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Sunday, October 14

14th Oct - Weekender: Markets & Economics

This week the main themes are the need for banking reform – limiting the scale and scope of banks, and the resistance to, and perhaps futility of such efforts. The IMF’s recent economic outlook pointed the underestimation of fiscal multipliers. This is just a fancy way of stating that making budget cuts tends to lower growth and thus the previous “cult of austerity” was wrong.
The IMF's revision of fiscal multipliers is questionable

My view on this: the potential losses first had to be moved from the evil banks to the official sector. IMF and everyone else knew perfectly well that austerity would not work. It was needed to keep the PIIGS “alive” for the time it took to transfer the banks’ eventual losses to tax payers and central banks. Austerity policies gave both time to do this, but more importantly, made it politically possible.

Now that the losses have been moved to the official sector, they can finally start restructuring the sovereign debts and recapitalize the banking system from mutual rescue vehicles.

Previously on MoreLiver’s

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Regulatory Omniscience is A Fictional ConceitThe Psy-Fi Blog
If you’re a regulator you’re likely to be conditioned by motivated reasoning: you should want more stringent regulation because, after all, that’s what you get paid to do.  You’ll base the need for more rules on reasoned analysis, but your analysis will be directed by your incentives. Regulators are human; ergo, they’re subject to behavioural bias.

Why are we bailing out the banks? Part One. The Simple Answer.Golem XIV
A full five years of pumping money in to the banks and still our leaders will not even consider that they might be wrong. They still insist, as they have from the start, that “There is no alternative’. Call it bail outs, call it QE, call it monetary policy, rescue or suicide, it doesn’t matter. What matters is we’re still doing it.

Impact of Basel liquidity rules on interbank money
Will the new Basel rules make monetary policy less effective? This column looks at how banks responded to the introduction of the Dutch quantitative liquidity requirement. It concludes that a liquidity rule does influence lending rates and volumes in the interbank money market. These effects, however, are at least partially intended and the overall effect of a binding liquidity rule is still positive.

Banks: Hedgeless Horsemen, VAR, & Bear Stearns - TF Market Advisors

Why banks shouldn’t tradeFelix Salmon / Reuters
So banks therefore have two big reasons to move into trading: the paper calls the first one “time inconsistency”, and the second one “risk shifting”. The problem is that both of them make only a limited amount of sense at the margin, in small doses. In large doses, the benefit goes away — as we can see by the fact that trader-heavy investment banks nearly always trade on the stock market at very low multiples of earnings or of book value.

The risks of trading by
Liikanen, Vickers, and Volcker all question current banking-trading links. This column offers analytic scaffolding for thinking about the separation of banking and trading. Banking generates low risk returns from relationship-based activities; trading generates high-risk returns from short-term concentrated positions. The two are linked since trading allows banks to profit from the ‘spare’ banking capital, but deeper financial markets magnify problems of managing and regulating trading by banks.

Credit/mezz funds create a major hole in the Volcker RuleSober Look
The purpose of Volcker Rule is to focus the bulk of banks' capital on its primary business of lending. Seems clear-cut, right? But what if a bank invests in a finance company whose primary business is lending to corporations.

Stability through simplicityThe Physics of Finance
We can and should work hard to explore the space of what might happen, and so gain some forewarning of dangers, but we will still encounter surprises and we should expect to do so. So our approach to regulation ought to be centered on that premise -- that we face a world of uncertainty.

OECD: Foreign Investment in Sharp FallWSJ
Uncertainty about the outlook for the global economy and fears of rising protectionism have led to a sharp fall in foreign investment by businesses, the Organization for Economic Cooperation and Development said Thursday.

Tide barriersThe Economist
Capital controls would work better if there were some international norms

A Global 1937Krugman / NYT
There were many warnings to the effect that we must not repeat the infamous mistake of 1937, in which FDR was persuaded to focus on balancing the budget while the economy was still weak, terminating the recovery from 1933 and sending America into the second leg of the Great Depression. And what policy makers proceeded to do was, of course, to repeat the mistake of 1937.

Blogs review: Can we all be more like Scandinavians?bruegel
An interesting debate about the trade-off between innovation and redistribution has sparked over the (admittedly wonky) paper by Daron Acemoglu, James Robinson and Thierry Verdier in which the authors argue that the "cuddly" capitalism of Europe could not sustain high levels of growth in the absence of the "cutthroat" capitalism of America. Entrepreneurs in those ruthless economic models bear more risks – and thus move the technology frontier faster. While still in Working Paper format and written for an academic audience, the paper was picked up by several bloggers who criticized the premises, the methodology and the conclusions.

