Economic Rockstar

Connecting Brilliant Minds in Economics and Finance

056: Campbell Harvey on Improving Significance Tests, the Importance of Positive Skew and the Future of Blockchain

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056: Campbell Harvey on Improving Significance Tests, the Importance of Positive Skew and the Future of Blockchain

Campbell R. Harvey is Professor of Finance at the Fuqua School of Business at Duke University and a Research Campbell HarveyAssociate of the National Bureau of Economic Research in Cambridge, Massachusetts. He served as Editor of The Journal of Finance from 2006-2012 and is President-elect of the American Finance Association.

Professor Harvey obtained his doctorate at the University of Chicago in business finance. He has served on the faculties of the Stockholm School of Economics, the Helsinki School of Economics, and the Booth School of Business at the University of Chicago. He has also been a visiting scholar at the Board of Governors of the Federal Reserve System.

Campbell received the 2014 Reader’s Choice Award for the best paper published in the Financial Analysts Journal and the 2015 prize for the best paper published in the Journal of Portfolio Management. His recent work on evaluating trading strategies has won best paper awards.

Campbell’s research interests include statistical methods, risk management, asset allocation, real assets and cryptocurrencies. He is the Investment Strategy Advisor to the Man Group plc, the world’s largest, publicly listed, global hedge fund.

Economics:

In this interview, Campbell mentions: t-statistics, significance tests, trading strategies, investment premium, beta, correlation, standard deviation, confidence interval, P-value, Bonferroni multiple testing method, Type I error, Type II error, probability, normal distribution, optimal portfolio, volatility, expected returns, portfolio, pay-off, skew, over-fitting, regularisation, Efficient Market Hypothesis, Fractal Markets, stock market anomalies, Straw Man Model, momentum effect, mis-pricing and outliers.

Economists:

In this interview, Campbell mentions: Nassim Taleb, Benoit Mandlebrot, Peter Edgar, Yan Liu and Eugene Fama.

In this episode you will learn:

  • why it’s important to use t-statistics and significance tests and how it can be improved.
  • about the very simple idea Professor Campbell Harvey applies to his statistical modelling to improve the robustness of his tests.
  • why it’s wrong to use 2 standard deviations to have 95% confidence when running many tests.
  • about ‘Significant’, the XKCD cartoon that illustrates the vulnerability of statistical significance testing.
  • do green jelly beans really cause acne? How significance tests can mislead with a fluke.
  • how a trading strategy based upon picking a portfolio of shares based upon the first letter of a ticker symbol showed that those tickers that began with the letter A outperformed other stocks.
  • how testing multiple times is effectively data mining and what should be done about it.
  • about the meaning of 95% confidence and 5% level of significance.
  • what a p-value is and why we ant it to be as small as possible.
  • if it’s important for the finance and economics profession to look at how other sciences are applying testing methods?
  • whether we need a tougher standard to lower the possibility of false discoveries?
  • if there is a chance of a fluke finding and why we should apply the Bonferroni multiple testing method solve this?
  • about the decay signature of the Higgs Boson and whether it is just background noise.
  • whether the findings of many published academic peer-reviewed papers are wrong.
  • about Type I and Type II errors and their trade-off.
  • about All Trials’ mission to make all randomised control trials made public.
  • the problems when measuring and using volatility in asset returns.
  • why the level of skew in a distribution must play more of an important role in risk management and portfolio selection.
  • why Taleb’s Black Swan only looks at one side of the distribution – the negative side, and why we must also look at the positive side.
  • how applying ‘regularization’ to portfolio selection avoids ‘over-fitting’ the data so that unexpected future outcomes can be considered.
  • about the efficient market hypothesis and the 316 anomalies that have been published to refute this hypothesis.
  • why the best traders are in Asia and how insider activity makes them so.
  • about the rise of crypto currencies and Bitcoin and why schools across US universities are introducing modules on it.
  • what is blockchain and why its is safe.
  • about the bank’s idea of creating a permission blockchain.

The Problem with Significance Testing and How to Solve It

If you’re trying to see if a variable Y is associated with a variable in a significant way, we usually think of looking at that correlation and determining whether you’re 95% confident that you’ve got it right. Usually what that means is that you’re 2 standard deviations away from zero. So, zero would be there’s no relation.

It turns out that that is perfectly acceptable if we’re looking at one correlation between Y and X. However, if it’s not X, it’s X1 you try. You try X2. You try X3, you try … X100. You try 100 different things. Then the criteria of using 2 standard deviations to have 95% confidence is just plain wrong.

