• economic news summary and stock market crashes

    Using a Fat Tail to Describe Stock Market Risk

    Aug 25 • Behavioral Economics, Economic Thinkers, Financial Markets, fiscal policy, Government, Households, International Trade and Finance, Money and Monetary Policy, Regulation, Tech, Thinking Economically • 113 Views

    “If you want to make an impression at a board meeting or a Congressional hearing these bearish days, make a harrumphing noise and employ the figure of speech now sweeping the economic world: ‘But what about the fat tail?’”

    The quote came from a weekly NY Times Magazine column called “On Language.” While the year was 2009, it is especially relevant today.

    Fat Tails

    To understand a fat tail, we can start with a bell curve and height. As economist William Nordhaus explained, most women will measure between 58 and 70 inches with the mean at 64 inches. Using three inches as a standard deviation, an 11 foot woman would be placed 23 standard deviations away from the 64 inch mean. Because her height is a dot where the line should not even exist, we call it a tail event. A fat tail is the unexpected event located far from the mean.

    A Bell Curve:

    Stock Market risk and fat tails of bell curves

    From the Nordhaus paper on fat tails, here is a look at some from the stock market and for oil which indeed might now, at $40 a barrel, be displaying a fat tail.

    Stock market risk and fat tails

    From: “The Economics of Tail Events with an Application to Climate Change”

     

    Other financial fat tails? The 23 percent Dow plunge on October 19, 1987; the 2007-2008 meltdown, the U.S. housing market after 2006.

    Yesterday’s Fat Tail

    The largest point loss ever, the 1089 plunge when the market opened yesterday was a fat tail event. By midday it was down 102 points but then the decline resumed. The Dow was down 588 at the close.

    Stock market risk from 1000 point plunge and fat tail event

    Our Bottom Line: Risk

    Fat tail surprises can have a lasting impact because they change our perception of risk. After the 1987 crash, circuit breakers were implemented that temporarily halted precipitous trading. As for the 2007-2008 financial meltdown, couldn’t we say that Dodd-Frank was a result?

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  • Economic news summary and status symbols of grass

    How Your Lawn is About More Than Grass

    Aug 24 • Behavioral Economics, Economic Growth, Economic History, Economic Thinkers, Government, Households, Lifestyle, Regulation • 105 Views

    Wearing his “Grandpa Gone Wild” t-shirt, a 66 year old Hudson, Florida retiree was driven to jail by his daughter. The reason? When he refused to resod his weedy brown lawn, his neighborhood association filed a complaint. Since the community had his signed covenant, not complying meant he could sod or serve time. This gentleman remained in the slammer (as he called it) for 24 hours until a group of kind souls made his property presentable.

    Where are we going? To why lawns are about more than grass.

    Some Lawn History

    Think Downton Abbey. Rolling grass hills said Lord Grantham was rich enough to have servants mow and fertilize acres of green hills that had no practical function. At Monticello, there is a good chance that Thomas Jefferson was copying European aristocracy when he grew the first U.S. lawn in 1806. The rest of us waited another 80 years for the idea to catch on. Like Jefferson, though, I suspect we were trying to transplant an affluent image about ourselves and our neighborhoods.

    Our Bottom Line: Conspicuous Consumption

    One of my favorite economic thinkers is Thorstein Veblen (1857-1929). The first to explain and stigmatize why we conspicuously consume, Veblen said it was all about status.

    Thorstein Veblen explained the conspicuous consumption of a status symbol that displays affluence.

    Through his description of conspicuous consumption, Veblen made fun of us in The Theory of the Leisure Class (1899). Saying that more wealth leads to more wastefulness, he explained that the upper class has servants to wash, to clean, and to cook for them. The affluent spend their time engaged in sports and politics. To advertise what they have, they surround themselves with jewels, with cars, with art. And then the rest of us copy all of that through wasteful, aspirational purchases and activities that display our own ascent.

    And that could indeed take us back to our lawns.

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  • Economic news summary and soda taxes

    Berkeley’s Soda Tax Surprise

    Aug 23 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Debates, Government, Health Care, Lifestyle, Regulation • 115 Views

    Mandating one-cent per ounce,  the sugary drink tax in Berkeley, California was approved by voters during November 2014. Called Measure D, the proposal was supposed to diminish obesity and encourage healthy eating.

    It did not quite work out that way.

    Where are we going? To who winds up paying a tax.

    The Berkeley Tax

    As the first city level sugary drink tax in the U.S., the Berkeley penny per ounce approach targeted the producer side of the market. Advocates of the tax expected the cost to be passed from the sell-side to the consumer. Then, as any logical person would predict, consumers would buy less because of the price increase.

