Unintentionally hilarious Nobel coverage

Shawn Tully at Fortune wrote a very thoughtful piece describing Gene Fama's research and views on efficient markets.

The version I saw on  CNN money magazine is unintentionally both hilarious, and ends up making a far deeper point than I think Shawn intended.  It is chock full of little links trying to draw you off to other articles on the magazine. These were undoubtedly not put in or even reviewed by Shawn, but they tell you an enormous amount about the world of finance and finance journalism.

For example, here we are in the middle of an article describing Gene and efficient markets.

...Understanding Fama's evolving view of the market is one of the most valuable, practical guides for today's investors. 

MORE: 20 top picks from 20 star investors 

Fama's ideas may have received the ultimate validation, but they're still highly controversial.... 

Well, they haven't received the ultimate validation from the bots that run CNN money, that's for sure!

Learning the wrong lesson while waiting on hold

Health care policy debates seem to have become a war of anecdotes. Margaret Talbot of the New Yorker posted one titled "My canceled policy and my values" which is circulating the blogoshphere

... like many of the twelve million or so Americans who buy their own insurance, we received a letter from CareFirst in late October saying that our policy would be cancelled, because it didn’t conform to Affordable Care Act requirements. ...I stopped procrastinating and got on the phone with CareFirst... First lesson learned: healthcare.gov is not the only balky system around.

Fama Nobel En Espanol

Pedro Cervera kindly translated my short piece on Gene Fama's Nobel prize, which will appear in "Estrategia Financiera" next month:

Eugene Fama: Mercados eficientes, primas de riesgo y el premio Nobel.

En 1970, Gene Fama definió que un mercado era “informacionalmente eficiente” si los precios incorporaban en cada momento la información disponible relativa a los valores futuros.

“Un mercado en el que los precios reflejan la totalidad de la información existente es denominado eficiente “[Fama, 1970]. 

....

para el resto, haga clic aquí para un pdf

For the rest go here for a pdf (I don't speak Spanish and gave up trying to get accents right in blogger!)

Health economics and cognitive dissonance

PS: I will be talking about alternatives to Obamacare on Wed Dec 4 at the Cato Policy Perspectives event in Chicago.

After the ACA -- Crafting an Alternative to Obamacare

I gave a talk at Hoover, encouraging those of us who are less than fans to speak up and outline the alternative to Obamacare. Podcast here.

Repeal and status quo is not enough. We need to listen, and point out how a radically freed and competitive system will address the genuine concerns that motivate many to support the law despite its flaws -- preexisting conditions, health care for the poor, outrageous cost and so forth.

The essay "After the ACA" lays it out in some detail.  The talk is a lighter discussion of where we are, but emphasizes how sitting back and letting the ACA unravel will just lead to an even more expensive and incorherent system. Stand up and state the alternative.

A limited central bank

Philadelphia Fed president Charles Plosser gave a noteworthy speech, "A limited central bank." It's especially noteworthy in the context of Janet Yellen's nomination, discussion between Congress and Fed about how the Fed should be run, the Fed's focus on unemployment, and the current state of the hawks vs. doves debate.

We find out what he thinks of micromanaging the taper based on monthly employment reports:

The active pursuit of employment objectives has been and continues to be problematic for the Fed. Most economists are dubious of the ability of monetary policy to predictably and precisely control employment in the short run, and there is a strong consensus that, in the long run, monetary policy cannot determine employment....

New vs. Old Keynesian Stimulus

While fiddling with a recent paper, "The New-Keynesian Liquidity Trap" (blog post), a simple insight dawned on me on the utter and fundamental difference between New-Keynesian and Old-Keynesian models of stimulus.

The Work Behind the Prize: Video and Text

This is a link to the "Work Behind the Prize" event from Monday Nov 4. Our charge was, explain to the community of scholars at the University of Chicago, what Lars Hansen and Gene Fama's research was that won them Nobel Prizes. Jim Heckman and John Heaton talk about Lars Hansen's work, Toby Moskowitz and I talk about Gene Fama. 10 minutes each. I start at 33:50.

