If you like Wolfram Alpha how about learning about the man behind the plan…
Introduction (Via Youtube)
Noted scientist Stephen Wolfram shares his perspective of how the unexpected results of simple computer experiments have forced him to consider a whole new way of looking at processes in our universe.
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The point about this paper is that reference points in prospect theory mirror wealth positions. So, based on Kahneman & Tversky’s discoveries, wealthy people (or those experiencing gains relative to a reference point) are likely to become risk averse preserving capital and getting richer while poor people (those experiencing losses relative to a reference point) are likely to become risk seeking and thus risk capital impairment.
Click Here To Read About Risk Aversion, Decision Making, & Wealth Effects
Abstract (Via SJDM)
Some studies have found that choices become more risk averse after gains and more risk seeking after losses, although other studies have found the opposite. The latter tend to use hypothetical cases that encourage deliberation. In the current study, we examined the effects of prior gains and losses on a task designed to encourage less reflective decision making, the Iowa Gambling Task (IGT). Fifty participants conducted a manipulated decision-making task in which one group gained money, whereas the other group lost money, followed by the IGT. Participants who experienced a prior monetary loss displayed more risky choice behavior on the IGT than subjects who experienced a prior gain. These effects were not mediated by a positive or negative affect, although the sample size may have been too small to detect a small effect.
Introduction & Excerpts (Via SJDM)
Kahneman and Tversky (1979) noted that people are often risk averse for gains and risk seeking for losses. Whether people consider a consequence of their choice as a loss or as a gain is dependent on their point of reference. This reference point, which is often equivalent to the current wealth position, plays a key role in the theory of choice.
Hypothesis (Via SJDM)
The main hypothesis was that people who experienced a prior gain on a gambling task performed better (i.e., made more advantageous choices as a consequence of risk aversion) on the IGT as compared to persons who experienced a prior loss. Furthermore, we asked whether this effect was influenced by subjective affect, and various other individual differences.
Click Here To Read About Risk Aversion, Decision Making, & Wealth Effects
This study sheds some light on the priority heuristic and its place in the decision making process.
Click Here To Read About The Priority Heuristic
Abstract (Via JDM)
Although many models for risky choices between gambles assume that information is somehow integrated, the recently proposed priority heuristic (PH) claims that choices are based on one piece of information only. That is, although the current reason for a choice according to the PH can vary, all other reasons are claimed to be ignored. However, the choices predicted by the PH and other pieces of information are often confounded, thus rendering critical tests of whether decisions are actually based on one reason only, impossible. The current study aims to remedy this problem by manipulating the number of reasons additionally in line with the choice implied by the PH. The results show that participants’ choices and decision times depend heavily on the number of reasons in line with the PH — thus contradicting the notion of non-compensatory, one-reason decision making.
Excerpt-What Is The Priority Heuristic (Via JDM)
In the simple case of non-negative two-outcome gambles comprising a minimum gain, a maximum gain, and according probabilities, the PH claims that the following steps are taken by a decision maker: First, an aspiration level is computed which is 1/10 of the largest maximum gain (rounded to the nearest prominent number, Brandstätter et al., 2006). If the difference between the minimum gains exceeds this aspiration level, the gamble with the larger minimum gain is chosen; thus, information search is stopped after one piece of information has been examined (henceforth PH1 case) and all probabilities and maximum gains are ignored. If this is not the case, the probabilities (of the minimum gains) are considered: should these differ by at least .10 the gamble with the smaller probability (for the minimum gain) is chosen. So, search is terminated after the second reason has been examined (thus labeled PH2 case) and a choice is made ignoring all gains. Finally, if the probabilities yield no such difference, the maximum gains are considered (PH3 case) and the gamble comprising the larger maximum gain is chosen. No trade-offs are made and thus there is no integration of information in the process
Click Here To Read About The Priority Heuristic
Here’s a short summary of Peter Lynch’s book.
One Up on Wall Street - Peter Lynch
I’ve posted several of Dan Ariely’s papers and I can’t believe I found this full version of his book.
Please use this as an opportunity to browse the book and then purchase the original copy (here).
