frictionless market

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pages: 289 words: 113,211

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

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

In classical physics, any number of real-world effects such as friction or air resistance are assumed away to make mathematical analysis more tractable. Perfect vacuums and ideal gases provide a set of simplifying assumptions that allowed for the development of theories of the physical world. Similarly, in the study of economics it is necessary to assume a construct of frictionless markets to build a market theory out of the tools of mathematics. This assumption of frictionless markets included instantaneous and costless transactions devoid of real-world constraints. Buyers and sellers bought or sold at posted prices, with no associated fees, and their actions had no impact on the market—in the nomenclature of economics, the market participants were atomistic.

Senate hearings, 129–130 Epstein, Sheldon, 46–47, 49 index-amortizing swap, 116 Equity trading profitability, 71–75 proprietary reliance, 73–74 European Monetary System currency crisis (1992), 3 Event risk, 248–249 Factor exposures, 202 Fair value basis, 29 Federal Deposit Insurance Corporation (FDIC), 113 Federal Reserve policy shifts, 85 rate hike, impact, 53 Feduniak, Bob, 42, 52 Feuerstein, Donald, 196 Financial instability, aspects, 3–4 Financial markets, 224–225 Financial risk, 256–257 Fisher, Andy, 59, 80 Fixed income focus, 251–252 Fixed income research (FIR), 8–9, 43–44 Flood, Gene, 190 Franklin, Mark, 97 Free-floating anxiety, 235 Frictionless markets, 209 FrontPoint Partners, 204, 205 FTSE Index, 117 Fundamental data, 166 Furu, example, 233–235 Futures market, 17–19 Futures shock (1635), 175–177 Galbraith, John Kenneth, 16 Gamma, problems, 24–25 General Electric (GE), 41–42 Generally accepted accounting principles (GAAP), 135 Geographic regions, classification, 246 Global Crossing, restatements/liability, 135 Godel, Kurt, 222–224, 227–228 Gold, Jeremy, 8–9 Goldman Sachs acquisition, 75 public offering, delay, 109 Goldstein, Ramy, 116–118 Gracie family, 258–259 Gracie, Gastao, 258 Greenhill, Bob, 73 Greenmail, taxation, 13–14 Gross Domestic Product (GDP), 3–4 Growth bias, 202 Grubman, Jack, 128–130, 134 MCI/BT involvement, 69–71 nursery school admissions, 131–132 Gutfreund, John, 62–63, 105, 195–197 resignation, 199 Haghani, Victor, 102–104, 110, 112 Hall, Andy, 63–67 Hawkins, Greg, 51 Hedgefundedness, 243–244 Hedge funds, 165, 207, 214–215, 243 classification, problem, 245 classification, 245–246 control, 252–253 defining, 245 economic service, 219 existence, question, 244 regulation, 247–250 Heisenberg, Werner, 223–228 Hilibrand, Larry, 79, 110, 113 Human error, 149 272 bindex.qxd 7/13/07 2:44 PM Page 273 INDEX Kaplan, Joel, 44–45 Kaplanis, Costas, 63, 79 Kidder, Peabody, 39–42 Knowledge, limits, 221–230 Krasker, Bill, 86 Liquidity basics, 213–220 complexity, relationship, 145 demand, 26, 191 hedge fund classification, 246 history, 217–218 impact, 212–213 needs, 183 providers, 213–215 role, 215–220 squeeze, prospects, 105 suppliers, 22, 192–193 supply, price elasticity, 94–95 transparency, 226 Liquidity crisis cycle, 93–94 prevention, 94–95 providing, hedge funds (impact), 214–215 Long-range forecasting, 228 London Exchange, Rothschild visit, 90 London Interbank Offered Rate (LIBOR) government rates, parity, 57 higher-yielding LIBOR bond, 57 LIBOR-denominated debt, 56 Long-dated call options, 57 Long-Distance Discount Service (LDDS), acquisitions, 70 Long/short equity hedge funds, 200–205 Long-Term Capital Management (LTCM) capital reserves, assumption, 106–108 collapse, 93 decision point, 110 disaster, 57, 60, 92–93, 100, 145 hedge fund debacle/crisis, 1–3 leverage cycle, 97 liquidity risk, 107–108 losses, 108–111 management, initiation, 195–200 market price positions, feedback, 112 market risks, modeling/monitoring, 111–112 problems, public knowledge, 104–105 repurchase agreement, problem, 104 risk arbitrage position, 107 risk burden, 108 Long-term rates, short-term rates (interaction), 47 Loops, usage/impact, 45 Loosely coupled system, 157 Lorenz, Edward, 227–229 deterministic systems, 229–230 Langsam, Joe, 232, 236–237 Laplace, Pierre-Simon, 223, 225 Lead-lag strategy, 193–194 Leeson, Nick (impact), 38–39 Leibowitz, Marty, 8, 51, 53 Leland, Hayne, 10 Leverage, 244 amount, reduction, 260 crisis, occurrence, 111–113 regulations, imposition, 248 Levin, Carl, 130 Lewis, Michael, 52 Liquidation ability, 93 Mack, John, 28, 29, 35, 37 trader emulation, 35 Macro data, usage, 166–167 Macro strategies, 202 Maeda, Mitsuyo, 258 Margin-induced sale, 94 Market aberrations, opportunities, 122 breakdown, reaction, 146 crises, worsening (aspects), 3–4 cycle, basis, 169 decline, respite, 23–24 exponential growth, 17 Illiquidity, cost, 217–218 Index-amortizing swap, 46–48 Information flow, process, 210 implications, derivation, 170–171 overload, 220–230 Information-based trading, 166 Information Technology (IT), support function, 185–186 Initial public offerings (IPOs), 72 creation, 173–174 issuance, amount, 178–179 Innovation, positive effects, 255–256 INSEAD, 66 Intangibles, 137–138 Interactive complexity, 154–157 Interest only (IO), 55 Interest rate, 84–85, 87 International Monetary Fund (IMF) package, 103 Internet bubble, 179–181 businesses, virtual nature, 172 stocks, run-up (1998), 178 Interrelated markets, complexity (by-product), 143 Intraday price movement, 183 Inventory service, 71 Investment buyers, scare, 22 coverage, 249–250 investor behavior, 203–204 strategy, 247 type, classification, 246 Investors, irrational behavior, 203–204 Irrational markets, impact, 180–181 Iverson, Keith, 48 Iverson, Ken Japan, liquidity, 39 Japanese swap spread strategy/profit, 100 Jenkinson, Robert Banks, 89–90 Jett, Joe, 39–41 Jiu Jitsu Academy, 258 Jones, Paul Tudor, 165 Junk bonds, 71 273 bindex.qxd 7/13/07 2:44 PM Page 274 INDEX Market (Continued) failures, safeguards, 239–240 illiquidity, portfolio insurance by-product, 14 innovation, 11–12 makers, problem, 191–192 regulation, 146–154 risk, paradox, 1 volatility, 5, 25 vulnerability, 224–225 Market bubbles, 168–174 Market-to-book ratio, 138 Marx, Karl, 250 Marxist backward market, exploitation, 250 Material adverse change clause, 65 Maughan, Deryck, 59, 73–77 MCI Communications British Telecom (BT), merger/trade, 63–64, 67, 128 conclusion, 74 EPS, decline, 70 renegotiation, willingness, 67–68 stock, decline, 64 Mean-reversion analysis, 190 Mechanical failure, 149 Mercury Asset Management, 196 Mergers and acquisitions (M&A) advice/underwriting, 33 Meriwether, John, 52, 100, 197 resignation, 199 Merrill Lynch, 42 Merton, Robert, 9, 207 Metallgesellschaft Refining and Marketing (MGRM), oil price risk (offloading), 37–38 Mexican Brady bond/Eurobond spread, 107 Mexican peso crisis (1994), 3 Miller, Heidi, 78–80, 140 Modigliani, Franco, 208–209 Money flows, 167 Morgan Stanley APL, usage, 44–45 Dean Witter, merger, 75 IT department, 43 portfolio insurance, 10–12 risk arbitrage department, 15 risk manager, 42 Morgan Stanley Asset Management (MSAM), 11 Morgan Stanley Investment Management (MSIM), 205 Mortgage-backed securities (MBSs), 54–56, 213 Mortgage market, 35, 54–55, 102 Mortgages, opportunities, 35 Mozer, Paul, 195–198 Munger, Charlie, 62, 99, 101, 197–198 Myojin, Sugar, 59, 63, 78–79 Natural catastrophe, 257 New York Stock Exchange (NYSE) specialists, impact, 20–21 stock sale, 13 Noncash exchanges, 40 Norman Conquest, 215 Norris, Floyd (editorial), 91–92 O’Brien, John, 10 One-off events, 249 Opportunistic strategies birth/death cycle, 252 history, 251 Optimal behavior, mathematical framework, 237–240 Options, stripping, 117 Option theory, 24 Orange County, bankruptcy, 38 Organizational dysfunction, 134–136 Pacioli, Luca, 136–137 Pairwise stock trades, 187 Palmedo, Peter, 17, 28–29 Paloma Partners Management Company, 42 Pandit, Vikram, 12 Parets, Andy, 63–69 Parkhurst, Charlie, 85 Partnership model, 37 Perfect market paradigm, 209–210 imperfections, 210–212 liquidity, degree, 212–213 Phibro, Salomon acquisition, 66 Physical processes, modeling, 229 Platt, Bob, 7–8 Portfolio insurance, 10–15 market crash, 22 Portfolio managers, loss (risk), 204–205 Position disclosure, problems, 225 transparency, increase (financial market regulator advocacy), 225 Preference shares, illiquidity, 115 Price convergence, 121–122 Primal risk, 235–237 knowledge, limits, 230–232 Primogeniture, 215–220 implications, 216–217 objective, impact, 216 Principal only (PO), 54–55 Principia Mathematica (Russell), 221–223 Procter & Gamble, losses, 38 Program trading, absence, 24–25 Protest bids, 195–196 Quants, 8–9, 82–84 Quantum Fund, 180–181 Quattrone, Frank, 72 Rational man approach, 231 Real assets, valuation, 137–138 Real-world risk, 237–238 Reed, John, 127 Relative strength index (RSI), 190 Relative value trades, 101–102 Rhoades, Loeb, 125 RISC workstations, 191 Risk control, 220 knowledge, absence, 231–232 management, 36 nature, variation, 249 reduction, 185 progress/refinement, impact, 4 tactical usage, 200 274 bindex.qxd 7/13/07 2:44 PM Page 275 INDEX Risk arbitrage, 15–16, 65, 71 Risk Architecture, 126 Risk-controlled relative value trading, 102–103 Risk-management structure, 238 Robertson, Julian, 165, 179–182 Rosenbluth, Jeff, 59, 83 Rosenfeld, Eric, 51, 79, 86 Rothschild, Nathan, 88–89 trading strategy, 90–93 Waterloo, relationship, 89–90 Rubinstein, Mark, 10 Russell, Bertrand, 221–223 Russia default, 103–104 Russian short-term bonds, 103 Salomon Brothers arbitrage units, 73–74, 80–82 closure, 88–89 tracking error, problems, 86–89 competition, 60–61 fixed income trading floor, 82 Japanese unit, 56–62 July Fourth massacre, 86–89 mortgage position, loss, 55–56 organization, trader involvement, 73 risk arbitrage group, mortgage position, 80–81 Travelers purchase, 77 Salomon North, 81, 100, 199 Salomon Smith Barney convergence trades, 120–124 proprietary trading, reduction, 92 risk management committee, 98–101 risk measuring/monitoring, 126 Travelers, interaction, 125 U.S. fixed income arbitrage group, 91–93 U.S.