The reason why this is wrong, is that when you’re running 100 tests, there is going to be a high probability that something will turn up that’s 2 standard deviations from zero just by chance.

The ‘Jelly Bean’ cartoon by XKCD called ‘Significant’ illustrates how testing a hypothesis can become misleading when conducting a significance test. The hypothesis being tested here is whether jelly beans causes acne.

A randomised control trial is ‘conducted’ by scientists. This is done where, say we have 50 people with jelly beans and 50 people with no jelly beans and we count the acne. And what basically happens is that there is no significance. So the scientists don’t achieve the 95% and conclude that there is no relation between jelly beans and acne.

However, the cartoon further illustrates what happens when the color of each jelly bean is tested to see if a particular color causes acne. 20 additional randomised control trials are conducted. The cartoon shows that the link between the Red Jelly Bean and acne is insignificant. Blue Jelly Bean – insignificant. Until you get to the last jelly bean, the 20th, which is the Green Jelly Bean. They find that there is a significant relation between Green Jelly Beans and acne. The final frame in the cartoon is a headline saying ‘Green Jelly Beans Linked to Acne’.

So, if you do 20 trials, one of those is likely to show up as significant using the standard criteria and it’s a fluke.

“The idea of my research is that we need to raise the bar that 2 standard deviations is no longer – that 2 sigma is no longer – something that should be considered. We need to go much higher.” – Professor Campbell Harvey

http://imgs.xkcd.com/comics/significant.png

The Bonferroni Multiple Testing Method

When we say that there is 95% confidence, we are saying that there is a 5% chance that the finding is a fluke. The 5% is called the p-value. What you would like is for that p-value to be as small as possible. You want as small as possible probability that the finding is a fluke. So the usual p-value for a single test with just X and Y for 5%, would imply 2 standard deviations. When you do multiple tests, you need more than 2 standard deviations from zero. If there is a chance of a fluke finding, then we should apply the Bonferroni multiple testing method solve this.

What the Bonferroni does is a simple correction. What it says is ‘you discover a p-value which is, say, 0.004 and you multiply by the number of things or X’s you’ve tried, which is, say, X1 to X100. All of a sudden, your p-value transforms to 0.4 or 40%. That means there is a 40% chance that in repeated trials that this thing you’ve identified, say X57, is a fluke. So when you use this adjustment, you discard that variable.

Quotes by Professor Campbell Harvey in Episode 56 of the Economic Rockstar Podcast:

In the practice of finance, some investment manager goes to a client and shows a great strategy and looks amazing. But they don’t tell the client or potential client that they tried 499 other possibilities and this is the only one out of 500 that worked – Professor Campbell Harvey. 

“Over half of what’s published in empirical asset pricing is probably incorrect” – Professor Campbell Harvey

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“The problem with volatility is that it is a symmetric measure, that if you’re way above the average that contributes to the same volatility as if you’re way below the average” – Professor Campbell Harvey

“I’ve being pushing for the last 15 years to reform the way that we do our portfolio analysis, our standard models, to have the skew play a role.” – Professor Campbell Harvey

“It’s also a fact that it’s really hard to find any asset return that adheres to a normal distribution. If it does, it is very unusual.” – Professor Campbell Harvey

“What we want in economics and finance is repeatability.” – Professor Campbell Harvey

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“I believe, just as Gene Fama believes, that markets are inefficient.” – Professor Campbell Harvey

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“Blockchain provides a way to give unprecedented security. You’re immune effectively from this hacking.”

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Books:

Papers:

Other Resources:

Websites:

Where to Find Campbell: 

Website: Duke University

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039: David Zetland on Aguanomics, Water Scarcity, Water Wars and ‘Toilet-to-Tap’

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039: David Zetland on Aguanomics, Water Scarcity, Water Wars and ‘Toilet-to-Tap’

David Zetland is an assistant professor at Leiden University College, where he teaches various classes on economics. He was a PostdoctoralDavid Zetland Fellow in Natural Resource Economics and Political Economy at UC Berkeley (2008-2010) and a Senior Water Economist at Wageningen University (2011-2013). David blogs on water, economics and politics at aguanomics.com and gives many talks to public, professional and academic audiences.

David has two books The End of Abundance: economic solutions to water scarcity (2011)  and Living with Water Scarcity (2014). He received his PhD in Agricultural and Resource Economics from UC Davis in 2008. David lives in Amsterdam.

Influencers:

Adam Smith, Friedrich Hayek and Nassim Taleb.