Background On Dan Ariely (Via Wikipedia)
Dan Ariely is an Israeli professor of behavioral economics. He teaches at Duke University and is head of the eRationality research group at the MIT Media Lab.
Predictably Irrational; The Hidden Forces That Shape Our Decisions (Harper; 2008)
Dear readers,
Given the fantastic feedback and massive requests for more Hyman Minsky material I decided to compile a list of free research papers (and corresponding abstracts)that you can download below.
Best,
Miguel Barbosa
1. The Financial Instability Hypothesis - Via SSRN - (Click Here To Download This Paper)
The Financial Instability Hypothesis (FIH) has both empirical and theoretical aspects that challenge the classic precepts of Smith and Walras, who implied that the economy can be best understood by assuming that it is constantly an equilibrium-seeking and sustaining system. The theoretical argument of the FIH emerges from the characterization of the economy as a capitalist economy with extensive capital assets and a sophisticated financial system. In spite of the complexity of financial relations, the key determinant of system behavior remains the level of profits: the FIH incorporates a view in which aggregate demand determines profits. Hence, aggregate profits equal aggregate investment plus the government deficit. The FIH, therefore, considers the impact of debt on system behavior and also includes the manner in which debt is validated. Minsky identifies hedge, speculative, and Ponzi finance as distinct income-debt relations for economic units. He asserts that if hedge financing dominates, then the economy may well be an equilibrium-seeking and containing system: conversely, the greater the weight of speculative and Ponzi finance, the greater the likelihood that the economy is a “deviation-amplifying” system. Thus, the FIH suggests that over periods of prolonged prosperity, capitalist economies tend to move from a financial structure dominated by hedge finance (stable) to a structure that increasingly emphasizes speculative and Ponzi finance (unstable). The FIH is a model of a capitalist economy that does not rely on exogenous shocks to generate business cycles of varying severity: business cycles of history are compounded out of (i) the internal dynamics of capitalist economies, and (ii) the system of interventions and regulations that are designed to keep the economy operating within reasonable bounds.
2. Financial Crises: Systemic or Idiosyncratic - Via SSRN (Click Here To Download This Paper)
The presentations at this conference are by economists from Academies and economists who professionally confront real world problems, either in private finance or in public policy. As economists we accept that the remarks made by Keynes in the closing passage of The General Theory are true: “… the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. …. I am sure the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. … Soon or late it is ideas, not vested interests, which are dangerous for good or evil.” We like this assertion not only because it makes us important but also because it makes good sense. The ideas that Keynes refers to are theories. A theory prior for rational action. A of system behavior is a proposed action, whether by individual agents in households or firms, a bank, a government agency or a legislative body is appropriate action only as a theory connects the action to the desired result. Because some institutions, such as deposit insurance, the savings and loan industry, and a number of the great private banks, that served the economy well during the first two generations after the great depression, seem to have broken down, the need to reform and to reconstitute the financial structure is now on the legislative agenda. As we try to fix the financial system three questions should be asked of the pushers of a policy proposal: 1. “What is it that is taken to be broke?”, 2. “What theory about proposal?” 3. What are the dire consequences of not fixing that which you assert is broke? In what follows I will take up three points 1. Two views of the results of the economic process 2. Systemic and idiosyncratic sources of financial crises 3. Some ideas about the scope for policy in the present “crisis”.
