55 Roddick, Anita, 232–4 Rogoff, Kenneth, 271, 280 Roman Catholic Church, 15, 19 Rombo, Tanzania, 190 Rome, Ancient, 13, 48, 154 Romney, Mitt, 92 Roosevelt, Franklin Delano, 37 rooted membership, 190 Rostow, Walt, 248–50, 254, 257, 267–70, 284 Ruddick, Will, 185 rule of thumb, 113–14 Ruskin, John, 42, 223 Russia, 200 rust belt, 90, 239 S S curve, 251–6 Sainsbury’s, 56 Samuelson, Paul, 17–21, 24–5, 38, 62–7, 70, 74, 84, 91, 92, 93, 262, 290–91 Sandel, Michael, 41, 120–21 Sanergy, 226 sanitation, 5, 51, 59 Santa Fe, California, 213 Santinagar, West Bengal, 178 São Paolo, Brazil, 281 Sarkozy, Nicolas, 43 Saumweder, Philipp, 226 Scharmer, Otto, 115 Scholes, Myron, 100–101 Schumacher, Ernst Friedrich, 42, 142 Schumpeter, Joseph, 21 Schwartz, Shalom, 107–9 Schwarzenegger, Arnold, 163, 167, 204 ‘Science and Complexity’ (Weaver), 136 Scotland, 57 Seaman, David, 187 Seattle, Washington, 217 second machine age, 258 Second World War (1939–45), 18, 37, 70, 170 secular stagnation, 256 self-interest, 28, 68, 96–7, 99–100, 102–3 Selfish Society, The (Gerhardt), 283 Sen, Amartya, 43 Shakespeare, William, 61–3, 67, 93 shale gas, 264, 269 Shang Dynasty, 48 shareholders, 82, 88, 189, 191, 227, 234, 273, 292 sharing economy, 264 Sheraton Hotel, Boston, 3 Siegen, Germany, 290 Silicon Valley, 231 Simon, Julian, 70 Sinclair, Upton, 255 Sismondi, Jean, 42 slavery, 33, 77, 161 Slovenia, 177 Small Is Beautiful (Schumacher), 42 smart phones, 85 Smith, Adam, 33, 57, 67, 68, 73, 78–9, 81, 96–7, 103–4, 128, 133, 160, 181, 250 social capital, 76–7, 122, 125, 172 social contract, 120, 125 social foundation, 10, 11, 44, 45, 49, 51, 58, 77, 174, 200, 254, 295–6 social media, 83, 281 Social Progress Index, 280 social pyramid, 166 society, 76–7 solar energy, 59, 75, 111, 118, 187–8, 190 circular economy, 221, 222, 223, 224, 226–7, 239 commons, 203 zero-energy buildings, 217 zero-marginal-cost revolution, 84 Solow, Robert, 135, 150, 262–3 Soros, George, 144 South Africa, 56, 177, 214, 216 South Korea, 90, 168 South Sea Bubble (1720), 145 Soviet Union (1922–91), 37, 67, 161, 279 Spain, 211, 238, 256 Spirit Level, The (Wilkinson & Pickett), 171 Sraffa, Piero, 148 St Gallen, Switzerland, 186 Stages of Economic Growth, The (Rostow), 248–50, 254 stakeholder finance, 190 Standish, Russell, 147 state, 28, 33, 69–70, 78, 82, 160, 176, 180, 182–4, 188 and commons, 85, 93, 197, 237 and market, 84–6, 200, 281 partner state, 197, 237–9 and robots, 195 stationary state, 250 Steffen, Will, 46, 48 Sterman, John, 66, 143, 152–4 Steuart, James, 33 Stiglitz, Joseph, 43, 111, 196 stocks and flows, 138–41, 143, 144, 152 sub-prime mortgages, 141 Success to the Successful, 148, 149, 151, 166 Sugarscape, 150–51 Summers, Larry, 256 Sumner, Andy, 165 Sundrop Farms, 224–6 Sunstein, Cass, 112 supply and demand, 28, 132–6, 143, 253 supply chains, 10 Sweden, 6, 255, 275, 281 swishing, 264 Switzerland, 42, 66, 80, 131, 186–7, 275 T Tableau économique (Quesnay), 16 tabula rasa, 20, 25, 63, 291 takarangi, 54 Tanzania, 121, 190, 202 tar sands, 264, 269 taxation, 78, 111, 165, 170, 176, 177, 237–8, 276–9 annual wealth tax, 200 environment, 213–14, 215 global carbon tax, 201 global financial transactions tax, 201, 235 land-value tax, 73, 149, 180 non-renewable resources, 193, 237–8, 278–9 People’s QE, 185 tax relief v. tax justice, 23, 276–7 TED (Technology, Entertainment, Design), 202, 258 Tempest, The (Shakespeare), 61, 63, 93 Texas, United States, 120 Thailand, 90, 200 Thaler, Richard, 112 Thatcher, Margaret, 67, 69, 76 Theory of Moral Sentiments (Smith), 96 Thompson, Edward Palmer, 180 3D printing, 83–4, 192, 198, 231, 264 thriving-in-balance, 54–7, 62 tiered pricing, 213–14 Tigray, Ethiopia, 226 time banking, 186 Titmuss, Richard, 118–19 Toffler, Alvin, 12, 80 Togo, 231, 292 Torekes, 236–7 Torras, Mariano, 209 Torvalds, Linus, 231 trade, 62, 68–9, 70, 89–90 trade unions, 82, 176, 189 trademarks, 195, 204 Transatlantic Trade and Investment Partnership (TTIP), 92 transport, 59 trickle-down economics, 111, 170 Triodos, 235 Turkey, 200 Tversky, Amos, 111 Twain, Mark, 178–9 U Uganda, 118, 125 Ulanowicz, Robert, 175 Ultimatum Game, 105, 117 unemployment, 36, 37, 276, 277–9 United Kingdom Big Bang (1986), 87 blood donation, 118 carbon dioxide emissions, 260 free trade, 90 global material footprints, 211 money creation, 182 MONIAC (Monetary National Income Analogue Computer), 64–5, 75, 142, 262 New Economics Foundation, 278, 283 poverty, 165, 166 prescription medicines, 123 wages, 188 United Nations, 55, 198, 204, 255, 258, 279 G77 bloc, 55 Human Development Index, 9, 279 Sustainable Development Goals, 24, 45 United States American Economic Association meeting (2015), 3 blood donation, 118 carbon dioxide emissions, 260 Congress, 36 Council of Economic Advisers, 6, 37 Earning by Learning, 120 Econ 101 course, 8, 77 Exxon Valdez oil spill (1989), 9 Federal Reserve, 87, 145, 146, 271, 282 free trade, 90 Glass–Steagall Act (1933), 87 greenhouse gas emissions, 153 global material footprint, 211 gross national product (GNP), 36–40 inequality, 170, 171 land-value tax, 73, 149, 180 political funding, 91–2, 171 poverty, 165, 166 productivity and employment, 193 rust belt, 90, 239 Transatlantic Trade and Investment Partnership (TTIP), 92 wages, 188 universal basic income, 200 University of Berkeley, 116 University of Denver, 160 urbanisation, 58–9 utility, 35, 98, 133 V values, 6, 23, 34, 35, 42, 117, 118, 121, 123–6 altruism, 100, 104 anthropocentric, 115 extrinsic, 115 fluid, 28, 102, 106–9 and networks, 110–11, 117, 118, 123, 124–6 and nudging, 112, 113, 114, 123–6 and pricing, 81, 120–23 Veblen, Thorstein, 82, 109, 111, 142 Venice, 195 verbal framing, 23 Verhulst, Pierre, 252 Victor, Peter, 270 Viner, Jacob, 34 virtuous cycles, 138, 148 visual framing, 23 Vitruvian Man, 13–14 Volkswagen, 215–16 W Wacharia, John, 186 Wall Street, 149, 234, 273 Wallich, Henry, 282 Walras, Léon, 131, 132, 133–4, 137 Ward, Barbara, 53 Warr, Benjamin, 263 water, 5, 9, 45, 46, 51, 54, 59, 79, 213–14 wave energy, 221 Ways of Seeing (Berger), 12, 281 Wealth of Nations, The (Smith), 74, 78, 96, 104 wealth ownership, 177–82 Weaver, Warren, 135–6 weightless economy, 261–2 WEIRD (Western, educated, industrialised, rich, democratic), 103–5, 110, 112, 115, 117, 282 West Bengal, India, 124, 178 West, Darrell, 171–2 wetlands, 7 whale hunting, 106 Wiedmann, Tommy, 210 Wikipedia, 82, 223 Wilkinson, Richard, 171 win–win trade, 62, 68, 89 wind energy, 75, 118, 196, 202–3, 221, 233, 239, 260, 263 Wizard of Oz, The, 241 Woelab, 231, 293 Wolf, Martin, 183, 266 women’s rights, 33, 57, 107, 160, 201 and core economy, 69, 79–81 education, 57, 124, 178, 198 and land ownership, 178 see also gender equality workers’ rights, 88, 91, 269 World 3 model, 154–5 World Bank, 6, 41, 119, 164, 168, 171, 206, 255, 258 World No Tobacco Day, 124 World Trade Organization, 6, 89 worldview, 22, 54, 115 X xenophobia, 266, 277, 286 Xenophon, 4, 32, 56–7, 160 Y Yandle, Bruce, 208 Yang, Yuan, 1–3, 289–90 yin yang, 54 Yousafzai, Malala, 124 YouTube, 192 Yunnan, China, 56 Z Zambia, 10 Zanzibar, 9 Zara, 276 Zeitvorsoge, 186–7 zero environmental impact, 217–18, 238, 241 zero-hour contracts, 88 zero-humans-required production, 192 zero-interest loans, 183 zero-marginal-cost revolution, 84, 191, 264 zero-waste manufacturing, 227 Zinn, Howard, 77 PICTURE ACKNOWLEDGEMENTS Illustrations are reproduced by kind permission of: archive.org


pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, Right to Buy, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, survivorship bias, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

In their 1967 book Beat the Market, mathematicians Sheen Kassouf and Edward Thorp outlined the relationship between the price of an option and the price of the underlying stock. Thorp, whose interest was gambling and beating the casino at roulette and baccarat, developed a model, anticipating the Black-Scholes equation. With a background in physics and mathematics, Fischer Black worked at Arthur D. Little, a financial consulting firm. While at the University of Chicago, Black collaborated with Myron Scholes, whose Ph.D. focused on using arbitrage to ensure that securities with similar risks offered similar returns. Black and Scholes built upon Kassouf and Thorp’s idea of hedging options using the underlying stock. The value of the option must be determined by the value of the stock. As the stock price changes, so should the price of the option. If a stock price moves from $10 to $11, then the price of the call option should also increase.

After leaving Salomon Brothers in 1991 following a trading scandal, John Meriwether established LTCM in 1994 with capital of $4 billion. Investors paid a 2 percent management fee and 25 percent incentive fee on earnings after a threshold level of return. The operation sought to replicate Salomon Brothers’ successful fixed income arbitrage unit. Joining Meriwether were key Salomon traders Eric Rosenfield, Lawrence Hilibrand, Victor Haghani, and Greg Hawkins. Nobel Prize winners Robert Merton and Myron Scholes, as well as former Fed vice-chairman David Mullins, also joined. The principals invested, in some cases their entire wealth, in LTCM. They bristled with indignation at suggestions that LTCM was a hedge fund. LTCM’s strategies were vague, emphasizing research, sophisticated analysis, proprietary modeling, relative value, and convergence trading. It identified small pricing discrepancies between securities, taking advantage of opportunities when prices deviated from long-run equilibrium values, due to short-term market disturbances.

In August 2007, the imbeciles, knaves, and fools (Taleb’s descriptions) devoted an entire issue of The American Statistician to the black swan hypothesis. On the Charlie Rose Show, Taleb dismisses all criticism as ad hominen, a logical fallacy that the validity of a premise is linked to the advocating person. Statisticians do not like the grandiose prose or tangential literary flights that Taleb defends, arguing that his book is a work of literature and philosophy. Taleb suggests that Myron Scholes, the co-author of the famed option pricing model, return his Nobel Prize as he is responsible for the crisis. He points to the failures of LTCM (where Scholes was a partner) and a subsequent hedge fund he started. Taleb suggests Scholes should be playing Sudoku in a retirement home, not lecturing anyone on risk. Stating he does not play Sudoku, Scholes accuses Taleb of being ‘popular’, trying to make money selling his book.


pages: 374 words: 114,600

The Quants by Scott Patterson

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Albert Einstein, asset allocation, automated trading system, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Meriwether, John Nash: game theory, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

He attended Harvard, grew fascinated with computers, and eventually gravitated toward finance after working for a management-consulting firm near Boston called Arthur D. Little. In the fall of 1968, he met Myron Scholes, a young MIT economist from Canada. Scholes had recently started thinking about a tough problem: how to price stock warrants. Black had been mulling over the same puzzle. The pair teamed up with Robert Merton and several years later published their groundbreaking research, with a little help from Thorp, on how to price stock options. In the early 1970s, Black took a job teaching finance at the University of Chicago. His third-floor office in Rosenwald Hall was sandwiched between the offices of Myron Scholes and Eugene Fama. He then took a job teaching at MIT for the following nine years. But he was getting restless, stymied by the slow pace of academia.

Thorp programmed formulas for tracking and pricing warrants into a Hewlett-Packard 9830A he’d installed in his office in Newport Beach, Keeping tabs on Wall Street thousands of miles away from the edge of the Pacific Ocean. In 1973, Thorp received a letter from Fischer Black, an eccentric economist then teaching at the University of Chicago. The letter contained a draft of a paper that Black had written with another Chicago economist, Myron Scholes, about a formula for pricing stock options. It would become one of the most famous papers in the history of finance, though few people, including its authors, had any idea how important it would be. Black was aware of Thorp and Kassouf’s delta hedging strategy, which was described in Beat the Market. Black and Scholes made use of a similar method to discover the value of the option, which came to be known as the Black-Scholes option-pricing formula.

In a matter of weeks in the summer of 1998, LTCM lost billions, threatening to destabilize global markets and prompting a massive bailout organized by Fed chairman Alan Greenspan. LTCM’s trades, based on sophisticated computer models and risk management strategies, employed unfathomable amounts of leverage. When the market behaved in ways those models never could have predicted, the layers of leverage caused the fund’s capital to evaporate. The traders behind LTCM, whose partners included option-formula creators Myron Scholes and Robert Merton, have often said that if they’d been able to hold on to their positions long enough, they’d have made money. It’s a nice theory. The reality is far more simple. LTCM went all in and lost. Black Monday left an indelible stamp on the very fabric of the market’s structure. Soon after the crash, options traders started to notice a strange pattern on charts of stock-option prices.


pages: 204 words: 58,565

Keeping Up With the Quants: Your Guide to Understanding and Using Analytics by Thomas H. Davenport, Jinho Kim

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Black-Scholes formula, business intelligence, business process, call centre, computer age, correlation coefficient, correlation does not imply causation, Credit Default Swap, en.wikipedia.org, feminist movement, Florence Nightingale: pie chart, forensic accounting, global supply chain, Hans Rosling, hypertext link, invention of the telescope, inventory management, Jeff Bezos, margin call, Moneyball by Michael Lewis explains big data, Myron Scholes, Netflix Prize, p-value, performance metric, publish or perish, quantitative hedge fund, random walk, Renaissance Technologies, Robert Shiller, Robert Shiller, self-driving car, sentiment analysis, six sigma, Skype, statistical model, supply-chain management, text mining, the scientific method

Bill Franks, “Why Nobody Is Actually Analyzing Unstructured Data,” International Institute for Analytics blog post, March 9, 2012, http://iianalytics.com/ 2012/03/why-nobody-is-actually-analyzing-unstructured-data/. 13. Peter Passell, “Wine Equation Puts Some Noses Out of Joint,” New York Times, March 4, 1990. 14. “Alternative Rich List,” FT.com, September 22, 2006. 15. Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, no. 3 (1973): 637–654; “Black–Scholes,” Wikipedia, http://en.wikipedia.org/wiki/Black–Scholes; “The Prize in Economics 1997,” press release, Nobelprize.org, http://nobelprize.org/nobel_prizes/economics/ laureates/1997/press.html. 16. Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, no. 3 (May 1973). 17. R. J. Larsen and M. L. Marx, An Introduction to Mathematics Statistics and Its Applications (Englewood Cliffs, NJ: Prentice-Hall, 1981), 159.

