Predictability and correlation

Today another little note that I discovered while teaching. Warning: this will only be of any interest at all to time-series finance academics. I'll try to come back with something practical soon!

Does the predictability of stock returns from variables such as the dividend yield imply that stocks are safer in the long run? The answer would seem to be yes -- price drops mean expected return rises, bringing prices back and making stocks safer in the long run. In fact, the answer is no: it is possible to see strong predctability of returns from dividend yields, yet stocks are completely uncorrelated on their own.

I've been through three versions of showing how this paradox works. In  Asset Pricing the best I could come up with was a complex factorization of the spectral density matrix in order to derive the univariate process for returns implied by the VAR. In later Ph.D. classes, I found a way to do it more simply, by seeing that returns have to follow an ARMA(1,1), and then matching coefficients. This year, I found a way to show it even more simply and intuitively. Here goes.

Prices and Returns

Warning: this will only be interesting to academic finance people.

One of the fun things about teaching is that it forces me to look back at old ideas and refine them. Last week, I needed a problem set for my MBA class. It occurred to me, why not have them do for returns what Shiller did for dividends?

Here it is

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Larry Summers' Martin Feldstein Speech

The latest NBER Reporter has the speech Larry Summers gave at the annual NBER "summer camp" for economists. As you would expect, there are some really interesting bits, which provoked a good lunchroom discussion. To my mind it (and this blog post) gets much better toward the end.

The organizing thread is Larry's worries about long term trends in employment and income distribution, and how trends in productivity and innovation affect it. If the word did not have negative connotations, I might term the talk "neo-Luddite," the worry that this time, unlike all the others, technical change, primarily information technology, will be really bad for workers.

Ouch. "Unemployment" figures in the popular press, but it is the fraction of people actively looking for jobs. The far bigger worry among many economists is the rise in "non-employment." One in ten men, 25-50, are simply not working at all or even looking for work.

The Big Question: Is there an alternative to Obamacare?

A health policy discussion with Booth colleagues Matthew Gentzkow and Matthew Notowidigdo.


The original is here at the Booth / Capital Ideas website. The other "big ideas" videos are really good.

My views expressed here are summed up a bit more eloquently in a recent WSJ Oped, here, and a longer essay "After the ACA" available here. More on health economics and insurance, including how individual insurance can protect against preexisting conditions on my webpage here, and by clicking the "health economics" link to the right.

Two points on inequality

I've stayed out of the inequality - minimum wage business, largely because it strikes me as mostly political posturing rather than serious policy or economics.

A few small points from the blogosphere struck me as interesting enough to pass on, and indicative of that conclusion.

What's the Fed doing? One view

Torsten Slok of Deutsche Bank Research, showed me a slide deck he prepared for evaluating the US economy. Here are a few fascinating graphs. Sorry, the slide deck isn't public -- you have to pay DB for this kind of art!

Most hilariously, "forward guidance" seems to be getting harder.

Torsten also makes the case that interest rates are much below the Fed's usual "Taylor rule." Implicitly, it's supply now not "demand." The market of people who are working looks recovered, the large number of people out of the labor force is the problem, and addressing that is, at least, a deviation from usual policy.

The rest of Torsten's slide deck makes a persuasive case that strong growth may finally be just around the corner, a warning to anyone spending a lot of time on "secular stagnation" models!

No editorial here, I just thought the graphs were really interesting. Thanks to Torsten for allowing me to post them.

Alternative Lenders

I found an interesting article in the Wall Street Journal on Alternative Lenders to small businesses.  Some highlights with comments.

With Credit for Businesses Tight, Nonbank Lenders Offer Financing at a Price

When Khien Nguyen needed $180,000 to open his 13th nail salon near Philadelphia in November, he didn't go to a bank. Mr. Nguyen's credit score had dropped during the recession, so he figured a bank would put him through weeks of aggravation, then reject him.

He turned instead to one of the nonbank, short-term lenders that have been gaining traction since the financial crisis. The lenders cater to small businesses, often at high cost.