3. Finance and Stability: The Limits of Capitalism Via SSRN (Click Here To Download This Paper)
Once again the United States economy is facing a crisis, resolution of which first requires the realization that there are many types of capitalism: Solutions implemented in the past, therefore, may or may not be an appropriate solution today, as they could have been implemented as an answer to a problem posed within the context of a different model. Alternatively, the solution may lie in the implementation of a totally new economic regime in answer to reoccurring problems inherent in capitalism in general. The implementation of a new model is not a unique happening in United States economic history. The interventionist model–set in motion by President Roosevelt in answer to the failure of the laissez-faire model in the 1930s–dealt with the obvious flaw inherent in capitalism in general, namely, its inability to maintain a level of aggregate demand consistent with full employment. Implementation of the interventionist model prevented a massive depression of the type experienced in the 1930s from being repeated due to the larger role played by the government sector in maintaining demand via active fiscal policy, while moderating inflation through the use of monetary policy. The interventionist model also recognized the less obvious, deeper flaw of capitalism–namely, the manner in which the financial system can adversely affect the price of assets relative to that of current output. Absent any interventionist policy, the resulting decline in private investment and profits leads to a downward spiral and collapse of the financial sector. The institutional roadblocks included in the interventionist model were sufficient to avert large disequilibriums in asset and output prices, thereby sustaining profits and precluding a deep recession. (Indeed, the Federal Reserve was not forced to act to avert a financial crisis until 1968, when problems arose in the commercial paper market.) The interventionist model, however, was abrogated during the 1980s with the reinstitution of a new laissez-faire model. The new model eliminated many of the restrictions imposed on financial sector, massive increases in national deficits through unproductive public sector spending (made even more inefficient by the resulting interest on the debt), and the growth of speculative financing schemes that left us with too many highly indebted firms. A large, financially induced depression was contained only through the reintroduction of massive governing monetary and fiscal intervention in the form of the S&L bailout and the maintenance of profits with massive deficits. Although the subsequent drop in interest rates has resulted in a rise in asset values and somewhat abated the turmoil in the financial markets, the economy continues to stagnate.
4. Financial Instability and the Decline of Banking: Public Policy Implications - Via SSRN (Click Here To Download The Paper)
Banking plays two roles in a modern capitalist economy: It provides a means of payment and channels resources into capital development. These functions are being performed to a decreasing extent by banks, and it appears that this trend will continue. Such developments suggest that the economic role of central banks needs to be reviewed because the role of banks is significant in the ability of the central bank to conduct monetary policy. This ability is changing due the transformation of the channels through which Federal Reserve operations affect the economy away from affecting the availability or cost of financing and toward affecting uncertainty, the evaluation by portfolio managers of the viability of enterprises, and the stability of markets. When central bank operations affect the uncertainty of financial market agents, market reactions will often be out of proportion to the size of the operation.
5. The Transition to a Market Economy: Financial Options - Via SSRN (Click Here To Download The Paper)
The social transformation of Eastern Europe has proceeded much faster, and the destruction of communism’s legitimacy and efficacy has been more complete, than was deemed possible even a few years ago. A common tenet among the economies now emerging from communism is the lack of significant private wealth, even though there are capital assets that are used in production and have the potential to generate profits. However, since there is no relevant history of profits in the emerging economies, there is no way to meaningfully assess values of capital assets. The financial system provides for linkages through time: Exchanges of money for well-defined claims to future-money flow are made daily. Thus, the financial structure and the physical capital assets of a capitalist economy link the present and the past to the future. The options available to the emerging economies with respect to their financial structure are limited-the lack of significant private wealth leads to weak market for financial instruments and poor prospects for market-based financing. The initial choice of a financial structure is constrained to universal banks or public holding companies. Special venture capital holding companies and local independent banks should be integrated into the financial structure to facilitate entrepreneurial spirit. The public holding company is favored as a transitional instrument to foster the development of information and private wealth, and should be modeled after the Reconstruction Finance Corporation of the New Deal era.
6. The Capitalist Development of the Economy and the Structure of Financial Institutions - Via SSRN (Click Here To Download The Paper)
This paper evolves from the sharp contrast in Smithian and Keynesian views about the relationship between the financial structure and the economy. The Smithian perspective implies that the financial structure is irrelevant, whereas the Keynesian position concludes that effective financing is necessary for the “capital development of the economy”- there is also a need to constrain any tendency of what Keynes referred to as speculation to dominate. Thus, the essential elements of equilibrium in Keynesian theory, the financial theory of investment and the investment theory of business cycles, are most apt when examined as outcomes of processes that operate over time. During the 1980s, there was a sharp increase in speculative financing resulting from the trend toward leveraged buyouts and the rising demand for short-term marketable corporate liabilities. A main characteristic of a capitalist economy that is stagnant or immersed in a depression is that the capital development of the economy is not progressing. The 1980s were filled with examples of financing inept investments, while the current climate is one of grossly inadequate investment levels to create a progressive full-employment economy. The financial instability interpretation of Keynes rests upon the profitability of debt financing, and incorporates the potential collapse of asset values in an environment of speculative and Ponzi financing. Consequently, the financial structure is significantly more fragile today than earlier in the post World War II era.