Here is the text of my remarks. (Faithful blog readers will note some recycling. Let's call it "refining.") A pdf with embedded pictures is here. The video on youtube is here

Eugene Fama: Efficient markets, risk premiums, and the Nobel Prize

In 1970, Gene Fama defined a market to be “informationally efficient” if prices at each moment incorporate available information about future values.

A market in which prices always `fully reflect’ available information is called `efficient.’” - Fama (1970)

If there is a signal that future values will be high, competitive traders will try to buy. They bid prices up, until prices reflect the new information, as I have indicated in the little picture. “Efficient markets” just says that prices in a competitive asset market should not be predictable.


“Efficient markets” is not a complex theory. Think Darwin, not Einstein. Efficiency is a simple principle, like evolution by natural selection, which organizes and gives purpose to a vast empirical project.

The Work Behind the Prize

This afternoon (Monday November 4) a panel of four will try to explain the research that Gene Fama and Lars Hansen did to win the Nobel Prize for the University of Chicago community.

This is classic University of Chicago, community of scholars stuff: Yes, we've congratulated you.  Now, let's talk seriously about the ideas and the research.

My job: Explain efficiency, long run returns and volatility in 10 minutes flat. Wish me luck. John Heaton and Jim Heckman will describe Lars Hansen's work, and Toby Moskowitz will join me on the Fama panel.  Gary Becker will moderate

The announcement is here; RSVP if you want to attend as seating is limited. The event will be web-cast here

The Next Obamacare Fiasco

Thousands Of Consumers Get Insurance Cancellation Notices Due To Health Law Change Kaiser Health News

Some health insurance gets pricier as Obamacare rolls out Los Angeles Times

Kaiser:

Health plans are sending hundreds of thousands of cancellation letters to people who buy their own coverage,...The main reason insurers offer is that the policies fall short of what the Affordable Care Act requires starting Jan. 1

Florida Blue, for example, is terminating about 300,000 policies, about 80 percent of its individual policies in the state. Kaiser Permanente in California has sent notices to 160,000 people – about half of its individual business in the state. Insurer Highmark in Pittsburgh is dropping about 20 percent of its individual market customers, while Independence Blue Cross, the major insurer in Philadelphia, is dropping about 45 percent.

LA Times:

Blue Shield of California sent roughly 119,000 cancellation notices out in mid-September, about 60 percent of its individual business. About two-thirds of those policyholders will see rate increases in their new policies....

Middle-income consumers face an estimated 30% rate increase, on average, in California due to several factors tied to the healthcare law. Some may elect to go without coverage if they feel prices are too high. Penalties for opting out are very small initially. Defections could cause rates to skyrocket if a diverse mix of people don't sign up for health insurance

This is interesting. Obamacare could actually increase the number of people without insurance, because you are not allowed to keep (consumer) or sell (insurance company) simple cheap insurance.

Bob Shiller's Nobel

As with Lars Hansen and Gene Fama, Bob Shiller has also produced a span of interesting innovative work, that I can't possibly cover here. Again, don't let a Nobel Prize for one contribution overshadow the rest. In addition to volatility, Bob did (with Grossman and Melino) some of the best and earliest work on the consumption model, and his work on real estate and innovative markets is justly famous.  But, space is limited so again I'll just focus on volatility and predictability of returns which is at the core of the Nobel.

Source: American Economic Review

The graph on the left comes from Bob's June 1981  American Economic Review paper. Here Bob contrasts the actual stock price p with the "ex-post rational" price p*, which is the discounted sum of actual dividends. If price is the expected discounted value of dividends, then price should vary less than the actual discounted value of ex-post dividends.  Yet the actual price varies tremendously more than this ex-post discounted value.

This was a bombshell. It said to those of us watching at the time (I was just starting graduate school) that you Chicago guys are missing the boat. Sure, you can't forecast stock returns. But look at the wild fluctuations in prices! That can't possibly be efficient. It looks like a whole new category of test, an elephant in the room that the Fama crew somehow overlooked running little regressions.  It looks like prices are incorporating information -- and then a whole lot more!  Shiller interpreted it as psychological and social dynamics, waves of optimisim and pessimism.

Lars Hansen's Nobel

Lars has done so much  deep and pathbreaking research, that I can't begin to even list it, to say nothing of explain the small part of it that I understand.  I wrote whole chapters of my textbook "Asset Pricing" devoted to just one Hansen paper. Lars writes for the ages, and it often takes 10 years or more for the rest of us to understand what he has done and how important it is.

So I will just try to explain GMM and the consumption estimates, the work most prominently featured in the Nobel citation. Like all of Lars' work, it looks complex at the outset, but once you see what he did, it is actually brilliant in its simplicity.

The GMM approach basically says, anything you want to do in statistical analysis or econometrics can be written as taking an average.

Understanding Asset Prices

The Nobel Committee's "Understanding Asset Prices" "scientific background" paper for the Fama, Hansen, Shiller award is excellent. It is pretty much a self-contained graduate course in empirical finance.

Gene Fama's Nobel

(For a pdf version click here.)

Photo: Elizabeth Fama

Gene Fama’s Nobel Prize

Efficient Markets

Gene’s first really famous contributions came in the late 1960s and early 1970s under the general theme of “efficient markets.” “Efficient Capital Markets: a Review of Theory and Empirical Work’’ [15] is often cited as the central paper. (Numbers refer to Gene’s CV.)

“Efficiency” is not a pleasant adjective or a buzzword. Gene gave it a precise, testable meaning. Gene realized that financial markets are, at heart, markets for information. Markets are “informationally efficient” if market prices today summarize all available information about future values. Informational efficiency is a natural consequence of competition, relatively free entry, and low costs of information in financial markets. If there is a signal, not now incorporated in market prices, that future values will be high, competitive traders will buy on that signal. In doing so, they bid the price up, until the price fully reflects the available information.

Like all good theories, this idea sounds simple in such an overly simplified form. The greatness of Fama’s contribution does not lie in a complex “theory” (though the theory is, in fact, quite subtle and in itself a remarkable achievement.) Rather “efficient markets” became the organizing principle for 30 years of empirical work in financial economics. That empirical work taught us much about the world, and in turn affected the world deeply.

For example, a natural implication of market efficiency is that simple trading rules should not work, e.g. “buy when the market went up yesterday.” This is a testable proposition, and an army of financial economists (including Gene, [4], [5],[ 6]) checked it. The interesting empirical result is that trading rules, technical systems, market newsletters and so on have essentially no power beyond that of luck to forecast stock prices. It’s not a theorem, an axiom, or a philosophy, it’s an empirical prediction that could easily have come out the other way, and sometimes did.

Fama, Hansen, and Shiller Nobel

Gene Fama, Lars Hansen and Bob Shiller win the Nobel Prize. Congratulations! (Minor complaint: Nobel committee, haven't you heard of Google? There are lots of nice Gene Fama photographs lying around. What's with the bad cartoon?)

I'll write more about each in the coming days. I've spent most of my professional life following in their footsteps, so at least I think I understand what they did more than for the typical prize.

As a start, here is an an introduction I wrote for  Gene Fama’s Talk, “The History of the Theory and Evidence on the Efficient Markets Hypothesis” given for the AFA history project. There is a link to this document on my webpage here. The video version is here at IGM.

Introduction for Gene Fama

On behalf of the American Finance Association and the University of Chicago Graduate School of Business, it is an honor and a pleasure to introduce Gene Fama. This talk is being videotaped for the AFA history project, so we speak for the ages.

Gene will tell us how the efficient-markets hypothesis developed. I’d like to say a few words about why it’s so important. This may not be obvious to young people in the audience, and Gene will be too modest to say much about it.

“Market efficiency” means that asset prices incorporate available information about values. It does not mean that orders are “efficiently” processed, that prices “efficiently” allocate resources, or any of the other nice meanings of “efficiency.” Why should prices reflect information? Because of competition and free entry. If we could easily predict that stock prices will rise tomorrow, we would all try to buy today. Prices would rise today until they reflect our information.

Friday Art Fun

Totally off topic. It's Friday, time to relax.

Source: Nina Katchadourian

15th Century Flemish Style Portraits Recreated In Airplane Lavatory Click the link for the full set.

From the artist:

While in the lavatory on a domestic flight in March 2010, I spontaneously put a tissue paper toilet cover seat cover over my head and took a picture in the mirror using my cellphone. The image evoked 15th-century Flemish portraiture. <…> I made several forays to the bathroom from my aisle seat, and by the time we landed I had a large group of new photographs entitled Lavatory Self-Portraits in the Flemish Style

From the art critic (Sally Cochrane)

What no one's saying, though, is that she was hogging the bathroom while a line of antsy people held their bladders! 

In related art news, the street artist Banksy is prowling New York. A group of Brooklyn locals, seeing people coming in to photograph the stencil, promptly covered it with cardboard and starting charging $5 per shot. Entrepreneurship and property rights are still alive.

Krugtron parts 2 and 3

Niall Ferguson has completed his Krugtron trilogy, with Part 2 and Part 3, (Part 1 here FYI, which I blogged about earlier.)

Part 2 continues Part 1. In fact, Krugman is as human as the rest of us, and the future is hard to see. Niall compiles a long record of what Krugman actually said at the time. As before, those of us on the sharp end of Krugman's insults enjoy seeing at least his own record set straight.

But Niall admits what I said last time: we don't really learn much from anyone's prognostication

In the past few days, I have pointed out that he has no right at all to castigate me or anyone else for real or imagined mistakes of prognostication. But the fact that Paul Krugman is often wrong is not the most important thing. ..

What Niall is really mad at are the insults, the lying and slandering (I'm sorry, that's what it is and there are no polite words for impolite behavior), and the lack of scholarship -- Krugman does not read the things he castigates people for.

And it matters.

Mulligan on Obamacare Marginal Tax Rates

Casey Mulligan wrote a nice Wall Street Journal Oped last week, summarizing his recent NBER Working Paper (also here on Casey's webpage) on marginal tax rates.

What do I mean, tax, you might ask. Obamacare is about giving people stuff, not taxing. Sadly, no. Obamacare gives subsidies that are dependent on income. As you earn more, you receive fewer subsidies for health care, reducing the incentive to earn more. Casey tots this sort of thing up, along with the actual taxes people will pay.

Economists use the word "tax" here and we know what we mean, but it would be better to call it "disincentives" so it's clearer what the problem is, and just how painful we make it for poor people in this country to rise out of that poverty.

As you can see, the average marginal "tax" rate went up 10 percentage points since 2007, and about 5 percentage points due to Obamacare alone.

Going back to the working paper, I think this is actually an understatement. (Probably the first time Casey or I have ever been accused of that!)

Margins on Exchanges

A nice Bloomberg View by David Goldhill offers an Econ 101 lesson in incentives. Though the average subsidy rate to health insurance is limited, the marginal subsidy rate is 100% once consumers hit the income limits -- so many consumers have no incentive at all to shop for lower prices. In turn, this greatly lowers the chance that insurers will compete on price.

David:

Let’s take an example. A family of four at 138 percent of the poverty level ($32,499) has its premium capped at 3.29 percent of income or $1,071. The rest is subsidy. So, if the cost of a silver plan is $10,000, the subsidy for this family is $8,929. A family at 400 percent of the poverty level ($94,200) has to pay up to 9.5 percent of its income for a plan, or $8,949. So the same $10,000 premium carries a subsidy of only $1,051.

But now look at those two families from the insurer’s perspective. A $10,000 plan already costs more than the maximum amount either family would pay. If the insurer raises the premium to $10,001, both families get $1 in additional subsidy. If it raises premiums to $11,000, both families get $1,000 in additional subsidy. In other words, no matter how much an insurer raises rates, a subsidized household pays zero more.

Ferguson on Krugtron

A fun show is breaking out. Niall Ferguson on "Krugtron the invincible."

Paul Krugman, for a while now, has been lambasting those he disagrees with by trumpeting their supposed "predictions" which came out wrong, and using words like "knaves and fools" to describe them -- when he's feeling polite. These claims often are based on a rather superficial, if any, study of what the people involved actually wrote, mirroring the sudden narcolepsy of Times fact-checkers any time Krugman steps in to the room. Niall has lately been a particular target of this calumnious campaign.

Niall's fighting back. "Oh yeah? Let's see how your "predictions" worked out!" Don't mess with a historian. He knows how to check the facts. This is only "part 1!" Ken Rogoff seems to be on a similar tear. (and a new item here.) This will be worth watching.