Welcome to the ‘Desert of the Real’ — a postmodern economyalphaville / FT
Volatility guru Christopher Cole, who heads up the volatility fund Artemis Capital Management, is known for making interesting arguments when it comes to volatility and risk…His latest note, though, takes us to an entirely new dimension of market abstraction.

Global liquidity: concepts, measurements and implications from a monetary policy perspectiveECB (pdf)

Money as a passion, not a standardalphaville / FT
Are money and value, much like time, a function of relativity rather than a definable and quantifiable substance?

History, gravity and international financeECB (pdf)

Interdependence and contagion in global asset marketsECB (pdf)

  ECONOMICS: IMF (see also previous post)
IMF: Austerity is much worse for the economy than we thoughtWonkblog / WP

Robustness of IMF data scrutinizedGlobal Economy / FT

IMF Admits It Prescribed Wrong Medicine; Is IMF Short for I Must Fail?Mish’s

Opening Remarks By Christine Lagarde, Managing DirectorIMF
Bank of Japan-IMF High-Level Seminar “Challenges of the Global Financial System: Risks and Governance under Evolving Globalization”

Times Like This Are DifferentKrugman / NYT
More on multipliers: why does it matter?Not the treasury view

Multipliers: using theory and evidence in macroeconomicsmainly macro

Transcript of a Press Conference on the Global Financial Stability Report IMF
European Equity Pairs Trading: The Effect of Data Frequency on Risk and ReturnSSRN
This article examines an equity pairs trading strategy using daily, weekly and monthly European share price data over the period 1998–2007. The authors shows that when stocks are matched into pairs with minimum distance between normalised historical prices, a simple trading rule based on volatility between these prices yields annualised raw returns of up to 15% for the weekly data frequency. Bootstrap results suggest returns from the strategy are attributable to skill rather than luck, while insignificant beta coefficients provide evidence that this is a market neutral strategy. Resistance of the strategy’s returns to reversal factors suggest pairs trading is fundamentally different to previously documented reversal strategies based on concepts such as mean reversion.

Tactical Asset Allocation for DummiesTurnkey Analyst

“you don’t win by predicting the future; you win by getting the odds right”Farnam Street

Blogs review: The Events Study methodologybruegel
The event study approach – a methodology in finance and economics used to detect the presence of event-induced returns within a period – has become ubiquitous in recent debates about the impact of unconventional monetary operations. But its identifying assumptions are generally not very well understood. In this review, we explain the different steps followed by researchers to perform event-study analyzes; we point out some of their pitfalls, based on recent discussions following the latest Jackson Hole meeting; and we illustrate its growing popularity in a variety of fields.

Death of a marketSober Look
Volumes on SovX, particularly SovX Western Europe have collapsed. The chart below from BNP Paribas shows how this market is beginning to disappear. Positions from the older series are still outstanding, but the new series now barely trade.

Buffet vs Modigliani-MillerThe View from The Blue Ridge
We think the same behavioral errors that tempt “gamblers” to buy lottery tickets, seduce “investors” to speculate in high risk stocks.  The result: a structural overvaluation in excitement and a systematic undervaluation in high quality stocks.

Macro hedge funds stink at market timingSober Look
And now they are positioned with a long bias. Given Macro funds' average track record recently, that bet does not bode well for the equity markets going forward.

Notes from The Big Picture ConferenceThe Big Picture

Citi On The Five FX Issues Waiting To Play OutZH
QE, electoral politics and fiscal cliff, emerging markets, euro, reserve managers

Meet The People Behind The Vacuum Tubes In The World's Largest HFT ShopZH

Book BitsThe Capital Spectator

Reckoning with Risk 12/12: The Greatest Risk of AllAbove the Markets
Final piece of a 12-part article – see the bottom of the post for links to the previous ones.

You're an Idiot. Statistically Speaking.The Motley Fool
Statistically, the SEC found that American investors -- regardless of age, race, or gender -- "lack basic financial literacy," and that they generally do not understand even "the most elementary financial concepts such as compound interest and inflation."

How do skirts differ from computers?John Kay
But there is no right or wrong answer. In all problems of this kind, the relevant measure is specific to the particular purpose you have in mind.

Taking Hard New Look at a Greenspan Legacy (2008)NYT

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