pages: 791 words: 85,159

Social Life of Information by John Seely Brown, Paul Duguid

Alvin Toffler, business process, Charles Babbage, Claude Shannon: information theory, computer age, Computing Machinery and Intelligence, cross-subsidies, disintermediation, double entry bookkeeping, Frank Gehry, frictionless, frictionless market, future of work, George Gilder, George Santayana, global village, Goodhart's law, Howard Rheingold, informal economy, information retrieval, invisible hand, Isaac Newton, John Markoff, John Perry Barlow, junk bonds, Just-in-time delivery, Kenneth Arrow, Kevin Kelly, knowledge economy, knowledge worker, lateral thinking, loose coupling, Marshall McLuhan, medical malpractice, Michael Milken, moral hazard, Network effects, new economy, Productivity paradox, Robert Metcalfe, rolodex, Ronald Coase, scientific management, shareholder value, Shoshana Zuboff, Silicon Valley, Steve Jobs, Superbowl ad, tacit knowledge, Ted Nelson, telepresence, the medium is the message, The Nature of the Firm, the strength of weak ties, The Wealth of Nations by Adam Smith, Thomas Malthus, transaction costs, Turing test, Vannevar Bush, Y2K

Experiments at both IBM and MIT with bots in apparently frictionless markets indicate potential for destructive behavior. Not "subject to constraints that normally moderate human behavior in economic activity," as one researcher puts it, the bots will happily destabilize a market in pursuit of their immediate goals. In the experiments, bots engaged in savage price wars, drove human suppliers out of the market, and produced unmanageable swings in profitability. "There's potential for a lot of mayhem once bots are introduced on a wide scale," another researcher concluded. 25 The research suggests that frictionless markets, run by rationally calculating bots, may not be the efficient economic panacea some have hoped for.


