Peter Levin’s Rethinking Markets

August 20, 2008

Something New - Markets and Art

Filed under: Art, Culture, Institutional, Markets, Organizations, Prices — Peter @ 8:48 am

As an experiment in sociology and blogging, Jenn (from whatisthewhat.wordpress.com) and I have put together a brief video on culture and markets, the beginning of what we hope will be a conversation at the intersection of culture, sociology, and economics. We’ll work on the lighting and switch off the big-head/small-head, but we hope you like it.

If you have thoughts, we’d love to hear them, but we hope you’ll be at least a little kind - this is one of those situations where your self-identity as brutally honest should not trump your self-identity as gracious.

And the links to the videos we reference: Fashion File: Making an Hermes Bag, and Contemporary Art Preview

Art and Markets 1: Selling Crafts and Art from Peter Levin on Vimeo.

July 21, 2008

Unhelpful institutional theory, real world

Filed under: Institutional — Peter @ 10:41 am

Let’s say that the CEO of an organization publicly announces during a board meeting that if the org misses its (ambitious) numbers over the coming year, she will eliminate X employees. We know that often, public announcements of impossible goals get met not by actually meeting those goals, but by shifting the goalposts down the line - (i.e., that the $10 million gap somehow gets filled at the last moment, or that fuzzy ‘productivity’ numbers come into line somehow). But just as often, those publicly-stated goalposts force company’s do make real changes, despite their often-symbolic nature (i.e., that Exxon commits itself publicly but symbolically to ‘green technologies,’ which then gives employee activists ammunition to start up a costly recycling program which otherwise the company would reject).

But when are ambitious, symbolic statements going to be decoupled from on-the-ground changes, and when are ambitious, symbolic statements going to be the impetus for on-the-ground changes? Absent a wave to ‘well-situated activists’ or somesuch, do we really have an answer here?

February 19, 2008

Setting a Meeting, Academia-style

Filed under: Institutional — Peter @ 12:59 pm

Having trouble finding a common time to set a meeting? Problem solved! Pass this handy-dandy sheet along to all the member of the committee, and let the matchy-matchy begin! I guarantee that, unless someone is out of town, you will be able to nail down a time within an absolute maximum two-week window.

Make-a-meeting

February 7, 2008

What is XBRL, and Who does XBRL help?

Filed under: Data, Institutional, Markets, Technology — Peter @ 10:02 am

Put it on your radar screens, the next big thing is going to be XBRL. It stands for extensible business reporting language, and it is meant to commensurate business reporting via standardization. So instead of entering text into an annual report, companies, governments, NGOs, anyone who would like to comply with governmental mandate will be using XBRL. You can think of XBRL as a set of metatags for financial and company data, so that instead of bracket-tags for header, title, links, etc. you would have bracket-tags for earnings, time periods, definitions of costs, etc.

From CoreFiling’s insight blog: “It won’t be very long before it is those documents - the bar-coded financial disclosures - that will be the primary materials consumed by financial market systems to help analysts and investors make decisions about the best way to invest. This is vastly more sophisticated than today’s processes that rely on slow and inaccurate re-keying of a subset of the financial information published by companies.”

This is commensuration more than just standardization, since the tags are designed to be specific to a particular business enough so that everyone is not required to give the same information, yet the tags are standardized enough that everyone is required to give information that can be made comparable. The pitch for companies (other than, because otherwise we’ll fine you and take away your business license) is that XBRL will make their financial reporting less costly, less prone to error, and ultimately more efficient.

Personally, I think this is a flat out misrepresentation of what’s going on here. XBRL helps one group of people orders of magnitude more than anyone else: investors. And the trade-off between increased government efficiency and business streamlining of compliance data on the one hand, and increased ability for data-gatherers for banks, hedge funds, and the investor class is totally totally off the charts. What this will end up doing is: 1) creating a standard way for companies to report financials; 2) creating some increased efficiency for government entities to keep tabs on the finances of these organizations; and 3) create a massive additional datastream for financial services and investment firms to work with. If you think it is a challenge for public firms to resist making short-term decisions based on financial analysts’ quarterly reports of earnings now, wait until this information is directly readable by quant trading models.

This would be an amazing dissertation topic. I would track: a) the creation of the standard; b) the adoption of the standard around the world; c) how XBRL is being incorporated into financial modeling; d) the before-and-after effects of XBRL on market prices for firms; and e) qualitatively, what gets excised from XBRL, or rather, what remains incommensurable about firms, governments, etc.

UBMatrix
XBRL’s main site
US SEC’s ‘Interactive Data Viewers’
Microsoft uses XBRL
US GAAP XBRL Taxonomy (GAAP is the accounting standard in the US)
CoreFiling

February 6, 2008

Black Swans, Risk Management, and Undersea Cables

Filed under: Institutional, Technology — Peter @ 11:16 pm

I’ve taken issue before with Nassim Nicholas Taleb’s black swan thesis, that high-impact, low-probability events are responsible for market crises and accidents. The more general implication is, as Taleb and Pilpel note:

What matters in life is the equation probability × consequence. This point might appear to be simple, but its consequences are not.