    However, as you can see below, the price barely budged. Rather close to San Francisco’s prices where no sugary drink tax had been levied, Coke’s mean price per 20-ounce bottle increased by 8.2 cents rather than 20 cents (a penny an ounce).

    the incidence of Berkeley's sugary drink tax

    From: “The Incidence of Taxes on Sugar-Sweetened Beverages: The Case of Berkeley California”

    As a result, consumers had little incentive to change their buying behavior.

    What Happened?

    The Berkeley response was a surprise. On the national level, from Fiji to Finland to France, sugary drink taxes have affected consumption. Furthermore, when a tax had to be paid by the supply side, as in Mexico, some sellers even increased that price more than the tax.

    So, some economists are hypothesizing that Berkeley was too small a geographical unit to have success. After all, extending across only only 10.5 square miles, Berkeley is rather small. It is possible that sellers decided it would be too easy to shop outside the city. Consequently they absorbed more than half of the tax.

    Out Bottom Line: Incidence of a Tax

    When a tax is levied on the supply side, lawmakers can never be sure who will pay it. If the distributor or the retailer passes along to the consumer a price hike higher than a tax, we say the incidence has been overshifted. On the other hand, if consumers wind up paying less, we say the tax has been undershifted. In econ texts, undershifting can be explained by demand elasticity. If buyers have a disproportionate response to price, sellers will have an incentive to bear at least some of the burden or the incidence of a tax.

    And that returns us to Berkley’s sugary drink tax. Whether a municipality wants to control obesity or just to raise revenue with taxes on soda and other drinks to which sugar has been added, it needs to know about incidence and elasticity.

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  • The econlife.com economics news summary

    Weekly Roundup: From Slow Mommy Tracks to Fast Wall Street Traders

    Aug 22 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Developing Economies, Economic Debates, Economic Growth, Economic History, Financial Markets, Gender Issues, Households, International Trade and Finance, Labor, Tech, Thinking Economically • 114 Views

    Posts Roundup

    Google's new name and branding Sunday 8.16.15

    Why Google changed its name…more

    Chinese yuan and the currency war created by devaluation Monday 8.17.15

    The devalued yuan and the Big Mac…more

    economic news summary and parental leave Tuesday 8.18.15

    How parental leave hurts women…more

    Economic news summary and The American Dream Wednesday 8.19.15

    Where families earn more…more

    Economic news summary and pay what you want Thursday 8.20.15

    How we respond to choosing our own price…more

     

    economic news summary and high speed trading Friday 8.21.15

    Why investors needed pigeons…more

    Ideas Roundup

    • branding
    • oligopoly
    • market structure
    • oligopoly
    • foreign exchange
    • purchasing power parity
    • devaluation,incentives
    • parental leave
    • unintended consequences
    • tradeoffs
    • inequality
    • income mobility
    • poverty
    • free riders
    • prices
    • social norms
    • behavioral economics
    • arbitrage
    • high speed trading
    • investing
    • asymmetric information
    • stock markets

     

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  • economic news summary and high speed trading

    Some High Speed Trading History

    Aug 21 • Behavioral Economics, Demand, Supply, and Markets, Economic History, Financial Markets, Innovation, Tech • 100 Views

    As the first U.S. Congress met in Federal Hall on Wall Street, rumors spread outside that they might fund worthless Revolutionary War bonds. Reacting quickly, speculators were said to have boarded fast boats for New Jersey (and beyond). Their goal was to purchase cheap war bonds from holders with no access to up-to-date news. The story ends with the speculators making huge money but being vilified as “rapacious wolves” who took advantage of the ignorant souls who owned the bonds.

    For us though, the story is about information. Wherever we have financial markets, the speed with which investors secure information has affected their ability to profit.

    There are some good speed stories.

    Pigeons and Optical Networks

    During the 19th century, investors used pigeons and optical networks for early access to information that they could use for trading decisions.

    Pigeons

    During the 19th century, the Rothschilds used homing pigeons to transport information. Written in coded Hebrew characters, information that no one else yet knew was flown to their offices in Vienna, London, Frankfurt, Paris and Naples. I’ve read that they used a code: “A B in our pigeon dispatches means buy stock, the news is good. C D … means sell stock the news is bad…” One legend has them learning about and profiting from Napoleon’s 1815 defeat at Waterloo 24 hours before the British government.

    Optical Networks

    The Chappe telegraph was a system spaced every 10 or 20 miles composed of telescopes on towers that had wooden arms with seven positions (users had a code book). First located between Paris and Bordeaux, the network passed along information from station to station. Whereas the trip between the two cities could take several days, the signal reached its destination in hours. In the U.S. during the 1840s, this sort of optical network was used to convey stock and bond prices between New York and Philadelphia.

    Our Bottom Line: Information Asymmetry

    As an investor, being able to benefit from little known information just means beating how fast the news travels. Centuries ago, pigeons came in handy. Now we have computers doing high speed trading. Both though facilitate an information asymmetry through which one group of investors profits from knowing more than anyone else.

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