PrefBlog

Interesting take on chaotic theories of markets:

Dr Tobias Galla from The University of Manchester and Professor Doyne Farmer from Oxford University and the Santa Fe Institute, ran thousands of simulations of two-player games to see how human behaviour affects their decision-making.

In simple games with a small number of moves, such as Noughts and Crosses the optimal strategy is easy to guess, and the game quickly becomes uninteresting.

However, when games became more complex and when there are a lot of moves, such as in chess, the board game Go or complex card games, the academics argue that players’ actions become less rational and that it is hard to find optimal strategies.

This research could also have implications for the financial markets. Many economists base financial predictions of the stock market on equilibrium theory – assuming that traders are infinitely intelligent and rational.

This, the academics argue, is rarely the case and could lead to predictions of how markets react being wildly inaccurate.

I wouldn’t call the subjects of the following story “quants”. I’d call them technical analysts. A technical analyst with a computer is simply a technical analyst, and is still going to lose money:

Hedge funds that use computers to follow trends lost money for a second straight year in 2012 as political debates over the U.S. fiscal cliff and Europe’s sovereign-debt crisis roiled markets.

The Newedge CTA Trend Sub-Index, which tracks the performance of the largest computer-driven, or quant funds, fell 3.4 percent last year after a 7.9 percent decline in 2011. David Harding’s $10 billion Winton Futures Fund Ltd. slid 3.5 percent in 2012, its second annual decline since opening in 1997, investors in the pool said. Man Group Plc (EMG)’s $17 billion AHL Diversified fund fell 2.1 percent, while BlueCrest Capital Management’s $14 billion trend-following fund gained 0.02 percent, said the investors, who asked not to be identified because the figures are private.

The performance of the funds belies their popularity with investors, who’ve poured $108.2 billion into the pools since the end of 2008, according to Fairfield, Iowa-based BarclayHedge Ltd.
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Trend-followers try to profit by tracking momentum in prices, whether rising or falling. They often use technical indicators, such as moving averages or Bollinger bands, to predict movements for stocks, bonds and commodities. Quants use mathematical algorithms to decide when to buy or sell and rely on computers to respond to price signals in fractions of seconds.

Not only that, but quants do not necessarily engage in High Frequency Trading, either.

OSFI’s Mark Zelmer gave a speech at the 2013 RBC Capital Markets Canadian Bank CEO Conference:

An important New Year’s resolution for OSFI will be to assess which banks in Canada should be designated as domestically systemically-important (D-SIBs). We expect to announce our decision within a few months. Any bank receiving a D-SIB designation can also expect some additional prudential requirements, including having to carry more common equity. The extra capital requirements will take effect in January 2016; the start date for those that will be imposed internationally on globally systemically-important banks. This provides plenty of time for the designated banks to plan accordingly.
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Another important resolution for us this year is contingent capital. As of January 1, Canadian deposit-taking institutions are no longer able to include new issues of preferred shares and subordinated debt in their Tier 1 and Total Capital ratios unless those instruments carry Non-Viability Contingent Capital (NVCC) conversion triggers. Existing instruments are being phased out of regulatory capital at a rate of ten per cent per year. Like living wills and other resolution measures, these new instruments are an important ingredient in making sure that all deposit-taking institutions can be resolved in an orderly fashion in times of stress without taxpayers being the first port of call for new capital. OSFI is looking forward to the emergence of a market in Canada for NVCC preferred shares and subordinated debt instruments in 2013.

It was another mixed day for the Canadian preferred share market, with PerpetualPremiums up 7bp, FixedResets off 1bp and DeemedRetractibles down 5bp. Volatility was negligible. Volume was a little below average.

We have more welfare payments to dinosaurs:

The federal government announced a five-year extension of its $250-million Automotive Innovation Fund Friday that was immediately deemed by some industry observers as the ongoing cost of Canada’s continued participating in the North American auto industry.

Why do we subsidize them? Because they’re good jobs. Why are they good jobs? Because they’re subsidized.

The Basel III liquidity rules have been modified:

Global central bank chiefs agreed to water down and delay a planned bank liquidity rule to counter warnings that the proposal would strangle lending and stifle the economic recovery.