Things change, and being able to adjust is what has made Mr. Simons so successful. He says: “Statistic predictor signals erode over the next several years; it can be five years or ten years. You have to keep coming up with new things because the market is against us. If you don’t keep getting better, you’re going to do worse.” Analytical Thinking Example: Black-Scholes Option Pricing Model Fischer Black and Myron Scholes solved a problem in stock valuations that had long bedeviled investors.15 Black, a PhD in applied mathematics from Harvard, was then working at the consulting firm of Arthur D. Little, Inc.; Scholes, a freshly minted PhD in economics from Chicago, had just joined the faculty of the MIT Finance Department. There is a lot of specialized terminology in options pricing. An option is a security giving the right, but not the obligation, to buy or sell an asset, subject to certain conditions, within a specified period of time.


pages: 369 words: 128,349

Beyond the Random Walk: A Guide to Stock Market Anomalies and Low Risk Investing by Vijay Singal

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3Com Palm IPO, Andrei Shleifer, asset allocation, capital asset pricing model, correlation coefficient, cross-subsidies, Daniel Kahneman / Amos Tversky, diversified portfolio, endowment effect, fixed income, index arbitrage, index fund, information asymmetry, liberal capitalism, locking in a profit, Long Term Capital Management, loss aversion, margin call, market friction, market microstructure, mental accounting, merger arbitrage, Myron Scholes, new economy, prediction markets, price stability, profit motive, random walk, Richard Thaler, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, survivorship bias, transaction costs, Vanguard fund

LSV Asset Management, which manages about $8 billion, is owned by Josef Lakonishok of the University of Illinois, Andrei Shleifer of Harvard, and Robert Vishny of the University of Chicago. Long Term Capital Management, whose failure shook world financial markets in 1998 and which had to be rescued by a group of large banks prodded on by the Federal Reserve, was advised by Nobel laureates Robert Merton and Myron Scholes. 2 The January Effect and the New December Effect Small loser stocks are known to appreciate considerably in January, giving rise to the so-called January effect. The primary explanation for the January effect is tax-loss selling by investors in December to realize capital losses that are used to offset capital gains. When the selling pressure abates in January, the loser stocks appreciate.

See also price drift, short-term Index Review of Financial Studies, 7–8 risk adjustments for, 65 aversion and tolerance for, 6– 7, 13–14, 232–33, 255, 266–67, 287 currency markets and, 247, 254, 270, 279–80 diversification, 233–35, 242– 43, 249, 292 estimates of, 13–14 exchange-traded funds and, 252–53 exploiting mispricings and, 18 forward rate bias, 265, 269, 280 hedging the market, 329 industry momentum and, 81–82, 91–92, 100 international investing, 232, 238–39, 244, 248–49 irrational trading, 291–92 liquidity risk, 248 market inefficiency, 248 merger arbitrage, 198, 211, 226, 227 political and economic risks, 247–48 price drift, 67 rates of return and, 13, 233, 235 risk arbitrage, 196–99, 230n1 Sharpe ratios, 81–82, 92, 100, 103n2, 265, 276, 279 short selling, 44, 200, 326 volatility and, 239 Ross, Steve, 8 Rule 144A, 251 rules of thumb, 285–86 Russell indexes, 49–51, 50, 82, 116, 320–21. See also Nasdaq 100 Index; Standard and Poor’s (S&P) indexes; Wilshire index Rydex Funds Dynamic funds, 317n6 industry momentum and, 85, 86, 93–98, 96, 100 Mekros Fund, 51 Sector Rotation Fund, 99 Standard and Poor’s 500 index compared to, 97 transactions costs, 95 Ursa, 129 Sabre Holdings, 201–2, 204 sampling bias, 11, 12 SAS software, 133n6 Saturday trading, 46 Sauter, Gus, ix Scholes, Myron, 22n3 Scottrade, 115 Scudder Investments, 252 SDC Mergers and Acquisitions database, 219 seasoned issues, 305, 312, 317n1 sector funds, 85, 86, 89, 98–99, 100 Securities and Exchange Act (1924), 46 Securities and Exchange Commission (SEC) American depository receipts (ADRs) and, 250– 51 insider trades and, 135, 142, 149 Internet resources, 160 merger arbitrage and, 197 Ownership Reporting System, 138 reporting requirements, 134, 136, 146–47, 149 345 346 Index selection bias, 12 self-attribution, 286 Seyhun, Nejat, 147 share repurchases, 136, 309–10, 317n4 Sharpe, William, 8 Sharpe ratios forward rate bias strategies, 276, 279 in forward rate bias strategies, 265 industry momentum and, 81–82, 92, 100, 103n2 Shleifer, Andrei, 22n3 short selling described, xi, xiv, 323–27 difficulties, 5 exchange-traded funds, 322 futures, 110 hedged short sales, 326 hedging, 49, 185 history, 46 industry momentum and, 79, 80 insider trading, 136, 157 merger arbitrage, 199, 202, 217–18, 225–26, 231n3 mutual fund mispricings, 127, 131 price drift, 65, 69, 71–73 process described, 323–26 restrictions on, 16, 317n7, 326 returns and, 302 risks, 5–6, 200 short interest of companies, 45, 48, 49, 52, 54 short squeeze, 325 shorting against the box, 44 speculative short sellers, 327 Standard and Poor’s (S&P) 500 index changes, 163, 180, 182–84, 185–90, 192 stock mergers, 222 unhedged, 44 weekend effect, 40, 43, 44–45 short-term price drift.


pages: 500 words: 145,005

Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

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3Com Palm IPO, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, Berlin Wall, Bernie Madoff, Black-Scholes formula, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, market clearing, Mason jar, mental accounting, meta analysis, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, Paul Samuelson, payday loans, Ponzi scheme, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

This launched the Center for Research in Security Prices, known as CRSP (pronounced “crisp”). CRSP released its first database in 1964, and research in the field immediately took off, with University of Chicago locals leading the way. Chief among these were Miller, Fama, and a group of exceptional graduate students including Michael Jensen, Richard Roll (a distinguished scholar and longtime professor at UCLA), and Myron Scholes, the co-inventor of the Black–Scholes option-pricing model. Research proceeded quickly. By 1970 the theory and evidence supporting the EMH was sufficiently well-established that Fama was able to publish a comprehensive review of the literature that stood for many years as the efficient market bible. And just eight years after Fama had established this foundation, Jensen would publish the sentence declaring the efficient market hypothesis to be proven.

Petersburg paradox, 27 sales, 61–62 Samuelson, Paul, 159 economics formalized by, 44, 94 financial economics work of, 208 “public goods” formalized by, 144–46 on rationality of repeat betting, 192–95, 197 time inconsistency and, 92 utility measured by, 89–90, 92, 99 Save More Tomorrow, 314–22, 318, 341 lack of randomized control trial test of, 338n savings, 54 after-tax financial return on, 309–13 standard theories of, 309 savings, for retirement, 7, 9, 50, 52, 80, 345, 370 automatic enrollment, 313–22, 318 inertia in, 313 loss aversion in, 313–14 and marginal propensity to consume, 98 narrow framing of, 195–98, 196 nest egg amount and, 309–10 and present bias, 314 self-control and, 314 Scarcity (Mullainathan and Shafir), 58n, 366 Schachter, Stanley, 180 Schelling, Thomas, 12–13, 14, 37n, 100, 104n, 178 in Behavioral Economics Roundtable, 181 Schiphol International Airport, 326 Scholes, Myron, 208 Schwartz, Alan, 197 Science, 22, 319 scientific revolutions, 167–68, 169–70 secret sales, 119–20 Security Analysis (Graham and Dodd), 219–20 Seeger, Pete, 65 self-control, 54, 85–86, 99–111, 115 as about conflict, 103 retirement savings and, 314 and savings for retirement, 309 two selves in, 103–5 willpower and, 87–99, 363 self-interest, bounded, 258 selfishness, 145–46 Sen, Amartya, 145 sense of humor, 218, 219, 223 Shafir, Eldar, 58n, 67–68, 69, 71, 179, 257, 366 Shankar, Maya, 344 Shapiro, Jesse, 75–76, 357 Sharpe, William, 208, 226, 229 Shaton, Maya, 198 Shea, Dennis, 315–17 Shefrin, Hersh, 98, 104, 164–66, 167, 223–24 Shiller, Robert, 5n, 176, 242 in behavioral economics debate, 159, 167–68 in Behavioral Economics Roundtable, 181 behavioral finance workshop organized by, 236 and behavioral macroeconomics, 349 housing prices studied by, 235, 252 as president of AEA, 347 on variability of stock prices, 230–33, 231 Shleifer, Andrei, 175, 178 closed-end fund paper of, 240–43, 244 on limits of arbitrage, 249 Signal and the Noise, The (Silver), 292 Silva, Rohan, 330–33, 334 Silver, Nate, 47, 292 Simon, Herbert, 23, 29 in behavioral economics debate, 159, 162 Sinden, John, 148–49 skiing, 115–20, 138 Slovic, Paul, 21, 36, 48 slow hunch, 39–40 Small Business Administration, 351, 352n Smith, Adam, 7, 51–52, 58, 87–88, 89, 103 Smith, Cliff, 206 Smith, Roger, 123 Smith, Vernon, 40, 41, 148, 149 “learning” critique of experimental economics, 153 snow shovels, 20, 64–65, 127–29, 133, 136, 137 Snyder, Daniel, 288–89, 290n Social Security, 322 Society for Judgment and Decision Making, 180n Society of Actuaries, 14 Soll, Jack, 75 Solow, Robert, 259 Soman, Dilip, 66–67 Sony, 135–36 sophisticated agents, 110–11 sporting events, tickets for, 18–19, 57–58 spreadsheets, 214n Stanford Law Review, 258–59 Stanford University, 35–41, 125, 126, 185 statistical lives, 13 Statman, Meir, 104, 164–66, 167 status quo, 131 bias, 154 and Weber-Fechner law, 32 Staw, Barry, 65 Steinberg, Saul, 91 Stewart, Jon, 352 sticky wages, 131–32 Stigler, George, 37n, 87, 162–63 Stigler, Stephen, 296n Stigler’s Law, 296n Stiglitz, Joseph, 170 stock market, stocks, 7 beating, 206, 207 bonds vs., 191–92, 195–98, 196 calendar effects in, 174 cheap, 219–21 growth, 28, 214–15, 222, 227 October 1987 crash of, 7, 232 regression toward the mean, 222–23 value, 214–15, 220–21, 222, 227–28 variability of prices of, 230–33, 231, 367 “Stock Prices and Social Dynamics” (Shiller), 233 strikes, 372 Strotz, Robert, 99–100, 102, 108 Structure of Scientific Revolutions, The (Kuhn), 169 Stubhub.com, 18–19 stub value, 246, 246 Stulz, René, 243 Sufi, Amir, 78 suggested retail price, 61–63 Summers, Larry, 178, 239–40, 247 sunk costs, 21, 52, 64–73, 118, 180, 261 and revised Ultimatum Game, 266–67 Sunstein, Cass, 258, 260, 269, 322, 323–25, 330, 333, 343, 345 on ethics of nudging, 337n Super Bowl, 139n, 359 supermarkets, 62n supposedly irrelevant factors (SIFs), 9, 24, 315 budgets and, 74 luck on Deal or No Deal, 298 noise traders’ use of, 240 purchase location as, 61 in retirement savings, 310–11, 312, 315 and returns on investments, 196 sunk costs as, 267 tax cuts as, 350 surcharge, discount vs., 18 surge pricing, 136–38, 200n surplus value, 285–86, 285, 286, 288 Susanne (game show contestant), 299–300 Sydney, Australia, 138n Tarbox, Brian, 317–19, 321 tax cuts, 350–51 taxes, 165 compliance with, 334–36 and savings, 309–13 taxi drivers, hours worked by, 11, 199–201, 295 Taylor, Tim, 173n technology bubble, 7, 78, 220, 234, 250, 252 teenage pregnancy, 342 Teichman, Doron, 269 10% club, 277–78, 293–94 test periods, 227 texting, 190n, 342 Thaler, Alan, 14 Thaler, Jessie, 129 Thaler, Maggie, 118n theories, normative vs. descriptive, 25 theory-induced blindness, 93–94, 128 Theory of Games and Economic Behavior, The (von Neumann and Morgenstern), 29 Theory of Interest, The (Fisher), 88–89 Theory of Moral Sentiments, The (Smith), 87–88 “THERE ARE IDIOTS” paper (Summers), 240–41 Thinking, Fast and Slow (Kahneman), 38, 103n, 109, 186 Thompson, Rex, 242 Tierney, John, 327 time, value of, 21 time-inconsistency, 92–93, 99 time-shares, 71 Tirole, Jean, 307 Tobin, James, financial economics work of, 208 tokens, 149–53, 151, 263, 264–65 Tories, see Conservative Party, U.K.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, Gunnar Myrdal, haute couture, illegal immigration, income inequality, industrial cluster, information asymmetry, intangible asset, invention of the telephone, invention of the wheel, invisible hand, John Meriwether, John Nash: game theory, John von Neumann, Kenneth Arrow, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, light touch regulation, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, Pareto efficiency, Paul Samuelson, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, Right to Buy, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Vilfredo Pareto, Washington Consensus, women in the workforce, yield curve, yield management

Hudson's boss, Jack Lavin, was cruder still: "I think my dick just fell of(" Transactions at Long-Term Capital Management were much more Culture and Prosperity { 237} sophisticated. Most investment funds simply buy portfolios of stocks and bonds. A hedge fund such as LTCM trades derivatives and arbitrages between similar securities in different markets. LTCM's partners included Robert Mertonn and Myron Scholes,n who won the Nobel Prize in 1997 for their contributions to financial economics. Merton and Scholes operated with experienced Wall Street traders. Sophisticated investors can use derivative markets to insure their portfolios. By buying a put option at 10% below the current market price, you limit your maximum loss to 10%-the cost of the option is your insurance premium. After the Asian crisis and Russia's debt default in 1998, investors were particularly nervous.

., 116 Rousseau, Jean-Jacques, 242,247,253,290 Roux,Paul,85-86,89,90, 137,180,293 rule oflaw, 13, 75, 254, 352 rules, 73-82 Russia debt default (1998), 237 privatization in, 11, 13, 128, 288, 295, 306-7,319,344,355 See also Soviet Union Sachs, Jeffrey, 335 Samuelson, Paul, 179,210,324,330,335,359 San Remo flower market, 14, 146-48, 149, 151-52 Say,Jean-Baptiste, 174, 175, 179 Scherer, Mike, 334 Scholes, Myron, 159, 160-61, 237, 359 Scottish Enlightenment, 83, 126 "second-price auction," 102, 103 securities markets, 91, 92, 148 bonds, 50, 167-69 derivatives, 160-61, 237 and efficient market hypothesis, 236 "equity premium," 235 inception of, 55 investment strategy, 300 knowledge transmission, 270-71 speculation, 150, 151,341 traders' compensation, 321 valuation, 170-71 See also risk; stock markets self-interest, 11, 12-13, 16, 17, 20, 78, 127, 314,327,340 adaptive, 217, 252, 256, 343 American business model, 21, 62,313, 314-18,343-44 and cooperation, 247-48,250,253, 255-56,320 in politics, 12, 250-51 and redistributive market liberalism, 314-15 and Smith (Adam), 197-98 values of, 315-18,342,347 self-regarding materialism, 198,207,217, 315-18 expectation/achievement gap, 286,287 nonmaterialist motives vs., 320, 340 public goods vs., 248 rationality as, 210, 212, 219, 347 self-perpetuating, 216 social norms vs., 255 self-regulation, 349 Sen, Amartya, 327, 359 settlements.


pages: 537 words: 144,318

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

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Albert Einstein, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, business process, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, Commodity Super-Cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, invisible hand, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, market microstructure, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, purchasing power parity, quantitative easing, random walk, reserve currency, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, survivorship bias, The Great Moderation, Thomas Bayes, time value of money, too big to fail, transaction costs, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

If someone really has an outstanding talent that distinguishes him, whether that be intellect, mathematical aptitude, a talent for reading market psychology, or a mixture of other factors, this person will probably migrate to where he gets the best reward for his effort, where he will be able to play amongst the best and thus get even better, and where he is the least constrained. So the weaknesses in the real money world are structural. How would you go about maximizing the strengths, such as the strong balance sheet and credit worthiness that you mentioned? The most obvious way is to get paid for pockets of illiquidity in the market, and the easiest way of doing that is by investing in safe but less liquid securities. This is one way of being what Myron Scholes calls a liquidity provider to the market, something difficult to be if you are a leveraged player with redemptions, like a hedge fund. A liquidity provider should ideally have long-term money, say for the next 20 or 30 years, maybe forever. This is an underutilized resource among most pension funds, who often think that being fully invested means they have 100 percent of their assets allocated and thus no more liquidity.

