Latest Stoies

• Interest rate futures: The next big leap (Financial Express)
• Japan reports record deflation (FT Alphaville)
• China: A tale of extreme views (FT Alphaville)
• U.S. Economy’s Contraction Slowed to 1% Last Quarter (Bloomberg)
• The 40th Anniversary of Apollo 11(Scientific American)
• Did an ice age boost human brain size? (New Scientist)
• Stumbling Over Data: Mistakes Fuel Climate-Warming Skeptics (Scientific American)

Economist on high frequency trading

Last evening I collected some links on high-frequency trading (HFT) and I was amazed to see Economist running a story on HFT in its new edition a few hours later. This is not to suggest that I did something amazing; I was amazed to see that even Economist is covering HFT.

The article says that "The basic idea of HFT is to use clever algorithms and super-fast computers"; it however stops short of explaining the role and complexity of algorithms. The article started with an ex-Goldman employee stealing the proprietary code and went on to explain the impact of high computation speed of trade execution using super computers etc.

All the big banks have access to super computers which may perform same number of computations per unit of time. All the banks try to search (or poach you can say) the best price for the trade however what really differentiate their trading strategies are the algorithms that are developed by the "quants". It is the models and their complexity that determine the execution speed and execution efficiency (in terms of price searching); and not the computational power of the computer alone.

Private equity is back

Economist runs a story "The barbarians are coming, again" (link). The article not only briefs the woes of PE industry off late but also sheds some light on the hopes of recovery as seen by PE players. View points like this

"The first area to see an increase in dealmaking is likely to be “roll-ups”, in which firms already backed by private equity will consolidate fragmented industries by buying small competitors from their troubled owners"

certainly makes the story an interesting read.

High Frequency Trading

There has a lot of action on web / blogs related to high-frequency trading and SEC's probe on Goldman's role in market manipulation using the algorithms. Here is a small collection of interesting links from the web

• How to Understand High Frequency Trading (The Atlantic)
• High-frequency trading (Marginal Revolution)
• Hurrying Into the Next Panic? (New York Times)
• High frequency trading as a liquidity tax (Reuters)

I wonder why I could not find any good links and thoughts from India. Although it is not allowed in India but I was expecting to see some good thoughts on high frequency trading. I will jot down my thoughts soon on this blog.

When is a SWF not a SWF?

Well, this is the story that is published on FT Alphaville; but I did not include this in the links list because it was just too important to be mentioned and studied separately. The chief executive of Singapore's SWF Temasek has announced that Temasek may allow public investment in the fund for the first time. This may raise several new issues related to investment objectives, transparency and exits.

The instant issue which crops up is - who is the investor in a foreign company. Suppose a partiular foreign entity is not allowed to invest in a restricted sector in India and the same entity invests in a foreign SWF. Now is this SWF (being a SWF) invests in the restricted sector then what kind of regulations / policies will govern the transaction? (The underlying assumption is that a trusted SWF shall be given some concession).

Sovereign Wealth Fund Institute lists various SWF and also rates them on transparency on a scale of 10. If we assume that their ranking methodology closely resembles the actual transparency, then we find that Temasek is ranked at highest 10.

Latest stories

• High-frequency trading under scrutiny (FT)
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• The Great Preventer (RGE Monitor)
• Ben Bernanke Got Poorer Last Year, Unless He Got Richer (Business Insider)
• Why Is Obama's Top Antitrust Cop Gunning for Google? (Wired)
• Microsoft, Yahoo Said to Be Near Agreement for Web-Search Ads (Bloomberg)
• Grantham: China Will Collapse (Business Insider)

Latest Stories

• Cleantech, Biggest Investment Opportunity of The Century: KPCB's Nazre (VC Circle)
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• Investments in US Treasuries hit record $38.8 b in May (Hindu Business Line)
  

Turner Review - Stress VaR

I read a post on FT about Stressed out VaR which discussed one of the salient point in the Turner Review - shortcomings of Value at Risk (VaR) and potential of Stressed-out VaR. This prompted me to read the complete Turner Review. The review is accompanied by a discussion paper (Oops ... 219 pages long) which recommends several steps to enhance regulatory standards and supervisory.

In addition to the Stressed-Out Var (this is very interesting so please read the FT post as well as the related links), the problem of procyclicity with the Basel-II accord is also addressed.

The discussion paper says (Point 3.49) that
"In the FSA’s implementation a stress test reflecting an economic downturn such as might be experienced once in 25 years is employed, which is likely to be more stringent than that required by the Basel framework"

FSA recommends more stringent stress tests and it admits that (3.51) "recent experience of firms’ stress testing has been quite negative. Indeed, in many cases firms were over-optimistic about their ability to manage their capital effectively through a downturn"

The most important point according to my understanding was pointing out the procyclicity in the trading books. FSA says that "a fundamental review of the trading book is needed and must include consideration of the procyclicality of market risk capital requirements"

So far so good.
But the fundamental question is how to implement the recommendations and how to bring international community on a common platform. Famously, US did not agree to the recommended Basel-II accord and implemented its own version. The other question is how to standardize "more stringent stress tests" that FSA is recommending.

Auto (commercial vehicles) sales graph - interesting pattern

This chart below shows sales of HML commercial vehicles (Heavy, medium and light commercial vehicles). The data was collected by me; and the chart and pointers given below were given to me by my friend Ankit.

1. From 2001 onwards, a secular rise at a stable growth rate can be seen
2. Every quarter end, the sales rise. Then next month they drop, pick up somewhat in second month and peak to a new high at the end of next quarter
3. As the volumes have increased, absolute swings have also increased. (2001 vs. 2007-08). However, the percentage swing appears to be the same
   

Some explanation of point 2 from an analyst Richard (he covers auto sector) in my company - " Spikes in September and March are easy to explain … they are due to depreciation benefits which a buyer can claim"

My understanding of quarter end spikes (which is actually very obvious, nothing special) - Probably auto manufacturers give some sops / discounts to increase year end and quarter end sales.

Highlighting the problems of Economics

The recent edition of Economist runs the cover story What went wrong with economics.

The article highlights the sentiments against economics and also tries to defend economics. I am just quoting some of the most striking lines -

• OF ALL the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself
• In the public mind an arrogant profession has been humbled
• In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far
• Economics is less a slavish creed than a prism through which to understand the world
• Finance professors are not to blame for this, but they might have shouted more loudly that their insights were being misused
• Add these criticisms together and there is a clear case for reinvention, especially in macroeconomics
  

My thoughts -
Economics (or any other scientific theories per say) always work with certain assumptions and conditions. It is a discipline and science to think and understand the market realitie; and NOT a tool to predict the future outcomes.

If wasteful spending, illiquidity, negative sentiments and inadequate regulation leads to a crisis then I don't understand why macroeconomics has to be blamed. Markets work on "Greed and Fear" and no theory can ascertain the future outcomes. We can only understand the conditions under which a particular situation may arise. Yes, I agree that conditions like illiquidity were not touched or well understood in the past and macroeconomists could not detect the bubble but that does not mean that economics is discredited.

However I totally agree with the closing lines of the article - "Economists need to reach out from their specialised silos: macroeconomists must understand finance, and finance professors need to think harder about the context within which markets work". Although I am relatively a novice, in my understanding, economists need to understand the behavior of market participants better. We cannot assume that markets are perfect. Moreover it is a known fact that policies, regulations etc. can be fiddled for the advantage of few organizations / lobbies. In my opinion, new age economists need to incorporate the two above mentioned conditions in the theories.