Lenders will be allowed to use an expanded range of assets including some equities and securitized mortgage debt to meet the so-called liquidity coverage ratio, or LCR, following a deal struck by regulatory chiefs meeting today in Basel, Switzerland. Banks will also have an extra four years to fully comply with the measure.
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A sample of 209 banks assessed by the Basel committee had a collective shortfall of 1.8 trillion euros ($2.3 trillion) at the end of 2011 in the assets needed to meet the 2010 version of the LCR, according to figures published by the Basel group.

Banks had warned that the initial LCR proposal would force them to buy additional sovereign debt, more closely tying their fate to governments’ solvency. The 2010 rule was drafted before the EU was fully confronted by a sovereign debt crisis that challenged traditional assumptions about the credit worthiness of government bonds.

Forcing banks to buy government debt is a form of financial repression.

Bloomberg’s editors are upset about this:

Not for the first time, the panel has retreated from its initial demands, and the final liquidity rule is far less rigorous than the committee had said it wanted and financial markets had been expecting.
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The committee issued its draft liquidity rules in 2010. The idea was to lay down the quantity and quality of liquid assets (in theory, assets that can be sold quickly without driving down prices) that banks must hold to cover a run on deposits or some other interruption in short-term funding. Under pressure from banks, especially those in the U.S., most aspects of the draft proposal have been weakened in the final document.

For instance, the new rule says liquidity must be enough to cover a 30-day run on insured retail deposits of 3 percent, instead of 5 percent as proposed. It also expands the range of corporate debt securities that qualify as liquid to BBB- (the lower boundary of “investment grade”); previously, the committee said nothing less than AA- should be eligible. High-quality mortgage-backed securities will also count.

This broadening of qualifying assets means that almost all banks already satisfy the rule — a point that was acknowledged by Bank of England Governor Mervyn King, the chairman of the rule-setting committee.
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As guttings go, this is pretty thorough. It confirms the committee’s reputation for delay, backsliding and willingness to accommodate the preferences of banks — the industry it’s supposed to be supervising. If the panel had been mindful of its credibility, it would have issued a draft it was willing to defend in the face of expected pressure from the industry.

William Cohan on Bloomberg has a nice piece on the realities of regulation:

Instead of taking a job at a big Wall Street investment bank, he [“Dock2” Treece] returned home to Toledo, Ohio, and joined, as a partner, his father’s tiny investment-advisory firm, Treece Investment Advisory Corp., and the family broker-dealer, Treece Financial Services Corp. The two companies have five employees: Dock2 Treece, his father, his younger brother and two administrators.
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The Treeces’ 2010 Finra exam, however, went on for eight months, as the regulators kept asking for more and more documents to try to discover a minor technical point about what kind of mutual funds the firm sold to its customers.

Treece said Finra kept telling him to sell a kind of mutual fund that he knew he wasn’t supposed to sell, but the examiners seemed to not understand the rules. To fulfill one Finra request required 4,000 pages of documents to be copied and sent off.

“It had taken my staff two weeks to get together, literally, just standing in front of a copy machine for 12 hours a day, pull a file out, take the documents out that they wanted, copy them, put them in a box, put the originals back in the file, and put the file back,” Treece said. “I mean, talk about useless.”

He said he spent more than $30,000 in legal fees — chicken feed on Wall Street but a big deal at a tiny firm — trying to convince the examiners of something they should have known about all along.

Here’s an idea for Toronto – Subway Savings Bonds!

Malaysia, Southeast Asia’s biggest local-currency bond market, will let retail investors fund Kuala Lumpur’s new subway when it starts marketing its first exchange- traded notes to individuals.
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DanaInfra will offer 300 million ringgit ($99 million) of government-guaranteed Islamic securities to individuals, Ashraf Radzi, associate director of Prokhas Sdn., a financial adviser to the company, said in Jan. 3 interview. He declined to give specific details such as yields or maturity.

The bonds, which pay returns on assets to comply with the Koran’s ban on interest, will be sold in increments of 100 ringgit, or the equivalent of $33, with a minimum order value of 1,000 ringgit, Bursa Malaysia’s Tajuddin said.

