Category Archives: Guest Post

High-Frequency Trading and High Returns

This guest post is contributed by Ricardo Fernholz, a professor of economics at Claremont McKenna College. Some of his other work was profiled on this blog here

The rise of high-frequency trading (HFT) in the U.S. and around the world has been rapid and well-documented in the media. According to a report by the Bank of England, by 2010 HFT accounted for 70% of all trading volume in US equities and 30-40% of all trading volume in European equities. This rapid rise in volume has been accompanied by extraordinary performance among some prominent hedge funds that use these trading techniques. A 2010 report from Barron’s, for example, estimates that Renaissance Technology’s Medallion hedge fund – a quantitative HFT fund – achieved a 62.8% annual compound return in the three years prior to the report.

Despite the growing presence of HFT, little is known about how such trading strategies work and why some appear to consistently achieve high returns. The purpose of this post is to shed some light on these questions and discuss some of the possible implications of the rapid spread of HFT. Although much attention has been given to the potentially destabilizing effects of HFT, the focus here instead is on the basic theory behind such strategies and their implications for the efficiency of markets. How are some HFT funds such as Medallion apparently able to consistently achieve high returns? It is natural to suspect that such excellent performance is perhaps an anomaly or simply the result of taking significant risks that are somehow hidden or obscured. Indeed, this is surely the case sometimes. However, it turns out that there are good reasons to believe that many HFT strategies are in fact able to consistently earn these high returns without being exposed to major risks.

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The Price of Gold in the Year 2160

This piece of fun weekend reading is contributed by StatsGuy, an occasional commenter and guest contributor on this blog.

It’s become quite popular to talk about the price of gold . . . in blogs, the press, at dinner parties.  The latest topic of debate is not about the price of gold as a commodity, but about gold as the one and only king money.  The basic argument is that 5,000 years of tradition will overwhelm the tyranny of modern government and the fiat printing press.  The barbaric relic will defeat socialism, fascism, Obama-ism,  and restore liberty to the world, after a terrible economic collapse in which gold-owning visionaries become fabulously wealthy.

Perhaps they are correct—or perhaps not.  I don’t know what will happen in 10 years.  However, unless civilization utterly collapses (which is what gold hoarders seem to want), the gold bubble will collapse.  And I don’t mean the 10 year “bubble” . . . I mean the 5,000 year bubble.

This claim might sound crazy, but it’s quite easy to defend, for the simple reason that there is too darn much gold.  Gold enthusiasts will note that you can’t just print gold like fiat paper.  They will note that high quality mines are failing, and argue that we’ve passed “peak gold”.

The argument for the collapse has little to do with terrestrial mine quality (although massive amounts of money and new technology are flowing into exploration, long term mine development and extending the life of existing mines).  The argument merely requires that gold price ultimately responds to supply.

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For Profit or For Students?

This guest post is contributed by Mark Paul and Anastasia Wilson. Both are members of the class of 2011 at the University of Massachusetts-Amherst.

For-profit colleges are expanding enrollments at a rapid pace, but it is questionable whether these revenue-seeking universities give adequate consideration to students’ welfare, retention/graduation rates, and overall economic well-being alongside their bottom line profits.

A new post by Judith Scott-Clayton, a professor at Columbia Teachers College and new weekly contributor to the New York Times Economix blog, explores the merits of for-profit colleges, arguing that in many ways these schools are more efficient at seeking funding opportunities for students and adopting new teaching technologies. These schools procure more Federal dollars per student and employ more cost-saving technologies, in the classroom and online, than their non-profit public and private competitors.

However, the real question is not a matter of efficiency, but instead concerns students and the taxpayers funding Federal loans and grants consumed by for-profits. Are the relative merits of profit-oriented schools, including their comparative advantage in securing Federal funding, being used to improve the return on investment for students or for their shareholders? On the macro level, does the growth of for-profit higher education promote new risks in the economy, as drop-out and loan default rates continue to increase?

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How Are the Kids? Unemployed, Underwater, and Sinking

This guest post is contributed by Mark Paul and Anastasia Wilson. Both are members of the class of 2011 at the University of Massachusetts-Amherst.

In some cultures asking how the kids are doing is a colloquial way of asking how the individual is faring, acknowledging that the vitality of the younger generation is a good metric for the well-being of society as a whole. In the United States, the state of the kids should be an important indicator. Young workers bear the significant burden of funding intergenerational transfer programs and maintaining the structure of payments that flow in the economy. Today, the kids’ outlook is almost as bleak as the housing market; they are unemployed, underwater on student debt, and out of luck from a reluctant political system.

Currently, even after a slight boost in jobs growth, unemployment for 18-24 year olds [correction: should be 18-19 year olds] stands at 24.7%. For 20-24 year olds, it hovers at 15.2%. These conservative estimates, using the Bureau of Labor Statistics U3 measure, do not reflect the number of marginally attached or discouraged young workers feeling the lag from a nearly moribund job market.