Economics:

In this interview, David mentions and discusses: scarcity, shortage, commodity, supply, demand, marginal cost, opportunity cost, unintended consequences, monopoly, common-carrier system, the water-diamond paradox, development economics, governance, probability, fat tails, Buddhist economics, the problem of over-consumption, non-satiation assumption, GDP, pricing, fairness and efficiency.

Economists:

In this interview, David mentions and discusses: Adam Smith, Friedrich Hayek, Nassim Nicholas Taleb and Ernst Friedrich Schumacher.

The Water-Diamond Paradox (23rd minute in this Episode)

Find out:

  • if we should be worried more about a shortage of water or a scarcity of water.
  • if we should learn from the oil industry and develop the technology-equivalent of extracting oil from oil sands and desalinate the ocean water?
  • if we can tell whether we know the water footprint of a cow and if it’s different in California than Ireland.
  • why water is actually free and what you pay is for the delivery.
  • if there is an opportunity costs to acquiring water?
  • why people living in the slums of India pay up to 50 times the price for water than those who have cheaper piped water.
  • if a water monopoly is an effective market structure.
  • if price competition in the market for water would result in the over-use of water consumption.
  • about Scottish Water and how other utilities across the UK and adopting their distribution and pricing structure.
  • about the water-diamond paradox.
  • why David decided to do a PhD in economics after failing to get rich in the dotcom era.
  • how David came to get his family name ‘Zetland’.
  • about the coming ‘Water Wars’ and how it has already started.
  • about Sao Paulo’s troubled water situation and how it’s creating gang warfare on the streets.
  • who we should assign the property rights to water.
  • about Chile‘s exemplary assigning of water property rights.
  • what David proposes to be the most effective way of managing water.
  • how Singapore are becoming independent in creating their supply of water and are no longer depending on imports from Malaysia.
  • how Singapore are building technologies to recycle water from waste.
  • why the ‘toilet-to-tap’ water recycling initiative has failed in the US but is working in Singapore.
  • how marketing recycled water works in Singapore and not in the US – one known as ‘New Water’ and the other ‘Toilet-to-Tap Water’.
  • why Singapore treats water as a national security issue.
  • why it will take 20 years to build a desalination plant and why San Diego will need 15 of these plants to serve the water needs of the locals.
  • about the new Irish water utility, Irish Water, and how the management decided to ‘award’ themselves bonuses even before the Irish people payed for their water.
  • about ‘Buddhist Economics’ and the assumption of non-satiation.
  • what David would suggest if he was an Economic Advisor to any country regarding water policy.

Why David Studied Economics:

When I was between 25 and 30 years old, I travelled to 65 countries and when I came back to the States I was looking around and figuring out what to do. I tried to get rich in the dotcom era and that totally failed and I started to work with a bunch of academic mathematicians and they were really kinda cool people. But they were pretty cool and I thought ‘well this is interesting. Maybe I should go and do something academic’. I went back to grad school to get a PhD and I wanted to do development economics. My research project, which was to go and study cocaine production in South America, sounded to my advisors a littlest dangerous. Then one of my advisors said that there was this really strange case in Southern California where San Diego is in a big fight with other water utilities and maybe you should look into that. So that ended up being my dissertation – David Zetland.

David’s Advice to a Country Implementing a Water Policy:

“You have to take care of your environment. Then you have to commodify all the rest of the water. But all that revenue really should go to the citizens of that country. Other than that, I’m open to any other discussion about what’s a better system in terms of balancing between efficiency, which is pricing and fairness which is the distribution of those revenues” – David Zetland.

‘Water Water Everywhere and Not a Drop to Drink’: The Right to Water – It’s a Necessity After All

The ‘Right to Water’ is an important part of the conversation but it tends to confuse things. People need water for drinking, cleaning, washing and so on. But is there a right to water to put on your garden? Is there a right to water to wash your car? Do farmers have a right to water that goes on their fields if that means the river is going to be dry? So, there comes a point where the ‘Right to Water’ runs out and we have to start talking about water as a scarce good or an economic commodity. That’s the separation you need to start with.

Shortage is worse than scarcity because you can’t get any of what you want, even if you have time or money – David Zetland

David Zetland’s book ‘Living with Water Scarcity’ is about learning how to manage water scarcity, the same way we have learned to manage land scarcity, time scarcity and money scarcity. Water scarcity is not confined to any particular region or country. This is a global phenomenon. We can generalise water scarcity in terms of the lack of water available. But there exists specific concerns such as the scarcity of clean water, which is becoming a problem in northern European countries and eastern United States, where there’s lots of water but a lot of it is polluted.