Monte Carlo Simulation and Finance by Don L. McLeish

algorithmic bias, Black-Scholes formula, Brownian motion, capital asset pricing model, compound rate of return, discrete time, distributed generation, finite state, frictionless, frictionless market, implied volatility, incomplete markets, invention of the printing press, martingale, p-value, random walk, risk free rate, Sharpe ratio, short selling, stochastic process, stochastic volatility, survivorship bias, the market place, transaction costs, value at risk, Wiener process, zero-coupon bond, zero-sum game

If we can reproduce exactly the same (random) returns as the derivative provides using a linear combination of other marketable securities (which have prices assigned by the market) then the derivative must have the same price as the linear combination of other securities. Any other price would provide arbitrage opportunities. Of course in the real world, there are costs associated with trading, these costs usually related to a bid-ask spread. There is essentially a different price for buying a security and for selling it. The argument above assumes a frictionless market with no trading costs, with borrowing any amount at the risk-free bond rate possible, and a completely liquid market- any amount of any security can be bought or sold. Moreover it is usually assumed that the market is complete and it is questionable whether complete markets exist. For example if a derivative security can be perfectly replicated using other marketable instruments, then what is the purpose of the derivative security in the market?

Suppose that a security price is an Ito process satisfying the equation dS t = a(St , t ) dt + σ(St , t) dW t (2.33) Assumed the market allows investment in the stock as well as a risk-free bond whose price at time t is Bt . It is necessary to make various other assumptions as well and strictly speaking all fail in the real world, but they are a reasonable approximation to a real, highly liquid and nearly frictionless market: 1. partial shares may be purchased 2. there are no dividends paid on the stock 3. There are no commissions paid on purchase or sale of the stock or bond 4. There is no possibility of default for the bond 5. Investors can borrow at the risk free rate governing the bond. 6. All investments are liquid- they can be bought or sold instantaneously. 78 CHAPTER 2.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Alan Greenspan, Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, behavioural economics, Bernie Madoff, Black Swan, Bob Litterman, bond market vigilante , book value, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, carbon credits, Carmen Reinhart, central bank independence, classic study, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, deal flow, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global macro, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, inverted yield curve, invisible hand, John Bogle, junk bonds, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, low interest rates, managed futures, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, pension time bomb, performance metric, Phillips curve, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, savings glut, search costs, selection bias, seminal paper, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stock buybacks, stocks for the long run, survivorship bias, systematic trading, tail risk, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

This chapter reviews the revolution in academic thinking about expected returns. Twenty-five years ago the consensus assumptions included• a world with a single risk factor—the asset’s sensitivity to the equity market (i.e., the CAPM beta); • constant expected returns over time; • investors care only about the means and variances of asset returns; • frictionless markets; and • efficient markets/rational investors. The current view is more complex but also more realistic. There are• multiple risk factors (whose required rewards ultimately depend on their covariation with “bad times)”; • time-varying risk premia; • skewness and liquidity preferences (liking lottery tickets and liquid assets); • supply–demand effects on asset prices; and • market inefficiencies (due to investor irrationalities and/or market frictions).

I will not derive it formally here but show one traditional set of assumptions (that can later be relaxed):• one-period world (this implies a constant investment opportunity set and constant risk premia over time); • access to unlimited riskless borrowing/lending and tradable risky assets; • no taxes or transaction costs (i.e., frictionless markets); • investors are rational mean variance optimizers (only caring about means and covariances can be motivated by normally distributed asset returns or by a quadratic utility function); and • investors have homogeneous expectations (all agree about asset means and covariances; all investors see the same picture).

If any particular asset should offer a higher expected return due solely to the increase in the quantity outstanding, investors will soon arbitrage away such profit opportunities. Arbitrage is possible because assets are “not unique works of art” but have close counterparts in other assets or mixes of other assets (Scholes, 1972). If there are perfect substitutes and frictionless markets, buying a highexpected-return asset while selling a substitute with a lower expected return constitutes a riskless arbitrage. Subsequent empirical studies disputed the notion that perfect substitutes exist. Demand effects may play a key role in explaining time-varying risk premia, given the lack of substitutes for market risk exposures.


pages: 169 words: 43,906

The Website Investor: The Guide to Buying an Online Website Business for Passive Income by Jeff Hunt

buy low sell high, content marketing, deal flow, Donald Trump, drop ship, frictionless, frictionless market, intangible asset, medical malpractice, Michael Milken, passive income, Ralph Waldo Emerson, Skype, software as a service

Methods that attempt to put a value on such things, like traffic statistics or email list count, almost always fail because there are dramatic and substantive differences between one email list and another or one visitor to a website and a visitor to a different website. Market-Driven Comparisons One approach that does have some theoretical reliability involves analyzing actual sale prices of comparable web properties. Websites with similar characteristics should sell for similar prices—assuming a frictionless market. This process works because, at the end of the day, a site is only worth what a real buyer is willing to pay for it. So, given enough transactions by real buyers, one should be able to deduce going market rates. This is how it works when you are buying a house. Homes in the same general location with the same number of rooms, square footage, and amenities are considered “comparable.”


pages: 130 words: 11,880

Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu

asset allocation, call centre, constrained optimization, correlation coefficient, diversification, financial engineering, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk

The price of XYZ a month from today is random: Assume that its value will either double or halve with equal probabilities. 80=S (u) 1 * S0 =$40 HH . j20=S (d) H 1 Today, we purchase a European call option to buy one share of XYZ stock for $50 a month from today. What is the fair price of this call option? Let us assume that we can borrow or lend money with no interest between today and next month, and that we can buy or sell any amount of the XYZ stock without any commissions, etc. These are part of the “frictionless market” assumptions we will address later in the manuscript. Further assume that XYZ will not pay any dividends within the next month. To solve the pricing problem, we consider the following hedging problem: Can we form a portfolio of the underlying stock (bought or sold) and cash (borrowed or lent) today, such that the payoff from the portfolio at the expiration date of the option will match the payoff of the option?


