Financial Intermediation...

Another brilliant segment from the recent IMF conference on Financial Intermediation.  I particularly recommend the last two speakers: Hyun Song Shin (who comes on at about 45 minutes) and Adair Turner of the FSA (who follows Prof. Shin).



Update: Check out the Q&A session.  Adair Turner makes some very interesting remarks about high-frequency/algorithmic trading.  In particular, he questions their social value by first supposing that such algorithms are not destabilizing in and of themselves, and then asking the audience to consider under these ideal circumstances whether or not they are really necessary as a price discovery mechanism or whether they provide liquidity in a socially useful way.

Riding in a car with a Nobel laureate...

I had the experience of a life-time this past Tuesday when I attended a master class on mechanism design taught by 2007 Nobel Prize winner Prof. Eric Maskin at St. Andrews University. The morning lectures were on auctions and incomplete contracts, whilst the afternoon lecture was on voting theory.  I would provide link, but class materials have not been posted to the web (yet).

It was an absolutely amazing day all around...

Relevant to my ongoing research project, I would like to point out the following papers recommended by Prof. Maskin as being particularly relevant to understanding the recent financial crisis:

1. Diamond and Dybvig (1983): Bank Runs, Deposit Insurance, and Liquidity
2. Holmstrom and Tirole (1998): Private and Public Supply of Liquidity
3. Dewatripont and Tirole (1994): The Prudential Regulation of Banks
4. Kiyotaki and Moore (1997): Credit Cycles
5. Fostel and Geanakoplos(2008): Leverage Cycles and the Anxious Economy

Adair Turner of the FSA is saying interesting things...

I thought I would share some links relevant to a very fine speech given by FSA chairman Lord Adair Turner on the role of banks in the economy.  A summary of the speech can be found here (some of which I share below).  The speech in its entirety as well as the lecture slides can be found here.

Two of the more memorable (and relevant...for me at least) passages of the speech are below:

"Adair Turner noted the huge growth in scale of the financial system over the last 15 years, driven by increased leverage in household and some corporate sectors, complex securitisation and trading. He said it was important to ask whether this growth had created ‘economic value added’. In addition to his point about policy tools to influence credit, he made two additional conclusions:

• The financial innovations of complex securitisation and credit derivatives may, if purged of their excesses, have potential to improve bank risk management, but the pre-crisis argument they created major economic efficiency benefits was hugely overstated. We need to recognise that securitised credit can increase the volatility of supply: so macro prudential tools, therefore, need ideally to be able to constrain securitised credit markets as well as on-balance sheet credit.

• We need a new philosophical approach to “market liquidity” which recognises that market liquidity is beneficial up to a point but not beyond that point, so that more liquidity, supported by more trading, is not always necessarily beneficial.  This implies a bias to conservatism in our setting of capital requirements against trading activity: it reinforces the case for limiting via capital requirements the extent to which commercial banks are involved in proprietary trading; and it may argue in favour of financial transaction taxes." 

Brilliant set of videos from the IMF...

Below I have embedded the videos for the the first two sessions (the rest can be found by following the link) of the recent IMF conference on "Macro and Growth Policies in the Wake of the Crisis."  I haven't watched all of the videos (actually only in the middle of the first session on monetary policy), but thought I would share anyway...

Session I: Monetary Policy


Session II: Fiscal Policy


A summary of Olivier Blanchard's summary of the conference: In what follows things in bold and italics are a mixture of my emphasis and Blanchard's.  If you don't care what I think is important just follow the previous link...