Ireland's Anti-Water Charges Protest 2014

Ireland’s Anti-Water Charges Protest 2014

The irony for people living in Ireland, for example, is that the country is surrounded by water but yet availability of fresh, clean water can be scarce in some regions. There are a few towns and villages in Ireland who have been buying bottled water or are on boiling notices due the presence of cryptosporidium in their water. Water shortages is not necessarily an immediate concern for Ireland. However, California, on the other hand, is experiencing their 4th year of drought. This is something that is being experienced in many regions around the world, but ‘California has more reporters hanging around’ and other regions’ grief remain unreported.

The ‘Water Water Everywhere and Not a Drop to Drink’ problem leads people to think that we should desalinate the ocean and get all the water that we want from the ocean. This, however, would be a great physical and expensive task to undertake and the conversation on desalination tends to stop. Should we learn from the oil industry and develop the technology-equivalent of extracting oil from oil sands and desalinate the ocean water?

Adam Smith explained the value in exchange as being determined by labor: ‘The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it’.

David frames this as ‘Technologies and Techniques’; techniques meaning how we use technologies and how we use water. “In the case where you have scarcity, you could say we’re going to build a desalination plant, drill a deeper well, build aqueducts, take shorter showers or stop watering our lawns. We should try and help people use as many ways as possible instead of focusing on one particular silver bullet.”

Who’s the Straw that Broke the Camels Back?

Numerous groups are pointing the finger at each other and casting blame each others way for causing pollution, drought and water scarcity. Besides the natural precipitation, farmers use half as much water as people in the city, such as industries and municipalities. In California, farmers use four times as much water as cities, say in the UK. Farmers obviously use water in various forms, but they’re not necessarily using more than the cities.

Then there’s the big discussion about who should be allowed to or who has the right to us water and that’s where the politics and mudslinging comes in. However, the level of precipitation is different in Arizona and California, as well as in Spain and Cyprus, compared to regions in Ireland and the UK.

Quotes from David in this Episode:

“These pro-poor policies can end up being so anti-poor. It’s terrible, it’s actually almost a crime” – David Zetland

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on how cheap water in India results in water utilities not having the infrastructure to deliver water to the slum areas. These people end up paying up to 50 times for their water from tankards. This water is dirty and people, particularly children, queue up for hours to collect and carry this water to their homes which can often be on the 3rd or 4th floor of a building.

“The customer is vulnerable to being exploited by the monopoly and the monopoly is vulnerable to being exploited by the customer. And that’s where regulations come in” – David Zetland on the need for regulation in the market for water.

Why is water, which is something we need to live, so cheap, whereas diamonds, which are a pure frivolous luxury, so expensive? – David Zetland on the Water-Diamond Paradox.

Water Wars in Sao Paulo, Brazil

Sao Paulo’s reservoirs have fallen to such low levels that their supply fails to meet with their expected demand. There were a lot of ways in which Sao Paulo could’ve dealt with this risk, such as fixing their leaky networks. They cannot get water from somewhere else. You’ve got a limited amount of water and 10 to 20 million people who need water to drink. The utility can shut off the water supply at various locations if they like and that raises the question of rich versus poor. That kind of decision is not going to please anybody. There have been protests over this.

David’s assessment of this is that if Sao Paulo wants to avoid a war on the streets, they need to shut of everybody’s water and have tankard trucks distributing water in Jerry cans in the corners – one man, one bottle. And that’s because you’d be addressing the concern of social equality and human rights.

Israel is not going to invade Turkey for their water. You can’t win that battle. You can’t bring back the water – it’s too heavy.There won’t be wars of plunder, there’ll be just conflicts over who’s going to get the water. Water gangs will form and they will take your water.


Recommended Books:

  • Check out David’s review of ‘Small is Beautiful’ by E. F. Schumacher.
  • Find out here why David decided to give his book away for FREE.

Where to Find David Zetland:

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036: Jason Shogren on Music and Endogenous Risk and Rationality in the Environmental Goods Market

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036: Jason Shogren on Music and Endogenous Risk and Rationality in the Environmental Goods Market

Jason Shogren is the Stroock Professor of Natural Resource Conservation and Management and Chair of the Department of Economics and Finance at the University of Wyoming.Jason Shogren

Professor Shogren’s background and research interests include the economics of environmental and natural resource policy, experimental methods; endangered species; invasive species; climate change; agricultural and forest management; energy; health; regulation; and paleoeconomics.

Jason has been named a fellow of the Association of Environmental and Resource Economists (AERE), the nation’s pre-eminent professional society for environmental economists and policy.