See Risk premia payment Price/earnings (P/E) multiples, exchange rate valuation (relationship) Primary Dealer Credit Facility, placement Prime broker risk Princeton University (endowment) Private equity cash flow production tax shield/operational efficiency arguments Private sector debt, presence Private-to-public sector risk Probability, Bayesian interpretation Professor, The bubble predication capital loss, avoidance capital management cataclysms, analysis crowding factor process diversification efficient markets, disbelief fiat money, cessation global macro fund manager hedge fund space historical events, examination idea generation inflation/deflation debate interview investment process lessons LIBOR futures ownership liquidity conditions, change importance market entry money management, quality opportunities personal background, importance portfolio construction management positioning process real macro success, personality traits/characteristics (usage) returns, generation risk aversion rules risk management process setback stocks, purchase stop losses time horizon Titanic scenario threshold trades attractiveness, measurement process expression, options (usage) personal capital, usage quality unlevered portfolio Property/asset boom Prop shop trading, preference Prop trader, hedge fund manager (contrast) Protectionism danger hedge process Public college football coach salary, public pension manager salary (contrast) Public debt, problems Public pensions average wages to returns endowments impact Q ratio (Tobin) Qualitative screening, importance Quantitative easing (QE) impact usage Quantitative filtering Random walk, investment Real annual return Real assets Commodity Hedger perspective equity-like exposure Real estate, spread trade Real interest rates, increase (1931) Real macro involvement success, personality traits/characteristics (usage) Real money beta-plus domination denotation evolution flaws hedge funds, differentiation impacts, protection importance investors commodity exposure diversification, impact macro principles management, change weaknesses Real money accounts importance long-only investment focus losses (2008) Real money funds Commodity Hedger operation Equity Trader management flexibility frontier, efficiency illiquid asset avoidance importance leverage example usage management managerial reserve optimal portfolio construction failure portfolio management problems size Real money managers Commodity Investor scenario liquidity, importance long-term investor misguidance poor performance, usage (excuse) portfolio construction valuation approach, usage Real money portfolios downside volatility, mitigation leverage, amount management flaws Rear view mirror investment process Redemptions absence problems Reflexivity Rehypothecation Reichsmarks, foreign holders (1922-1923) Relative performance, inadequacy Reminiscences of a Stock Operator (Lefèvre) Renminbi (2005-2009) Repossession property levels Republic of Turkey examination investment rates+equities (1999-2000) Reserve currency, question Resource nationalism Returns forecast generation maximization momentum models targets, replacement Return-to-worst-drawdown, ratios (improvement) Reward-to-variability ratio Riksbank (Sweden) Risk amount, decision aversion rules capital, reduction collars function positive convexity framework, transition function global macro manager approach increase, leverage (usage) measurement techniques, importance parameters Pensioner management pricing reduction system, necessity Risk-adjusted return targets, usage Risk assets, decrease Risk-free arbitrage opportunities Risk management Commodity Hedger process example game importance learning lessons portfolio level process P&L, impact tactic techniques, importance Risk premia annualization earning level, decrease specification Risk/reward trades Risk-versus-return, Pensioner approach Risk-versus-reward characteristics opportunities Roll yield R-squared (correlation) Russia crisis Russia Index (RTSI$) (1995-2002) Russia problems Savings ratio, increase Scholes, Myron Sector risk, limits Securities, legal lists Self-reinforcing cycles (Soros) Sentiment prediction swings Seven Sisters Sharpe ratio increase return/risk Short-dated assets Short selling, ban Siegel’s Paradox example Single point volatility 60-40 equity-bond policy portfolio 60-40 model 60-40 portfolio standardization Smither, Andrew Socialism, Equity Trader concern Society, functioning public funds, impact real money funds, impact Softbank (2006) Soros, George self-reinforcing cycles success Sovereign wealth fund Equity Trader operation operation Soybeans (1970-2009) Special drawing rights (SDR) Spot price, forward price (contrast) Spot shortages/outages, impact Standard deviation (volatility) Standard & Poor’s 500 (S&P500) (2009) decrease Index (1986-1995) Index (2000-2009) Index (2008) shorting U.S. government bonds, performance (contrast) Standard & Poor’s (S&P) shorts, coverage Stanford University (endowment) State pension fund Equity Trader operation operation Stochastic volatility Stock index total returns (1974-2009) Stock market increase, Predator nervousness Stocks hedge funds, contrast holders, understanding pickers, equity index futures usage shorting/ownership, contrast Stops, setting Stress tests, conducting Subprime Index (2007-2009) Sunnies, bidding Super Major Survivorship bias Sweden AP pension funds government bond market Swensen, David equity-centric portfolio Swiss National Bank (SNB) independence Systemic banking crisis Tactical asset allocation function models, usage Tactical expertise Tail hedging, impact Tail risk Take-private LBO Taleb, Nassim Tax cut sunset provisions Taxes, hedge Ten-year U.S. government bonds (2008-2009) Theta, limits Thundering Herd (Merrill Lynch) Time horizons decrease defining determination shortening Titanic funnel, usage Titanic loss number Titanic scenario threshold Topix Index (1969-2000) Top-line inflation Total credit market, GDP percentage Total dependency ratio Trade ideas experience/awareness, impact generation process importance origination Traders ability Bond Trader hiring characteristics success, personality characteristics Trades attractiveness, measurement process hurdle money makers, percentage one-year time horizon selection, Commodity Super Cycle (impact) time horizon, defining Trading decisions, policy makers (impact) floor knowledge noise level ideas, origination Tragedy of the commons Transparency International, Corruption Perceptions Index Treasury Inflation-Protected Securities (TIPS) trade Triangulated conviction Troubled Asset Relief Program (TARP) Turkey economy inflation/equities (1990-2009) investment rates+equities (1999-2000) stock market index (ISE 100) Unconventional Success (Swensen) Underperformance, impact Undervaluation zones, examination United Kingdom (UK), two-year UK swap rates (2008) United States bonds pricing debt (1991-2008) debt (2000-2008) home prices (2000-2009) hyperinflation listed equities, asset investment long bonds, market pricing savings, increase stocks tax policy (1922-1936) trade deficit, narrowing yield curves (2004-2006) University endowments losses impact unlevered portfolio U.S.


pages: 422 words: 113,830

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism by Kevin Phillips

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algorithmic trading, asset-backed security, bank run, banking crisis, Bernie Madoff, Black Swan, Bretton Woods, BRICs, British Empire, collateralized debt obligation, computer age, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency peg, diversification, Doha Development Round, energy security, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, George Gilder, housing crisis, Hyman Minsky, imperial preference, income inequality, index arbitrage, index fund, interest rate derivative, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, large denomination, Long Term Capital Management, market bubble, Martin Wolf, Menlo Park, mobile money, money market fund, Monroe Doctrine, moral hazard, mortgage debt, Myron Scholes, new economy, oil shale / tar sands, oil shock, old-boy network, peak oil, Plutocrats, plutocrats, Ponzi scheme, profit maximization, Renaissance Technologies, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, shareholder value, short selling, sovereign wealth fund, The Chicago School, Thomas Malthus, too big to fail, trade route

When Richard Nixon “closed the gold window” in 1971, ending Federal Reserve authority to let foreign central banks buy gold with dollars, he “floated” the currency on restless global seas. Currency trading and foreign exchange markets boomed, with currency futures launching in 1972, and foreign exchange in one form or another growing into the world’s largest financial market. The extent to which financial firms and markets were rapidly computerizing was likewise essential to this kind of trading, and together with the pioneering work of Fischer Black and Myron Scholes in options theory in 1973, the elements of primordial soup were set for a new hedging and speculative universe, one that supported so-called derivative instruments. The first two introduced were foreign currency futures in 1972 and equity futures in 1973; T-bill futures and futures on mortgage-backed bonds followed in 1975. Figure 2.3 shows the early emergence of derivatives in the seventies, together with their much grander and sophisticated permutation in the upward-bound eighties and nineties.

Roosevelt, Theodore Rosenberg, David Rove, Karl Royal Dutch Shell see also Shell Rubenstein, David Rubin, Robert ruble, Russian Ruskin, Alan Russia capitalism of currency policy of oil policy of oil production oil reserves of petro-diplomacy of Russian Export Blend Crude Oil (REBCO) Ryan, Timothy SAC Capital Partners S&L crisis S&P/Case-Shiller Home Price Index S&P Sarkozy, Nicolas Saudi Arabia China’s arms sales to U.S. currency and U.S.’s economic relationship with Saudi Aramco Saut, Jeff Say, Jean-Baptiste Schama, Simon Schiff, Peter Schlesinger, Arthur Schlesinger, James Scholes, Myron Schumer, Charles Schumpeter, Joseph Schwartz, Anna Scott, Walter Secret, The (Byrne) “Securities: The New World Wealth Machine” (Edmunds) Securities and Exchange Commission securitization CDOs and defined deregulation and derivatives and entrepreneurialism and family income and federal mortgage enterprises and hedge funds and housing and mortgage crisis and opacity and principal categories of pseudomonetary products and rating services and risk burden and shadow banking system and Three-M conundrum and Senate, U.S.


pages: 479 words: 113,510

Fed Up: An Insider's Take on Why the Federal Reserve Is Bad for America by Danielle Dimartino Booth

Affordable Care Act / Obamacare, asset-backed security, bank run, barriers to entry, Basel III, Bernie Sanders, break the buck, Bretton Woods, central bank independence, collateralized debt obligation, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, George Akerlof, greed is good, high net worth, housing crisis, income inequality, index fund, inflation targeting, interest rate swap, invisible hand, John Meriwether, Joseph Schumpeter, liquidity trap, London Whale, Long Term Capital Management, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, moral hazard, Myron Scholes, natural language processing, negative equity, new economy, Northern Rock, obamacare, price stability, pushing on a string, quantitative easing, regulatory arbitrage, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, short selling, side project, Silicon Valley, The Great Moderation, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, yield curve

The brainchild of John Meriwether, former head of bond trading at Salomon Brothers, LTCM was launched in February 1994 with $1.25 billion in capital and a cadre of hotshots who built financial models that would take bond arbitrage to never-before-seen heights of profitability. Meriwether hired PhD economists David Mullins, former vice chairman of the Federal Reserve, and Robert C. Merton and Myron Scholes, two academics who would share the 1997 Nobel Prize in Economics for creating a new method to value derivatives. (This unusual trio should have been investors’ first red flag.) By 1996, LTCM’s model-driven investments had proven phenomenally successful. The partners of the firm earned reputations as arrogant, conceited, and secretive, hiding their trades by scattering them among different banks so competitors couldn’t replicate their strategies.

., 93–95, 167 Ranieri, Lew, 16 Raskin, Sarah Bloom, 194 Rattner, Steve, 146 Reagan, Ronald, 104, 220 regulatory capture, 258 rehypothecation, 127–28 renters, 215 repo market, 108, 124, 126–29 Requiem for the American Dream (Chomsky), 9 Reserve Management Company, 140 Reserve Primary Fund, 140–41 Richards, James, 97 “Rise and Fall of Subprime Mortgages, The” (Duca & DiMartino Booth), 74 “Rise and Fall of the Shadow Banking System” (Pozsar), 121 risk management, 255–56 Ritholtz, Barry, 222 Roach, Steve, 227 Roche, Cullen, 198 Rogoff, Ken, 82 Romney, Mitt, 223 Roosa, Robert, 61–62 Rosenblum, Harvey, 55, 59–65, 72–73, 82, 91, 93, 163, 165, 178–79, 185, 244–45 Bernanke and, 83–84 DiMartino Booth and, 30–32, 117, 183, 201, 202, 204, 221, 222 Yellen and, 59–60 Rosengren, Eric, 179–80 Rosner, Josh, 222 Roubini, Nouriel, 114 Rubin, Robert, 15–17, 53 Russo, Tom, 146 Ryan, Paul, 199 Sack, Brian, 181 Sanders, Bernie, 9, 168 San Francisco Fed, 44, 47, 63, 88 Santelli, Rick, 233 Sarao, Navinder Singh, 190 savers, 5 Scholes, Myron, 14 Schumpeter, Joseph, 63 Schwartz, Alan, 107–8, 114, 136 Schwarzman, Steve, 166 screwflation, 215–16 seasonal adjustments, in data, 39–40 Segarra, Carmen, 257–58 “Shadow Banking” (Poszar/Market Desk), 191 shadow banking system, 121–29, 167–69, 191–93 shadow unemployment rate, 7–8 Sheets, D. Nathan, 174 Shelby, Richard, 195 Shiller, Robert, 21, 50, 176–77, 232 short sellers/short selling, 107, 143 Silverblatt, Howard, 31, 207 silver market, 216 60 Minutes (TV show), 171–72, 214 Smith, Adam, 125–26 Sneider, Amanda, 207 Sociéte Générale, 103 S&P, 27, 120 Spiegel, Der, 88 Squawk Box (TV show), 26 St.


pages: 464 words: 139,088

The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King

Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock, oil shale / tar sands, oil shock, open economy, paradox of thrift, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, quantitative easing, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Satoshi Nakamoto, savings glut, secular stagnation, seigniorage, stem cell, Steve Jobs, The Great Moderation, the payments system, Thomas Malthus, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, yield curve, Yom Kippur War, zero-sum game

To understand the demand for safe assets, and the extent to which our banking system as presently constituted can respond to that demand, requires a deeper analysis of the nature of uncertainty. 4 RADICAL UNCERTAINTY: THE PURPOSE OF FINANCIAL MARKETS And what you do not know is the only thing you know And what you own is what you do not own And where you are is where you are not. T.S. Eliot, ‘East Coker’, The Four Quartets ‘You’ve got to expect the unexpected.’ Paul Lambert, Aston Villa manager, press conference, 22 November 2013 Are we really capable of expecting the unexpected?1 In 1998, the hedge fund Long-Term Capital Management (LTCM) failed, although its senior management team comprised two Nobel Laureates in Economic Science, Myron Scholes and Robert Merton, and an experienced practitioner in financial markets, John Meriwether. Their strategy, successful at first, was to create a highly leveraged fund that bought large amounts of one asset and sold equally large amounts of a slightly different asset (for example, government bonds of slightly different maturities), so as to exploit anomalies in the pricing of those assets. The return on each transaction was tiny but done on a sufficiently large scale, it generated huge profits.

., 308 resolution mechanisms, 256, 279 Richardson, Gordon, 176 risk, 84, 121–2, 123, 124, 126–9, 143, 254; implicit taxpayer subsidy for, 191–2, 207, 254–5; maturity and risk transformation, 104–15, 117–19, 250–1, 254–5; ‘optimising’ model, 129–31, 132, 134, 138, 309, 311; risk premium, 32–3, 115, 183; risk weights, 138–9, 258–9, 277 Robinson, Joan, 12, 292–3 Rodrik, Dani, 348 Rogoff, Kenneth, 44, 308 Rome, ancient, 59, 164, 216 Roosevelt, President Franklin, 91, 316 Royal Bank of Scotland (RBS), 37, 89, 118, 206, 243 Russia, 121, 159 saving, 101–2, 155, 308–17, 362–3; in emerging economies, 22–3, 27–8, 29, 30; ‘paradox of thrift’, 297, 326; ‘savings glut’, 28, 29, 30, 46, 319, 325; as source of future demand, 11, 46, 84–5, 185, 325–6, 356 Schacht, Hjalmar, 341–2, 343 Schäuble, Wolfgang, 211 Scholes, Myron, 120–1 Schumpeter, Joseph, 152 Schwartz, Anna, 192, 328 Scotland, 218, 243–7, 248 Second World War, 20, 21, 219, 242, 317, 342 secular stagnation theory, 44, 291–2, 355 Seneca, 123–4 11 September 2001 terrorist attacks, 124 ‘shadow’ banking system, 107, 112–14, 256, 262, 274 Shiller, Robert, 151 Silber, William, 206 Simons, Henry, 262 Sims, Christopher, 79 Slovakia, 216 Smith, Adam, 17–18, 54–5, 79–80, 163 Smith, Ed, 124 sovereign debt (government bonds), 32, 65, 92, 138, 182–4, 196–7, 203, 258, 259, 338–40; bond yields, 29, 183–4, 224, 227, 228, 231, 299, 336; in euro area, 162, 190, 224, 226–31, 258, 338, 339–40, 342–4; framework for restructuring, 346–7; need for export surplus before payment, 339–40, 341–3; WW1 reparations, 340–2, 343, 345–6 Soviet Union, 27, 68, 216 Spain, 47, 93, 159, 216, 221, 222, 227–8, 229, 257–8, 355, 363–4 special purpose vehicles, 113–14 stock markets, 102, 125–6, 133, 151–4, 194, 195, 200, 347 Stresemann, Gustav, 219 Summers, Larry, 44 Sweden, 159, 166, 173, 179, 216–17, 279, 335 Swift, Jonathan, ‘Thoughts on Various Subjects’ (1703), 250, 290 Switzerland, 33, 70, 100, 118, 184, 216, 335 Syed, Matthew, 124 Taylor, John, 168 technological change, 83–4, 127, 129, 153–4, 281, 291, 354, 355, 365 Tequila crisis (1994), 367 Thaler, Richard, 132 Thornton, Henry, 188 Tobin, James, 262 trade surpluses and deficits, 33, 34, 46, 319, 321–2, 329, 352, 356, 364; in emerging economies, 27–8, 30, 329; in EMU, 222, 232–3, 236, 363–4; and exchange rates, 22–3; and interest rates, 23, 30, 46, 319–20; likely re-emergence of, 48–9 trading, financial, 3, 24, 64, 99–100, 257; bonuses, 99, 101, 117, 144, 147; erosion of ethical standards, 100–1, 288; ‘front-running’, 153–4, 284 Transatlantic Trade and Investment Partnership (TTIP), 361 Trans-Pacific Partnership (TPP), 361 Trichet, Jean-Claude, 225 trust, 10, 81–3, 106; and monetary unions, 220, 232, 237; and money, 8, 55, 57, 66–71, 82–3, 155 Tsipras, Alexis, 230, 231 Tuckett, Professor David, 133–4 Turner, Adair, 324 Tversky, Amos, 132 unemployment, 38, 292, 293, 294, 297–9, 302, 326–7, 329, 330; in euro area, 45, 226, 228, 229–30, 232, 234, 345; and inflation targeting, 168, 169; and interest rates, 169, 298–300; ‘stagflation’ (1970s), 5, 302–3, 318 United Kingdom: Acts of Union (1707), 215; alternative strategies for pre-crisis period, 328–32; Banking Act (2009), 40; Banking and Joint Stock Companies Act (1879), 109; Banking Reform Act (2013), 40; ‘Big Bang’ (1986), 23; City of Glasgow Bank failure (1878), 108–9; commercial property market, 47, 118; Currency and Bank Notes Act (1914), 198; Labour government (1964-70), 20; as monetary union, 215; need for export sector support, 357, 364; return to gold standard (1920s), 76; Scottish independence referendum (2014), 218, 243–5, 248; trade deficits, 30, 321, 322, 329, 364; tradition of national branch banking, 116; see also Bank of England United Nations, 214–15 United States: 1914 financial crisis, 192–201, 206; Aldrich-Vreeland Act (1908), 196, 206; Bureau of War Risk Insurance (1914), 200; Constitution, 286; Dodd-Frank Reform (2010), 40, 260; dollar and gold link, 73, 195, 200–1; dollar as world’s reserve currency, 25, 28, 34; ‘double liability’ (1865-1934), 107–8; ‘free banking’ era, 60–2, 77, 161; Glass-Steagall Act (1933), 23, 98, 260; gold reserves, 74, 77; Gramm-Leach-Bliley Act (1999), 23, 98; history of money in, 57–8, 67, 68, 160–1, 187, 188, 212, 215; as monetary union, 212, 215, 234; need for export sector support, 357, 364; New York becomes world money centre, 194–5, 200–1; notes and coins in, 281; Office of the Comptroller of the Currency, 137, 206; trade deficits, 30, 34, 46, 49, 319, 321, 329, 364 Van Court’s Counterfeit Detector and Bank Note List, 61 Vietnam War, 5, 20, 73, 306 Viniar, David, 123 Volcker, Paul, 176, 288 Voltaire, 126 Wall Street Crash (1929), 347 Walpole, Horace, 369 Walras, Léon, 79 Washington, George, 286 Weatherstone, Sir Dennis, 136–7, 278 weights and measures, 212, 286, 287 Wheeler, Judge Thomas C., 162 wholesale funding, 97 Willetts, David, 83 Wilson, Brigadier-General Henry, 89 Wimbledon tennis championships, 142, 187–8 Wolf, Martin, 96, 262 World Bank, 21, 350 World Trade Organisation, 361 Yellen, Janet, 176, 287 Yugoslavia, break-up of, 216 Zimbabwe, 68, 69–70 ABOUT THE AUTHOR Mervyn King was Governor of the Bank of England from 2003 to 2013, and is currently Professor of Economics and Law at New York University and School Professor of Economics at the London School of Economics.