Suppose that you are deriving probabilities of future occurrences from the data, assuming that the past is representative of the future. An event can be an earthquake, a market crash, a spurt in inflation, hurricane damage in an area, a flood, crops destroyed by a disease, people affected in an epidemic, destruction caused by terrorism, etc. Note the following: the severity of the event, will be in almost all cases inversely proportional to its frequency: the ten-year flood will be more frequent than the 100 year flood – and the 100 year flood will be more devastating.

Now comes word that some number (actually up to 5 now) of undersea cables have been cut, knocking a wide area of the Middle East off the internet, particularly the route between Europe and Egypt, and from there to the rest of the Middle East.

But where is the 100 year flood? What appears to have happened is a connected series of accidents and snafus, including possibly the weather, an anchor dragging along the sea floor, or who knows what. Mysterious. What I would contend, drawing from org theory, is that what is more dangerous than a 100 year flood is a sequence of preventable, unforeseen errors. That is, it is the disruption of the routine more than a freakish activity that is most likely to create accidents and crises. The routine fire in a particularly bad location, a minor earthquake in an unexpected place, a sequence of coupled organizational routines that lead one-to-another into disaster. It’s not that you shouldn’t be looking for the next giant storm that’s inevitably coming down the pike, but more problematic are the breaks in the caulk around the tub that floods the electrical box, that shorts the grid. Or a failure in the bathrooms at the airport.

Read your Saul Alinsky, and get in the game.

January 24, 2008

Is qual/quant hybridity possible?

Filed under: Institutional, Markets — Peter @ 1:04 pm

Jeremy Grantham, principal of GMO, makes an interesting point about quants in his 4th quarter letter to investors (free registration required):

The good old days of the domination of the first generation quant models, where you simply show up with three concepts – value, momentum, and discipline – are over. But, even more critically and, perhaps like career and business risk, out at the limits of arbitrage, is this need for judgmental overrides on rare macro events. Quants like to show off their discipline by marching off the cliff in rows (it is said, I hope apocryphally, that Shaka, the great Zulu Chief, marched an impi, or regiment, off a cliff to impress European observers and I hope it did). Well, in real life it would be nice to stop at the edge and say “I don’t like the look of this, perhaps my model missed something.” The extremely difficult objective is to maintain the advantages of quant discipline 95% or so of the time and hand over to a human being when you reach the edge of the cliff. You can imagine the problems in making this kind of phase change. But only by slowly overcoming this problem and integrating this hybrid approach into the DNA of the investment process can one aspire to being very effective investors in the long run.

His point is that the benefits to quantitative investing are mostly in the fatter part of the outlier events curve. Or, in the language of March and Simon, quants are better at exploitation that exploration. Qualitative investors (stock pickers, in Grantham’s language) by contrast are potentially more helpful when the models depart from reality. An ideal world would have a hybrid model of quals and quants.

But that almost never works in practice. In practice, a qual firm uses quants as showcases to show their ‘balance’, while quants use quals to demonstrate their creative flexibilities. The underlying problem is that the two styles at their best represent different (and incompatible) views of the world. If you believe that human behavioral frailty gets in the way of seeing financial facts for what they are, it makes it difficult to envision a world where a stock picker can accurately tell you when you’re running off a cliff. By contrast, quals are simply limited by human cognitive capacity, combined with all sorts of cumulative social contexts, to never be able ‘really’ know why they are right or wrong. Leaving money on the table is also a form of running off a cliff. Just a different cliff.

Or rather, in Grantham’s story, there is simply no way to tell which 5% of the time is going to be the time when quals are going to be invaluable.

There might be an answer is abandoning the (theoretical) notion of maximizing efficiency, in favor of a more Type I versus Type II error view of the world. A Type I error is a false positive, in this context to believe there is risk where there actually is none. This is the ‘leave money on the table’ problem - if you cut back on the amount of risk you take, effectively you are underperforming the ‘economically efficient’ horizon. Type II errors are false negatives, to believe there is no risk where there actually is some. This results in many more ‘Whoa, we should have seen this coming!’ kinds of mistakes, I think.

In short, there is a collective action problem at work, insofar as we are collectively trained to believe that maximization is desirable. I would guess that 95%+ of the problems of the financial system are not due to institutions shooting for returns of 3% over prime. It’s when we build a system based on 20% over prime returns that we always seem to create incentives to blow up.

January 20, 2008

Another name for random. Or luck.

Filed under: Institutional, Markets, Organizations — Peter @ 3:43 pm

An anthropologist attempts to explain variation in how investment banks fared in the current credit crisis. Gilian Tett argues that three elements account for it: 1) successful firms have hands-on management (meddlers); 2) successful firms have management who rose through the ranks via trading desks rather than sales or legal; 3) successful firms have a ‘culture of power’ whereby firm members see themselves as tied to the firm rather than the business line, which creates a culture of accountability.

