Peter Levin’s Rethinking Markets

May 16, 2008

Commensuration across commodities

Filed under: Markets, Organizations, Prices — Peter @ 11:10 am

Commensuration, the making comparable of qualitative differences via a common third metric, is valuable for its theoretical contributions to cultural economic sociology. It is a process that makes some things visible and hides others, resulting in an extremely impressive if underrated shaping of the social world. Qualitative distinctions across individual student applicants to college, for instance, are wiped out, replaced by test scores, GPA’s, and comparable lists of extracurricular activities. These social realities can be re-made visible (ie a system whereby individuals are judged as individuals with a whole portfolio), but then easy comparisons are made more difficult.

It is also central to the making of commodities, as I’ve argued before. But if you are deciding how to make real-world investments, it is worth understanding the criteria by which the commodities you are interested in are judged. This is not a direct ‘buy company x’, ’sell company y’ kind of argument, just a way to help understand where experts are coming from. It is also where experts are most likely to be wrong in their misapplication of measures to the values they are measuring. That’s the Moneyball argument, that the ways that players were being commensurated were at best inaccurate.

In any case, I thought I’d post a table of what I have in mind, and see if it leads anyplace interesting. This is what blogs are for, right?

In these cases, the idea is that a simple quantified measure is not sufficient; you need to know enough content to understand the criteria used to make the transformative assessments of qualities through quantities. And though VaR has beautiful problems, it is in fact the ways that assessments across different kinds of financial instruments are made; likewise centrality, price per square foot, etc.

Incidentally, this conception I think bridges some of the more highfalutin discussions of performativity and social studies of finance to the more mundane world of organizations and work. But that’s not my point right here and now.

March 25, 2008

Housing CMO Primer

Filed under: Markets, Prices — Peter @ 4:05 pm

I want to re-tell a story from Frank Partnoy’s F.I.A.S.C.O., but a bit of background on Collatoralized Mortgage Obligations is first in order. CMOs, and their generalized cousin Collatoralized Debt Obligations (CDOs) are the current culprits in the sub-prime meltdown, so this is probably useful to know practically as it is to know theoretically. Also, I’m participating in a conference on Crisis, Emergency, and Global Processes, and I’m thinking about incorporating some of this thinking into that. This is a long post, and kind of technical, but probably not too much. There is a nice visual at Portfolio Magazine, so if this whole primer doesn’t help, perhaps that will. (more…)

December 31, 2007

January Effect

Filed under: Markets, Prices — Peter @ 2:14 pm

One of the better anomalies is about to occur, the so-called January Effect in financial markets. Back in the day, stocks would jump in the first 3-4 days of January as the depressed prices from the end-of-year selloff would rebound. Of course, as people became savvy about it, the effect shifted a bit to December (the so-called Santa Claus rally), but still, it’s one of those funny plate tectonics where institutional effects (US tax law) meets individual psychology (optimistic January) meets collective social practice (being on vacation for the New Year holiday).

Happy January Effect.

December 4, 2007

How to price cultural stuff

Filed under: Art, Prices — Peter @ 12:17 pm

Tricky tricky Dr. Lena. In her discussion of the great Canadian post-Woodstock, train-tour extravaganza, she asks the question: how should we price cultural stuff?

There are two main ways, though we should frankly see both as conventions. The first is cost-plus, as she rightly points out. The ‘plus’ is something to fuss about, and how much to pay artists does just regress the problem back into costs. In other words, deciding an appropriate ‘cost’ for artists reproduces the problem. Artists may say, well, “pay me cost-plus, where cost is expenses to get out there, lodging, time-for-my-talent.” And then we say deciding an appropriate ‘cost’ for time-for-my-talent reproduces the problem. And so on.

Which leads to the second method, something like ‘what the market will bear.’ In practice, this means what people are willing to pay, combined with what you’re willing to accept. But - the world doesn’t come with supply-and-demand curves attached. Most markets are not totally variable-priced markets - markets where every price is individually negotiated. Capital markets are exception more than rule, and even when organizations do try to achieve this ideal, we think they kind of suck (I’ve long thought it would be fascinating to walk down the aisle of an airplane in flight surveying passengers about how much they paid, then making your results public. And by fascinating I mean riot-inducing.)