pages: 338 words: 106,936

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall

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Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, beat the dealer, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, butterfly effect, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, Myron Scholes, new economy, Paul Lévy, Paul Samuelson, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, V2 rocket, Vilfredo Pareto, volatility smile

January 1962 came and went, and Black had done no more work toward his thesis. He was informed that he could not return to Harvard. Today, Fischer Black is one of the most famous figures in the history of finance. His most important contribution, the Black-Scholes (sometimes Black-Scholes-Merton) model of options pricing, remains the standard by which all other derivatives models are measured. In 1997, Black’s collaborators, Myron Scholes and Robert Merton, were awarded the Nobel Prize in economics for the Black-Scholes model. Black had died in 1995 and so was ineligible for the prize (the Nobel is never awarded posthumously), but in a rare nod, the Nobel committee explicitly acknowledged Black’s contribution in its announcement of the award. Every two years, the American Finance Association awards the Fischer Black Prize — one of the most prestigious awards in academic finance — to an individual under forty whose body of work “best exemplifies the Fischer Black hallmark of developing original research that is relevant to finance practice.”

Black set out to learn everything that Treynor knew about finance, so that when Treynor left ADL, just a year after he and Black first met, Black was the natural person to take Treynor’s place on ADL’s financial consulting team — and further perfect Treynor’s model. CAPM would form the foundation for virtually all of the work Black would go on to do. If Jack Treynor initiated Black’s transformation into a financial economist, Myron Scholes brought it to fruition. Scholes arrived in Cambridge in September 1968, a fresh doctorate from the University of Chicago in hand. A fellow graduate student in Chicago, Michael Jensen, had recommended that Scholes look up Black — an “interesting fellow,” in Jensen’s estimation. Scholes called soon after arriving in Cambridge. Both men were young: Scholes had just turned twenty-seven, and Black was thirty.

During the financial meltdown, even sophisticated investors, such as the banks that produced securitized loans in the first place, appear to have been mistaken about how risky these products were. In other words, the models that were supposed to make these products risk-free for their manufacturers failed, utterly. Models have failed in other market disasters as well — perhaps most notably when Long-Term Capital Management (LTCM), a small private investment firm whose strategy team included Myron Scholes among others, imploded. LTCM had a successful run from its founding in 1994 until the early summer of 1998, when Russia defaulted on its state debts. Then, in just under four months, LTCM lost $4.6 billion. By September, its assets had disappeared. The firm was heavily invested in derivatives markets, with obligations to every major bank in the world, totaling about $1 trillion. Yet at the close of trading on September 22, its market positions were worth about $500 million — a tiny fraction of what they had been worth a few months before, and far too little to cover the company’s loans.


pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

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Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

“It is not ordained in heaven, or by the second law of thermodynamics,” he wrote, “that a small group of intelligent and informed investors cannot achieve higher mean portfolio return with lower average variabilities.” Still, Samuelson didn’t see any convincing evidence that such people existed. You might compare his position to that of a present-day “skeptic society” on psychics or UFOs. Samuelson challenged the hotshot money managers to prove their superior abilities. Fama and other economists such as Jack Treynor, William Sharpe, Fischer Black, and Myron Scholes earnestly tried to find investors or investment techniques that really and truly beat the market. It seemed that (like other practitioners of the paranormal) superior portfolio managers had a convenient habit of touting their successes and forgetting their failures. In the majority of cases, claims of beating the market evaporate when subjected to scrutiny. It is worth spelling out exactly what kind of performance the economists were looking for—and what the efficient market theorists were not saying.

The following spring, Samuelson hired him as his research assistant, an incredible honor for someone who had only recently decided to study economics. Samuelson encouraged Merton to tackle the still-unsolved problem of pricing options. Samuelson had worked on this problem himself and had come close to a solution. He sensed that Merton might be the one to succeed. Other people at MIT were working on the problem. Merton soon became aware of the work of MIT’s Myron Scholes and Fischer Black, then employed at the consulting firm of Arthur D. Little. Merton reasoned that the “correct” price for options is the one where no one can make a profit by buying them or selling them short. This is the assumption of “no arbitrage.” From this, and the assumption that stock prices move in a geometric random walk, Merton derived Black and Scholes’s pricing formulas. All three men were curious about how well their new formulas reflected reality.

Like most of the new group of fund managers, Meriwether promised better-than-market returns through science and software. Meriwether did not himself possess a first-rate mathematical mind. Instead, he recruited the top academic talent. No finance professor was more respected than Robert C. Merton. Merton had consulted for Salomon Brothers, so Meriwether already knew him. He agreed to come on board. Meriwether’s other great coup was recruiting Myron Scholes. As journalist Roger Lowenstein said, that was like putting Michael Jordan and Muhammad Ali on the same team. Thorp decided not to put any of his money in the fund. He was concerned that Merton and Scholes, brilliant as they were, had little experience investing other people’s money. It didn’t help that Merton was second only to Samuelson as a critic of the Kelly criterion. Thorp also had heard that Meriwether was a “martingale man.”


pages: 840 words: 202,245

Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

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accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, John Meriwether, Kitchen Debate, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, Northern Rock, oil shock, Paul Samuelson, Philip Mirowski, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

By the early 1980s, Meriwether embarked on a more aggressive phase, having won the respect of, and therefore independence from, Salomon management. He hired mathematically oriented experts with Ph.D.’s in economics, finance, and physics who were more skilled than he. These men built computer models and teased out relationships within complex securities that others had not found. The computations were often based on an estimate of the value of a stock option first published by economist Myron Scholes of the University of Chicago and mathematician Fischer Black of MIT. The Black-Scholes model, based on estimated fluctuations (volatility) of securities prices, became the basis of derivatives trading and the measurement of portfolio risk. Mispricing in the markets was, with refinements, basically a deviation from the Black-Scholes price. Meriwether was able to understand these advanced models sufficiently and bridge the gap between his intellectual hirees and the more rough-and-tumble traditional traders at Salomon.

In the 1970s, with low stock prices, this relationship began to reverse, as underwriting volume and profits fell. By contrast, high inflation made bonds more volatile, which, coupled with new derivatives products, created a new and rising tide of profitable opportunities. In the 1980s, Meriwether hired several leading academic economists as consultants. They included Robert Merton, of MIT and then Harvard Business School, who had been a professor to several of Meriwether’s traders, and also Myron Scholes, who was at the University of Chicago. Fischer Black took a full-time job with Goldman Sachs. Scholes and Merton won the 1997 Nobel Prize in economics for their statistical theories (Black, who died in 1995, would have been named as well had he lived). After the stock market crash of 1987, most traditional hedge fund managers, including Soros, lost heavily (as noted, Paul Tudor Jones and Julian Robertson were conspicuous exceptions).

Germain, Fernand sales volume, 1.1, 12.1, 12.2, 16.1, 16.2, 16.3 Salomon, William Salomon Brothers, 1.1, 1.2, 3.1, 5.1, 6.1, 15.1, 15.2, 15.3, 16.1, 16.2, 17.1, 17.2, 17.3, 18.1, 18.2, 18.3, 18.4, 18.5, 18.6, 19.1, 19.2, 19.3 Salomon Smith Barney, 16.1, 17.1, 17.2, 17.3, 17.4, 17.5, 17.6, 17.7, 17.8 Sambol, David, 18.1, 18.2, 18.3 Samuelson, Paul, 2.1, 2.2, 19.1 Samuelson, Robert Sanford, Charles Sarbanes, Paul Sarbanes-Oxley bill, 17.1, 17.2 Saunders, Walter savings and loans (S&Ls), 6.1, 6.2, 11.1, 11.2, 12.1, 13.1, 13.2, 13.3, 14.1, 14.2, 17.1 18.1, 18.2, 18.3, 18.4, 19.1, 19.2, 19.3, 19.4, 19.5 Schlesinger, Arthur, Jr. Schlesinger, James Schmidt, Helmut Scholes, Myron, 15.1, 15.2, 15.3 Schonfeld, Reese Schultze, Charles, 9.1, 9.2, 9.3, 9.4, 11.1 Schwartz, Alan Schwartz, Anna, 2.1, 2.2, 2.3, 2.4 Schwartz, Peter Schwarzman, Stephen, 4.1, 18.1 Screen Actors Guild (SAG), 7.1, 7.2 Sears, 5.1, 6.1, 8.1, 14.1 Secondary Mortgage Market Enhancement Act (1984) Securities and Exchange Commission (SEC), 1.1, 4.1, 5.1, 6.1, 8.1, 12.1, 13.1, 13.2, 13.3, 14.1, 15.1, 15.2, 15.3, 15.4, 15.5, 15.6, 16.1, 16.2, 17.1, 17.2, 17.3, 17.4, 17.5, 17.6, 17.7, 17.8, 17.9, 17.10, 18.1, 18.2, 18.3, 19.1, 19.2, 19.3 Securities Investor Protection Corp.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

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Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, tulip mania, wage slave

The limitations of these tools ultimately exposed the potential for failure of even our most complex models. In particular, they led to the development of financial derivatives—financial tools referred to by investor Warren Buffett as “weapons of mass destruction,”1 but which are also are widely recognized as the fundamental tools of insurance and risk mitigation. We shall see that the work of three of the giants of modern finance, Robert Merton, Fischer Black, and Myron Scholes, built directly on the insights and techniques of the French mathematical tradition—both in terms of its strength and also its weakness. This last point is reserved for a discussion about a modern French mathematician, and my former Yale colleague, Benoit Mandelbrot. RANDOM WALKS Almost nothing is known about the nineteenth-century French stockbroker Jules Regnault (1834–1894). What we do know comes from the efforts of Franck Jovanovic, a lecturer in finance at Leicester University.

Over the 115-plus years since Bachelier’s thesis defense, his book came to be recognized as a classic of mathematical finance. It nearly, but not exactly, solved the problem of how to value an option—and thanks to Lefèvre, that means he came close to being able to value a complex portfolio of options, hedges, and speculations. The option pricing problem would not be solved precisely until much later in the twentieth century. The scholars who did so, Myron Scholes, Fischer Black, and Robert Merton, recognized Bachelier’s contribution. Scholes and Merton accepted the Nobel Prize in Economic Sciences in 1997 for their work on this important financial problem. Fischer Black had passed away before he could share in the award. MODELS AND MODERN MARKETS Scholes and Merton were professors of financial economics at the Massachusetts Institute of Technology in 1970, where they met the economist Fischer Black.

., 478, 480–81 Saint Petersburg Stock Exchange, 443–45 Salamis tablet, 83 salt mining, Chinese market for shares in, 197 salt monopoly of Chinese state, 174, 186, 190, 302, 431 salt taxes: of Genoese government, 291; of Venetian government, 228 salt vouchers, Chinese, secondary market in, 186 saving: by investment, 6; Keynes on, 456, 461; role of bonds in, 141. See also retirement Schaps, David, 99, 100 Scheiber, Sylvester, 497 Schmandt-Besserat, Denise, 23–24, 25–26 Scholastic philosophers, 233–34, 235–36, 246, 247, 248 Scholes, Myron, 276, 283–84 Science and Civilization in China (Needham), 194, 196, 270 scientific method in the West, 196–97 Scott, William Robinson, 328, 330, 341–42, 343 Seaford, Richard, 95 Second Punic War, 122, 128–29, 132 Securities and Exchange Commission (SEC): established during Depression, 490; fixing investment trusts of 1920s, 500–501, 503; rationale for, 8; skyscraper bonds and, 480–81 securitization: basic concept of, 382, 386; of land, 386–88, 393; of mortgages (see mortgage-backed securities) Security Analysis (Graham and Dodd), 489–90, 507 Sejanus, 107, 108 Seleucid empire, 70 Self-Strengthening Movement, Chinese, 430, 440 Seneca, 114–16, 120 serfdom, finance freeing Europeans from, 234 Sert, Josep Maria, 491–92 Shang dynasty (1766–1045 BCE), 143, 145–49, 151, 152, 158, 161, 271 Shanghai: as banking center, 141, 159; British trading rights in, 425; China Merchants Steamship Navigation Company in, 424, 430–32; Chinese investors in companies launched in, 429, 430–31; HSBC and, 427–28, 429, 431, 438, 440; as major financial center, 423, 424, 442; stock market of, 141, 438–42 shareholder democracy, 358, 469–70, 514 shareholders: in America of 1920s, 469–70; of ancient Rome, 17, 104, 122–25, 126–27, 135, 289; benefited by stock options for CEO, 171; in early twentieth-century China, 433–34, 435, 437; of European corporation, 289; of Honor del Bazacle, 297–301; of Muscovy Company, 309–10.


pages: 505 words: 142,118

A Man for All Markets by Edward O. Thorp

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3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy low sell high, carried interest, Chuck Templeton: OpenTable, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, compound rate of return, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, statistical arbitrage, stem cell, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

Using plausible and intuitive reasoning, I supposed that both the unknown growth rate and the discount factor in the existing warrant valuation formula could be replaced by the so-called riskless interest rate, namely that which was paid by a US Treasury bill maturing at the warrant expiration date. This converted an unusable formula with unknown quantities into a simple practical trading tool. I began using it for my own account and for my investors in 1967. It performed spectacularly. In 1969, unknown to me, Fischer Black and Myron Scholes, motivated in part by Beat the Market, rigorously proved the identical formula, publishing it in 1972 and 1973. This launched the development and widespread use of so-called derivative securities throughout the financial world. For their contributions, Myron Scholes and Robert Merton received the Nobel Prize in Economics in 1997. The Nobel committee acknowledged Fischer Black’s (1938–95) contributions, and it is generally agreed that he would have shared in the prize had he not died earlier from throat cancer. Powered largely by the formula, Princeton Newport Partners prospered.

This, in turn, used data such as the volatility of the stock (a measure of the recent daily percentage changes in the stock price), US Treasury interest rates, and any dividends paid by the stock during the life of the option. A couple of months before the CBOE opened, I was ready to trade with the formula for pricing options that I thought no one else knew. Princeton Newport was going to clean up. Then I received a letter and a prepublication copy of an article from someone I hadn’t heard of named Fischer Black. He said he was an admirer of my work and that he and Myron Scholes had taken a key idea from Beat the Market, known as delta hedging, a step further and derived an options formula. I scanned the article and saw it was the same formula I was using. The good news was that their rigorous proof verified that the formula I had discovered intuitively was correct. The bad news was that the formula was now public knowledge. Everyone was going to be using it. Fortunately, this took a while.

