Thursday, December 01, 2005

A case of Behavioral Economics

My Final paper for Behavioral Economics is due tomorrow, so here's what I started writing:

Several months ago, France and Denmark held votes on whether to approve the EU constitution. Both countries decided not to accept it. One of the main reasons for this, at least in France, was an antipathy to Globalization and world trade. France, as a country, has not welcomed free trade for a number of years now, but lately the antipathy has grown. After the election, even politicians of all stripes started denouncing the Evils of trade and liberal economics. This paper will endeavor to show that France’s population is acting in an irrational manner, as well as the fact that French politicians know this, and therefore are very experienced in many tenets of behavioral economics. Were the French to embrace globalization, the country as a whole would be much better off, while were the French people to close themselves off completely (as they say they want to do), they would be much worse off.

Many of the roots of this antipathy towards globalization can be found in the inception of the Common Agricultural Policy, or CAP. This policy established subsidies for farmers, mainly French, who were trying to survive after the destruction of World War II. In these days, the idea that Europe should try to be self-sufficient in case of another world war (and because it was not able to feed itself after the war) was the main reason for establishing the CAP. Today, almost 50% of the EU budget is spent on CAP, with French farmers still the main beneficiaries. Because of this, farmers in other countries, including other countries in the European Union, are not able to access the French market, which creates ill-will towards the French government. French citizens are also paying more money to maintain these farmers. This is because the farming subsidies need to be paid for with taxes. These taxes are then paid to farmers, who produce too much, and sell the remainder of their goods very cheaply abroad. Therefore French citizens are paying for cheap foodstuffs to other nations.

If the French had no CAP in place today, and were given a choice between installing it or not, they would probably choose not to. But, given the fact that it is already in place, they choose not to do away with it. This is because they are told it maintains their way of life. In a sense, they are scared of the changes that may occur. This is an example of Loss aversion. It is curious, however, because an entire population exhibits it collectively. One could try to argue that the French are just being Risk Averse, which may still fall under economic rationality. However, any careful analysis of the situation shows that their welfare would be much higher as a whole without these agricultural subsidies. The only ones acting rationally in this case are French farmers (about 4% of the population), who receive the benefits, as well as French politicians, who benefit off the French population’s irrationality.

Dealing with globalization in general, however, the French tend to have a general antipathy. They see foreign companies as encroaching upon their territory, and taking over. President Chirac said that “France will never let Europe become a mere Free-trade area” . Using that wording is a manner of attracting sympathy. The French population, generally speaking, does not like free-trade. The negative incidents and effects of free trade tend to be highlighted, while the benefits are rarely discussed. This is an example of Confirmation Bias of the population as a whole. The suffering and bad effects of globalization are talked about much more frequently, and the politicians know it, while the more positive effects are not, so the politicians also decide not to discuss them.


Only farmers benefit. People lose out (higher prices, other countries mad)
Loss aversion: Risk averse.
(Representativeness: Evil companies, corporations)Confirmationan Bias.
Other companies M&A: more FDI, more jobs.
Allow more French M&A: Expect retaliation
New news: Confirmation Bias (African countries not doing well).

And at this point I realized I was just trying to find more reasons to say bad things about the French and that, although it's plenty fun, I probably shouldn't turn it in as my Final paper.

Not to mention the fact that the case for average citizens being Economically Irrational and politicians being more Rational, as weird as that may sound, can probably be made in every country. Most forms of subsidies, especially in developed countries, can constitute some form of Inefficiency, and I'd probably say that any time there are lobbyists involved, the final outcome will be Inefficient and therefore Irrational in terms of the average citizen. So in conclusion this would mean all countries are Irrational and therefore all economics is irrelevant.

Thursday, November 17, 2005

Dead Weight Loss of Xmas

I realized over my Birthday what a loss Birthdays and these gift giving holidays are. We all follow this tradition of choosing something to give our loved ones, which they have about a 50% chance of liking, and then receiving gifts that we have a 50% chance of enjoying ourselves, and then calling the whole thing a success. I think it's interesting how rational human beings can follow the same routine year after year and realize this Dead Weight loss year after year.

