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Saturday, October 6

6th Oct - Weekender: Markets & Economics

This weekend’s edition has plenty to chew on. In addition to the ongoing discussion on central bank policy, Basel 3 reports from BIS and the very helpful “understanding repo markets” are some of the highlights. For traders, the absolute must-read is the piece on how Keynes traded for 25 years. And do take the time to see the free coursebook on international economics!

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Top 10 Operational Risks: The third and fourth risk areas in a 10-part seriesAll About Alpha

Implementation of capital standards: assessment reports published by Basel CommitteeBIS
Three reports assessing the rules that will implement Basel III in the European Union, Japan and the United States.

Wanting to Hedge and Wondering HowAll About Alpha
State Street Global Advisors hosted a webinar Thursday morning on the management of tail risk, based largely on a survey of institutional investors and consultants, both in the United States and in Europe.

Financial innovation: The bright and the dark
Even before the crisis, many economists warned that financial innovation has a dark side. This column uses new cross-country data on financial innovation and provides evidence that financial innovation can lead to more volatility, more fragility, and more severe losses. But it also finds evidence of improved growth opportunities, better financing, and increased R&D expenditure.

Ex-SAC Capital Manager Tells FBI Fund Used Insider DataBB

Triparty repo and the clearing bank risks Sober Look
Repo markets have functioned well for decades. However this recent paper published by the NY Fed (below) outlined potential systemic risks in the tri-party markets that became apparent in 2008. The concerns are not with the repo market itself or the lenders/borrowers under the contract, but with the clearing banks that facilitate triparty repo transactions.

Repo transactions and shadow bankingSober Look
We continue to get questions about the repo markets and the structure of repo transactions. The attached paper from the Financial Stability Board provides a good overview of repo and securities lending markets (including rehypothecation practices).

Money, Power and the Rule of LawSimon Johnson / EconoMix / NYT
Economic policy is always torn between helping the broader social interest – lots of ordinary people – and favoring particular special interests. Unfortunately, special interests typically win out in the kind of situation we have in America in 2012, when it’s all about spending money to win friends and influence people.

SEC Technology Roundtable: How To Test Your Software To Avoid Technical GlitchesAdvanced Trading

This Is Why High Frequency Trading Will Never Go AwayZH

A Speed Limit for the Stock MarketNYT

The problem with high frequency tradingFelix Salmon / Reuters

Keynesian Investing: Changing Facts, Changing MindsThe Psy-Fi Blog
John Maynard Keynes’ remarkable investment record as the effective Chief Investment Officer of Kings College Cambridge over a period of a quarter of a century.  It’s a fascinating insight into the evolution of one individual from underperforming, overconfident, macro-based and behaviorally biased to an outperforming, realistic, stockpicking rationalist. 

An Investor's Guide to Famous Last WordsMotley Fool

What If Google Had a Hedge Fund?HBR
The world's biggest and fastest search engine can't help but generate terabytes and petabytes of actionable investment intelligence.

The New Nonsense: Leaving FinanceThe Big Picture
Every now and again, a meme pops up that cries out to have its head chopped off. The latest such idiocy: People leaving finance to find more “fulfilling” work.

Goldman Sees Stock Plunge Then SurgeZH

Investing in credit markets, with matricesalphaville / FT

Six observations about index CDS marketsSober Look

When Career Risk ReignsJohn Mauldin / The Big Picture
A tour of recent research, which shows that correlations among a wide variety of asset classes are increasing. It comes as no surprise to serious investors that it is getting ever more difficult to construct a diversified portfolio.

Why do top economists think the recovery has been so slow?Free exchange / The Economist
Survey Sep18-28:  we asked economists why they thought the recovery had been so slow.

The tightest pursesButtonwood’s / The Economist
Here lies a problem that has dogged nations all through this crisis (and still dogs nations outside the euro zone like Britain and America). The collapse of tax revenues in 2008 and 2009 caused deficits to soar, and made public finances look unsustainable. But when you start from a very large fiscal deficit, it is hard to get back to balance.

Why the UK output gap could be a chasmalphaville / FT
Capital Economics published a long report: a) fiscal and monetary policies may be far too tight and b) there could be plenty of scope for the economy to grow strongly without inflation rearing its ugly head.

Macrofinancial Stress Testing - Principles and PracticesIMF
The recent financial crisis drew unprecedented attention to the stress testing of financial institutions. On one hand, stress tests were criticized for having missed many of the vulnerabilities that led to the crisis. On the other, after the onset of the crisis, they were given a new role as crisis management tools to guide bank recapitalization and help restore confidence. This spurred an intense debate on the models, underlying assumptions, and uses of stress tests. Current stress testing practices, however, are not based on a systematic and comprehensive set of principles but have emerged from trial-and-error and often reflect constraints in human, technical, and data capabilities.