Jason served as professor to Sweden’s King Carl Gustaf XVI in 2012 and is a 2007 Nobel Peace Prize winner (shared with Al Gore) as a member of the United Nations team working on climate change.

He has also served as a senior economist on the Council of Economic Advisers in the White House under the Clinton Administration.

Professor Shogren’s teaching include Global Economic Issues, Natural Resource and Environmental Economics, Environmental Risk and Conflict and Experimental Economics.

Jason is well published with over 200 articles and is the author and editor-in-chief of numerous books including Encyclopedia on Resource, Environmental, and Energy Economics, Experimental Auctions and Fat Economics: Nutrition, Health, and Economic Policy

Jason loves fishing and music. He spends his time composing acoustic roots songs that he describes as catawampus Americana music, has five albums and will be touring this summer.

Economists:

In this interview, Jason mentions and discusses:

Janet Yellen, Thomas Sowell, Daniel Kahneman, Amos Tversky, Gary Becker, Isaac Ehrlich, Ralph C. D’Arge, Tom Crocker, Peter Baum, Karl-Göran Mäler, Vernon Smith and Charlie Plott.

Economic Themes:

In this interview, Jason mentions and discusses:

Carbon tax, cap and trade market, the Coase Theorem, probability, general equilibrium models, expected utility, nudge, rationality, irrationality, risk aversion, loss aversion, homo economicus, soft paternalism, trade-off, scarcity, endogenous risk and extreme tail-end events.

“I spent most of my life before becoming a PhD economist as a musician” -Jason Shogren.

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“I like to think of economics as applied philosophy”- Jason Shogren.

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Find Out:

  • about the Cap and Trade Market for carbon emissions is a failure and would only work in a micro-management setting.
  • why its best to implement a carbon tax.
  • the difference between luxury emissions and survival emissions and why it maybe difficult for China and India to reduce their carbon.
  • how Jason’s depiction of a low probability-high severity event influenced Janet Yellen to take action on climate change.
  • if we are acting rationally or irrationally toward the environment.
  • how we can exploit rationality ‘for the good’.
  • how, over the last 30 years, we have become averse to just about everything.
  • how we can take advantage of peoples’ status quo to increase their contribution of paying a carbon tax.
  • how designing the right system can nudge people to do the right thing – just like soft paternalism.
  • how Jason sought inspiration about rationality from other disciplines, such as English literature and music composition, rather than from economics.
  • how Jason uses music as a form of escapism.
  • about the inspiration Jason gets for writing songs from economics.
  • who the talented people are behind the creation of Jason’s amazing artwork and photography.
  • about the concerts that Jason Shogren will be playing at each year.
  • about Jason’s hitch-hiking experience in Ireland in 1985 from the Giants Causeway and down along the West Coast (now known as the Wild Atlantic Way).
  • about Jason theoretical thought process regarding endogenous risk and  how he applies it to different environmental risks.
  • what Jason would do if he was once again Economic Advisor to the US government.
  • a little about the Endangered Species Act.
  • what I saw on Professor Shogren’s whiteboard when I spoke to him on Skype. Hint: It’s his next economic model.
  • about the 25% chance you have in meeting Jason in Centennial, Wyoming – it involves the population and the number of pubs!
  • about Jason’s plastic Nobel Prize keychain and where he hangs it.

Jason Shogren band

Influencers:

Ralph C. D’Arge, Tom Crocker (Wyoming), Peter Baum (University of Stockholm) , Karl-Göran Mäler, Vernon Smith  and Charlie Plott.

An Economic Theory that Influenced Jason Shogren:

A paper by Ehrlich and Becker on self-protection and self-insurance, i.e. endogenous risk, where people invest to change the lottery they face in life, influenced Professor Shogren’s theoretical approach to economics. Once Jason started looking at economics from that perspective, he began to see a lot of models in which the states of nature where independent. To Jason, that seemed too fatalistic for how we spend our resources and how we invest. Most environmental policies are a lottery because we can’t guarantee that somebody’s going to live or not get sick based on exposure (to environmental risk).

We have an estimate and ‘safe’ minimum standards, but there’s no guarantee. So we’re really talking about policies at a collective level that are moving probabilities and damages around. We also have investment at a private level in which we’re doing the same thing – Jason Shogren

What, therefore, struck Jason was asking people about their value of reducing risk and they giving him a value of zero. He questioned people’s decision of applying a value of zero to reducing risk. The reason was that they valued the ‘collective’ reduction as zero and not their ‘individual’ reduction because they took care of the risk themselves.