pages: 504 words: 139,137

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

activist fund / activist shareholder / activist investor, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Black-Scholes formula, book value, Brownian motion, business cycle, buy and hold, buy low sell high, buy the rumour, sell the news, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, currency risk, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, global macro, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, junk bonds, late capitalism, law of one price, Long Term Capital Management, low interest rates, managed futures, margin call, market clearing, market design, market friction, Market Wizards by Jack D. Schwager, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, Phillips curve, price discovery process, price stability, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Thaler, risk free rate, risk-adjusted returns, risk/return, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, short squeeze, SoftBank, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, tail risk, technology bubble, time dilation, time value of money, total factor productivity, transaction costs, two and twenty, value at risk, Vanguard fund, yield curve, zero-coupon bond

But outside the classroom, finance professors often run around chasing arbitrage opportunities. Fortunately, the arbitrage pricing theory not only tells you how to price securities in the absence of arbitrage, it also tells you how to exploit arbitrages if they do exist. Simply using the no-arbitrage condition and frictionless markets, we get a beautiful theory of relative asset pricing: A security can be “priced by arbitrage” in the sense that we can compute its fundamental value based on the value of other related securities. Arbitrage pricing can be done in the following three ways (of increasing complexity): 1. If two securities have the same payoffs, they must have the same value. 2.

Banks and hedge funds take the other side of this trade, making an expected profit, but not a certain arbitrage profit, as the option prices adjust to an efficiently inefficient level.5 ___________________ 1 See Frazzini and Pedersen (2013). 2 This version of the put-call parity requires that the stock does not pay any dividends before the option expiration. Otherwise, one must subtract the present value of the dividends on the right-hand side. 3 For American-type derivatives, one should check at every “node” in the tree whether exercise is optimal, but early exercise is not optimal for call options written on non-dividend-paying stocks in a frictionless market. 4 See Black and Scholes (1973) and Merton (1973), for which Myron Scholes (whom we meet in the interview in chapter 14) and Robert C. Merton won the Nobel Prize in 1997. (The Nobel Prize is not given posthumously, and Black passed away in 1995.) 5 Bollen and Whaley (2004) find evidence that option demand moves option prices and Gârleanu, Pedersen, and Poteshman (2009) present a model of demand-based option pricing with consistent evidence.


pages: 242 words: 68,019

Why Information Grows: The Evolution of Order, From Atoms to Economies by Cesar Hidalgo

Ada Lovelace, Albert Einstein, Arthur Eddington, assortative mating, business cycle, Claude Shannon: information theory, David Ricardo: comparative advantage, Douglas Hofstadter, Everything should be made as simple as possible, Ford Model T, frictionless, frictionless market, George Akerlof, Gödel, Escher, Bach, income inequality, income per capita, industrial cluster, information asymmetry, invention of the telegraph, invisible hand, Isaac Newton, James Watt: steam engine, Jane Jacobs, job satisfaction, John von Neumann, Joi Ito, New Economic Geography, Norbert Wiener, p-value, Paul Samuelson, phenotype, price mechanism, Richard Florida, Robert Solow, Ronald Coase, Rubik’s Cube, seminal paper, Silicon Valley, Simon Kuznets, Skype, statistical model, Steve Jobs, Steve Wozniak, Steven Pinker, Stuart Kauffman, tacit knowledge, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, total factor productivity, transaction costs, working-age population

He noted that descriptions of the economy overlooked obvious aspects, such as the fact that workers who relocate from one department to another within a company are responding not to the price system but to the orders of a manager, or that drafting and executing contracts often involves an awful lot of work. Coase noted that economic transactions were not easy, and that the economy was not as fluid as many of his colleagues liked to assume. In Coase’s view, the economy was not a collection of fluid and frictionless market transactions but a set of islands of conscious power, shielded from each other and from the dynamics of the price mechanisms. Firms are hierarchical, Coase emphasized, and the interactions between a firm’s workers are often political. So in Coase’s view, hiring a worker was a form of contract in which a person was hired to do a task that had not yet been specified, since what a worker will be asked to do a few months down the road is rarely known when she is hired.


Global Governance and Financial Crises by Meghnad Desai, Yahia Said

Asian financial crisis, bank run, banking crisis, Bretton Woods, business cycle, capital controls, central bank independence, corporate governance, creative destruction, credit crunch, crony capitalism, currency peg, deglobalization, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, floating exchange rates, frictionless, frictionless market, German hyperinflation, information asymmetry, Japanese asset price bubble, knowledge economy, liberal capitalism, liberal world order, Long Term Capital Management, low interest rates, market bubble, Meghnad Desai, Mexican peso crisis / tequila crisis, moral hazard, Nick Leeson, Nixon triggered the end of the Bretton Woods system, oil shock, open economy, Post-Keynesian economics, price mechanism, price stability, Real Time Gross Settlement, rent-seeking, short selling, special drawing rights, structural adjustment programs, Tobin tax, transaction costs, Washington Consensus

There is, first, the neo-liberal position, the dominant political economy perspective of the present period. There are several strands within neo-liberalism. At one extreme, neo-liberals are hyper-globalists, believing that globalisation is sweeping away all obstacles to free competition and frictionless markets (Held et al. 1999). The main obstacles that remain are nation-states and their attempts to safeguard and police their territorial jurisdictions. For these neo-liberals, the cause of financial crises is to be sought in the powers and activities of governments, which by intervening in inappropriate ways in financial markets, prevent them from working as they should and precipitate crises.


pages: 313 words: 84,312

We-Think: Mass Innovation, Not Mass Production by Charles Leadbeater

1960s counterculture, Andrew Keen, barriers to entry, bioinformatics, c2.com, call centre, citizen journalism, clean water, cloud computing, complexity theory, congestion charging, death of newspapers, Debian, digital divide, digital Maoism, disruptive innovation, double helix, Douglas Engelbart, Edward Lloyd's coffeehouse, folksonomy, frictionless, frictionless market, future of work, game design, Garrett Hardin, Google Earth, Google X / Alphabet X, Hacker Ethic, Herbert Marcuse, Hernando de Soto, hive mind, Howard Rheingold, interchangeable parts, Isaac Newton, James Watt: steam engine, Jane Jacobs, Jaron Lanier, Jean Tirole, jimmy wales, Johannes Kepler, John Markoff, John von Neumann, Joi Ito, Kevin Kelly, knowledge economy, knowledge worker, lateral thinking, lone genius, M-Pesa, Mark Shuttleworth, Mark Zuckerberg, Marshall McLuhan, Menlo Park, microcredit, Mitch Kapor, new economy, Nicholas Carr, online collectivism, Paradox of Choice, planetary scale, post scarcity, public intellectual, Recombinant DNA, Richard Stallman, Shoshana Zuboff, Silicon Valley, slashdot, social web, software patent, Steven Levy, Stewart Brand, supply-chain management, synthetic biology, the Cathedral and the Bazaar, The Death and Life of Great American Cities, the long tail, the market place, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Tragedy of the Commons, Whole Earth Catalog, work culture , Yochai Benkler, Zipcar