The list of issues goes on, the point being that hedge fund investors don’t have much protection and that the most important single thing to check before investing is the honesty, ethics, and character of the operators. The hedge fund Long-Term Capital Management was launched in 1994 with a dream team of sixteen general partners, led by the legendary former Salomon Brothers trader John Meriwether and two future (1997) Nobel Prize winners in economics, Robert Merton and Myron Scholes. The group included other former Salomon traders, more distinguished academics, and a former Federal Reserve vice chairman. Investors included the central banks of eight countries, plus major brokerages, banks, and other institutions. The principals of a financial engineering group I knew, who were coincidentally doing work for LTCM at that time, asked if I had an interest in investing in the fund.


pages: 309 words: 95,495

Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe by Greg Ip

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Affordable Care Act / Obamacare, Air France Flight 447, air freight, airport security, Asian financial crisis, asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, capital controls, central bank independence, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, Daniel Kahneman / Amos Tversky, diversified portfolio, double helix, endowment effect, Exxon Valdez, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, global supply chain, hindsight bias, Hyman Minsky, Joseph Schumpeter, Kenneth Rogoff, London Whale, Long Term Capital Management, market bubble, money market fund, moral hazard, Myron Scholes, Network effects, new economy, offshore financial centre, paradox of thrift, pets.com, Ponzi scheme, quantitative easing, Ralph Nader, Richard Thaler, risk tolerance, Ronald Reagan, savings glut, technology bubble, The Great Moderation, too big to fail, transaction costs, union organizing, Unsafe at Any Speed, value at risk, William Langewiesche, zero-sum game

., February 27, 1998, available at http://www.berkshirehathaway.com/letters/1997.html. 19 They start with the assumption that: Carolyn Kousky and Roger Cooke, “Explaining the Failure to Insure Catastrophic Risks,” The Geneva Papers 37 (2012): 206–227. 20 Hayne Leland, a professor: Hayne E. Leland and Mark Rubinstein, “The Evolution of Portfolio Insurance,” in Dynamic Hedging: A Guide to Portfolio Insurance, Don Luskin, ed. (Hoboken, N.J.: Wiley, 1988). 21 Around this time, Myron Scholes: Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, no. 3 (1973): 637–654. 22 to boost their returns: Leland and Rubinstein, “The Evolution of Portfolio Insurance,” 7. 23 By the eve of the October 1987 crash: Report of the Presidential Task Force on Market Mechanisms, Nicholas F. Brady, Chairman (Washington: U.S. Government Printing Office, 1988), http://archive.org/stream/reportofpresiden01unit/reportofpresiden01unit_djvu.txt. 24 Portfolio insurers accounted: Ibid., 36. 25 by Leland and Rubenstein: Leland and Rubinstein argued that portfolio insurance could not explain either the run-up of the stock market in 1987 nor several important aspects of the stock market’s behavior during the crash and in its aftermath.

But whereas regular insurance generally worked for uncorrelated risks, such as fire and death, stocks were highly correlated: they tended to go up and down together. This meant that the seller of that sort of insurance couldn’t rely on the premiums earned on stocks that didn’t go down to make up for losses on those that did. He needed a way to protect against the entire market going up or down. Around this time, Myron Scholes and Fischer Black, two academic economists, had devised a formula for valuing options. The formula contains several principal elements: the asset’s current price, the option’s strike price, the time until the option expires, interest rates, and volatility. These conditions help determine the premium you must pay an option seller. The formula can also be reversed: if you know the premium, you can figure out how volatile the stock is assumed to be.


pages: 162 words: 50,108

The Little Book of Hedge Funds by Anthony Scaramucci

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Andrei Shleifer, asset allocation, Bernie Madoff, business process, carried interest, corporate raider, Credit Default Swap, diversification, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, fixed income, follow your passion, Gordon Gekko, high net worth, index fund, John Meriwether, Long Term Capital Management, mail merge, margin call, mass immigration, merger arbitrage, money market fund, Myron Scholes, NetJets, Ponzi scheme, profit motive, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, risk/return, Ronald Reagan, Saturday Night Live, Sharpe ratio, short selling, Silicon Valley, the new new thing, too big to fail, transaction costs, Vanguard fund, Y2K, Yogi Berra, zero-sum game

And Now for the Not-Quite-as-Successful By the mid-90s, it appeared that hedge funds had found the Shangri-La of investments. But just as they were about to meet the leprechaun and his pot of gold at the end of the rainbow, it happened—Long-Term Capital Management (LTCM) collapsed in 1998 and was later rescued by the federal government. Founded in 1994 by a proprietary trading legend, John Meriwether from Solomon Brothers; two Nobel Prize-winning economists, Robert C. Merton and Myron Scholes; and a slew of finance wizards, LTCM used an arbitrage strategy that exploited temporary changes in market behavior. By pair trading and betting on price convergence over a range of scenarios (we’ll discuss those strategies in Chapter 7), the LTCM band of brothers leveraged their $4 billion fund until it had a notional exposure of over $1 trillion dollars. Fear not, with propellers spinning on top of their heads, they were sure that they were making the right investment decisions based on the historical models.

A Word of Caution In the 1980s, Long-Term Capital Management (along with its legendary credit arbitrageur leader, John Meriwether) was one of the first hedge funds to quantify the estimate of the correlations among various trades and mathematically measure risk through a technique known as “value at risk.” Although we learned of LTCM’s eventual demise caused by hubris in Chapter 2, Meriwether, Robert Merton, and Myron Scholes helped facilitate the correlation model. Which brings me to an important note on correlations—as Warren Buffett famously said after the 2007–2009 crash, “Beware of geeks bearing formulas.” While correlation is a helpful tool in the market, security and portfolio analysis should never be overly reliant on formulas. Formulas are like records; they are made to be broken or, in this case, disproven.


pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

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Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, John Meriwether, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, Paul Samuelson, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs

At the University of Chicago’s Graduate School of Business, his thesis adviser was Eugene Fama, one of the fathers of the efficient-market hypothesis. But by 1988, when Asness arrived in Chicago, Fama was leading the revisionist charge: Along with a younger colleague, Kenneth French, Fama discovered non-random patterns in markets that could be lucrative for traders. After contributing to this literature, Asness headed off to Wall Street and soon opened his hedge fund. In similar fashion, the Nobel laureates Myron Scholes and Robert Merton, whose formula for pricing options grew out of the efficient-markets school, signed up with the hedge fund Long-Term Capital Management. Andrei Shleifer, the Harvard economist who had compared the efficient-market theory to a crashing stock, helped to create an investment company called LSV with two fellow finance professors. His coauthor, Lawrence Summers, made the most of a gap between stints as president of Harvard and economic adviser to President Obama to sign on with D.

As a rising star at Salomon Brothers in the mid-1980s, he had set out to transform the small trading group he managed into “a quasi-university environment.”3 Meriwether’s plan was to hire young stars from PhD programs and encourage them to stay in touch with cutting-edge research; they would visit finance faculties and go out on the academic conference circuit. He recruited Eric Rosenfeld, a Harvard Business School professor, then scooped up Larry Hilibrand, who had not one but two degrees from the Massachusetts Institute of Technology. By 1990 Meriwether’s team included Robert Merton and Myron Scholes, who would later win the Nobel Prize for their pioneering work on options pricing. In the mid-1980s, most Salomon partners had not gone to college, much less a PhD program.4 The personification of the firm’s trading culture was Craig Coats Jr., a tall, handsome, charismatic stud believed by many to be the model for the hero in Tom Wolfe’s The Bonfire of the Vanities. Coats ran Salomon’s government-bond trading the old-fashioned way: While Meriwether’s professors debated whether the relationship between two bonds was out of its normal range, or whether the volatility of a bond price was likely to decelerate, Coats’s main tool was a firm belief in his own instincts.

The way Meriwether saw it, he was inventing a new kind of financial institution for a new age. A world in which a small brotherhood of academics could earn more than a large bank required a fresh kind of setup. It required “Salomon without the bullshit.”7 IN FEBRUARY 1994, MERIWETHER LAUNCHED LONG-TERM Capital Management. He brought along Eric Rosenfeld, Larry Hilibrand, Robert Merton, and Myron Scholes; in all, eight members of his Salomon brain trust joined in setting up the company. The professors leased space at 600 Steamboat Road in Greenwich, Connecticut, in the same four-story building overlooking the Long Island Sound to which Paul Tudor Jones had moved recently. Instead of New York suits and ties, they showed up for work in golf shirts and chinos. Sometimes in the lunch hour, bluefish could be spotted jumping out of the sound, and a team of eager quants would arm themselves with fishing rods and race out in hot pursuit of them.


pages: 236 words: 77,735

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

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affirmative action, asset allocation, backtesting, barriers to entry, Bernie Madoff, Bretton Woods, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fiat currency, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, High speed trading, housing crisis, index fund, joint-stock company, money market fund, moral hazard, Myron Scholes, passive investing, Ponzi scheme, price discovery process, random walk, risk tolerance, risk-adjusted returns, risk/return, too big to fail, trade route, Vanguard fund, walking around money

Growth investors could focus on the rising stock price and ignore questions of valuation of balance sheets. In the end what was truly irrelevant was not the capital structure, but rather investors’ desire to study that structure. How does this affect the investment results? If it is just a preference by the clientele to go for dividends or growth, is there a clear winner? Ten years after Miller and Modigliani theorized about how the crowd acted, Fischer Black and Myron Scholes wrote “The Effects of Dividend Yield and Dividend Policy on Common Stock Prices and Returns.”3 They set out to look at the empirical evidence to put to rest the question of dividends or no dividends. After looking back at the performance of both groups of stocks, the conclusion was not what some had expected: “First, dividend yield does not have a consistent impact on expected return . . . second . . . expected return on the [higher yielding] portfolio, given its level of risk, will be lower than it might be with a better diversified portfolio.”

Banks should pay out money when they can, but the whole idea of building up what appears to be a constant dividend policy for a type of business that can go south along with the economy will never make sense. If you are looking for dividends, look someplace else. Notes 1. Graham, Benjamin. “A Conversation with Benjamin Graham.” Financial Analysts Journal 32, no. 5 (1976): 20–23. 2. Miller, Marton H., and Franco Modigliani. “Dividend Policy, Growth, and the Valuation of Shares.” The Journal of Business 34, no. 4 (1961): 411–433. 3. Black, Fischer, and Myron Scholes. “The Effects of Dividend Yield and Dividend Policy on Common Stock Prices and Returns.” Journal of Financial Economics 1, no. 1 (1974): 1–22. CHAPTER 12 The New Scam Most of you may already think our representatives in Congress are out of their minds. Representatives in Congress create new laws without being able to know the unintended consequences. In this final chapter, let’s look beyond Wall Street’s desire to rig the investing game.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

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Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, break the buck, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

.… The more placid days of the past were gone forever.”39 There was still no coherent program or ideology that laid out what the financial services industry should look like and what its relationship to the government should be. But that was changing. At the time, a movement was growing in the halls of America’s leading universities that would help transform the financial sector. This movement was the discipline of academic finance, pioneered by economists such as Paul Samuelson, Franco Modigliani, Merton Miller, Harry Markowitz, William Sharpe, Eugene Fama, Fischer Black, Robert Merton, and Myron Scholes, most of whom went on to win the Nobel Prize. These scholars brought sophisticated mathematics to bear on such problems as determining the optimal capital structure of a firm (the ratio between debt and equity), pricing financial assets, and separating and hedging risks.40 Academic finance had a tremendous impact on the way business is done around the globe. For example, research on capital structure contributed to a significant increase in indebtedness by corporations.41 (Debt provides leverage, and therefore increases expected returns along with risk.)

Investments can be economically value-creating or value-destroying; when financial intermediation increases to the point where value-destroying investments are being funded, financial innovation is doing more harm than good. But in the 1990s and 2000s, the theory of risk unbundling and diversification reigned largely unchallenged in Washington; people who didn’t subscribe to it could be written off as ignoramuses who failed to understand the elegance of modern finance. Merton and his colleague Myron Scholes, after all, won the Nobel Prize in economics in 1997 (a year before the collapse of their hedge fund). It also helped that financial services were one arena where U.S. firms were in the international vanguard, inventing most of the new products and markets of the past few decades. With the trade deficit in manufactured goods widening continuously, structured securities were one of our most attractive exports, especially to European banks and investors looking for higher-yield investments.


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

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asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, break the buck, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

And if markets were efficient—in other words, if people like Meriwether did their job—then the prices of futures contracts should be mathematically related to the underlying asset using “no-arbitrage” principles. Bending Reality to Match the Textbook The next leg of my U.S. trip took me to Boston and Connecticut. There I met two more Nobel-winning finance professors—Robert Merton and Myron Scholes—who took Miller’s idea to its logical conclusion at a hedge fund called Long-Term Capital Management (LTCM). Scholes had benefited directly from Miller’s mentorship as a University of Chicago PhD candidate, while Merton had studied under Paul Samuelson at MIT. What made Merton and Scholes famous (with the late Fischer Black) was their contemporaneous discovery of a formula for pricing options on stocks and other securities.

The lesson of history is clear: faced with such debts, either Americans themselves (via their tax burden, their subsidized homes, or their benefits) will lose out, or their dollar-owning creditors will—in a big way. What started out as an arcane twist of high finance—derivatives—has now corrupted the entire financial world, and has set a hellish trap for taxpayers and their representatives that offers no way out. Appendix A timeline of some significant historical events referred to in the book, and episodes involving the book’s key characters. 1973 Fischer Black, Myron Scholes, and Robert Merton publish seminal papers on option pricing 1974 Robert Merton publishes paper using option theory to link debt and equity 1986 Start of S&L crisis 1987 Oldrich Vasicek publishes working paper applying Merton’s work to credit portfolios Federal Reserve protects Wall Street securities firms from October stock market crash by ensuring that banks lend 1988 Basel I bank capital accord agreed Nick Sossidis and Stephen Partridge-Hicks set up Alpha Finance for Citibank 1994 VAR models protect commercial banks from market turmoil 1995 Barings Bank almost bankrupted by Nick Leeson’s rogue trading Sossidis and Partridge-Hicks set up Sigma 1996 Basel Committee agrees to incorporate VAR-based trading book rules into bank capital accord Citibank launches Centauri SIV Moody’s binomial expansion technique CDO rating model published 1997 J.P.


pages: 153 words: 12,501

Mathematics for Economics and Finance by Michael Harrison, Patrick Waldron

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Brownian motion, buy low sell high, capital asset pricing model, compound rate of return, discrete time, incomplete markets, law of one price, market clearing, Myron Scholes, Pareto efficiency, risk tolerance, riskless arbitrage, short selling, stochastic process

MARKET EQUILIBRIUM AND THE CAPM CHAPTER 7. INVESTMENT ANALYSIS 137 Chapter 7 INVESTMENT ANALYSIS 7.1 Introduction [To be written.] 7.2 Arbitrage and the Pricing of Derivative Securities 7.2.1 The binomial option pricing model This still has to be typed up. It follows very naturally from the stuff in Section 5.4. 7.2.2 The Black-Scholes option pricing model Fischer Black died in 1995. In 1997, Myron Scholes and Robert Merton were awarded the Nobel Prize in Economics ‘for a new method to determine the value of derivatives.’ See http://www.nobel.se/announcement-97/economy97.html Black and Scholes considered a world in which there are three assets: a stock, whose price, S̃t , follows the stochastic differential equation: dS̃t = µS̃t dt + σ S̃t dz̃t , where {z̃t }Tt=0 is a Brownian motion process; a bond, whose price, Bt , follows the differential equation: dBt = rBt dt; and a call option on the stock with strike price X and maturity date T .

The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals by Daniel R. Solin

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asset allocation, corporate governance, diversification, diversified portfolio, index fund, market fundamentalism, money market fund, Myron Scholes, passive investing, prediction markets, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund, zero-sum game

Su Asset Allocation Questionnaire retirement plans (RRPs and RRSPs) ETFs in, 139-40, 169-70 Risk and Return Summary, 179-80 Risk Assessment Score (RAS), 17S--78 Ser also Asset Allocation Questionnaire risk management about risk management, 41 about asset allocation and, 40-41,70-72, 121 - 22 abo ut investment portfolios, 122-23 buying on margin and, 77-78 ETI;s and, 86-87 international stocks and, 130-31,169 prospectus information on risks,60 research on, 162--63 risk return comparison (chart), 14, 74-76 standard deviation to measure risk, 67--68, 85, 126, 138 Su also asset allocation; investment portfolios Rodgers, Kelly, 161 Ross, Ron, 132, 136 RRPs and RRSPs, ETFs in, 139-40, 169-70 Samuelson, Paul A., 107, 163 Sanford, Jeff, 164 Savings-Age Score (SAS), 172-73 Srr also Asset Allocation Questionnaire Scholes, Myron S., 107 Schwab, C harles, 59 Securities Exchange Commission (U.S .), 163 securities industry about the industry, 8-9 analyst fraud in, 39-40, ISS broker/client trust issues, 37, 39-41 , 98-101 ,138, J55, 168 disadvantages of use of, 149-50, ISS-56 house funds, 77-78, 163 myths of, 3-4, 9, 12, 146 qualifications of advisors, 42-43,52 regulation of, 82, 14 1-42, 164, 165, 170 U.S. brokers in Canada's industry, 119, 152 U.S.lCanada similarities, xi-xii Su also financial media; market timing {predicting the future}; stock and fu nd picking Sharpe, William E, 13, 34, 107 Siegel, Jeremy, 73 Simon, Scott, 148 Singer, Brian D., 121 , 162 Index 193 Sinha, Rajceva, 51, 107, 151 Sinquefield, Rex, 145 "sizzle" in H yperactive Trwestor, 32-33 small cap stocks, 113-14 Smart Investo rs about being a Smart Investor, 18-19,75, 144 benefits of being a, 6, 25, 137 books for, 93,152, 181-82 fa mous investors as, 107-9, 168 institutional investors as, 89, 105-7.114,168 percent of all trades, 138 See auo ETFs (exchange traded fu nds); Four-Step Process for Smart Investors; index funds; ris k management Smarr Investor Advisors contact with investors, 133 DFAas, 11 2-14, 168 for large investors, 89 for risk management, 40 when to use an advisor, 114 Smith Barney ho use funds, 77, 163 S&P 500 ETF, 15 S&P 500 Index, 15, 24 S&P Composite Index (U.S.), 29,45, 151 S&prrSX Composite Index about S&PfT'SX composite index, 23-24 standard deviation and risk, 68 use as a benchmark, 46, 83, 135 speculative investing and gambling, 30-3 1,153-54 Spinet, Eliot L, 39, 40 standard deviation, as risk measurement, 67-68, 85, 126, 138 State Street Global Advisors, 106 Stiglin, Joseph E., 163 stocks about stocks, 13-14, 84-87 as asset class, 13,40, 71, 121 buying on margin, 77-78 earnings per share (EPS), 14 international stocks, 19, 130-3 1, 169 prospectus for a stock, 60 risk and, 122-23 risk return comparison (chart), 14, 74-76 small-cap stocks, 113-14 standard deviation to measure price fluctuations, 67-68, 85,126, l38 U.S. stocks. 19, 119, 160 value stocks, 84-87, 114 Su also investment portfolios stock and fu nd picking about stock picking, 6-7, 17, 51-54 COSts and fees, 27-28, 35 decline of, 109-10, 149-50, 168 as desire for order, 31 myths of,}-4, 37, 70,146 research on, 53, 168 stock brokers.