1. We’ve entered a brave new world in the wake of the crisis; a very different world in terms of policy making and we just have to accept it. 
2. In the age-old discussion of the relative roles of markets and the state, the pendulum has swung—at least a bit—toward the state. 
3. The crisis made it clear that there are many distortions relevant for macroeconomics, many more than we thought earlier. We had ignored them, thinking they were the province of the micro-economist. As we integrate finance into macroeconomics, we’re discovering distortions within finance are macro-relevant. Agency theory—about incentives and behavior of entities or “agents”—is needed to explain how financial institutions work or do not work and how decisions are taken. Regulation and agency theory applied to regulators is important. Behavioral economics and its cousin, behavioral finance, are central as well. 
4. Macroeconomic policy has many targets and many instruments (that is, the tools we use or variables to implement policy). There are many examples of this that were discussed at the conference 
5. We may have many policy instruments, but we are not sure how to use them. In many cases, we are uncertain about what they are, how they should be used, and whether or not they will work. Again, many examples came up during the conference.
1. We don’t quite know what liquidity is, so a liquidity ratio is one more step into the unknown.
2. It was clear that some people believe capital controls work and some don’t. 
3. Paul Romer made the point that, if you adopt a set of financial regulations and keep them unchanged, the markets will find a way around, and ten years later, you’ll have a financial crisis. 
4. Mike Spence talked about the relative roles of self-regulation and regulation. Both are needed, but how we combine them is extremely unclear. 
6. While these instruments are potentially useful, their use raises a number of political economy issues. 
7. Where do we go from here? In terms of research, the future is exciting. There are many topics on which we should work—namely macro issues with, as Joe Stiglitz said, the right micro foundations. 
8. Things are harder on the policy front. Given we don’t quite know how to use the new tools and they can be misused, how should policymakers proceed? While we have a good sense of where we want to get to, a step-by-step approach is the way to do it. Pragmatism is of the essence. This was a general theme that came up, for example, in Andrew Sheng’s discussion of the adaptive Chinese growth model. We have to try things carefully and see how they work. 
9. We have to keep our hopes in check. There are going to be new crises that we have not anticipated. And, despite our best efforts, we could have old-type crises again. That was a theme in Adair Turner’s discussion of credit cycles. Can we, using agency theory and the right regulations, get rid of credit cycles? Or is it basic human nature that, no matter what we do, they will come back in some form?

Really interesting interview with BoE Governor Mervyn King...

Excellent, wide-ranging interview.  The following quote made me stop and think...

“The more I’ve thought about how labour markets work, the more I’ve realised that there are hardly any jobs whose tasks you can describe exactly. Nowadays, most jobs have the property that employees can choose to do them well or badly, so employers need to think about the long-term welfare of the staff not just pay today.”

Another nice comment more relevant to my current line of research:

“I wish I’d spoken out more forcefully about the build-up of leverage.”

Amen, brother...Amen.

Quote of the Day...

"Let me begin by asserting that the world we live in is not an ergodic world; it is a non-ergodic world.  I like the term 'ergodic'.  If I say the world is ergodic, I mean that it has stable underlying structure, such that we can develop theory that can be applied time after time consistently.  It is very important to understand that the world with which we are concerned is continually changing, is continually novel.  That does not mean that there are not ergodic aspects of the world.  But we can not develop theory that can be used over and over again and over time.  For an enormous number of issues that are important to us, the world is one of novelty and change; it does not repeat itself."

-Douglass North, 1993 Nobel Laureate in Economics

Update: The formulation of the above quote was taken from an article in the Royal Statistical Society's Significance Magazine, and is different than the verbatim quote from Douglass North's article I link to above.  Though the magazine article is good, North's journal article is one of the best, most thought provoking articles that I have read in some time.  It would definitely be worth reading...

South Shiel Ridge...

Just got back from an excellent weekend hillwalking in Glen Shiel with the EUHWC.  The weather on Saturday was superb, and a group of us decided to take advantage of the weather and tackle the long traverse of the seven Munros on the South Glen Shiel Ridge.  What follows are my pics and trip report...

The Morning View...
My friends and I stayed at the Ratagan Youth Hostel.  This was the view that I had while drinking coffee and getting ready to head into the hills...

The South Glen Shiel Ridge, Saturday 5 March 2011:


The route begins at the parking lot across the road from the Cluanie Inn.  From there cross the road and head south along a well kept land-rover track towards the Cluanie Lodge.

Continue past the turn-off to the lodge along the land-rover track about a mile or so until you reach stream and a fence crossing.  At this point you can either continue along the land-rover track around behind the ridge and follow a well marked path to the top of Creag a'Mhaim (the first of the seven Munros), or you can cross the fence and head off-road along a much steeper (but more direct route) to the top.  I chose the steeper more direct route.  Here is a shot from about half-way up...

Here is another one of the group crossing the upper "snow field" just below the summit.  We were carrying ice axes and crampons, but we encountered very little snow.  I pulled the ice axe out a few times, but never had to bother with the crampons...

The view of the north Glen Shiel Ridge from the top of Creag a'Mhaim...