Rob Carrick of the Globe has weighed in on trailers:

What regulators should do is order the replacement of trailing commissions with a fee that is set by the adviser as a percentage of the client’s assets, to be withdrawn quarterly from cash holdings in the client’s account. The investment industry should introduce the phrase “advice fee” and create standards under which this fee would cover not only investment management, but financial planning.

He means, fees should be charged in the way an actual portfolio manager charges fees, forgetting that there’s one problem with this model: a huge segment of the investing public doesn’t want it. ‘There was no trading!’ says Joe Blow. ‘Why should I pay if there was no trading?’.

I also see that Mr. Carrick wants to force me to offer financial planning, despite the fact that I do not want to offer financial planning. It’s a ludicrous idea … any single person can be good at only so many things; I have chosen to be good at quantitative investment strategies, fixed income in general and preferred shares in particular. Now I’m going to be forced to offer financial planning? What’s next, I have to offer golf games and hockey tickets to big clients and hire a pretty receptionist?

Still another hurdle is you, the investor. You can be half to two-thirds excused for your fee ignorance because of the way you’ve been manipulated by the investing industry.

Totally wrong. There is full disclosure all over the place. Anybody who doesn’t know about fees hasn’t done any work at all. Is that another job Mr. Carrick wants to give me? Reading aloud the prospectus to prospective clients?

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums up 8bp, FixedResets down 3bp and DeemedRetractibles off 2bp. Volatility was average. Volume recovered, to average levels.

There was a decent, but by no means stellar, US jobs number:

Employers added workers in December at about the same pace as the prior month, and the unemployment rate matched a four-year low, showing sustained gains in the U.S. labor market even as lawmakers were struggling to reach a budget deal.

Payrolls rose by 155,000 workers last month following a revised 161,000 advance in November that was more than initially estimated, Labor Department figures showed today in Washington. The median estimate of 82 economists surveyed by Bloomberg called for a increase of 152,000. The unemployment rate held at 7.8 percent after the November figure was revised up from a previously reported 7.7 percent.

The S&P 500 reached a milestone of sorts:U.S. stocks rose, sending the Standard & Poor’s 500 Index above the highest closing level since December 2007, after data showed employers added workers in December at about the same pace as the prior month.

Mark Whitehouse of Bloomberg writes an interesting review of an IMF paper by two IMF officials, chief economist Olivier Blanchard and economist Daniel Leigh, titled Growth Forecast Errors and Fiscal Multipliers:

This paper investigates the relation between growth forecast errors and planned fiscalconsolidation during the crisis. We find that, in advanced economies, stronger planned fiscal consolidation has been associated with lower growth than expected, with the relation being particularly strong, both statistically and economically, early in the crisis. A natural interpretation is that fiscal multipliers were substantially higher than implicitly assumed by forecasters. The weaker relation in more recent years may reflect in part learning by forecasters and in part smaller multipliers than in the early years of the crisis.
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First, because of the binding zero lower bound on nominal interest rates, central banks could not cut interest rates to offset the negative short-term effects of a fiscal consolidation on economic activity. Christiano, Eichenbaum, and Rebelo (2011) have shown, using a dynamic stochastic general equilibrium (DSGE) model, that under such conditions, fiscal multipliers can exceed 3. Since episodes characterized by a binding zero lower bound (also referred to as “liquidity trap” episodes) have been rare, only a few empirical studies investigate fiscal multipliers under such conditions. Based on data for 27 economies during the 1930s—a period during which interest rates were at or near the zero lower bound—Almunia and others (2010) have concluded that fiscal multipliers were about 1.6.

Second, lower output and lower income, together with a poorly functioning financial system, imply that consumption may have depended more on current than on future income, and that investment may have depended more on current than on future profits, with both effects leading to larger multipliers (Eggertsson and Krugman, 2012).

Third, and consistent with some of the above mechanisms, a number of empirical studies have found that fiscal multipliers are likely to be larger when there is a great deal of slack in the economy. Based on U.S. data, Auerbach and Gorodnichenko (2012b) have found that fiscal multipliers associated with government spending can fluctuate from being near zero in normal times to about 2.5 during recessions.5 If fiscal multipliers were larger than normal and growth projections implicitly assumed multipliers more consistent with normal times, then growth forecast errors should be systematically correlated with fiscal consolidation forecasts.