Just for the record, I'm not talking about anything any reader may have given to me on my Birthday. Ok ok, I'll speak hypothetically about Christmases, and analyze what goes on. Basically, person A finds a gift for person B and vice versa. A doesn't want to give cash, because that's assumed to be tacky, and wants to give something that B doesn't expect. B is thinking the same. Assuming these 2 people know each other fairly well, A will buy a present that B has a 75% chance of enjoying. However, if B had just received the cash, it's very likely he or she would've bought a different model/color/edition/version etc. etc. I will then (optimistically) say there's a 33% chance that the present is EXACTLY what B desired. Counting in the chance that some other person (C or D etc.) gives the same or similar present, I will bring it down to 25%, which I still find rather optimistic.

So Person A is spending 100% of the price for an object that person B will get 25% of value from, and Person B does the same to A, resulting (let's count percentage as utility) in (25x2)-(100x2)= -150 utiles. For every Christmas, and times the number of people involved.

So both A and B lose out, and where does the extra utility go? The answer, obviously, is to the manufacturers. Well, assuming Person A and B aren't entirely nitwits, they'll know there is an element of risk with each present, so they will try to maximize their chance of providing as high a utility as possible. The manufacturers will help them with this by making products: A) discounted, B) look expensive and thoughtful. Therefore, the best way for the manufacturer to sell products on Christmas is entirely through signalling. Person A will care less about the inherent value of a present, as long as it signals value to Person B, and vice versa.

Person B, on his part, will know this is occurring and expect a present to show more value than usual. In other words, he will assume that Person A spent the least amount for the highest amount of possible utility. So therefore B will assume discounts, rebates, etc. etc. Which means Person A could buy a present for 100 utiles of value, while B will assume it to have been something less (say 80), and A chose that because it was discounted or available in bulk etc. Here we're assuming Person B knows the inherent value which, if it's something Person B wanted in the first place, is safe to say he'll know.

Well, I might be missing something, but it seems to me that in conclusion you're better off giving money, so that everyone knows the value and achieves the full satisfaction, while with presents they'll know the value, assume it cost less, and only achieve 25% satisfaction from it. So from now on, everyone can just give me cash. Thanks.

Wednesday, November 09, 2005

Thesis blabbering

Ok, there are several things I wanted to talk about, but I'll discuss my thesis now, since it's rather pressing for me, and it's really long and boring.

In a nutshell, my thesis idea is based on the efficiency of markets and on rationality in general. Predicting future events is never an easy task, in that no one has a crystal ball. In International affairs we see this with country evaluators. Many institutions and organizations spend a great deal of money and resources in trying to predict economic risk, political risk, debt default rates, human rights indices, among many others. The problems with this are obvious. Variables may be missing, not relevant, or weighted incorrectly. Analysts can also be biased or have other aims.

My idea would be to improve on this by changing the method entirely. Basically, looking at empirical data, markets have been more precise in predicting events than any form of polls or analysts. Markets use an infinite amount of information, gather it together, and incorporate it in the security much more quickly than any single agent would be able to.

This might seem weird, in that any form of analysis of trends or fundamentals would make no difference. Well of course information can be useful, but it's also known that constant investment in a diversified porfolio (read, shooting darts at a WSJ stock list) gives you just as good returns as any.

Ok, there's also one interesting example of this. Michael Maboussin, a business prof in Columbia, asks his incoming students every year what the total number of assetts for IBM was in 1989. Obviously, their answers are all over the board (no one knows that by heart). But, every year, the mean of the glass is within 5% of the true number. Cool, eh?

Anyway, so that's all fine and dandy, and I can find 100 more examples of this, but in order to prove my point, I'd like to recreate it.

Ah, by the way, my idea would be to use this market method to predict FDI into different countries. This could serve public policy in that, if we have a more precise way of predicting this, then companies, organizations and others can use it as an indicator.

Ok great, so now I have to try to recreate this whole market in a lab setting, so I'm wondering what to do. Since I'm getting no funding my options are:

A) Send out e-mails to many people, telling them they can trade on future values of say 5 countries, and they're given an endowement of $1000, and they can trade until the day before new FDI levels (for 2005) are announced. The more precise ones are paid off. (trading would be done by e-mailing me, and i'd post what levels we're at at the end of everyday or week)

B) Perform this in a lab. One of my professors offered this, but since a futures market should be conducted over time and with new information and whatnot, I said it wasn't ideal.

C) Take experimental Econ next semester and do it as my major assigment.


Anyway, I'm going with option A for now, and seeing if it's feasible. Option B wouldn't reflect real life enough, and Option C is too late for me (there's still a chance none of this works out, in which case I'm screwed).