Deposit insurance, the savings and loan industry, facets of the insurance industry, and a significant number of private banks have all been plagued by recent collapse. The legislative agenda goes beyond merely funding the shortfall in deposit insurance funds: Congress has suggested that reforming the deposit insurance function, as well as the associated regulatory and supervisory structure, is imperative to avoid a recurrence of Treasury financing. An assessment of the problem, and also the prescriptions for a cure, rest on the particular theoretical perspective of the observer. The Smithian view asserts that markets always lead to the promotion of public welfare, while Keynesian theory states that market processes may lead to malfunction of the capital development of the economy-that is, something other than the promotion of public welfare. For example, the crisis in finance during 1991 is largely a delayed response to the experiment in practical monetarism that occurred from 1979 to 1982. In typically simplistic fashion, monetarism suggests that inflation is always the result of too much money chasing too few goods: Hence, controlling inflation rests on controlling money supply. The fundamental flaw in the Bush administration’s proposals is that they subscribe to a Smithian theme. They impute the problems afflicting the finance industry (e.g. lack of capital development of the economy) to a minor flaw in the institutional structure rather than to basic characteristics of the economy. The recommendations submitted in the paper are inherently distinct from the administration’s proposal and have evolved from a Keynesian model of the economy specifying the processes and determinants of the performance of the economy.
8. Uncertainty and the Institutional Structure of Capitalist Economies - Via SSRN (Click Here To Download The Paper)
In this working paper Distinguished Scholar Hyman P. Minsky explores the theoretical and practical causes of today’s rising economic uncertainty and insecurity. He begins by noting views of uncertainty held by Keynes and adherents of the new classical economics by comparing Keynes’ The Treatise on Probability and Sargent’s Bounded Rationality in Macroeconomics. According to both views, decisions are made by agents based on varying degrees of ignorance and supposition; the agents have a more or less limited amount of knowledge and base their judgements on their own idea of how the economy works (their “model of the model”). In addition, agents are not homogeneous but have differing abilities and histories. Thus the internal models used to guide decisions are not consistent from agent to agent. Minsky notes that although according to Sargent’s concept of bounded rationality all agents at any one time need not be acting according to mutually consistent models, Sargent ignores a point stressed by Keynes about the decision-making process: Economic events at any one time are the result of past mental models (and corresponding actions and expectations), and those past models are different from current models (and correspondingly different actions and expectations); therefore, factors that might determine long-term expectations are in a continuous state of flux. Despite this difference, the gap between the ideas of the two schools of thought have narrowed. Minsky points out that capitalism in the United States is an ever-evolving construct that recently entered a new stage: money manager capitalism. In this form of capitalism, nearly all businesses are organized as corporations; pension and mutual funds are the predominant owners of financial assets; and managers of these funds are judged solely on the total return on fund assets (dividends and interest plus appreciation in share value). One consequence of the money manager structure is predominance of short-run considerations in decision making. Historically, the public has had limited tolerance for uncertainty. During the New Deal era this intolerance led to the creation of institutions and arrangements to reduce uncertainty and create transparency in both financial markets and corporate governance. For example, crop insurance set floors to farmers’ incomes, and deficits run by the federal government set floors to aggregate profit flows. However, the focus of money manager capitalism on short-run returns and uncompromised profit margins has increased economic uncertainty at the firm and plant levels through the chronic need to reduce overhead and variable costs. These activities have unraveled the traditional relationships between firms and workers and increased economic insecurity among employees. Minsky asserts that since existing institutions and arrangements cannot contain this uncertainty, new institutions and arrangements must be created to offset the effects felt by the “losers” in the gamble imposed by uncertainty. Such measures are necessary to prevent these individuals from becoming alienated and hence recruits for an alternative to democracy. Accepting the view of Henry Simons that the focus of economic policy is not narrowly the economy but rather to “assure that the economic prerequisites for sustaining the civil and civilized standards of an open liberal society exist,” Minsky suggests that full employment programs