That is not to say that these critics do not raise important points, but they are qualifiers, not the main story. The fourth group argue the net will be mainly good for us. The members of this group, however, differ over why and how the net will be useful for society. The libertarian, free market wing believe the Internet is creating more diversity and choice, resulting in faster, frictionless markets and an abundance of free culture. In fact, the web is no less than a capitalist cornucopia. Chris Anderson, the editor of Wired and author of The Long Tail is the cheerleader for this camp. The communitarian optimists take a contrary view. They see in the Internet the possibility of community and collaboration, commons-based, peer-to-peer production, which will establish non-market and non-hierarchical organisations.


pages: 302 words: 95,965

How to Be the Startup Hero: A Guide and Textbook for Entrepreneurs and Aspiring Entrepreneurs by Tim Draper

3D printing, Airbnb, Apple's 1984 Super Bowl advert, augmented reality, autonomous vehicles, basic income, Berlin Wall, bitcoin, blockchain, Buckminster Fuller, business climate, carried interest, connected car, CRISPR, crowdsourcing, cryptocurrency, deal flow, Deng Xiaoping, discounted cash flows, disintermediation, Donald Trump, Elon Musk, Ethereum, ethereum blockchain, fake news, family office, fiat currency, frictionless, frictionless market, growth hacking, high net worth, hiring and firing, initial coin offering, Jeff Bezos, Kickstarter, Larry Ellison, low earth orbit, Lyft, Mahatma Gandhi, Marc Benioff, Mark Zuckerberg, Menlo Park, Metcalfe's law, Metcalfe’s law, Michael Milken, Mikhail Gorbachev, Minecraft, Moneyball by Michael Lewis explains big data, Nelson Mandela, Network effects, peer-to-peer, Peter Thiel, pez dispenser, Ralph Waldo Emerson, risk tolerance, Robert Metcalfe, Ronald Reagan, Rosa Parks, Salesforce, Sand Hill Road, school choice, school vouchers, self-driving car, sharing economy, Sheryl Sandberg, short selling, Silicon Valley, Skype, smart contracts, Snapchat, sovereign wealth fund, stealth mode startup, stem cell, Steve Jobs, Steve Jurvetson, Tesla Model S, Twitter Arab Spring, Uber for X, uber lyft, universal basic income, women in the workforce, Y Combinator, zero-sum game

The tokens purchased could be immediately marketable, and the price would fluctuate as the value of the underlying asset grew. Any project could be funded by a DAO offering, and any startup could raise money by simply initiating their own currency. In fact, it wouldn’t be limited to startups. Anyone could set up an ICO. Imagine the societal change and the frictionless market, the wealth and the jobs that could be created if everyone could raise their own money and have their labor valued through a fresh currency. As of this writing, Draper Associates has funded three ICOs. Bancor has the potential to transform marketplaces for projects and startups, Tezos has the potential to change how we govern ourselves globally, and Credo can be the vehicle we all use to put a value on email attention.


pages: 356 words: 103,944

The Globalization Paradox: Democracy and the Future of the World Economy by Dani Rodrik

"World Economic Forum" Davos, affirmative action, Alan Greenspan, Asian financial crisis, bank run, banking crisis, Bear Stearns, bilateral investment treaty, borderless world, Bretton Woods, British Empire, business cycle, capital controls, Carmen Reinhart, central bank independence, classic study, collective bargaining, colonial rule, Corn Laws, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, Doha Development Round, en.wikipedia.org, endogenous growth, eurozone crisis, export processing zone, financial deregulation, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, George Akerlof, guest worker program, Hernando de Soto, immigration reform, income inequality, income per capita, industrial cluster, information asymmetry, joint-stock company, Kenneth Rogoff, land reform, liberal capitalism, light touch regulation, Long Term Capital Management, low interest rates, low skilled workers, margin call, market bubble, market fundamentalism, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, microcredit, Monroe Doctrine, moral hazard, Multi Fibre Arrangement, night-watchman state, non-tariff barriers, offshore financial centre, oil shock, open borders, open economy, Paul Samuelson, precautionary principle, price stability, profit maximization, race to the bottom, regulatory arbitrage, Savings and loan crisis, savings glut, Silicon Valley, special drawing rights, special economic zone, subprime mortgage crisis, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tobin tax, too big to fail, trade liberalization, trade route, transaction costs, tulip mania, Washington Consensus, World Values Survey

The “rational expectations” revolution, which took as its premise that individuals do not make systematic prediction errors about the future course of the economy, gave us a better appreciation of the role that anticipatory, forward-looking behavior by firms, workers, and consumers plays in shaping economic outcomes. The “efficient market hypothesis,” built on the joint supposition of rational expectations and frictionless markets, taught us about the good that financial markets can do in the absence of transaction costs. These ideas made useful contributions to economics and to economic policy. But they did not upend everything we already knew. They simply gave us additional tools with which we could anticipate the economic consequences of different circumstances.


pages: 350 words: 103,988

Reinventing the Bazaar: A Natural History of Markets by John McMillan

accounting loophole / creative accounting, Albert Einstein, Alvin Roth, Andrei Shleifer, Anton Chekhov, Asian financial crisis, classic study, congestion charging, corporate governance, corporate raider, crony capitalism, Dava Sobel, decentralized internet, Deng Xiaoping, Dutch auction, electricity market, experimental economics, experimental subject, fear of failure, first-price auction, frictionless, frictionless market, George Akerlof, George Gilder, global village, Great Leap Forward, Hacker News, Hernando de Soto, I think there is a world market for maybe five computers, income inequality, income per capita, independent contractor, informal economy, information asymmetry, invisible hand, Isaac Newton, job-hopping, John Harrison: Longitude, John Perry Barlow, John von Neumann, Kenneth Arrow, land reform, lone genius, manufacturing employment, market clearing, market design, market friction, market microstructure, means of production, Network effects, new economy, offshore financial centre, ought to be enough for anybody, pez dispenser, pre–internet, price mechanism, profit maximization, profit motive, proxy bid, purchasing power parity, Robert Solow, Ronald Coase, Ronald Reagan, sealed-bid auction, search costs, second-price auction, Silicon Valley, spectrum auction, Stewart Brand, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, trade liberalization, transaction costs, War on Poverty, world market for maybe five computers, Xiaogang Anhui farmers, yield management