So that's basically it. I'm just writing it down because I have no idea what's going to happen with this. So it'll be interesting for me to look back in a couple months. Or not. Actually it won't. There's a big chance that none of this works out, in which case I'll be changing my thesis to the 6 party talks on North Korea. But I don't know when the cut off date for this should be. At some point I need to choose one or the other and stick with it, otherwise I'll be spreading myself way too thin.

If you got through this whole thing I'm impressed. But if you have any suggestions please let me know. I hate being all up in the air like this.

Thursday, November 03, 2005

Connections

Ok, I learned something interesting about connections in my OB class.
Connections, or contacts, can be classified in two main groups: Close contacts and Institutional contacts. Close contacts would be close friends and whatnot. Insitutional contacts are ones you can still use for jobs or whenever needed, but they aren't as close. The question is which are better, and how many, in what sort of mix, etc. etc.

Anyway, in class we came to the conclusion that it is best to have contacts in many different groups. In other words, to have a contact in investment banking, another one in law, another in medicine, etc. That way, you can use your banking contact for any banking needs you may have, or your law contact for any legal needs, without too many redundancies. Plus, if your legal contact needs some investment banking help you can be the middleman, which gives you that power and makes sure you're not a redundant member of some group, as in they need to turn to you, like so:


PEOPLE IN INVESTMENT BANKING <-----------> ME <--------------> PEOPLE IN LAW

(Those arrows mean they are connected. Ok nevermind)

However, then we learned about a study performed at the Pentagon where contact groups were analyzed, and they found that there was precisely this sort of relationship going on. There were higher up managers, lower managers, and one person who was seen as the go between and the person people turned to (As a sidenote, no one saw him as this, but after analyzing each person's group it became obvious that he was the so-called power-broker). So we decided that he must have had a lot of power. The interesting thing is, shortly after the study, he quit. And then the whole department pretty much fell apart. So so much for that.

The fact was, he was contacted to broker between the two groups continuously, and he couldn't take anymore of it so he quit.

So is it good to be a power-broker, a middleman, a go-between, or whatever you want to call it? The fact is, it gives a sense of power, and so many people assume that's what they want to be, but it may be much better to know someone else in that position, and let them worry about all this, as in:

ME(IN INVESTMENT BANKING) <-----------> MIDDLEMAN <--------------> PERSON IN LAW


Well, in conclusion, I think it can be good to be the middleman when dealing with close friends. When you do favors for close friends there's more of a chance they'll feel indebted towards you, or that they'll find a way of repaying you either way or allow you to benefit from their advantage. With institutional investors, however, it may be better not to be in that position. Say a TASIS grad sees I'm looking for a job and to show how much influence he has he lands me a good job. Chances are I'll send him a nice letter and maybe a bottle of wine, but I probably won't remember much about him 10 or 20 years down the line, when he may be in need.

I guess the secret is to keep close friends as they are, but to take advantage of the fact that others like to show how influential they are by using them as "middlemen". The trick is to find enough of these "middlemen" to have a pretty much exhaustive network, and to play on their egos whenever you need a favor done. Your payoff is the favor, while theirs is an ego-boost, and it seems to me you get the better deal by far.

Tuesday, November 01, 2005

Since our debate idea worked out so well, and since I update LJ too much, I decided I'll keep the school/thesis related updates on this blog, and the usual crap for crap updates on LJ. No one else is using this, so whatevs.

Anyway, so since there's a risk that I may have to change my thesis to something North Korea related, I have started receving news updates re: North Korea and whatnot. Here are some for today:


Reuters Tue, 01 Nov 2005 8:57 AM PST
Visitors to North Korea's capital, Pyongyang, say traffic pollution is not a
major environmental concern simply because there is hardly any traffic. Fuel is
short and so are vehicles -- whether with four or two wheels.


World Peace Herald Tue, 01 Nov 2005 7:26 AM PST
SEOUL -- Three out of four North Korea defectors living in Seoul say they
witnessed public executions in their communist homeland, according to a recent
survey by South Korea's government-run human rights body.


That's it. I don't really have any comments. They were just interesting.