analogous to certain New Deal programs (the Works Progress Administration, the Civilian Conservation Corps, and the National Youth Administration, for example) should be considered to meet these goals. How would such programs be financed? According to Minsky, the U.S. economy has ample resources, but the question is one of how willing we are to mobilize these resources, that is, to tax and borrow for such projects. For example, welfare in its current form (AFDC and food stamps) exists because it is the cheapest way (short of a policy of doing nothing at all) to take that ratio care of the population in need. Full employment policies are more humane but more expensive and require a larger and more innovative public sector. For government to institute programs to offset the uncertainties of money manager capitalism, it must validate government debt with government revenues. The current high rate of government debt to gross domestic product (GDP) is the result of the irresponsible fiscal policies of the 1980s; a responsible program would assure the decline of the ratio of federal debt to GDP over time from its current 65 percent to about 50 percent. The reduction could be accomplished by transforming the tax structure to a value-added revenue system in which, for example, the individual income tax is replaced by a progressive consumption tax with broad bands and a high per person deduction and value-added taxes are levied on production or distribution and on imports. Imposing such a revenue system would allow the United States to transform its economy from one based on transfer payments to a full employment economy, from one that generates resentment to one that maintains commitment to democracy.
Recently I linked to several articles which are quite critical of Nassim Taleb. Now its time to post some positive content .
The following video was linked on the Farnam Street blog. (Great job FS)
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A teaspoon of Mises a day keeps inflation at bay.
Click Here To Read Mises.Org’s Analysis Of Inflation
Introduction (Via Mises.Org)
The Federal Reserve is lying about the nation’s money supply (M1). The current figure for money supply is being given as $1.6 trillion. The actual number is $2.34 trillion. The reported number is equivalent to an increase of 16% over the past year. The actual number is equivalent to an increase of 70% over the past year. This compares with the nation’s high money-supply increase of 16.9% in 1986.
Excerpts (Via Mises.Org)
However, the monetary base is a part of the money supply. How can the part exceed the whole? (Money is created in 2 basic steps. First, the Federal Reserve prints up paper money. This is called special money and is usable by private banks as reserves. It is treated in the system in the way gold used to be. This money is measured by Federal Reserve credit, or Reserve Bank credit. With a few adjustments, this becomes the monetary base, which can be thought of as the special money that is available to the banking system for the second step. In the second step, the private banks create money in the form of demand, and other checkable, deposits. They do this in the process of making loans. Essentially, the nation’s money supply is cash — the special money — plus bank deposits.)
Last year practically every newspaper in the country was telling you that the problem we faced was “deflation.” That was a gigantic piece of propaganda designed to frighten you into holding cash. Remember the flight to “safety” into T-bills and T-bonds? Most people fled from hard assets. These are the victims. They believed the propaganda of the establishment. When the debris of our collapsing society starts to come down, they will be its victims. Their assets will be “safe” in the US dollar as it loses its place as the world’s reserve currency.
Click Here To Read Mises.Org’s Analysis Of Inflation
More interesting comments on the health care part of the video. Enjoy!
Introduction (Via CNN)
Paul Krugman and John B. Taylor debate the origins of the financial crisis and the proposed health care plan.
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My friend James Montier would probably agree that time spent reading Minsky or Kindleberger would save investors from making foolish mistakes.
Background (Via Wikipedia)
Hyman Minsky was an American economist and professor of economics at Washington University in St. Louis. His research attempted to provide an understanding and explanation of the characteristics of financial crises. Minsky was sometimes described as a post-Keynesian economist, because, in the Keynesian tradition, he supported some government intervention in financial markets and opposed some of the popular deregulation policies in the 1980s, and argued against the accumulation of debt. His research, nevertheless, endeared him to Wall Street.
Excerpt Of Minsky’s Contributions (Via Wikipedia)
Dr. Minsky proposed theories linking financial market fragility, in the normal life cycle of an economy, with speculative investment bubbles endogenous to financial markets. Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts.
Minsky Stabilizing an Unstable Economy Complete
Macroeconomics Meets Hyman P. Minsky the Financial Theory of Investment