The Age of Turbulence: Adventures in a New World (Hardback) - Common by Alan Greenspan

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air freight, airline deregulation, Albert Einstein, asset-backed security, bank run, Berlin Wall, Bretton Woods, business process, call centre, capital controls, central bank independence, collateralized debt obligation, collective bargaining, conceptual framework, Corn Laws, corporate governance, corporate raider, correlation coefficient, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cuban missile crisis, currency peg, Deng Xiaoping, Dissolution of the Soviet Union, Doha Development Round, double entry bookkeeping, equity premium, everywhere but in the productivity statistics, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, full employment, Gini coefficient, Hernando de Soto, income inequality, income per capita, invisible hand, Joseph Schumpeter, labor-force participation, labour market flexibility, laissez-faire capitalism, land reform, Long Term Capital Management, Mahatma Gandhi, manufacturing employment, market bubble, means of production, Mikhail Gorbachev, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, oil shock, open economy, Pearl River Delta, pets.com, Potemkin village, price mechanism, price stability, Productivity paradox, profit maximization, purchasing power parity, random walk, reserve currency, Right to Buy, risk tolerance, Ronald Reagan, shareholder value, short selling, Silicon Valley, special economic zone, the payments system, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, trade liberalization, trade route, transaction costs, transcontinental railway, urban renewal, working-age population, Y2K, zero-sum game

Meanwhile Bill McDonough, the head of the New York Fed, took on the challenge of coping with the implosion of one of Wall Street's largest and most successful hedge funds, Long-Term Capital Management. Hollywood could not have scripted a more dramatic financial train wreck. Despite its boring name, LTCM was a proud, high-visibility, highprestige operation in Greenwich, Connecticut, that earned spectacular returns investing a $125 billion portfolio for wealthy clients. Among its principals were two Nobel-laureate economists, Myron Scholes and Robert Merton, whose state-of-the-art mathematical models were at the heart of the firm's money machine. LTCM specialized in risky, lucrative arbitrage deals in U.S., Japanese, and European bonds, leveraging its bets with more than $120 billion borrowed from banks. It also carried some $1.25 trillion in financial derivatives, exotic contracts that were only partly reflected on its balance sheet.

., 361 n Roosa, Robert, 84 Roosevelt, Franklin Delano, 3 1 , 159, 246, 337, 431, 439 New Deal and, 2 1 , 30, 279, 504 Roosevelt, Theodore, 336 Roth, William, 92 Rove, Karl, 223 Royal Dutch Shell, 336, 339n, 438 Rubin, Robert, 7, 145, 146, 157-62, 170, 210, 220, 405 Asian contagion and, 188, 189-90, 195 budget surplus and, 185 Russian crisis and, 193 stock market and, 174-75, 179 Rubinomics, 161, 236 rule of law, 15, 16, 255-56, 297, 365, 396, 502 economic future and, 467, 468, 469-70, 503 in Europe, 277, 287 in Russia, 190, 327, 331-32, 500 Smith and, 261 in United States, 52, 278 Rumsfeld, Donald, 62, 64, 209, 210 Russia, 135-36, 139-40, 259, 275, 293, 310, 3 2 2 23, 334n debt default of, 190-96, 250, 328, 331 future of, 500 market capitalism in, 123-24, 139-40, 323-27, 503 oil and gas in, 190, 3 2 4 - 3 1 , 440, 443 oligarchs in, 139, 140, 190, 324, 326 property rights in, 139-40, 190, 327, 331-32, 389, 500 shock therapy in, 138—40 technology in, 3 3 1 , 388 see also Soviet Union Safire, William, 57 Sala-i-Martin, Xavier, 259n-60n Samuelson, Robert, 230 S&P 500, 207, 224, 426n, 465 Sao Tome and Principe, 258-59 Sarbanes, Paul, 154-55, 2 2 1 , 478 Sarbanes-Oxley Act (2002), 374, 430-31 Sarkozy, Nicolas, 288, 500 Saudi Arabia, 79-80, 334n, 351, 438n oil of, 79, 438n Saudi Aramco, 79, 439, 440, 442 savings, 12, 138, 185, 270, 348-52, 362, 369, 3 8 4 88, 4 7 8 , 4 9 9 cross-border, 348, 352, 484 in developing vs. industrialized countries, 13, 386, 484 domestic, current account balance and, 348—49, 350 excess of, 13-14 future standards of living and, 413 investment vs., 348-49, 385, 386-87 savings accounts, 114, 115 savings and loans (S&Ls), 6, 114-17, 290, 357n SBC Communications, 229 Scargill, Arthur, 283 Scholes, Myron, 193 527 More ebooks visit: http://www.ccebook.cn ccebook-orginal english ebooks This file was collected by ccebook.cn form the internet, the author keeps the copyright. INDEX Schubert, Franz, 298 Schumann, Robert, 20 Schumer, Chuck, 405 Schumpeter, Joseph, 48, 5 1 , 167, 174 science education, 399, 403, 405 Scotland, 2 6 0 - 6 1 , 265 Scowcroft, Brent, 65 Second Treatise of Civil Government (Locke), 252n Securities and Exchange Commission, 33, 257, 375, 431 Securities Industry and Financial Markets Association, 83 n Seevers, Gary, 64 Seidman, Bill, 116 self-interest, 256, 262, 368, 490 Sen, Amartya, 253 Senate, U.S., 7, 8, 64, 115, 156, 158, 199, 222, 223 Banking Committee of, 8, 10, 150, 239 Bentsen in, 144, 145^46 Budget Committee of, 70, 185, 217, 219 Clinton budget and, 148, 149 Ethics Committee of, 115 Republican control of 211 service economy, 173, 315, 4 0 1 , 470 Shanghai, 2 9 8 , 3 0 1 , 3 0 8 Shaw, Artie, 23, 27 Sheiner, Bill, 26 Shevardnadze, Eduard, 135 Shultz, George, 9 1 , 92-93, 312 Siegman, Charlie, 189 Siemens, 381 silicon, 11,12 Silicon Valley, 127, 164, 167, 181, 271, 504 Silva, Luiz Inacio Lula da, 340, 341 Silva, Mario (Murray Goldsmith), 20 Simon, Bill, 67, 91 Simons, James, 405 Singapore, 13, 188, 253, 275, 276, 311, 312 education in, 399, 400 Singh, Manmohan, 318-19, 321-22 Sitaryan, Stepan, 128, 129, 130 skilled workers, shortage of, 3 9 9 ^ 0 0 , 404-7, 409, 413,505 Skilling, Jeffrey, 423 Skinner, Richard Dana, 44 Smith, Adam, 10, 250n, 257, 260-66, 276, 370, 502 invisible hand of, 15, 89, 262, 325, 367, 488 Smith, John, 283 Snow, John, 238, 241 Snowe, Olympia, 222 socialism, 126, 130-31, 139, 141, 252, 272, 281, 300 in China, 295 Fabian, 264-65, 266, 283-84, 317, 480, 499, 501 in India, 265, 316-19, 382, 501 social safety nets, 13, 272, 305, 4 8 1 , 504 in Europe, 276-77, 2 8 0 - 8 1 , 283, 285, 286, 291 Social Security, 109, 143, 146-47, 237, 280, 41 In, 412-14,415-19,504 budget surplus and, 185, 186, 215 defined-benefit plans vs., 421-22 indexing of, 94, 125 "lockboxes" and, 417 reform of, 94-96, 211, 215, 217, 218, 220, 241 Social Security Board of Trustees, 411 "soft landing," use of term, 155-56, 163 software, 164, 169, 493-94, 495 solar power, 453 Solidarity, 125, 132 Solomon, Claire, 23 Solow, Robert, 474 Song of Love, 20 Sonthi Boonyaratglin, 313 South Korea, 13, 188-89, 190, 260, 334n China compared with, 384, 477 Soviet bloc, former, 132, 309, 326 market capitalism and, 12, 502 Soviet Union, 40, 88-89, 122, 123-31, 134-41, 182,251,281,298,300,333 AG's travels to, 119, 123-30, 135-37, 190 arms race and, 129-30 collapse of, 8, 12,40, 123-24, 135-41, 161, 190, 250, 259, 275, 315, 329, 365, 366, 382 food shortages in, 126, 136 military of, 136, 137 nuclear power in, 453 nuclear weapons of, 8, 34 in space race, 155 as superpower, 137 transition to market economy in, 136-39 see also Russia space race, 155 Spain, 273, 351 specialization, 262, 502 U.S. current account deficit and, 347, 353, 356, 359, 361 Spencer, Herbert, 278-79 Sperling, Gene, 158, 170, 182-83, 186 stabilization fund, 259, 330 stagflation, 6 0 - 6 1 , 72 Stalin, Joseph, 126, 127, 281, 299, 504 Standard Oil of New Jersey, 336, 438 Standard Oil trust, 444 standards of living, 13, 256, 257, 259n-60n, 265, 275,335,337,356,391 central planning and, 127 in China, 251, 297, 299 competition and, 268-69, 3 9 2 - 9 6 democracy and, 332 in East Asia, 3 1 3 , 3 1 5 in East vs.


pages: 772 words: 203,182

What Went Wrong: How the 1% Hijacked the American Middle Class . . . And What Other Countries Got Right by George R. Tyler

8-hour work day, active measures, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, bank run, banking crisis, Basel III, Black Swan, blood diamonds, blue-collar work, Bolshevik threat, bonus culture, British Empire, business process, capital controls, Carmen Reinhart, carried interest, cognitive dissonance, collateralized debt obligation, collective bargaining, commoditize, corporate governance, corporate personhood, corporate raider, corporate social responsibility, creative destruction, credit crunch, crony capitalism, crowdsourcing, currency manipulation / currency intervention, David Brooks, David Graeber, David Ricardo: comparative advantage, declining real wages, deindustrialization, Diane Coyle, Double Irish / Dutch Sandwich, eurozone crisis, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, George Akerlof, George Gilder, Gini coefficient, Gordon Gekko, hiring and firing, income inequality, invisible hand, job satisfaction, John Markoff, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, labour market flexibility, laissez-faire capitalism, lake wobegon effect, light touch regulation, Long Term Capital Management, manufacturing employment, market clearing, market fundamentalism, Martin Wolf, minimum wage unemployment, mittelstand, moral hazard, Myron Scholes, Naomi Klein, Northern Rock, obamacare, offshore financial centre, Paul Samuelson, pension reform, performance metric, pirate software, Plutocrats, plutocrats, Ponzi scheme, precariat, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, reshoring, Richard Thaler, rising living standards, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Sand Hill Road, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, Steve Ballmer, Steve Jobs, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transcontinental railway, transfer pricing, trickle-down economics, tulip mania, Tyler Cowen: Great Stagnation, union organizing, Upton Sinclair, upwardly mobile, women in the workforce, working poor, zero-sum game

For their part, always thinking about money gives economists finely tuned financial antennae, and some from prominent universities wasted little time in seizing the opportunity to moonlight as advocates of deregulation. Milton Friedman and Alan Greenspan were not the only prominent economists whose reputation suffered greatly from the notion of market perfection. The bankruptcy of the hedge fund Long Term Capital Management in 1994 humiliated Myron Scholes and Robert Merton, both Nobel laureates and champions of flawed economic theory. Other academicians closely identified with Reaganomics, including Hubbard, Mankiw, and Martin Feldstein, became controversial as well.48 Europeans even have a name for them, calling such American economists “the secret lobbyists.”49 The economics profession owes you an apology for permitting Reagan and George W.

., 133 (chart) Samson, Danny (professor), 374 Samuels, John (GE) 277 Samuelson, Paul (economist), 13, 219, 321, 358 Samuelson, Robert J. (Washington Post columnist), 30, 109 Sanders, William Gerard (professor), 142 Sapir, André, 366 Sauer, Stefan (journalist), 314 Sawhill, Isabel (Brookings), 133, 263, 296-300, 402-6 “say-on-pay” law, 461 Scheuer, Markus, 354 Schmitt, John (economist), 229, 340 Schnabel, Claus (economist), 172–73, 175 Schoar, Antoinette (economist), 156 Scholes, Myron (Nobel Laureate), 34 Schott, Peter K. (professor), 345 Schulz, Thomas, 3, 43, 154 Schumpeter, Joseph (economist), 84–85, 233, 243, 274, 309, 384, 416 creative destruction, 83–4 Schwartz, Emma (Center for Public Integrity), 19 Schwartz, Nelson (New York Times journalist), 111 Scott, Robert E. (economist), 229, 346 Sen, Amartya (economist), 82, 112, 289 Sennet, Richard (sociologist), 108 Shapiro, Robert (former Undersecretary of Commerce for Economic Affairs), 353 Shays, Christopher (former Republican Congressman), 188 Shareholder capitalism.


pages: 651 words: 180,162

Antifragile: Things That Gain From Disorder by Nassim Nicholas Taleb

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Air France Flight 447, Andrei Shleifer, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, Chuck Templeton: OpenTable, commoditize, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discrete time, double entry bookkeeping, Emanuel Derman, epigenetics, financial independence, Flash crash, Gary Taubes, George Santayana, Gini coefficient, Henri Poincaré, high net worth, hygiene hypothesis, Ignaz Semmelweis: hand washing, informal economy, invention of the wheel, invisible hand, Isaac Newton, James Hargreaves, Jane Jacobs, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, knowledge economy, Lao Tzu, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, Marc Andreessen, meta analysis, meta-analysis, microbiome, money market fund, moral hazard, mouse model, Myron Scholes, Norbert Wiener, pattern recognition, Paul Samuelson, placebo effect, Ponzi scheme, principal–agent problem, purchasing power parity, quantitative trading / quantitative finance, Ralph Nader, random walk, Ray Kurzweil, rent control, Republic of Letters, Ronald Reagan, Rory Sutherland, selection bias, Silicon Valley, six sigma, spinning jenny, statistical model, Steve Jobs, Steven Pinker, Stewart Brand, stochastic process, stochastic volatility, The Great Moderation, the new new thing, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Malthus, too big to fail, transaction costs, urban planning, Vilfredo Pareto, Yogi Berra, Zipf's Law

Further, there is convincing evidence that a PhD in economics or finance causes people to build vastly more fragile portfolios. George Martin and I listed all the major financial economists who were involved with funds, calculated the blowups by funds, and observed a far higher proportional incidence of such blowups on the part of finance professors—the most famous one being Long Term Capital Management, which employed Fragilistas Robert Merton, Myron Scholes, Chi-Fu Huang, and others. CHAPTER 15 History Written by the Losers The birds may perhaps listen—Combining stupidity with wisdom rather than the opposite—Where we look for the arrow of discovery—A vindication of trial and error Because of a spate of biases, historians are prone to epiphenomena and other illusions of cause and effect. To understand the history of technology, you need accounts by nonhistorians, or historians with the right frame of mind who developed their ideas by watching the formation of technologies, instead of just reading accounts concerning it.

Now, reader, let us take a minute and pay some respect. Consider our ingratitude to those who got us here, got our disrespect, and do not even know that they were heroes. 1 According to David Edgerton, the so-called linear model was not believed in much in the early twentieth century; it is just that we believe now that we believed then in the supremacy of teleological science. 2 We also figured out that two fragilistas, Myron Scholes and Robert Merton, got the Memorial Prize in Economics called “Nobel” for the packaging of a formula that other people discovered in much more sophisticated form before them. Furthermore, they used fictional mathematics. It is quite unsettling. 3 I remind the reader that the bone in Book IV is teleology and sense of direction, and while this is largely skeptical of formal academia (i.e. anti-universities), this is staunchingly anti-pseudoscience (or cosmetic science) and ultra-pro-science.