Alternatively, Michael Lewis noticed the way that Goldman Sachs has profited by the dramatic increase in credit defaults. Effectively, someone higher up in the firm made a series of dramatically-large trades against the CDOs that everyone else (including GS) was creating, marketing, and purchasing. In other words:

Enter two smart guys who trade Goldman’s proprietary books to argue to the CEO and chief financial officer that the subprime market feels soft and that Goldman should short it. This they do, in such massive quantities that they more than offset the long positions in subprime held throughout the rest of the firm, leaving Goldman short the subprime market and in a position to make billions when it crashes. End of story.

And it’s a good story. But consider what it implies. Their own traders and salespeople in subprime mortgages and related securities had put Goldman in exactly the same position as every other Wall Street firm: long subprime mortgages.

The only difference between Goldman and everyone else was that Goldman had, in effect, an entirely separate enterprise, sitting on top of the firm, with the power to reverse the judgment of its own supposed experts in various markets. They were able to do this, apparently, without ever saying a word about it to their own traders. Instead of telling the fools trading subprime mortgages that they are wrong, and that they should unwind their positions, they simply offset their trades.

This does not imply anything about the management team, where they come from, or the firm’s culture. Instead, it describes a firm where higher-up risk managers have the ear of people in power, and this allowed them to cancel out the stupidity of the rest of their own firm.

Or, perhaps this is all a fancy way of saying that there is a huge amount of luck and randomness happening at the organizational level in perhaps the most important core sector of the contemporary economy.

January 13, 2008

Two forms of institutions

Filed under: Institutional, Markets — Peter @ 8:37 am

I’ve been thinking a lot about institutions lately, in light of my earlier post on check-lists and medical practices. I originally had in mind a post about how the Berger and Luckmann version of institutionalization at the more marco-level is about the crystallization of practices. So what check-lists are theoretically are the same as other kinds of models and technologies: they are congealed expertise. For good and for bad, technologies, models, and checklists act as an alternative to pure expertise and craft knowledge. To the extent that they become taken-for-granted, they become the cognitive institutions envisioned by B&L. This does not imply a break from creativity, or ’structure’ as the opposite of ‘action’ (insert Giddens here if you like). They enable creative action as well. They also preclude new action or mask the world sometimes, if the world changes but the knowledge remains stuck in a model or technology. But the point is that we can look at institutions broadly as congealed knowledge.

But then I ran across the recent news that Second Life is banning banks. The issue is that virtual banks offer interest, which can then be returned to depositors, but they do not offer protections of real-world banks. Because Linden Dollars can be exchanged for real dollars, SL banks can actually be sources of profit and loss in the real world. And now they’re being banned:

as of January 22, Linden Lab will be removing all objects that are related to in-world banking. Until then, the company hopes that the banks will settle their debts with residents as best they can, but if they are caught trying to operate after January 22, they will be punished by possible suspension, termination of accounts, and (*gasp*) loss of land. Legitimate banks that provide a government registration statement or financial institution charter will be allowed to continue doing business, as will entities conducting marketing or education.

No FDIC in real-life means no banking in Second Life. This is institutions in the more Douglas North, economic sense. Here, banking ‘institutions’ act as rules of the game, and the Linden Labs folks act as rules and structures of SL. And we might be witness to a singular event: a set of runs on virtual banks as customers line up to take their Linden Dollars out before 1/22.

What’s interesting is the power of real-world institutions to actually impinge on a made up reality. After all, SL could have been created with any number of rules and ties to real life. Or no ties at all, as there’s no ‘rule’ in SL that people who cannot fly in RL are also not allowed to fly in SL.

There’s good stuff in between these two visions of institutions. For instance, think about which sets of conventions and rules are reproduced in an SL environment and which are not. Physical laws are often ditched, but those pertaining to land and real estate are kept. Gambling was eliminated because it might have been subject to RL laws and regulations, but laws regarding appraisals and insurance of real estate are left out despite the centrality of those kinds of transactions.

In any event, I’m not sure that institutions are anything, but I do think there are some specific phenomena amenable to one or another institutional distinction.

April 27, 2007

History of Risk

Filed under: Institutional — Peter @ 7:49 pm

Summary: An investigation into the history of risk as an economic concept and the origins of economic risk as part of the institutionalization of futures trading in the latter half of the 19th century US. Conceived with Marc Ventresca, this research shows how risk became a solution to a political (not economic) problem: how to distinguish futures trading from gambling. By using risk and hedging, members of the Chicago Board of Trade were able to make convincing arguments about the social value of futures trading. We use court cases, legislation, and expert discourses in the form of early economics writings about futures trading to show how futures went from being understood as akin to gambling, to being treated like insurance.