Since price dispersion continues to exist, it must be that even internet markets are subject to frictions—there are still some transaction costs. These are not costs of locating sellers or learning their prices, for those costs are close to zero. The remaining transaction costs are more subtle. They come from difficulties of observing quality. The internet has not created perfectly frictionless markets. The need for buyers to be able to trust sellers has been heightened by the internet. The hype notwithstanding, the internet in fact has not made information free. If shopping were merely a matter of finding the lowest price, the internet’s comparison shopping devices would eventually force all retailers to match their lowest-priced competitors.


Trading Risk: Enhanced Profitability Through Risk Control by Kenneth L. Grant

backtesting, business cycle, buy and hold, commodity trading advisor, correlation coefficient, correlation does not imply causation, delta neutral, diversification, diversified portfolio, financial engineering, fixed income, frictionless, frictionless market, George Santayana, global macro, implied volatility, interest rate swap, invisible hand, Isaac Newton, John Meriwether, Long Term Capital Management, managed futures, market design, Myron Scholes, performance metric, price mechanism, price stability, proprietary trading, risk free rate, risk tolerance, risk-adjusted returns, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, the scientific method, The Wealth of Nations by Adam Smith, transaction costs, two-sided market, uptick rule, value at risk, volatility arbitrage, yield curve, zero-coupon bond

., private equity investments), trade execution considerations and liquidity constraints may be such that you may have to suffer significant drawdown in order to achieve the desired returns. In such a case, it is instructive to understand the associated magnitudes. By contrast, short-term trading of liquid securities in relatively frictionless markets should not demand that enormous pain be endured in order to achieve your targeted objectives. • Return over Maximum Drawdown (ROMAD). This statistic, in which annual returns are expressed as a percentage of the worst drawdown experienced over a specified period of analysis, actually represents what many people believe to be the most accurate available measure of risk-adjusted return.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

Affordable Care Act / Obamacare, Alan Greenspan, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bear Stearns, Bernie Madoff, book value, break the buck, centre right, collapse of Lehman Brothers, collateralized debt obligation, commoditize, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Future Shock, Glass-Steagall Act, government statistician, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, junk bonds, light touch regulation, Long Term Capital Management, low earth orbit, low interest rates, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Neil Armstrong, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, plutocrats, Ponzi scheme, price anchoring, price stability, proprietary trading, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Ronald Reagan, tail risk, too big to fail, trickle-down economics, value at risk, yield curve

That sad tale is the story of the next chapter. 11 Collecting nickels in front of steamrollers The previous chapter looked at the monumental risks that have built up in a system dedicated to the management, dispersal, and efficient pricing of risk. There’s quite a paradox here. Financial markets are often said to come as close as is possible to the economists’ ideal of a competitive, well-informed, frictionless market. If neoclassical economic theory made any kind of sense, financial markets should be its showcase: the best possible example of markets in action. Unfortunately, markets don’t follow theory; they prefer reality. And reality is messy, full of compromise and skewed, absent, or contradictory incentives.


pages: 446 words: 117,660

Arguing With Zombies: Economics, Politics, and the Fight for a Better Future by Paul Krugman

affirmative action, Affordable Care Act / Obamacare, Alan Greenspan, Andrei Shleifer, antiwork, Asian financial crisis, bank run, banking crisis, basic income, behavioural economics, benefit corporation, Berlin Wall, Bernie Madoff, bitcoin, blockchain, bond market vigilante , Bonfire of the Vanities, business cycle, capital asset pricing model, carbon footprint, carbon tax, Carmen Reinhart, central bank independence, centre right, Climategate, cognitive dissonance, cryptocurrency, David Ricardo: comparative advantage, different worldview, Donald Trump, Edward Glaeser, employer provided health coverage, Eugene Fama: efficient market hypothesis, fake news, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, frictionless, frictionless market, fudge factor, full employment, green new deal, Growth in a Time of Debt, hiring and firing, illegal immigration, income inequality, index fund, indoor plumbing, invisible hand, it is difficult to get a man to understand something, when his salary depends on his not understanding it, job automation, John Snow's cholera map, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, large denomination, liquidity trap, London Whale, low interest rates, market bubble, market clearing, market fundamentalism, means of production, Modern Monetary Theory, New Urbanism, obamacare, oil shock, open borders, Paul Samuelson, plutocrats, Ponzi scheme, post-truth, price stability, public intellectual, quantitative easing, road to serfdom, Robert Gordon, Robert Shiller, Ronald Reagan, secular stagnation, Seymour Hersh, stock buybacks, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, trade liberalization, transaction costs, universal basic income, very high income, We are all Keynesians now, working-age population

And if the analysis of where we are now rests on this fudge factor, how much confidence can we have in the models’ predictions about where we are going? The state of macro, in short, is not good. So where does the profession go from here? VII. FLAWS AND FRICTIONS Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision—that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don’t have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal.


Adam Smith: Father of Economics by Jesse Norman

active measures, Alan Greenspan, Andrei Shleifer, balance sheet recession, bank run, banking crisis, Basel III, Bear Stearns, behavioural economics, Berlin Wall, Black Swan, Branko Milanovic, Bretton Woods, British Empire, Broken windows theory, business cycle, business process, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, centre right, cognitive dissonance, collateralized debt obligation, colonial exploitation, Corn Laws, Cornelius Vanderbilt, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, David Ricardo: comparative advantage, deindustrialization, electricity market, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, Fellow of the Royal Society, financial engineering, financial intermediation, frictionless, frictionless market, future of work, George Akerlof, Glass-Steagall Act, Hyman Minsky, income inequality, incomplete markets, information asymmetry, intangible asset, invention of the telescope, invisible hand, Isaac Newton, Jean Tirole, John Nash: game theory, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, lateral thinking, loss aversion, low interest rates, market bubble, market fundamentalism, Martin Wolf, means of production, mirror neurons, money market fund, Mont Pelerin Society, moral hazard, moral panic, Naomi Klein, negative equity, Network effects, new economy, non-tariff barriers, Northern Rock, Pareto efficiency, Paul Samuelson, Peter Thiel, Philip Mirowski, price mechanism, principal–agent problem, profit maximization, public intellectual, purchasing power parity, random walk, rent-seeking, Richard Thaler, Robert Shiller, Robert Solow, Ronald Coase, scientific worldview, seigniorage, Socratic dialogue, South Sea Bubble, special economic zone, speech recognition, Steven Pinker, The Chicago School, The Myth of the Rational Market, The Nature of the Firm, The Rise and Fall of American Growth, The Theory of the Leisure Class by Thorstein Veblen, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, time value of money, transaction costs, transfer pricing, Veblen good, Vilfredo Pareto, Washington Consensus, working poor, zero-sum game