Angell used to be the editor of The New England Journal of Medicine and distrusts a large number of clinical studies. Further, how money is not spent on speculative research, but on “safe” bets with regular drugs, Light and Lexchin (2012). Contradicting studies: Kahneman brought to my attention studies such as Malmendier and Tate (2008, 2009) showing managers investing more than needed in their companies, hence excess skin in the game as a result of overconfidence. Myron Scholes and Robert Merton had investments in LTCM. Indeed—but overall the free option dominates (just measure the aggregate payment of managers relative to gains by shareholders). There are “fools of randomness” and “crooks of randomness”; we often observe a combination. (Credit: Nicolas Tabardel.) Asymmetries and extractive: Acemoglu and Robinson (2012) discusses an asymmetry with their notion of extractive economic institutions and environment, in which someone gets rich at the expense of someone else, the opposite of the convex collaborative framework in which one’s wealth leads to a compounding pie.


pages: 586 words: 159,901

Wall Street: How It Works And for Whom by Doug Henwood

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

A single "IBM July 90 call" gives the buyer the right to buy 100 shares (a "round lot") of IBM at $90 a share; an "IBM July 90 put" gives its buyer the right to sell IBM at 90. The price of an option is generally a reflection of market interest rates, the time to maturity, the closeness of the price of the underlying asset to its strike price, and that underlying asset's historical price volatility. Higher interest rates, a longer time to maturity, and greater volatility tend to raise prices. In the 1970s, Fischer Black and Myron Scholes developed an options pricing formula that has become a classic; it's been tinkered with over the years, but their fundamental technique remains canonical. from 1,300% returns to the sidewalk Put- and call-buying is fairly simple. Things do get more complicated, much more complicated. An owner of 100 shares of IBM can sell a call against those shares; should the price rise, he or she would have to buy back the call at a loss — the loss being partly offset by the (paper) rise in the value of the underlying shares — or run the risk of having the stock "called INSTRUMENTS away" by the fortunate buyer of the call.

"Administrative Costs of Debt Restructurings," Ohio State University mimeo (May). Bhagat, Sanjai, Andrei Shleifer, and Robert W. Vishny (1990). "Hostile Takeovers in the 1980s: The Return to Corporate Specialization," Brookings Papers on Economic Activity: Microeconomics, pp. 1-85. Bilello, Suzanne (1992). "Free-Trade Pact Stirs Emotions," New York Newsday, August 7. Black, Fisher (1986). "Noise," Journal of Finance i\ (July), pp. 529-543. Black, Fisher, and Myron Scholes (1973). "The Pricing of Options and Corporate Liabilities," Journal of Political Economy d>\, pp. 637-654. Blair, Margaret M, ed. (1993). The Deal Decade: What Takeovers and Leveraged Buyouts Mean for Corporate Governance C^diShmgion: Brookings Institution). — (1995). Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century V^zshm^ion: Brookings Institution). Blair, Margaret M., and Martha A.


pages: 415 words: 125,089

Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

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Albert Einstein, Alvin Roth, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, Bayesian statistics, Big bang: deregulation of the City of London, Bretton Woods, buttonwood tree, capital asset pricing model, cognitive dissonance, computerized trading, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Lloyd's coffeehouse, endowment effect, experimental economics, fear of failure, Fellow of the Royal Society, Fermat's Last Theorem, financial deregulation, financial innovation, full employment, index fund, invention of movable type, Isaac Newton, John Nash: game theory, John von Neumann, Kenneth Arrow, linear programming, loss aversion, Louis Bachelier, mental accounting, moral hazard, Myron Scholes, Nash equilibrium, Paul Samuelson, Philip Mirowski, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Thaler, Robert Shiller, Robert Shiller, spectrum auction, statistical model, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, Thomas Bayes, trade route, transaction costs, tulip mania, Vanguard fund, zero-sum game

The puzzle was finally solved in the late 1960s by an odd threesome, none of whom was yet thirty years old when their collaboration began.' Fischer Black was a physicist-mathematician with a doctorate from Harvard who had never taken a course in economics or finance. He soon found his scientific academic studies too abstract for his taste and went to work at the Boston-based management consulting firm of Arthur D. Little. Myron Scholes had a fresh Ph.D. in finance from the Graduate School of Business at the University of Chicago, to which he had fled to escape his family's publishing enterprise; he had just joined the MIT faculty. Robert C. Merton, whose first published paper was titled "The `Motionless' Motion of Swift's Flying Island," had received a B.S. degree in mathematical engineering at Columbia but was teaching economics at MIT as an assistant to Samuelson and was as yet without a Ph.D.

A passionate believer in free markets, Black decided to apply Treynor's ideas to the valuation of options, and, to help himself along, he took Treynor's advice to join a Thursday evening finance workshop at MIT. Three years later, Black was still staring at equations that refused to produce an answer. Treynor's analysis of how market fluctuations influence the valuation of individual securities simply did not fit the bill. At that point, Black recalls, "Myron Scholes and I started working together." They had met each other at the Thursday evening workshops, where Black discovered that Scholes had been frustrated in taking the same approach to the same problem. The more they worked together over their equations, the clearer it seemed that the answer had nothing to do with Treynor's models of risk and reward. In the spring of 1970, Scholes told Merton about the troubles he and Black were having.


pages: 493 words: 132,290

Vultures' Picnic: In Pursuit of Petroleum Pigs, Power Pirates, and High-Finance Carnivores by Greg Palast

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anti-communist, back-to-the-land, bank run, Berlin Wall, Bernie Madoff, British Empire, capital asset pricing model, capital controls, centre right, Chelsea Manning, clean water, collateralized debt obligation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, Donald Trump, energy security, Exxon Valdez, invisible hand, means of production, Myron Scholes, offshore financial centre, random walk, Ronald Reagan, sensible shoes, transfer pricing, uranium enrichment, Washington Consensus, Yogi Berra

Gambling in the stock market by investment banks would be, necessarily, eliminated. No more picking stocks, a fool’s errand. Financial rewards would be small, but risk would vanish. The world’s financial panics would be left to history, and all economic booms and busts smoothed into calm waves. I met Black not long after he’d put this Drunk’s Random Walk into an academic paper with his friend Myron Scholes. They called it the Capital Asset Pricing Model.19 About the same time, a newly expanding investment bank, a small house on the edge of the financial universe, Goldman Sachs, also fell in love with Dr. Black’s Magic Model, and hired all his best students and, eventually, Dr. Black himself. Black’s magic crew at Goldman looked at the stock market but, instead of seeing securities, saw simply a soup of financial molecules, which could be manipulated and sliced and rejoined in strange and wonderful combinations.

Securities derived from securities derived from securities set off that feared chain reaction. While panicked regulators watched the explosion with fear, Clinton’s Treasury Secretary, Robert Rubin, who’d come from Goldman Sachs, saw only one new world, a post-industrial America. The USA would “manufacture” and sell financial “products,” while we would leave the dull manufacturing of objects to China. In 1997, with the world’s stock markets climbing through the clouds, Myron Scholes received the Nobel Prize for the Black-Scholes Model. The committee could not honor Black, my guide to the Brave New Numerology, who had died of throat cancer years earlier. Then the rains came. How could my master Black have gotten it so horrifically wrong? He had slipped on the banana peel dropped by Milton Friedman. Friedman had sold Black and the world the idea that markets are perfectly “efficient,” from its pricing of French fries to derivatives and money itself, all set in a perfectly rational and fair way.


pages: 305 words: 69,216

A Failure of Capitalism: The Crisis of '08 and the Descent Into Depression by Richard A. Posner

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Andrei Shleifer, banking crisis, Bernie Madoff, collateralized debt obligation, collective bargaining, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, diversified portfolio, equity premium, financial deregulation, financial intermediation, Home mortgage interest deduction, illegal immigration, laissez-faire capitalism, Long Term Capital Management, market bubble, money market fund, moral hazard, mortgage debt, Myron Scholes, oil shock, Ponzi scheme, price stability, profit maximization, race to the bottom, reserve currency, risk tolerance, risk/return, Robert Shiller, Robert Shiller, savings glut, shareholder value, short selling, statistical model, too big to fail, transaction costs, very high income

I thank my co-blogger, Gary Becker, for fruitful discussions of a number of the issues that I cover in the book, and Laura Bishop, Ralph Dado, Justin Ellis, Anthony Henke, and Michael Thorpe for their very helpful research assistance. I gained valuable insights from a talk by Robert Lucas and from helpful materials that he furnished me, and from a discussion with Lynn Maddox and an email exchange with Myron Scholes. Lee Lockwood and Christian Opp carefully checked the manuscript for technical economic errors and in the process made valuable suggestions for improving the book. Michael Aronson, Douglas Baird, Larry Bernstein, Michael Boudin, Nathan Christensen, Kenneth Dam, Benjamin Friedman, Rebecca Haw, Ashley Keller, William Landes, Jonathan Lewinsohn, Jennifer Nou, Charlene Posner, Eric Posner, Kenneth Posner, Raghuram Rajan, Andrew Rosenfield, Andrei Shleifer, and Luigi Zingales gave me extremely helpful comments on a previous draft.


pages: 892 words: 91,000

Valuation: Measuring and Managing the Value of Companies by Tim Koller, McKinsey, Company Inc., Marc Goedhart, David Wessels, Barbara Schwimmer, Franziska Manoury

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activist fund / activist shareholder / activist investor, air freight, barriers to entry, Basel III, BRICs, business climate, business process, capital asset pricing model, capital controls, Chuck Templeton: OpenTable, cloud computing, commoditize, compound rate of return, conceptual framework, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, discounted cash flows, distributed generation, diversified portfolio, energy security, equity premium, fixed income, index fund, intangible asset, iterative process, Long Term Capital Management, market bubble, market friction, meta analysis, meta-analysis, Myron Scholes, negative equity, new economy, p-value, performance metric, Ponzi scheme, price anchoring, purchasing power parity, quantitative easing, risk/return, Robert Shiller, Robert Shiller, shareholder value, six sigma, sovereign wealth fund, speech recognition, survivorship bias, technology bubble, time value of money, too big to fail, transaction costs, transfer pricing, value at risk, yield curve, zero-coupon bond

In the case of earnings multiples, we recommend using ratios of enterprise value to NOPLAT rather than price to earnings or enterprise value to EBITDA. We also urge you to be careful when choosing the comparable companies. Not only should the comparable companies be in the same industry, but they should also have similar performance, as measured by ROIC and growth. Real Options In 1997, Robert Merton and Myron Scholes won the Nobel Prize in economics for developing an ingenious method to value derivatives that avoids the need to estimate either cash flows or the cost of capital.18 Their model relies on what today’s economists call a “replicating portfolio.” They argued that if a portfolio exists of traded securities whose future cash flows perfectly mimic the security you are attempting to value, the portfolio and security must have the same price.

See Return on invested capital (ROIC) Roll-up strategies, 611–612 RONIC (return on new invested capital), 262–263, 268–269 Russian government default crisis, 11 S Sale-leaseback transactions, 41–42 Sales productivity, 583 Savings and loan crisis, 11 Scalability of products/processes, 104 Scenario analysis, 339, 344–348 Scenario DCF approach, 711–716, 729–730, 785–786 Scenario development, 743–744 Scenarios, creating, 533–534 Scenario weighting, 742–743 Schiller, Robert, 65 Scholes, Myron, 165 Securitized receivables, 327–328, 440 Sell-side analysts, 689 Sensitivity analysis, 339, 342–344 Shareholder capitalism, 6–10 Shareholder payouts, 663–668 Shareholder returns. See Total returns to shareholders (TRS) The Shareholder Value Myth (Stout), 7 Share repurchases, 38–39, 197, 649, 664–668 Short-termism, 11–14 Siemens, 629, 640 Simplified intermediate forecast, 230 Single-path DCF, 785 Social responsibility, 6, 9–10 Sodexo, 215–216 Solvency, 847–849 Spin-offs, 641, 642–643 Split-offs, 643 Stakeholder interests, 6–10 Stochastic simulation DCF, 786 Stock market: bubbles, 68–69 (see also Financial crises) cross-listings, 86–88 diversification, 83–84 earnings (see Earnings per share (EPS)) fundamentals of, 66–74 growth vs. value stocks, 68 index membership impact on company, 85–86 informed investors vs. noise investors, 66–68 market mechanics, 85 relationship of company size to value, 84–85 stock splits, 88–90 total returns to shareholders (see Total returns to shareholders (TRS)) understanding expectations, 61–62 Stock splits, 88–90 Stout, Lynn, 7 Stranded costs, 638–639 Strategic vision, 625 Subsidiaries, 150–151, 181–182 T Taiwan Semiconductor, 24 Target-setting, 589–592, 651–652 Target weights, 308–312 Taxes, 397–410 deferred, 184–186, 404–410 forecasting, 242–243 operating, 398–407 (see also Operating taxes) provisions and, 429 Tax loss carryforwards, 182, 324 Tax-loss carryforwards, 405 Tax on a maturity mismatch (TMM), 771 Tax penalty on equity, 769–770 Tax shields, valuing, 159–160 Technology bubble, 10–11, 72–73, 297–298, 302 Top-down forecasting, 235–237 Total debt, 244 Total funds invested, computing, 180–182 870 INDEX Total returns to shareholders (TRS), 5, 69–70 correlation with employment growth, 8–9 decomposing, 54–61 diversification and, 567–568 enhanced approach to analyzing, 58–59 impact of debt financing on, 59 key drivers of, 57 managerial implications, 62–63 as measure of management performance, 49–50 and spin-offs, 643 traditional approach to analyzing, 54–57 traditional vs. enhanced decomposition, 58 Tracking stock, 641, 645 TradeCo, 465–467 Traders, 686–687 Trade sales, 641 Transformational mergers, 612–613 Transparency, 594–595, 689–690, 692–693 Triangulation, 736–738 TRS.


pages: 1,242 words: 317,903

The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby

airline deregulation, airport security, Andrei Shleifer, anti-communist, Asian financial crisis, balance sheet recession, bank run, barriers to entry, Benoit Mandelbrot, Bretton Woods, central bank independence, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, energy security, equity premium, fiat currency, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, Hyman Minsky, inflation targeting, information asymmetry, interest rate swap, inventory management, invisible hand, Kenneth Rogoff, Kitchen Debate, laissez-faire capitalism, Long Term Capital Management, low skilled workers, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon shock, Northern Rock, paper trading, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, popular capitalism, price stability, RAND corporation, rent-seeking, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, Saturday Night Live, savings glut, secular stagnation, short selling, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, unorthodox policies, upwardly mobile, WikiLeaks, women in the workforce, Y2K, yield curve, zero-sum game

With the benefit of hindsight, the Fed’s refusal to be emotionally exercised by the disruptive proliferation of unregulated swaps was a failure of the Greenspan era. • • • If there was one institution that embodied Greenspan’s optimism about the new finance, it was Long-Term Capital Management. Founded four years earlier by quantitative wizards from Salomon Brothers, Long-Term’s partners included the financial economists Myron Scholes and Robert Merton, who had received the Nobel Prize for their “new method to determine the value of derivatives.” David Mullins, the former Fed vice chairman who had lectured Mike Prell about the efficiency of markets, was another principal at LTCM; and for its first two and a half years, the firm performed spectacularly. Its approach was to use the new science of risk management to identify hazards that others feared too much—and then to be paid handsomely for absorbing them.