So, the interesting part is in how the theory of ‘what the market will bear’ meets the practice of ‘how much do we charge for this concert/album/art?’ And all of JL’s subsequent discussion is indeed the practical implementation of this second strategy.

Of course, this doesn’t answer her question, which is, what’s the appropriate comparable: 1) compare by artist?; 2) compare based on format?; or 3) compare based on venue? My real answer to that specific question is, I have no idea. It certainly appears that the concert organizers are pushing for ‘based on venue’, while some people recognize ‘based on artist’. I would say that the ‘based on format’ is harder, since the format is the unique part.

To get more general, let me hypothesize that comparables are more likely to be based on things that are, well, comparable. A CD of a totally unique band with a totally unique sound would be more likely to be priced based on ‘other CDs’. Outsider artists doing unique photography would be compared with other outsider artists (rather than other photographs). This is certainly an empirical question, but there’s my stake in the ground.

There is still a paper or book or something to be written about baselines, but this is not it. My nephew (who loves Mr. Krabs from Spongebob) will tell you that you need money to buy one of his toy cars from him, but the amount of money you need is incomprehensible. It’s all ‘coin money’ to him, regardless of whether it’s 3 dimes, two quarters, or 20 pennies - he has no baselines and so no means by which to compare.

November 27, 2007

The Blow-Up

Filed under: Prices, Technology — Peter @ 6:01 pm

There’s a lot to say about Bryant Urstadt’s article about quant traders in this past fall’s Technology Review (free reg required), called “The Blow-up.” Combined with Amir Khandani and Andrew Lo’s “What Happened to the Quants in August 2007″ (.pdf link), it gives a fuller picture of how quantitative finance is altering markets.

Clumping quantitative derivatives traders together is getting to be a little too gross a distinction, but there are, it seems, a small number of strategies being pursued by these kinds of traders. Two of the most important are: 1) pairs trading and 2) long-short equity trading. Pairs trading is where an historical relationship between two securities are found, tested, and analyzed; and then when the pairs get out of this relationship for no good reason, trades are executed expecting that this relationship reasserts itself. This differs in spirit, but not entirely in practice, from arbitrage trading, which is trading on the differences between two kinds of products which are ’supposed’ to be identical (a company’s stock and its bonds, for example, or a company’s stock in two trading environments).

Long/short equity trading is when a market-neutral position is taken, whereby long positions are made up of ‘losers’ (under-performing stocks), while short positions are made up of ‘winners’ (over-performing stocks). This strategy is based on the idea that outliers will eventually revert to the mean - effectively betting on consistent market overreaction. Given the behavioral finance work on how people tend to, you know, overreact to news, this makes sense. And because your position is effectively market-neutral - long positions offset short positions - it is possible (for broker/dealers) to highly leverage these positions.

These are two main strategies, and for the most part, they work. So, what happened in August? Here’s my reading of the two articles: First CDOs - the bundled up derivatives from housing loans that are spoken about when we talk about the ’sub-prime lending crisis’, went into the sink. Second, an outlying series of days in the week of August 6 caused a dramatic drop in the long-short strategy.

The effects of these two events (possibly, though it’s not clear if they were linked) was the following: a bunch of funds began selling equities to liquidate positions in order to meet margin calls for their CDO investments, which pushed pairs trading into abnormal positions. This caused more hardship, and all sorts of things happened - funds sold blue-chips to raise margin cash; and bought back short positions causing price relationships to swing further out of historical norms. Khandani and Lo speculate that one or more of the long-short funds liquidated its position, and that it turned out that many other funds were also engaged in these kinds of trades, so that when one or two got out, everyone else got hammered.

What makes this interesting? A couple of things. First, as markets are brought into tension with one another via pairs trading, they effectively create a new product, with new features and sometimes not-well-understood properties. A Collateralized Debt Obligation (CDO) can package together such disparate cash flows as sub-prime loans and airplane leases; by virtue of the CDO itself, these otherwise distinct streams are linked together. Second, as traders and funds are brought into tension with one another via sharing similar trading strategies, it creates collective action events that simply do not resemble atomized traders. It’s not surprising that the expression of these problems is always liquidity - IMHO that’s a fancy finance way of saying that people act in concert, when they are ’supposed’ to act according to their own preferences.

