Saturday Sep 20, 2008

Strong Positive Feedback and Tippy Markets

In network economies, the number of compatible users (or network end points) determine the value of the network. In such economies, one may experience strong negative or positive feedback. When the number of compatible users goes down, the network will eventually suffer a "vicious" cycle of collapse. On the other hand, when the number of compatible users goes up, the network will enjoy a "virtuous" growth cycle.

In Web 2.0: A Strategy Guide — Business thinking and strategies behind successful Web 2.0 implementations, Amy Shuen writes:

When two or more companies are in a competitive race for market share where there is strong positive feedback due to network effects, only one company emerges as the winner. (Economists call this market tippy because it can tip in favor of one company or the other.) Strong positive feedback can lead to a winner-take-all market dominated by a single firm or technology.


Monday Sep 15, 2008

Avoiding "Moral" Hazard

In a credit crisis, the "lender of last" will weigh options, now having to balance the desire to provide liquidity versus its desire to ensure market dynamics ("Credit Crisis Strains Government's Options," WSJ, Sept. 12, 2008):

Officials are also acutely aware of the problem of "moral hazard." Bailing out too many firms, the reasoning goes, would encourage more risk taking in the future. That makes officials reluctant to be seen as rescuing another institution. The Fed made a $29 billion loan to help J.P. Morgan take over Bear Stearns. It's not clear that it would be willing to do that for another firm.

Treasury Secretary Henry Paulson has said that institutions must be allowed to fail and that markets can't expect the government to lend money or support every time there's a crisis. "For market discipline to constrain risk effectively, financial institutions must be allowed to fail," Mr. Paulson said in a speech in July.


Thursday Aug 07, 2008

A Little Big Grain of Truth

There's a little big grain of truth in what Daniel Altman says ("Fluid Dynamics and Alternative Fuels"), based on macro-energy balances which one can imagine grounded in some solid macro-economic and micro-economic analysis.

Saturday Aug 11, 2007

Lender of Last Resort

Charles P. Kindleberger describes the concept of "lender of last resort," in great detail in his Manias, Panics, and Crashes: A History of Financial Crisis

As of late last week, central banks in the EU, the US, Japan and Canada have begun claiming their mantle as lender of last resort within their economies, pumping lubricating liquidity into financial markets (at least some $120B of it) to put a break on an impending credit crunch. The coming weeks will reveal more. (John Authers speaks about it here. He calls it "very dangerous times" and speaks of a potential "melt-down" and hopes that this injection of liquidity can push back the tide of "bad news.")

Sunday Jul 15, 2007

Markets and Standards

 

Much has been written about the role of dominant standards in growing markets in complementary products. In their Competing for the Future, Gary Hamel and C. K. Prahalad summarize the main points:

In the absence of one or two dominant standards, vendors of complementary products can't capture economies of scale because they must design different products for different standards.  The result is diminished potential for economies of scale, higher prices for consumers, and a market much slower to take off. Competing standards confuse customers and make them less apt to buy; many will prefer to wait until a clear winner emerges. When an industry finally coalesces around one or two primary standards, market growth spurts ahead.

For the most part, therefore, companies competing for the future are keen for standards to emerge as early as possible. Not only does this accelerate market development, it also reduces the risk of committing resources to technology or approach that ultimately fails to become the dominant standard.

This view of standards has proved valid in business history. One area where dominant standards play a very definite role involves industries that depend on very large "networks" such as the Internet, telecommunications or various other social and peer-to-peer networks.

The classical view regarding markets and standards needs to be complemented. First, we should be able to observe and try to explain the diversity of standards and markets. There are various niche markets and communities of exchange that require their own particular ways (or standards) for doing and building things. Here, we have a diversity of products that are available in each market community.

Second, standard dominance can be very "thin." Consider the (non-medical) shoe market. When it comes to the design of shoes, there are no "dominant" standards, other than the natural ones such as the bounds dictated by the physiology of feet and the demands of leather or other materials used.

Third, a particular standard can be rooted in a simple response to an inherent need, in a rather informal way. Later, it may become the "dominant standard" where the need has produced a community.

For example, we can investigate the case of giveh. In some rural communities, giveh became the standard shoe. These shoes are still manufactured by hand on a mass scale for everyday use. Givehs have surprisingly standard shapes, and one may encounter highly specialized markets in standard sole pieces, top pieces, thread, lace, etc. Here, we have a prime example of how rural communities give rise to their own standards for purposes of reducing transaction and manufacturing costs without ever holding a standards conference. The "tolerance" of these standards is good enough to serve their community and the relevant markets.

Friday Feb 16, 2007

Maturity and Interest Rate Risks

China seems prepared to deal with some interest rate and maturity risks.

Monday Jan 29, 2007

Derivatives at Davos

Back in December of 2004, in a weblog entry entitled The Basel Accord and the Value at Risk (VaR), I wrote the following:

While the advance in synthetic financial derivatives have allowed hedging of bets across the board and through the wide range of financial institutions, since these derivatives have also led to greater interlocking and entanglement of all aggregate financial bets across institutions, they may leave the whole system under a larger meta-level risk. The only breathing space left as an influence factor seems to be how the system is connected and interacts with its "edges" such as the emerging economies. In other words, while entanglement of bets has led to greater distribution of risks into a lower overall risk aggregate, the boundaries still determine how stability may "leak."

Now, at the Davos 2007 World Economic Forum, Jean-Claude Trichet, the president of the European Central Bank seems to be moaning the opacity of fancy derivatives and hedge funds who use them.  Trichet spoke as part of a session dedicated to whether central banks could manage global financial risks. As reported by Financial Times from Davos:

Conditions in global financial markets look potentially “unstable”, suggesting investors need to prepare for a “repricing” of some assets, Jean-Claude Trichet, president of the European Central Bank, said over the weekend in Davos ......

“There is now such creativity of new and very sophisticated financial instruments ... that we don’t know fully where the risks are located.” He added: “We are trying to understand what is going on but it is a big, big challenge.”

Mr Trichet’s comments reflect a debate in policymaking circles about the implications of the growth in derivatives.

Many investment bankers and some regulators and economists argued at last week’s World Economic Forum in Davos that the growth of the $450,000bn (€350,000bn, £230,000bn) derivatives sector had helped reduce market volatility and made the system more resilient to shocks by spreading credit risk. But other officials fear these instruments may be raising leverage and risk-taking to dangerous levels and keeping the cost of borrowing artificially low, potentially increasing the chance of financial crises.

I have to say that at least in my 2004 blog entry, I had some conjectures regarding the form of the risks and how they may leak out of the system so tightly bound together in hedges, bets and counter-bets.

Friday Nov 24, 2006

Mr. AI or Mr. Market

So, has Mr. AI any advantages (other than speed, which may cause some self-defeating dynamic instabilities) in comparison to Mr. Market when it comes to voting for stocks? Or will it be any better than a good investor when it comes to weighting the value of stocks?

In general, Mr. Market represents the leveled investing masses roaming the market. There is nothing they do that has any special upside. The good, contrarian investor takes care to stand judiciously apart from such masses.

A given AI algorithm can hardly be said to be any better than any other (composed with the same level of parametrization). If anything, a large number of these algorithm, including neural networks, Baysian belief nets, Markov models, Guassian classifiers, fuzzy ones, etc., are intelligence-equivalent for most practical purposes. Their marginal advantages (in speed and parametrization) when used for leverage can amplify value impact of common investment risks and "errors" just as they may find interesting points in the market for leverage.

So, in the final analysis, while Mr. AI may even choose random rules for analzsis, it will most probablz remain an unrully side-kick of the good investor.

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