Applying this theoretical thought process to climate change, endangered species, health risks, pandemics, invasive species or any other problem, will most likely have some element of endogenous risk. Once you add that element to it, the model gets a little richer and once the model gets a little richer, then you can explain a little more behaviour. By adding the behavioural element to the model, the question is ‘What drives things more? Technology of reducing risk? Tastes? How do they work together or how they work apart?’.

“If you can strip it down to that level, then you can really look at a lot of different problems using that type of kit”– Jason Shogren. It can become very flexible as a theoretical framework and model, that it is the reason why Jason, his peers and his students were able to look at a lot of different problems in terms of endogenous risk. It allows for focus on a particular research topic, otherwise it would be too scattered.

Jason on Carbon Emissions:

“We still have to figure out a Plan B, because there is no Planet B” – Jason Shogren.

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Putting a price on carbon has been the way to reduce carbon emissions. Trying to set up cap and trade markets has been too hard. The cap and trade market has allowed the supply to increase – Jason Shogren.

“If you’re waiting for people to do the right thing for the right reason, you can wait a long time. We’ve seen that throughout history. Economists would say that ‘if you want to do the right thing at the right time, let’s get the prices right and then people will make their own choices’. But if you get prices to reflect true costs and reveal hidden costs that are being imposed on others, then hopefully we don’t have to job-own them and nudge them. Maybe we have to nudge people and get the price right. Both theoretical aspects of economics should be complementary and we should not substitute one for the other” – Jason Shogren.

Before we start calling it nudging, there was a saying “The target is the target and the costs are regrettable but not really decisive” – Thomas Sowell.

Rationality in the Environmental Goods Market:

Rationality in psychology is very different to rationality in economics, in that when we think about rationality in economics we think about a social construct. People are making choices within an active exchange institution like a market and if they start making their emotions run wild, then there are people to arbitrage them. Either they like less money to more or they adjust and they start looking for opportunities themselves. It’s not that we all have to be 100% rational. As long as the folks at the margin who are making those trades pay attention, the market is powerful enough to move it along as if everybody was rational. But they don’t have to be.

The problem with environmental goods is that we don’t have markets like that. So now we have to figure out the problem of how to aggregate up in a way that would incorporate both economic monetary decisions and economic non-monetary decisions. That becomes trickier. Up to quite recently, the only thing economists were dealing with in terms of aversion was risk aversion. Typically it was believed that risk was the only thing that people were averse of. And then Kahneman and Tversky came along and we were now averse to losses and we treated gains and losses differently.

Over the last 30 years, we have become averse to just about everything – ambiguity, inflation aversion, equity aversion, disappointment aversion, envy aversion, lying aversion, guilt aversion. And so by adding all of these emotions into our typical economic model, the question is ‘How and when do we stop?’. Do we add all 40 emotions into our models? And now how do we sort out cross-partial derivatives between equity and envy and disappointment and suspicion and regret? And those are jobs that economists have not been typically trained to deal with – assigning complementarities or substitutabilities between different emotional factors.

So part of this working on nudges is trying to understand that if we tweak the models so that we can take advantage of how people feel guilty about this or how they opt-in or opt-out about different things, we can exploit that irrationality ‘for the good’. For example, people like status quo, so let’s take advantage of that. So instead of buying an airline ticket, nowadays you have to opt-in to add in a carbon price or you can buy a carbon off-set. What we should do is get all the airlines to opt out of buying that carbon off-set. And giving our tendencies not to want to opt out of things, we would probably buy a whole lot more carbon off-sets.

If we can exploit those at the same time as having an active market for those off-sets and a price, then it’s not irrational or rational. It’s understanding that there is some instinctual behaviour that people at a ground level will stick with. That’s the whole soft paternalism idea that we know that you know what’s right and we’re just designing the system to help you get there as opposed to us telling you what’s right.

It is extremely difficult to single out one emotion and to identify it as the one emotion that is driving homo economicus away from our rational base-line. It’s going to take us a while to say ‘Here are the ten big emotions that we can live with and let’s just work on those’.

On Human Behavior:

“If I really want to understand human behaviour, who should I read – Shakespeare or Gary Becker?” – Jason Shogren.

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If we really want to study emotions we should study literature. If you really want to be economical about how people think, then you should study poetry. Then if you want to convey all of that in a compact form that people will pay attention to then you add music. Now you’ve got a melody and lyrics  and you have a path where essentially you are projecting what you are considering to be an important story to tell. Song writing has its structures and its forms that you can easily translate into guidelines and rules and math models, just like we do in economics. To me, arts and science – I don’t know if they’re ying and yang – to me they go parallel and spillover all over each other – Jason Shogren.