And as with physics, it purported to be memoryless; for what could the point be of memory or history in a hard science, where present results supersede past ones? And the idea of homo economicus changed as well. As general equilibrium thinking moved to centre stage, individuals came to be seen increasingly not even as human at all, but as mere economic agents, atoms cut off from others, perfectly rational, operating in an exceptionless way in frictionless markets possessed of perfect information. The theory itself was highly abstract, not to say utopian—no such state of affairs existed or ever could exist in nature—and rather than reasoning from nature directly, it took perfect market conditions as its starting point. And it was static in character.


pages: 567 words: 122,311

Lean Analytics: Use Data to Build a Better Startup Faster by Alistair Croll, Benjamin Yoskovitz

Airbnb, Amazon Mechanical Turk, Amazon Web Services, Any sufficiently advanced technology is indistinguishable from magic, barriers to entry, Bay Area Rapid Transit, Ben Horowitz, bounce rate, business intelligence, call centre, cloud computing, cognitive bias, commoditize, constrained optimization, data science, digital rights, en.wikipedia.org, Firefox, Frederick Winslow Taylor, frictionless, frictionless market, game design, gamification, Google X / Alphabet X, growth hacking, hockey-stick growth, Infrastructure as a Service, Internet of things, inventory management, Kickstarter, lateral thinking, Lean Startup, lifelogging, longitudinal study, Marshall McLuhan, minimum viable product, Network effects, PalmPilot, pattern recognition, Paul Graham, performance metric, place-making, platform as a service, power law, price elasticity of demand, reality distortion field, recommendation engine, ride hailing / ride sharing, rolodex, Salesforce, sentiment analysis, skunkworks, Skype, social graph, social software, software as a service, Steve Jobs, subscription business, telemarketer, the long tail, transaction costs, two-sided market, Uber for X, web application, Y Combinator

Visualizing a Two-Sided Marketplace Figure 13-1 illustrates a user’s flow through a two-sided marketplace, along with the key metrics at each stage. Figure 13-1. Two-sided marketplaces—twice the metrics, twice the fun Wrinkles: Chicken and Egg, Fraud, Keeping the Transaction, and Auctions In the early days of the Web, pundits predicted an open, utopian world of frictionless markets that were transparent and efficient. But as Internet giants like Google, Amazon, and Facebook have shown, parts of the Web are dystopian. Two-sided marketplaces are subject to strong network effects—the more inventory they have to offer, the more useful they become. A marketplace with no inventory, on the other hand, is useless.


Analysis of Financial Time Series by Ruey S. Tsay

Asian financial crisis, asset allocation, backpropagation, Bayesian statistics, Black-Scholes formula, Brownian motion, business cycle, capital asset pricing model, compound rate of return, correlation coefficient, data acquisition, discrete time, financial engineering, frictionless, frictionless market, implied volatility, index arbitrage, inverted yield curve, Long Term Capital Management, market microstructure, martingale, p-value, pattern recognition, random walk, risk free rate, risk tolerance, short selling, statistical model, stochastic process, stochastic volatility, telemarketer, transaction costs, value at risk, volatility smile, Wiener process, yield curve

We briefly discuss the bid-ask bounce—namely, the bid-ask spread introduces negative lag-1 serial correlation in an asset return. Consider the simple model of Roll (1984). The observed market price Pt of an asset is assumed to satisfy S Pt = Pt∗ + It , 2 (5.9) 180 HIGH - FREQUENCY DATA where S = Pa − Pb is the bid-ask spread, Pt∗ is the time-t fundamental value of the asset in a frictionless market, and {It } is a sequence of independent binary random variables with equal probabilities (i.e., It = 1 with probability 0.5 and = −1 with probability 0.5). The It can be interpreted as an order-type indicator, with 1 signifying buyer-initiated transaction and −1 seller-initiated transaction.


pages: 442 words: 39,064

Why Stock Markets Crash: Critical Events in Complex Financial Systems by Didier Sornette

Alan Greenspan, Asian financial crisis, asset allocation, behavioural economics, Berlin Wall, Black Monday: stock market crash in 1987, Bretton Woods, Brownian motion, business cycle, buy and hold, buy the rumour, sell the news, capital asset pricing model, capital controls, continuous double auction, currency peg, Deng Xiaoping, discrete time, diversified portfolio, Elliott wave, Erdős number, experimental economics, financial engineering, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, global village, implied volatility, index fund, information asymmetry, intangible asset, invisible hand, John von Neumann, joint-stock company, law of one price, Louis Bachelier, low interest rates, mandelbrot fractal, margin call, market bubble, market clearing, market design, market fundamentalism, mental accounting, moral hazard, Network effects, new economy, oil shock, open economy, pattern recognition, Paul Erdős, Paul Samuelson, power law, quantitative trading / quantitative finance, random walk, risk/return, Ronald Reagan, Schrödinger's Cat, selection bias, short selling, Silicon Valley, South Sea Bubble, statistical model, stochastic process, stocks for the long run, Tacoma Narrows Bridge, technological singularity, The Coming Technological Singularity, The Wealth of Nations by Adam Smith, Tobin tax, total factor productivity, transaction costs, tulip mania, VA Linux, Y2K, yield curve

As a consequence, Bachelier and Samuelson argued that any advantageous information that may lead to a profit opportunity is quickly eliminated by the feedback that their action has on the price. Their point is that the price variations in time are not independent of the actions of the traders; on the contrary, it results from them. If such feedback action occurs instantaneously, as in an idealized world of idealized “frictionless” markets and costless trading, then prices must always fully reflect all available information and no profits can be garnered from information-based trading (because such profits have already been captured). This fundamental concept introduced by Bachelier, now called “the efficient market hypothesis,” has a strong counterintuitive and seemingly contradictory flavor to it: the more active and efficient the market, the more intelligent and hard working the investors; as a consequence the more random is the sequence of price changes generated by such a market.