Perhaps Keynesian economics will make a comeback! I’ve often remarked that I don’t mind large deficits in hard times … as long as there is a credible plan, with accompanying legislation, for paying off the new debt within 20-30 years.

America is a country in which rights are paramount. Unless you’re a bank:

“This dispute does not go to the merits of the matter but it does raise an important issue of principle: Whether we and other banks, large and small alike, have the fundamental right long recognized in this country to communicate freely with and seek confidential guidance from their lawyers,” Zuccarelli said in an interview.

Bryan Hubbard, an OCC spokesman, declined to comment on the agency’s inquiry.

In the letter sent to JPMorgan general counsel Stephen Cutler, the inspector general — the Treasury’s internal watchdog — dismissed JPMorgan’s arguments on attorney-client privilege, saying the OCC “could not do its work” if banks were allowed to withhold information on that basis. The OCC, an independent bureau of Treasury, asked the IG office to review the situation, Thorson said in the letter.

Failure to produce the records “will have to be seen as a continuing purposeful impediment to the authority of the OCC,” Thorson said in the letter, and would require “further action by our office.”

Coming up next: hand over your Facebook password or be charged with obstructing justice.

DBRS has a new methodology for rating life insurers, but there were no major changes and it did not result in any ratings actions. They did not opine on the result of OSFI’s consideration of the definition of capital.

It was a good day for the Canadian preferred share market, with PerpetualPremiums gaining 11bp, FixedResets winning 13bp and DeemedRetractibles up 12bp. Volatility was average, but all on the upside. Volume continued to be very low.

Suncor has a corporate policy of ineffective supervision:

Last June, Suncor told its workers it would introduce a sweeping random drug-and-alcohol testing policy for all employees in “safety-sensitive” roles, meaning they could be tested at any time.

Workers in safety-sensitive jobs aren’t supervised? What kind of company is this?

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 6bp, FixedResets down 5bp and DeemedRetractibles up 14bp. Volatility was low. Volume picked up, and is now merely very low.

Good news on pensions – but not for the sponsors:

The solvency of Canadian defined benefit pension plans improved in 2012, a new Mercer study says.

The consultant said Wednesday that its Pension Health Index stood at 82 per cent on Dec. 31, up two percentage points for the fourth quarter and up six percentage points for the year.

However, the global pension, health and investment consultancy said economic factors were largely a non-factor.

Most of the improvement was due to increased employer contributions to fund deficits.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 10bp, FixedResets up 23bp and DeemedRetractibles off 7bp – seemingly unaffected by excitement in the equity market. Volatility was higher than average, comprised of losing DeemedRetractibles and winning FixedResets. However, volume continued its recent stretch of extremely low number, so all this could just be a puff of smoke.

PerpetualDiscounts now yield 4.88%, equivalent to 6.34% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.25%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 210bp, unchanged from the figure reported December 27.

Fiscal madness continues in the US, with proposals to embed milkfare:

Under President Harry S. Truman’s farm policy, the government bought supplies of a product until its price reached “parity” with the cost immediately before World War I. Adjusted for a century of inflation, the Agriculture Department’s milk-support price today would be $39.08 per hundred pounds, more than double the dairy futures price of $18.60 at 8:34 a.m. in New York today.

Under the revised dairy plan, written by [Minnesota Rep. Collin] Peterson [D], the government would manage the milk supply by setting milk- production limits for farmers who enroll in a market- stabilization program. The proposal eliminates programs that pay farmers when prices fall below a certain level, replacing them with initiatives designed to protect profit margins through insurance programs and by limiting output, which would raise prices.

The year ended on a positive note, with PerpetualPremiums and DeemedRetractibles both up 2bp and FixedResets winning 12bp. Volatility was muted. Volume was near non-existent.

And that’s a wrap for 2012! The fund’s done rather well over the year … I’ve earned an extra half spoonful of cinnamon in my coffee tonight!