What Professor Shogren Would Do Today as Economic Advisor to the US Government:

  1. Figure out a way to introduce a carbon tax but difficulty would lie with the Senate and the House of Representatives since they are essentially run by the Republicans.
  1. Take on the Endangered Species Act because it’s being waiting to be revised for almost 22 years. The way that it is written is that any species has to be protected at any cost. That type pf pressure can’t hold without the economy bursting at the seams. It would be worth going through this Act and add safety valves in a systematic and coherent way. It’s too important for this Act to just sit idly by when people using discretion as to when it holds and when it doesn’t.

josh shogren

Takeaway:

As a younger man, everybody sort of hits that wall of maturity that you don’t really want to go through. Sometime you get forced through it and sometimes you walk through it and sometimes you fall through it. Once you get there and you decide you can’t control the universe, that’s a good place to be – Jason Shogren.

At the same time, you take care of what you can’t control. You know, it’s the oldest story in the book. Once you come to the realisation and you find that balance, things are just way more interesting, way easier to deal with and just, in general, happier. Being a good Scandinavian doesn’t mean I have my gloomy dark moments – Jason Shogren.

Songs Mentioned and Played in this Episode:

Concerts Where You Can See Jason Shogren:

On Ireland:

“I spent a month hitch-hiking in Ireland way back in ’85. I started up in Larne, went up through the Causeway, then all the way down the West coast. It was a great month of hitch-hiking, Guinness, rain, people and adventure. So, yeah, I’m ready to come again” – Jason Shogren.

On Conferences:

“It’s supposed to be fun. You’re supposed to live and learn and try to pass on something better. Sometimes it’s ideas and sometimes it’s ideas through songs” – Jason Shogren.

Musicians Mentioned in this Episode:

Recommended Book:

Where to Find Jason Shogren:

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016: Jack Schwager on How You Can Become a Market Wizard with Fundseeder.com

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016: Jack Schwager on How You Can Become a Market Wizard with Fundseeder.com

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Jack Schwager is a recognized industry expert in futures and hedge funds and the author of a number of widely acclaimed financial books. Mr. Schwager is one of the founders of Fund Seeder (FundSeeder.com), a platform designed to find undiscovered trading talent worldwide and connect unknown successful traders with sources of investment capital.

Previously, Mr. Schwager was a partner in the Fortune Group (2001-2010), a London-based hedge fund advisory firm. His prior experience also includes 22 years as Director of Futures research for some of Wall Street’s leading firms, most recently Prudential Securities.

Mr. Schwager has written extensively on the futures industry and great traders in all financial markets. He is perhaps best known for his best-selling series of interviews with the greatest hedge fund managers of the last three decades: Market Wizards (1989), The New Market Wizards (1992), Stock Market Wizards (2001), Hedge Fund Market Wizards (2012), and The Little Book of Market Wizards (2014).

His other books include Market Sense and Nonsense (2012), a compendium of investment misconceptions, and the three-volume series, Schwager on Futures, consisting of Fundamental Analysis (1995), Technical Analysis (1996), and Managed Trading (1996). He is also the author of Getting Started in Technical Analysis (1999), part of John Wiley’s popular Getting Started series.

Mr. Schwager is a frequent seminar speaker and has lectured on a range of analytical topics including the characteristics of great traders, investment fallacies, hedge fund portfolios, managed accounts, technical analysis, and trading system evaluation. He holds a BA in Economics from Brooklyn College (1970) and an MA in Economics from Brown University (1971).

Economic and Finance Themes:

In this interview, Jack mentions and discusses: chartists, technical analysis, fundamentals, futures, normal distribution curve, options, Black-Scholes Options Pricing Model, option warrant trading, efficient market hypothesis, probability, negative externalities, fiscal responsibility, Keynesianism, deficits and demand.

I chose economics because I wasn’t any good to major in physics or math. I just felt I would be mediocre if I went into those fields. On the positive side, I had a super professor for Econ1. He was just so clear and logical – Jack Schwager.

Economists and Traders:

In this interview, Jack mentions: David Shaw, Ed Thorp, John Bender, Michael Marcus, Fischer Black, Robert Merton, Myron Scholes, John Maynard Keynes, Michael Lewis, Nassim Nicholas Taleb, and Yoram Bauman.