The U3 measure also does not count underemployment, yet with only 50% of B.A. holders able to find jobs requiring such a degree, underemployment rates are a telling index of the squeezing of the 18-30 year old Millennial generation. While it appears everyone is hurting since the financial collapse, young adults bear a disproportionate burden, constituting just 13.5% of the workforce while accounting for 26.4% of those unemployed. Even with good credentials, it is difficult for young people to find work and keep themselves afloat.

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The Government Does Have Something To Do with It

This guest post on the relationship of business and government comes to us from Lawrence B. Glickman, chair of the History Department at the University of South Carolina; the author, most recently, of Buying Power: A History of Consumer Activism in America; and an occasional contributor to this blog.

One of the most telling statements of our political era, –made ten years ago this week by Dick Cheney during his Vice Presidential debate with Joe Lieberman on October 5, 2000, –was actually a misstatement that went largely unnoticed. And therein lies an important lesson about the place of government in our political culture.

In response to the Democratic nominee Lieberman’’s jibe that Cheney had profited handsomely from the job he had recently departed as CEO of the Haliburton Corporation, the Republican nominee replied, “”I can tell you, Joe, the government had absolutely nothing to do with it.”” Amid the laughter and applause of the audience, Leiberman chuckled good-naturedly and joked about joining the private sector himself.

Following the debate, media analysts focused on what the New York Times called Cheney’s “avuncular self-confidence” but, like his opponent, they largely passed over the fact that his statement was a whopping lie.  Despite his denial and his antigovernment rhetoric, the company Cheney ran depended on billions of dollars of government contracts and loan guarantees. It would not be an exaggeration to say that government was Haliburton’’s primary source of support.

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Central Clearing and Systemic Risk

This guest post is by Ilya Podolyako, member of the Yale Law School Class of 2009 and a friend of mine. Ilya led the Progressive Economic Policy reading group with me and served as an adjunct professor of law at DePaul University this past spring.

One of the key provisions of the Dodd-Frank Act is Title VII, which requires all non-exempt derivatives transactions to go through a central clearinghouse (this report provides a good summary). As James and Simon have explained, the Dodd-Frank Act uses the term “swap” as a big basket that captures most financial products that we would normally call derivatives: options, repos, credit default swaps, currency swaps, interest rate swaps, etc.

Prior to the passage of the Act, most of these products were sold over-the-counter by certain large institutions. That is, in form, a transaction where you wanted to buy a credit default swap triggered by some event (say, the bankruptcy of Ford Automotive) resembled a trip to the car dealership. The dealer had inventory on the lot; this inventory was split into several different models / types of product; individual instances of a given model were relatively homogenous and varied mostly by color and minor adornments (spoilers, leather seats, etc.). If you were looking for a car of a given make and model that had certain extra features, a dealer might be able to get one custom-built for you at the factory, but you’d have to wait for the item and pay extra. Of course, the salesperson would not be able to accommodate all requests – if you show up to your average Chevy dealership and ask to buy a jet-powered car, you are likely to leave empty-handed no matter how much money you have, even though a few other individuals have been able to procure said exotic item.

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It’s Not a Bailout — It’s a Funeral

The following guest post was contributed by Jennifer S. Taub, a Lecturer and Coordinator of the Business Law Program within the Isenberg School of Management at the University of Massachusetts, Amherst (SSRN page here).  Previously, she was an Associate General Counsel for Fidelity Investments in Boston and Assistant Vice President for the Fidelity Fixed Income Funds.

In poetry and politics, metaphor matters. Expect some fighting figures of speech on Thursday, when the conference committee takes up the topic of the Orderly Liquidation Fund or “OLF.” Under the proposed financial reform legislation, the OLF is the facility that would hold the money needed by the FDIC to shut down a systemically important, insolvent financial institution before its failure can contaminate other firms and the broader economy. In other words, one purpose of the resolution authority and OLF is to avoid repeating the disorder and disruption of either the Lehman bankruptcy or the AIG bailout.

To be clear, many question whether regulators will have the courage to invoke this provision and pull the plug on a dying bank. Accordingly, the “prevention” measures under discussion in the legislation are critical — these included the swaps desk spinoff, hard leverage caps on financial firms, regulatory oversight over shadow banks and inclusion of off-balance sheet transactions in capital standards, among others.

One of the hottest debates concerning funding the OLF is over who should pay into the fund and when should they pay. On the question of “who,” the choices have been framed as either industry or taxpayers. And the “when” options are described as in advance of or after a failure. Many, including the House majority in its bill and FDIC Chairman Sheila Bair, support an up-front assessment on industry. Those who oppose an industry pre-fund have tried to damn the OLF as a “bailout fund” and at times the financial reform legislation as a “bailout bill.”

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