After ascending Creag a'Mhaim and enjoying the view, we moved on towards the second Munro, Druim Shionnach.  Along the way I ran into my brocken-spectre and found myself in a full on cloud inversion...

This photo from the summit of Druim Shionnach of Ben Nevis in full cloud inversion is one of my all-time favourites.  Although it doesn't look it from the photo, the summit of Ben Nevis is roughly 400 meters higher than I was at the time the photo was taken...

From the summit of Druim Shionnach, we descended to a bealach before heading up towards the third Munro called Aonach air-Chrith.  At 1021 m, Aonach air-Chrith was the highest of the seven Munros I climbed on Saturday.  Here is a nice photo of our approach...

...and here is the view from the summit (where I ate my lunch)...

After a nice break on the summit of Aonach air-Chrith we descended to another bealach before ascending the fourth Munro, Maol chinn-Dearg. Here is the group on the approach.  The actual summit is the flat bit in the middle of the photo above the snow.

We didn't linger long on the summit, and instead pressed on towards the fifth Munro, Sgurr an Doire Leathain. Here is the group about mid-way between Maol chinn-Dearg and Sgurr an Doire Leathain.  We are a bit hard to pick out in the photo...but if you look closely you will see a group of people moving along the path about midway up the grassy slope.  Follow the ridge line up to the left and then back around to the right a bit and you will find the summit of Sgurr an Doire Leathain...

The sixth Munro, Sgurr an Lochain, is very close to the summit of the Sgurr an Doire Leathain and requires only a descent and re-ascent of about 100 m.  If any of the seven Munros of the South Shiel Ridge will ever get down-graded, I suspect this would be the one...

Last but not least, I include a nice shot of the approach to the last Munro, Creag nam Damh...

What a day!  Hope you enjoyed the photos.  In total, we climbed seven Munros over 14 miles in 10 hours with roughly 2000  meters (6500 ft.) of ascent.  Definitely one of my great days out in the hills...if only a certain someone and our Schnauzer had been able to come along it would have been perfect.

Why networks matter in finance...

I have recently been on the defensive regarding the importance of networks in financial markets, and I feel that I have not done a good job of explaining my position to a sceptical audience.  This post is an attempt to organize my thoughts on the subject in a manner that will make sense to non-network people.  For those readers who are "network people" and want to understand why/how networks matter check out the Financial Network Analysis research database.

First of all, I don't like the claim "networks matter."  It is much too general a statement to be of any use.  Context matters.  I claim that within the context of finance, thinking about the functioning (or lack thereof) of financial markets requires considering the inter-weaving of financial contracts across space and across time.  I further claim that network theory provides a useful set of analytical tools to model the complex interdependencies that such financial contracts create.

How does this relate to my own research? At its core, my model is a story about how spillovers across time are transformed by the credit network into spillovers across space.  The chief result being that the density of the network of financial contracts plays a key role in amplifying the transformation of spillovers across time into spillovers across space.

Does this make any sense?  I really made an effort to distil my point as much as possible...

Rejected for this year's Santa Fe CSSS...

Just found out that my application to this year's Santa Fe CSSS has been rejected.  Not sure what to say...attending the Santa Fe Institute's complex systems summer school has been a dream of mind ever since I was made aware of its existence.  I thought I had a really strong package.  I wrote a strong, and topical research proposal on computational approaches to studying financial networks with an eye towards systemic risk analysis, and I had excellent references (including a reference from a Santa Fe external faculty member).  The only thing that my application next year might have that is different is some publications (although given the time lags in publishing in economics journals even this is doubtful).

I think what frustrates me the most is that I started my PhD with a strong desire to do exactly the type of interdisciplinary research that has made the Santa Fe Institute so famous, and I feel like I am not off to a good start in this regard.  I was really hoping that Santa Fe would provide some much needed interaction with other researchers who thought and talked about the economy in the same way that I do.  For the most part I can't even get anyone at Edinburgh to acknowledge that networks can be a useful modelling tool to study complex economic interdependencies, much less that networks themselves might play an important role in economic activity.  I don't even attempt to mention complex systems...accept when I am in the School of Informatics...

OK, I am done ranting...now I need to decide whether or not I should bother applying (really gathering the additional references) for the Graduate Workshop in Computational Social Sciences...deadline is March 18th...only 10 spots are available...