., 466–69, 619–20 Sarbanes, Paul, 440 Saturday Night Special, 232–36, 261, 264, 332 Saudi Arabia, 186–90, 391–92, 394, 397 Saulnier, Raymond, 138–39 savings, 136–37, 149, 212, 421, 427, 431, 435, 534, 593 of consumers, 32, 46 global, 641–42, 655, 670 “glut” in, 641–42, 655, 670 protection of, 123, 148 ways to hold it, 49, 87–88 See also money-market funds savings and loan associations (S&Ls), 47–48, 79–80, 129–30, 148–50, 179, 218, 264, 294–96, 360, 379–82, 384–85, 389–90, 394, 405–6, 429, 441, 448, 501 Schlesinger, Arthur Jr., 64, 192 Schmidt, Helmut, 196–200 Schoenholtz, Kim, 643 Scholes, Myron, 536 Schumer, Charles, 342, 567 Schwartz, Anna, 88, 655 Scotland, 645 Scottsdale, Arizona, 562 Scowcroft, Brent, 179, 398 Sears, Roebuck, 320 Secret Service, 118, 120, 194, 245, 262, 591–92, 650 secular stagnation, 32–33, 72, 593–95, 606, 610 securities, 9, 198, 443, 522, 616 and 1987 crash, 356, 360 and banks, 403, 525, 559 and the Fed, 313–14 Greenspan on, 312, 321, 403 mortgage-backed, 8, 601–2, 618–20, 630 new types of, 466 trading in, 311–14, 321, 345 See also Glass-Steagall Act; mortgages: securities Securities and Exchange Commission (SEC), 296, 346, 449, 485, 533, 535, 545, 560, 599–600, 602, 657, 662–63 Seidman, Ellen, 534 September 11, 2001, 583–99 Sequoia smear campaign, 140–44 Serra, Jaime, 472 service businesses, 493–95, 503–4 Shah of Iran, 185–86, 189–91, 193–94 Shaw, Edward, 48–49, 213, 414, 593 Sheiner, Bill, 21–22 Shelby, Richard, 627–28, 630 Shiller, Robert, 502, 505 Shopkorn, Stanley, 358, 677 Shrum, Bob, 511 Shulman, David, 501, 546 Shultz, George, 2, 225–26 Siegman, Charles, 516–17 silo busting, 148, 523, 525–26, 544, 559 Silva Herzog Flores, Jesús, 282–83 Simon, William, 170–72, 175, 177, 193–94, 197 Sirhan, Sirhan, 118 Sixteenth Amendment, 159 Skinner, Richard Dana, 43–44, 47 Slate magazine, 655 Slifman, Larry, 492–93 Sloan, Alfred P., 60 Smelcer, Wilma, 351–52, 363 Smith, Adam, 147, 161, 645 Smith, Jim, 130 Social Security reform commission, 272–82, 287–88, 309–10, 319, 368, 471, 567, 572, 676 Social Security system, 272, 420, 567 socialism, 29 Solow, Robert, 77, 427 South Korea, 514–22, 537, 539, 541, 547 Soviet Union, 77, 109, 182, 191, 530.


pages: 302 words: 86,614

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

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activist fund / activist shareholder / activist investor, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bernie Madoff, Bretton Woods, business process, call centre, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, fixed income, high net worth, interest rate derivative, Isaac Newton, Long Term Capital Management, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Myron Scholes, NetJets, oil shock, pattern recognition, Ponzi scheme, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, systematic trading, zero-sum game

A special thank you to Mohamed El-Erian, PIMCO CEO and co-CIO, for being a superior mentor to me during the tedious writing process, and for such a well-thought-out and researched foreword to this book. To all the individuals who read my entire manuscript and provided very useful feedback, perspective, and comments, like Julian Robertson, Bill Ackman, Roxanne Donovan, Roy Katzovicz, Nouriel Roubini, Myron Scholes, Jeff Kaplan, Rick Sopher, Josh Friedlander, Mary Beth Grover, Jonathan Gasthalter, Parag Shah, Alexei Nabarro, Ryan Fusaro, Jim McCaughan, Jim Spellman, Mike Spence, Mario Gabelli, Leon Cooperman, and Meredith Whitney—I understand how valuable your time is; your support is priceless. A special thank you to CNBC president and CEO Mark Hoffman and senior vice president and editor-in-chief of Business News, Nik Deogun, for supporting me in writing this book.


pages: 364 words: 99,613

Servant Economy: Where America's Elite Is Sending the Middle Class by Jeff Faux

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back-to-the-land, Bernie Sanders, Black Swan, Bretton Woods, BRICs, British Empire, call centre, centre right, cognitive dissonance, collateralized debt obligation, collective bargaining, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, David Brooks, David Ricardo: comparative advantage, falling living standards, financial deregulation, financial innovation, full employment, hiring and firing, Howard Zinn, Hyman Minsky, illegal immigration, indoor plumbing, informal economy, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, lake wobegon effect, Long Term Capital Management, market fundamentalism, Martin Wolf, McMansion, medical malpractice, mortgage debt, Myron Scholes, Naomi Klein, new economy, oil shock, old-boy network, Paul Samuelson, Plutocrats, plutocrats, price mechanism, price stability, private military company, Ralph Nader, reserve currency, rising living standards, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, school vouchers, Silicon Valley, single-payer health, South China Sea, statistical model, Steve Jobs, Thomas L Friedman, Thorstein Veblen, too big to fail, trade route, Triangle Shirtwaist Factory, union organizing, upwardly mobile, urban renewal, War on Poverty, We are the 99%, working poor, Yogi Berra, Yom Kippur War

Jo Becker, Sheryl Gay Stolberg, and Stephen Labaton, “White House Philosophy Stoked Mortgage Bonfire,” New York Times, December 21, 2008. 14. Editorial, “Don’t Blame the New Deal,” New York Times, September 28, 2008. 15. Phil Angelides, “Fannie, Freddie and the Financial Crisis,”Bloomberg View, August 3, 2011, http://www.bloomberg.com/news/2011-08-04/fannie-freddie-role-in-the-financial-crisis-commentary-by-phil-angelides.html. 16. The critical work was done by Fischer Black, Myron Scholes, and, later, Robert Merton. Scholes and Merton shared the Nobel Prize in Economics for 1997. 17. Gretchen Morgenson, “Was There a Loan It Didn’t Like?,” New York Times, November 11, 2008. 18. Michael Lewis, “The End,” Portfolio.com, November 11, 2008, http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom. 19. Roger Altman, “Recent Financial Market Disruptions: Implications for the Economy and American Families,” Brookings Institution, September 26, 2007, www.brookings.edu/projects/hamiltonprojectevents. 20.


pages: 315 words: 93,628

Is God a Mathematician? by Mario Livio

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Albert Einstein, Antoine Gombaud: Chevalier de Méré, Brownian motion, cellular automata, correlation coefficient, correlation does not imply causation, cosmological constant, Dava Sobel, double helix, Edmond Halley, Eratosthenes, Georg Cantor, Gerolamo Cardano, Gödel, Escher, Bach, Henri Poincaré, Isaac Newton, John von Neumann, music of the spheres, Myron Scholes, probability theory / Blaise Pascal / Pierre de Fermat, Russell's paradox, The Design of Experiments, the scientific method, traveling salesman

Even the brief description I have presented so far already provides overwhelming evidence of a universe that is either governed by mathematics or, at the very least, susceptible to analysis through mathematics. As this book will show, much, and perhaps all, of the human enterprise also seems to emerge from an underlying mathematical facility, even where least expected. Examine, for instance, an example from the world of finance—the Black-Scholes option pricing formula (1973). The Black-Scholes model won its originators (Myron Scholes and Robert Carhart Merton; Fischer Black passed away before the prize was awarded) the Nobel Memorial Prize in economics. The key equation in the model enables the understanding of stock option pricing (options are financial instruments that allow bidders to buy or sell stocks at a future point in time, at agreed-upon prices). Here, however, comes a surprising fact. At the heart of this model lies a phenomenon that had been studied by physicists for decades—Brownian motion, the state of agitated motion exhibited by tiny particles such as pollen suspended in water or smoke particles in the air.


pages: 313 words: 101,403

My Life as a Quant: Reflections on Physics and Finance by Emanuel Derman

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Berlin Wall, bioinformatics, Black-Scholes formula, Brownian motion, capital asset pricing model, Claude Shannon: information theory, Donald Knuth, Emanuel Derman, fixed income, Gödel, Escher, Bach, haute couture, hiring and firing, implied volatility, interest rate derivative, Jeff Bezos, John Meriwether, John von Neumann, law of one price, linked data, Long Term Capital Management, moral hazard, Murray Gell-Mann, Myron Scholes, Paul Samuelson, pre–internet, publish or perish, quantitative trading / quantitative finance, Richard Feynman, Sharpe ratio, statistical arbitrage, statistical model, Stephen Hawking, Steve Jobs, stochastic volatility, technology bubble, the new new thing, transaction costs, value at risk, volatility smile, Y2K, yield curve, zero-coupon bond, zero-sum game

Before I went up to his office on the twenty-ninth floor to meet him, to show him what I had done so far, and, implicitly, to see if he would have me work with him, I read a little more on the history of options theory. Until the early 1970s, no one knew how to estimate the value of options in a convincing way. A call option that paid off when the stock price rose seemed much like a bet on a horse: The more optimistic you were about the stock's future prospects, the more you should be willing to pay for it. Each person set his own fair price. Then, in 1973, Fischer Black and Myron Scholes published their eponymous Black-Scholes equation for the value of an option. That same year, Robert Merton provided a more rigorous and insightful way of understanding the argument behind their equation. Eventually, his formalism came to supplant theirs, and became the standard. Merton and Scholes won the 1997 Nobel Prize in Economics for their work, but Fischer, who was certainly their equal, died in 1995.


pages: 354 words: 26,550

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

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algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business process, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, computerized trading, diversification, equity premium, fault tolerance, financial intermediation, fixed income, high net worth, implied volatility, index arbitrage, information asymmetry, interest rate swap, inventory management, law of one price, Long Term Capital Management, Louis Bachelier, margin call, market friction, market microstructure, martingale, Myron Scholes, New Journalism, p-value, paper trading, performance metric, profit motive, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, trade route, transaction costs, value at risk, yield curve, zero-sum game

Biais, B., P. Hillion and C. Spatt, 1995. “An Empirical Analysis of the Limit Order Book and the Order Flow in the Paris Bourse.” Journal of Finance 50, 1655– 1689. Black, Fisher, 1972. “Capital Market Equilibrium with Restricted Borrowing.” Journal of Business 45, 444–455. Black, F. and R. Jones, 1987. “Simplifying Portfolio Insurance.” Journal of Portfolio Management 14, 48–51. Black, Fischer and Myron Scholes (1973). “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy 81, 637–654. Bloomfield, R., M. O’Hara and G. Saar, 2005. “The ‘Make or Take’ Decision in an Electronic Market: Evidence on the Evolution of Liquidity.” Journal of Financial Economics 75, 165–199. Board, J. and C. Sutcliffe, 1995. “The Effects of Transparency in the London Stock Exchange.” Report commissioned by the London Stock Exchange, January 1995.


pages: 223 words: 10,010

The Cost of Inequality: Why Economic Equality Is Essential for Recovery by Stewart Lansley

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banking crisis, Basel III, Big bang: deregulation of the City of London, Bonfire of the Vanities, borderless world, Branko Milanovic, Bretton Woods, British Empire, business process, call centre, capital controls, collective bargaining, corporate governance, corporate raider, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, Edward Glaeser, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, Goldman Sachs: Vampire Squid, high net worth, hiring and firing, Hyman Minsky, income inequality, James Dyson, Jeff Bezos, job automation, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, laissez-faire capitalism, light touch regulation, Long Term Capital Management, low skilled workers, manufacturing employment, market bubble, Martin Wolf, mittelstand, mobile money, Mont Pelerin Society, Myron Scholes, new economy, Nick Leeson, North Sea oil, Northern Rock, offshore financial centre, oil shock, Plutocrats, plutocrats, Plutonomy: Buying Luxury, Explaining Global Imbalances, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, The Great Moderation, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, Tyler Cowen: Great Stagnation, Washington Consensus, Winter of Discontent, working-age population

These models, it was claimed, could predict with great accuracy the future path of a whole range of financial variables from equity and commodity prices to interest rates and house prices. According to their architects, by anticipating and controlling the level of risk, finance could increase the level of liquidity in the markets and improve the level of efficiency with which resources were allocated, thus enabling a higher level of national and world economic activity. This claim seemed to be vindicated when two hedge fund partners, Myron Scholes and Robert Merton, won the Nobel Prize for economics in 1997. Their Greenwichbased firm, Long Term Capital Management had been founded by John Meriwether, a former highly successful bond trader at Salomon, Lewis’s boss and widely believed to be the inspiration for the Bonfire of the Vanities , Tom Wolf’s 1980s novel of Wall Street excess. For a while the heavily-leveraged operation grew to be one of the most lucrative of the American hedge funds.


pages: 326 words: 106,053

The Wisdom of Crowds by James Surowiecki

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AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, John Meriwether, Joseph Schumpeter, knowledge economy, lone genius, Long Term Capital Management, market bubble, market clearing, market design, moral hazard, Myron Scholes, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, Yogi Berra, zero-sum game

The experts worked for Long-Term Capital Management (LTCM), a hedge fund that was started in 1994 by John Meriwether, a former bond trader whose trading skills had made him a legend on Wall Street. From the outside, LTCM looked a little like the Manhattan Project of investing. Meriwether had hired a host of Wall Street whiz kids who were experts in using computer models to figure out how to make money. And he’d brought on board some of the founding fathers of modern finance. Myron Scholes and Robert Merton had invented the model that investors everywhere use to figure out how much options are worth, and now they were working for LTCM. It was hard to see how such a dream team could go wrong. Even though investors had to put up a minimum of $10 million to get into the fund, and 25 percent of each year’s profits went to the fund’s managers, people still clamored to get in, especially after LTCM turned in impressive returns four years in a row.


pages: 261 words: 86,905

How to Speak Money: What the Money People Say--And What It Really Means by John Lanchester

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asset allocation, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, blood diamonds, Bretton Woods, BRICs, Capital in the Twenty-First Century by Thomas Piketty, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collective bargaining, commoditize, creative destruction, credit crunch, Credit Default Swap, crony capitalism, Dava Sobel, David Graeber, disintermediation, double entry bookkeeping, en.wikipedia.org, estate planning, financial innovation, Flash crash, forward guidance, Gini coefficient, global reserve currency, high net worth, High speed trading, hindsight bias, income inequality, inflation targeting, interest rate swap, Isaac Newton, Jaron Lanier, joint-stock company, joint-stock limited liability company, Kodak vs Instagram, liquidity trap, London Interbank Offered Rate, London Whale, loss aversion, margin call, McJob, means of production, microcredit, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, negative equity, neoliberal agenda, New Urbanism, Nick Leeson, Nikolai Kondratiev, Nixon shock, Northern Rock, offshore financial centre, oil shock, open economy, paradox of thrift, Plutocrats, plutocrats, Ponzi scheme, purchasing power parity, pushing on a string, quantitative easing, random walk, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Right to Buy, road to serfdom, Ronald Reagan, Satoshi Nakamoto, security theater, shareholder value, Silicon Valley, six sigma, South Sea Bubble, sovereign wealth fund, Steve Jobs, survivorship bias, The Chicago School, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, trickle-down economics, Washington Consensus, wealth creators, working poor, yield curve

.† Black-Scholes The name of the formula that made it possible to create prices in the derivatives markets; before the equation was discovered (or invented, depending on your view of what mathematics does), uncertainties about how probabilities changed made it impossible to create accurate prices for an option over time. Black-Scholes gave a way of mathematically modeling the price of the options, and led to a huge boom in the global market for derivatives. The equation is named after the two men who created it, Fischer Black and Myron Scholes. Black Swan A term coined by the philospher-investor Naseem Nicholas Taleb for an event so rare it doesn’t fit in normal models of statistical probability. As a result, institutions such as banks are grievously unprepared for this kind of very rare event. It is possible that humans are hardwired not to have a good intuitive understanding of these kinds of risks. An example would be Earth being hit by an asteroid big enough to cause global disaster, something NASA says happens every 500,000 years or so.22 That puts the odds of its happening in a typical 80-year life at one in 6,250—which is uncomfortably high.


pages: 345 words: 86,394

Frequently Asked Questions in Quantitative Finance by Paul Wilmott

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Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

His third claim to fame is that he was the first to use the ‘correct’ formulæ for pricing options, formulæ that were rediscovered and originally published several years later by the next three people on our list. Thorp used these formulæ to make a fortune for himself and his clients in the first ever quantitative finance-based hedge fund. See Thorp (2002) for the story behind the discovery of the Black-Scholes formulæ. 1973 Black, Scholes and Merton Fischer Black, Myron Scholes and Robert Merton derived the Black-Scholes equation for options in the early seventies, publishing it in two separate papers in 1973 (Black & Scholes, 1973, and Merton, 1973). The date corresponded almost exactly with the trading of call options on the Chicago Board Options Exchange. Scholes and Merton won the Nobel Prize for Economics in 1997. Black had died in 1995. The Black-Scholes model is based on geometric Brownian motion for the asset price S The Black-Scholes partial differential equation for the value V of an option is then 1974 Merton, again In 1974 Robert Merton (Merton, 1974) introduced the idea of modelling the value of a company as a call option on its assets, with the company’s debt being related to the strike price and the maturity of the debt being the option’s expiration.


pages: 111 words: 1

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb

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Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, Benoit Mandelbrot, Black Swan, commoditize, complexity theory, corporate governance, corporate raider, currency peg, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, endowment effect, equity premium, fixed income, global village, hindsight bias, Kenneth Arrow, Long Term Capital Management, loss aversion, mandelbrot fractal, mental accounting, meta analysis, meta-analysis, Myron Scholes, Paul Samuelson, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, Richard Feynman, road to serfdom, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Turing test, Yogi Berra

Somehow when one gets involved in financial economics, owing to the culture of the field, one becomes likely to forget these basic facts (pressure to publish to keep one’s standing among the other academics). An immediate result of Dr. Markowitz’s theory was the near collapse of the financial system in the summer of 1998 (as we saw in Chapters 1 and 5) by Long Term Capital Management (“LTCM”), a Greenwich, Connecticut, fund that had for principals two of Dr. Markowitz’s colleagues,“Nobels”as well. They are Drs. Robert Merton (the one in Chapter 3 trouncing Shiller) and Myron Scholes. Somehow they thought they could scientifically “measure” their risks. They made absolutely no allowance in the LTCM episode for the possibility of their not understanding markets and their methods being wrong. That was not a hypothesis to be considered. I happen to specialize in black swans. Suddenly I started getting some irritating fawning respect. Drs. Merton and Scholes helped put your humble author on the map and caused interest in his ideas.