In this episode, you will learn:

  • why Jack chose economics at University.
  • about the similarities between Physics and Economics and why they are so different as a science.
  • if there is a certain personality that is required in trading financial markets.
  • if there is a holy grail to trading the markets.
  • about the importance of discipline.
  • how an $18 ‘Job Wanted’ ad in the New York Times landed Jack a position as a key analyst.
  • the one trader that particularly impressed Jack.
  • about the different strategies of some of Jack’s Market Wizards.
  • why normal distribution tail events can have a higher probability of occurrence than is lead to believe.
  • about the tragic ending of Market Wizard John Bender and the current case against his wife by the Costa Rican authorities for his ‘murder’.
  • about Fund Seeder – the world’s first search engine for undiscovered trading talent.
  • about Jack’s forthcoming book with the working title ‘Undiscovered Market Wizards’ and how you could possibly feature it.
  • about the Market Wizards Roadshow coming soon in 2015.
  • why Jack wrote his book ‘Market Sense and Nonsense’.
  • about the debunking of the efficient market hypothesis.

Physics, Economics and the Stock Market: A Connection

Economics is more complex from a quantitative standpoint because in physics at least the rules are well-defined and don’t change and in economics they’re not stable.

Many schools in economics get it wrong because they fail to appreciate the influence of human behavior which is not stable.

Because of the human element it becomes much more difficult to forecast in economics than it is using physical laws.

A lot of traders interviewed for the Market Wizards book come from the higher level mathematics and physics spectrum. That’s one type of person who is attracted to the markets. It’s solving analytical problems that intrigues them.

Other traders are very intuitive and have a completely different approach to trading markets.

Trading with  Discipline in the Markets

There are no secrets to trading the markets. There are an untold number of ways in which the markets can be successfully approached.

They are all very difficult and most people will fail. There is no common approach and it’s more of a matter of finding an approach that works for you.

On Trading: Regardless of how you do it, you better have discipline – Jack Schwager

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It doesn’t matter if you’re quant or not quant, chart or fundamental,  long-term or short-term. Whatever approach you do use, you better be disciplined or it’s not going to work.

Once I got involved in futures, I quickly discovered that at that time, at least on the analytical side, there wasn’t much talent out there. I think I succeeded because competition was very easy at that time – Jack Schwager.

Life for almost all of us is tremendously influenced by chance more so than people would admit or realise – Jack Schwager.

Probability and Options

On Ed Thorp: He is the walking refutation of the Efficient Market Hypothesis – Jack Schwager

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The options markets are pricing for the assumption of equal probabilities at all times on both sides.

Options are priced for neutrality all of the time and that’s not reality. There are certain circumstances in the markets where something happening is much more likely to occur on one side of the distribution curve than the other.

The markets may assume a log normal distribution. But when there is a critical stop level at some price then, when the market goes to that price, the probability that the market will go below that price, what is considered within the tail events, will be much greater. Just getting to that critical price can trigger an avalanche of orders.

Fundseeder: The World’s First Search Engine for Undiscovered Trading Talent

The concept of Fund Seeder is to create a central place on the web where all traders, particularly undiscovered traders can establish their track records, have them verified and then have investors who are looking to allocate new trading talent find them.

The trader links their brokerage accounts with their own account on Fund Seeder so the numbers come directly from the traders’ brokerage account. That critical verification step occurs on this central platform allowing the traders and potential investors to verify the numbers.

There are traders from over 60 countries on Fundseeder who now have the opportunity to get in front of potential investors and establish a track record.

There is also the ‘seeding’ side where investor groups will participate to find traders and offer seed funding. It acts like venture capital where traders will receive seed funding to allow them trade larger accounts, which otherwise would not have been available to them outside Fund Seeder.

Many brokerage firms can be connected to Fund Seeder, including Interactive Brokers, and many more will connect in the near future.

Fund Seeder is a place where traders go to be discovered and where investors go to look for traders. You trade, we connect, they invest – Jack Schwager

Problems Jack Sees with Economics and Finance

  • The Efficient Market Hypothesis.
  • The Sharpe Ratio.
  • Looking at past returns to pick investments.
  • Volatility as a satisfactory and complete measure of risk.
  • Risk management.
On writing Market Sense and Nonsense: ‘I really wanted to throw stones’ – Jack Schwager

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Jack Schwager on Economists, Externalities and Fiscal Responsibility

I believe that 90% of economists will agree 90% of the time. Economists do agree on a lot of things. You can go from a liberal to a conservative spectrum in economics and still have wide agreement on a lot of things Jack Schwager.

The solution to global warming is a revenue-neutral carbon tax. You have a cost attached to the polluter side and you have a benefit attached to growth and expansion.

Keynes would never have argued for deficit spending in an expanding economy

Recommended Books:

Where To Find Jack Schwager: