Friday, 21 May 2010

Bob's Universal Political Law - number 3

So the Germans are taking on the markets. The announcement that they are banning naked short selling of CDS (a form of tradeable insurance against a counterparty defaulting) has had its inevitable consequence. I observe one common characteristics of all politicians and regulators. This is what I call Bob's Universal Political Law. They hate markets.
Markets are about democracy - literally the 'rule of the people'. Like democracy they need regulation but in essence they are the free expression of our individual and institutional rights to buy and sell what we want, when we want, how we want. Free and competitive markets where fundamental investors, speculators and arbitrageurs back their judgement - putting their money where their mouths are - provide high quality information about the value of financial securities and ultimately the state of the underlying economy. Speculators, taking huge risks, force price movements to completion much more rapidly than other investors playing the long game. Arbs make sure that securities trading in one market are identically priced in other markets. Politicians hate markets - they tell them what they do not want to hear. Markets find the weak point just like the ocean beating on a sea wall and rarely do they get it wrong.
The banking crisis was a salutory example of the efficiency of the markets - once the vulnerability of the banks to the sub-prime mortgage market was apparent, the markets reacted. Too fast for the politicians and the regulators to cope with. So they called foul and banned short selling in banking stocks. Again, the markets are testing the economies of the Eurozone and in particular the political weakness and risks attaching to sovereign debt. So how do the politicians react? Merkel, dithered over supporting the Greek economy, the markets saw the hole in the Eurozone project and went for it. Guess what? What do the politicians so? Blame the markets. Shoot the messenger.
So what about the first two laws. Well you will just have to wait and find out.


Anonymous said...

Dear Professor Bob
I have a quick but unrelated question about the volatility to input into Black Scholes when using ROPT to value a delay option. Should we input % standard deviation of NPV or $ volatility of PV. If we assume zero volatility of investment cost (as locked by strike price)then $ volatility of NPV = $ volatility of project returns, but relative % volatility of returns would be lower, and I think the more appropriate input as price of underlying has been input as PV of returns ratherb than NPV. Indeed, if mean NPV was zero, realtive deviation of NPV would be infinate which could not be input. So what to input, PV % volatility or NPV % volatility?

Anonymous said...

Does a free market not allow for huge organisations such as Goldman Sachs to influence share prices in a way that benefits themselves - with enough scope to collude with other market "speculators" can bets on the market become a sure thing? If the answer is yes, there is a clear need to regulate markets.

Anonymous said...

Agreed, a market is a combination of regulation and freedom - even street markets are regulated. What matters about regulation is that they enhance the allocative efficiency of the market. That means that no single player should be able to exercise sufficient market power to create a false market. The case of Goldman Sachs is beng pursued by the US authorities because it is alleged that they did abuse their market power.

Cheong said...

New regulation could be a tool that is outdated, as people will just find another way to "steal" money, thats how wall street works. Market crash is happened because people always make impulse reaction without second thought. Market is where smart people to seek opportunity, to set traps, and to control the emotion on many outsiders. And regulation itself could not stop people from being greed and jump into shark tank. Life will find its own way.

Anonymous said...

Very Tough paper Sir!

TsuChong said...

Dear Prof,

I hope this message reaches you.

I took your final P4 paper today and to me it was a fair paper. However, many of my peers and friends think otherwise.

I'm writing to sincerely thank you for lifting the standard of P4 to where it should be. It was a real nightmare when I first started studying for this option, but your high standards pushed me study the subject in great depth and to develop a good foundation on its principles.

P4 students are aware of your tough exam standards and I believe you've been criticized alot (my lecture deemed you insane!). But I hope you find fulfillment in knowing that some of us appreciate and understand why you're doing so.

If your exam papers were to be made easy, I'm sure studying for P4 will not be so stressful - all we need to do is practice a couple of past year questions, get the mechanism of answering, and sit for the exams. Sure, many people will be happy and pass, but at what cost?

I thank you again and wish you the very best of luck in everything that you do. Thanks!