Some other interesting things from the Blow-up:
- it’s estimated that 38% of all equities are traded automatically, and that this percentage may rise to over 50% in the next three years;
- computers for some high-frequency traders execute hundreds of thousands of trades every day.

There is a giant blind spot here, rooted in financial theory, enabled by even cautious policy-makers and economists, and executed by very smart people. Sometimes at home when we watch commercials, my partner and I play a game called ‘good for them, or good for us’ - to see if a product or policy or feature is good for the company or good for consumers. I would guess that the number of people who would argue that derivatives trading today is ‘good for us’ is very small.

November 15, 2007

Value and art, SK style

Filed under: Art, Front Page, Prices — Peter @ 10:44 am

I participated in a panel earlier this week at Columbia called ‘Unraveling the Art Market’. It was me, two incredibly insightful women from the Christie’s Art education program, and an artist named Steve Keene. Keene does these paintings on wood in mass execution fashion, 60-80 a day, and he sells them for $10-$15 online, sometimes less in person. He was brilliantly engaging, and in the middle of discussions about the multi-million dollar secondary art market, it is worth thinking more about what he’s doing…

For him, the art is one continuous, giant piece, and he sells off little pieces of it as it becomes finished. Starting with bands in the punk music scene, his notion of selling the art is like the idea of going to a (bygone era) concert and having the band try to sell the 15-20 tapes they made to people in the audience. He noted that for many, buying his art was their first art purchase, and that when they leave their apartments, his art is maybe something that might get left behind.

Two of the more interesting features to note. First, people sometimes try to resell his work on eBay, which annoys him, since: 1) he doesn’t get the money for it (and he needs it); and 2) because his art is supposed to be what it is - cheap, mass. People who buy his art, as he says, sometimes get annoyed that it doesn’t increase in monetary value, since 1) this indicates that it’s not a good investment; and 2) it indicates that its cultural value is not rising as well. That is, price is assumed to be an indicator of cultural value. If it doesn’t get more expensive, how can we know it’s really good?

Second, once a few of his pictures landed in the hands of JFK Jr. When he died, the pieces were put into a sort of estate sale/garage sale of Kennedy stuff, at Sotheby’s (the sale is here - reg required), and the lot (here - reg required) was estimated at $2000-$3000, and it sold for $12,000. SK was thrilled and hesitant, since he was not identified as the paintings’ author but he didn’t want to tell them and have the buyer feel silly for buying something he sells for $5. Anyhow, it’s the clearest example of identifying the value of Kennedy provenance yet.

November 8, 2007

Ban oil speculation?

Filed under: Prices — Peter @ 9:51 am

A proposal that comes around from time to time has re-emerged in light of the skyrocketing prices of oil in the global markets. As oil pushes towards $100/barrel, the petroleum secretary of India has proposed abolishing the trading of oil in commodity markets.

(more…)

November 7, 2007

Art market craziness

Filed under: Art, Prices — Peter @ 7:22 pm

As my friend Chuck says, even the crappy Picasso’s are bringing in $30 million. What in the world is going on? The all-art index is up 21% in the first half of 2007, compared to 14% for the S&P500. The November ArtNews reports that Sotheby’s and Christie’s are offering upwards of $1 billion in guarantees this year. Sotheby’s and Christie’s sold $7.5 billion in art in 2006, and more this year. Add Phillips de Pury & Co. (which emphasizes contemporary, where the action is), and it’s surreal.

(more…)

November 6, 2007

prices and baselines, part 2

Filed under: Prices, Technology — Peter @ 11:02 am

In an earlier attempt to think through pricing, I was trying to understand the importance of public, baseline prices from which traders, investors, potential buyers and sellers could determine commodity prices. This leads me to discussions of ‘dark pools’ of liquidity..