pages: 695 words: 194,693

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

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, book value, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, Cass Sunstein, classic study, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, Cornelius Vanderbilt, 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, equity risk premium, financial engineering, 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, land bank, Louis Bachelier, low interest rates, 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, public intellectual, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, subprime mortgage crisis, Suez canal 1869, Suez crisis 1956, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, tontine, too big to fail, trade liberalization, trade route, transatlantic slave trade, tulip mania, wage slave

The Black-Scholes formula, as it is now referred to, was mathematically sophisticated, but at its heart it contained a novel economic—as opposed to mathematical—insight. They discovered that the invisible hand setting option prices was risk-neutral. Option payoffs could be replicated risklessly, provided one could trade in an ideal, frictionless market in which stocks behaved according to Brownian motion. Later researchers4 developed a simple framework called a “binomial model” that was able to match the payoff of a put or a call by trading just the stock and a bond through time. These solutions to the option pricing problem linked finance and physics together forever afterward.


pages: 1,034 words: 241,773

Enlightenment Now: The Case for Reason, Science, Humanism, and Progress by Steven Pinker

3D printing, Abraham Maslow, access to a mobile phone, affirmative action, Affordable Care Act / Obamacare, agricultural Revolution, Albert Einstein, Alfred Russel Wallace, Alignment Problem, An Inconvenient Truth, anti-communist, Anton Chekhov, Arthur Eddington, artificial general intelligence, availability heuristic, Ayatollah Khomeini, basic income, Berlin Wall, Bernie Sanders, biodiversity loss, Black Swan, Bonfire of the Vanities, Brexit referendum, business cycle, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, carbon tax, Charlie Hebdo massacre, classic study, clean water, clockwork universe, cognitive bias, cognitive dissonance, Columbine, conceptual framework, confounding variable, correlation does not imply causation, creative destruction, CRISPR, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, dark matter, data science, decarbonisation, degrowth, deindustrialization, dematerialisation, demographic transition, Deng Xiaoping, distributed generation, diversified portfolio, Donald Trump, Doomsday Clock, double helix, Eddington experiment, Edward Jenner, effective altruism, Elon Musk, en.wikipedia.org, end world poverty, endogenous growth, energy transition, European colonialism, experimental subject, Exxon Valdez, facts on the ground, fake news, Fall of the Berlin Wall, first-past-the-post, Flynn Effect, food miles, Francis Fukuyama: the end of history, frictionless, frictionless market, Garrett Hardin, germ theory of disease, Gini coefficient, Great Leap Forward, Hacker Conference 1984, Hans Rosling, hedonic treadmill, helicopter parent, Herbert Marcuse, Herman Kahn, Hobbesian trap, humanitarian revolution, Ignaz Semmelweis: hand washing, income inequality, income per capita, Indoor air pollution, Intergovernmental Panel on Climate Change (IPCC), invention of writing, Jaron Lanier, Joan Didion, job automation, Johannes Kepler, John Snow's cholera map, Kevin Kelly, Khan Academy, knowledge economy, l'esprit de l'escalier, Laplace demon, launch on warning, life extension, long peace, longitudinal study, Louis Pasteur, Mahbub ul Haq, Martin Wolf, mass incarceration, meta-analysis, Michael Shellenberger, microaggression, Mikhail Gorbachev, minimum wage unemployment, moral hazard, mutually assured destruction, Naomi Klein, Nate Silver, Nathan Meyer Rothschild: antibiotics, negative emissions, Nelson Mandela, New Journalism, Norman Mailer, nuclear taboo, nuclear winter, obamacare, ocean acidification, Oklahoma City bombing, open economy, opioid epidemic / opioid crisis, paperclip maximiser, Paris climate accords, Paul Graham, peak oil, Peter Singer: altruism, Peter Thiel, post-truth, power law, precautionary principle, precision agriculture, prediction markets, public intellectual, purchasing power parity, radical life extension, Ralph Nader, randomized controlled trial, Ray Kurzweil, rent control, Republic of Letters, Richard Feynman, road to serfdom, Robert Gordon, Rodney Brooks, rolodex, Ronald Reagan, Rory Sutherland, Saturday Night Live, science of happiness, Scientific racism, Second Machine Age, secular stagnation, self-driving car, sharing economy, Silicon Valley, Silicon Valley ideology, Simon Kuznets, Skype, smart grid, Social Justice Warrior, sovereign wealth fund, sparse data, stem cell, Stephen Hawking, Steve Bannon, Steven Pinker, Stewart Brand, Stuxnet, supervolcano, synthetic biology, tech billionaire, technological determinism, technological singularity, Ted Kaczynski, Ted Nordhaus, TED Talk, The Rise and Fall of American Growth, the scientific method, The Signal and the Noise by Nate Silver, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, total factor productivity, Tragedy of the Commons, union organizing, universal basic income, University of East Anglia, Unsafe at Any Speed, Upton Sinclair, uranium enrichment, urban renewal, W. E. B. Du Bois, War on Poverty, We wanted flying cars, instead we got 140 characters, women in the workforce, working poor, World Values Survey, Y2K

They allow people to transfer money, order supplies, track the weather and markets, find day labor, get advice on health and farming practices, even obtain a primary education.50 An analysis by the economist Robert Jensen subtitled “The Micro and Mackerel Economics of Information” showed how South Indian small fishermen increased their income and lowered the local price of fish by using their mobile phones at sea to find the market which offered the best price that day, sparing them from having to unload their perishable catch on fish-glutted towns while other towns went fishless.51 In this way mobile phones are allowing hundreds of millions of small farmers and fishers to become the omniscient rational actors in the ideal frictionless markets of economics textbooks. According to one estimate, every cell phone adds $3,000 to the annual GDP of a developing country.52 The beneficent power of knowledge has rewritten the rules of global development. Development experts differ on the wisdom of foreign aid. Some argue that it does more harm than good by enriching corrupt governments and competing with local commerce.53 Others cite recent numbers which suggest that intelligently allocated aid has in fact done tremendous good.54 But while they disagree on the effects of donated food and dollars, all agree that donated technology—medicines, electronics, crop varieties, and best practices in agriculture, business, and public health—has been an unalloyed boon.