Tuesday, July 12, 2005

Saturday, June 11, 2005

Some Timekillers

Here are a couple of articles I've come across recently that someone might find interesting. It's just a good way to waste time if you have any to spare:

This first one is interesting since it's about the old Alma Mater. I guess I should've been more pushy about my grades there. I didn't even think of this option half of the time.
http://www.washingtonpost.com/wp-dyn/content/article/2005/06/02/AR2005060201593_pf.html


This next one is a cynical, but interesting, viewpoint on Live 8. How the world's poor are being called upon to help old, balding rock stars.
http://www.spiked-online.com/Articles/0000000CABA8.htm

This one seems like an interesting book. I might pick it up at some point, so if anyone else does please let me know. Time travel would be quite interesting.
http://www.washingtonpost.com/wp-dyn/content/article/2005/06/02/AR2005060200532.html

Ok I can't tell if this next one is a joke or if it's for real, but then again I've never returned a printer.
http://www.weeklystandard.com/Utilities/printer_preview.asp?idArticle=5666&R=C5AD125EC

This is just plain useful, if it's all true.
http://www.newscientist.com/channel/being-human/mg18625011.900


Ok these next two are just interesting news articles I came about. This first one must be complete baloney, otherwise I can't see how it hasn't received more coverage. At least I haven't seen any other articles about it:
http://www.etaiwannews.com/Taiwan/Politics/2005/06/09/1118281061.htm


And I don't understand this, but I guess I'm just getting old:
http://www.japantimes.co.jp/cgi-bin/getarticle.pl5?nn20050611f1.htm

Friday, May 27, 2005

2 books

Well I've been reading a couple of books lately so I thought I might as well write about them. Nothing to debate really, but no one's writing here so I shall.

The first book is A Random Walk down Wall Street by Burton Malkiel. I had to read this for my Managerial Finance class, so I wasn't really looking forward to it, but I have to say that it was really interesting, and I've ordered a copy for myself (the copy I read was my classmate's). Basically this provides a solid background for all that is financial, mainly for investing purposes. He talks about all the bubbles that have come about, from the tulip craze in Holland in the 1600's to the dotcom bubble, and what was happening during this time. He also talks about the different fads and methods that have existed for investing (such as growth investing, value investing, charting, etc).

I found it interesting because first of all, despite having majored in business, I was still pretty clueless about what really goes on in even the basics of stock prices and movements (For example, why should stock A be worth 40 and stock B be worth 50? Is it just speculation or are there fundamentals behind it, and if so, how do I know what they are?). He presents everything fairly clearly, and then proceeds to debunk almost every form of stock valuation that has existed in the past century. He especially goes to town on the chartists; those people who try to show you trends based on historical movements and whatnot. That section was especially interesting.

In the end, his conclusion is that index funds will be anyone's best bet, and people need to be diversified to different degrees based on their disposable income and their willingness to take on risk. If you don't care about the reasons behind everything, and think it's a waste to go through the whole book just to be told that index funds work best, I would still recommend the final chapter, on personal finance. Here he actually writes out what he believes would be your optimal investments based on income and risk (he calls risk 'the amount you can sleep at night'). So basically if you have any interest in investing in securities, funds, 401(k)'s, savings accounts, or if you want to make it out of debt quickly, I would recommend this book. There will be sections you're not interested in, so you can skip those (unless you have to read it for class) but the other parts should make up for those.


The second book I just finished is Freakonomics by Steven Levitt. I had never heard of this guy before, but searching around about him I found he's actually very well respected, so I wouldn't be put off by the somewhat pop-culturish title. Having said that, what he writes is very accessible, without any knowledge of Economics or statistics required.

It's hard to explain this book, but basically Levitt seems to not take any conclusions for granted. He dissects certain matters and aspects until he can arrive at (what he sees as) the core of the problem. An example would be that when crime in New york started decreasing, people were attributing it to gun control laws, to Giuliani's strict laws, as well as many other reasons. These were proffered by many experts, and then repeated by the media. While he aknowledges that these factors may have had effects, it's pretty interesting to see how he finds out that Roe v. Wade had more to do with it than anything.

He also talks about why drug dealers tend to live with their mothers, whether swimming pools are more dangerous than guns, and how someone's name might affect their future, among many other interesting studies. Two points about this, however: First of all, theories like this have been sprouting around forever. For example, I remember once hearing how the level of prosperity of a country might be correlated to the average hair length of girls in that country (as in, negatively correlated). Now this is a fun theory, but it's just a theory. The difference between these and Levitt's theories is that he goes through great pains to prove or disprove them. A second point is that you realize he obviously doesn't cover every area that could be covered. Even within his areas, there are many factors which may have been skipped. After reading the book, however, you have more of a feeling of seeing things differently, and wondering if, say, that butterfly flapping its wings in china really did cause the hurricane in the US or not.