(more…)

October 29, 2007

Why exchanges shift from open outcry to electronic trading

Filed under: Prices, Technology — Peter @ 8:32 am

An article in the NYT on the shift away from open outcry today, which gets it right and gets it wrong. The right part is that the shift and merger of the CME and CBOT onto a single floor located at the CBOT spells the end for open outcry. It’s a natural transition point, and the break will break what’s left of pit trading. There will likely continue to be a floor for the largest volume contracts, but even those won’t likely survive for long. I’ve long been agnostic over whether or not the floors will die (historically, there were dire warnings about the death of open outcry about every 20 years since the 1950s). But this may well be it.

What I think the article gets wrong is the why. The imagery is one of the futility of human labor against the labor of a machine. As one trader notes, “Sometimes it feels like we’re John Henry going up against the steam hammer.” Kate Zaloom is quoted as noting that in electronic trading is “the idea of having a more pure market, one that doesn’t have the complications of flesh and blood.”

This idea, that technology displaces humans, is way too undifferentiated to be a useful explanation. Stuart Elliot’s research for the National Research Council, in part estimating the occupational displacements due to technology by 2030 (I include the key table at the end, just to demonstrate how scary-screwed many workers might be), show pretty wide heterogeneity across occupations. So one question unanswered by the John Henry argument is, why trading? Lawyers don’t seem to be going anyplace, and I’m not convinced that the technical requirements of work are great explanations.

The second problem is this idea of a ‘more pure market.’ It’s kind of BS. I did a literature review on what financial economists themselves suggested were the differences/comparisons/reviews of open outcry and electronic trading, and the results are decidedly mixed.

In the table, the research is placed on the side that is ‘better’ in the estimation of the author, using the measures they use - liquidity, transaction costs, obtaining adverse (that is, private) information. So a study on the open outcry side suggests that it’s better than electronic trading. My favorite finding is that when comparing the actual prices with the theoretical prices you should get if markets were perfectly efficient (or, more precisely, if markets followed the formulae exactly), both open outcry and electronic trading kind of suck.

So the question remains, why did electronic trading displace open outcry? I think the answer is pretty simple:
1) The clients changed. The modal trader in the 1970s was a high-income individual who was looking to increase returns to his (yes, his) investments via a riskier kind of financial investing. Commission costs, transactions costs, these are important, but the form of trading mattered little. At the end of the 1990s, it was estimated that something like 97% of the trading in financial futures came from institutions. Electronic trading is great for these clients. They bought their own seats, demanded a voice in decision-making. Their interests are different from both floor traders and from wealthy individual clients. It cannot be stressed enough that electronic trading is best for institutions who are able to capitalize on the kinds of things that electronic markets are good at - speed, cross exchange trades, digitized, already-model-manipulable data.

2) Electronic trading changed the products of the CME and CBOT. The exchanges’ products are contracts, liquidity, and prices. Electronic trading changed what counts as a price, so that while the two products look the same, they are not the same. The information that is captured in an electronic price is qualitatively different from the information that is captured in an open outcry price. They overlap, but they are distinct constellations of information. Here I agree most with Daniel Beunza and Yuval Millo, that electronic trading is losing information that might be useful in the change-over. But if that information is not useful to someone who could actually, you know, use it, it doesn’t really matter. In any case, the idea that electronic markets win out because they’re more ‘pure’ is just not correct.

I think there’s something sad about the passing of open outcry. I’ll miss the guy from the meats who sold beef jerky out of a duffel bag. And the quick wit and black humor. I also am not terribly sad. The guy who got women to give him blowjobs behind the desk, the references to Lind-Waldock as Lind-Welfare because they actually hired Black people, the eye-candy summer interns, all that is part of the open outcry world too.

[Source: Stuart W. Elliott, "Projecting the Impact of Computers on Work in 2030," p. 37, available online [PDF].] (thanks, Alex)

October 12, 2007

Radiohead as Rorschach test

Filed under: Prices — Peter @ 11:08 am

It seems that Radiohead’s experiment into paying what you what for a digital download of their new album Rainbows. For anti-DRM activists, it’s the end of music labels. For skeptics, it’s just a demo teaser marketing scam designed to get you to buy their ‘real’ CD for more money. For market-is-everything economists, it’s an exercise in applying world-is-nail to I-have-hammer.

Of course, they’re all wrong. It’s clearly a dog chasing a squirrel. Or something.

(incidentally, the page on the edit wars over whether or not to show the inkblots themselves is a brain-squeezer.)