Fact-checking financial
The central part played by credit in the deep downturn and weak recovery fits a recurring historical pattern. Financial crises correlate with more painful recessions. This column takes a close look at 14 advanced economies over the past 140 years and shows that larger credit booms during expansions have been systematically associated with more severe and prolonged slumps. In short, credit bites back. Measured against the historical benchmark, the recent US recovery has been far better than could have been expected.

Annual Report 2012: Working Together to Support Global RecoveryIMF

Restoring Jobs by Restoring GrowthiMFdirect

What kind of austerity did Great Britain implement in the 1920s?Marginal Revolution
In other words, I don’t see how the episode as a whole supports the interpretative weight being placed upon it as an anti-austerity parable.

History, gravity, and international
International investment patterns play an important role in policy debates ranging from global imbalances to banking crises. This column shows that history should not be neglected on this score. It suggests that 10% to 15% of the cross-country variation in US investors’ foreign bond holdings is explained by this 'history effect', which reflects fixed costs of market entry and exit together with endogenous learning.

Does the current account balance help to predict banking crises in OECD countries?NIESR (pdf)
Given the magnitude of “global imbalances” in the run-up to the subprime crisis, we test for an impact of the current account balance on the probability of banking crises in OECD countries since 1980. This variable has been neglected in most early warning models to date, despite its prominence in theory and in case studies of crises. We find that a current account variable is significant in a parsimonious logit model also featuring bank capital adequacy, liquidity and changes in house prices, thus showing the patterns immediately preceding the subprime crisis were not unprecedented. Our model, even if estimated over an earlier period such as 1980-2003, could have helped authorities to forecast the subprime crisis accurately and take appropriate regulatory measures to reduce its impact. 

Currency wars as global stimulusalphaville / FT
Evidence that the effects of foreign exchange interventions are less ‘beggar-thy-neighbour’ and more global stimulus.

Global Economy Course materialsNYU Stern Economics
Required MBA course now online. Full course contents, including the textbook (pdf)

What have the economists ever done for us?
There is a long list of culprits when it comes to assigning blame for the financial crisis. This column argues economists are among the guilty, having succumbed to an intellectual virus of theory-induced blindness. It adds this calls for an intellectual reinvestment in models of heterogeneous, interacting agents, following in the footsteps of other social scientists. This will require a sense of academic adventure sadly absent in the pre-crisis period.

Are central bank balance sheets in Asia too large?BIS
This volume is a collection of the speeches, background papers and presentations from a conference on "Central bank balance sheets in Asia and the Pacific: the policy challenges ahead". The event was co-hosted by the Bank of Thailand (BOT) and the Bank for International Settlements (BIS) and was held on 12-13 December 2011.

Not so brokenFree exchange / The Economist
My colleague set out a fairly straightfoward balance-sheet-recession critique of the effectiveness of monetary policy.

Monetary MystificationJoseph Stiglitz / Project Syndicate
Central banks on both sides of the Atlantic took extraordinary monetary-policy measures in September, sending stock markets soaring. But politicians – and markets – in both Europe and America are mistaken if they believe that monetary policy can restore economic growth and boost employment.

Professor Woodford and the FedGavyn Davies / FT
Professor Michael Woodford of Columbia University is an extremely renowned macro-economist, and rightly so, but only recently has he occupied a central place in market thinking. Since his paper on US monetary policy at Jackson Hole, and the favourable remarks which Ben Bernanke made about him, everyone is trying to understand what his influence on the Fed might eventually mean.

The perils of inflation targeting (25 June 2007!)
An expansionary monetary policy and an historical conjuncture that happens to produce no inflation will lead to asset price inflation and deterioration of credit. At some stage, central banks will have to mop the liquidity or see inflation do it for them. (ahead of its time!)

Don’t call it money printing, rubiks cube editionalphaville / FT
HSBC had joined the cohorts of the “don’t call QE money-printing” brigade.  We thought this was a great positive for the mainstream analyst community. Moreover, we thought their explanation was really good.

Rubiks Revolutionsalphaville / FT
This post is a continuation, in which we apply the analogy to the crisis so far.

Currencies: The weak shall inherit the earthThe Economist
New government priorities and an enthusiasm for unconventional monetary policy are changing the way the currency markets work