Dual role of prices - endogenous and exogenous events

 

...dual role of prices. By “dual role”, we mean that prices not only reflect the underlying economic fundamentals, they are also an imperative to action. That is, prices induce actions on the part of the economic agents. If some actions are the consequence of binding constraints and exert harmful spillover effects on others, then price changes can bring about amplifying spillover effects that disrupt the smooth working of the market, and sometimes shut down the market completely.

Endogenous Extreme Events and the Dual Role of Prices

It is important to appreciate the dual role of prices, although this is a subtle concept. Prices first reflect exogenous events as markets reflect new information that impacts expectations. If inflation increases, for example, there will be a reaction in prices as investors adjust their expectations. However, investor will not just react to new information and adjust their portfolios. They will also adjust or take action when they see prices change. 

The reaction to price movements may be independent of the change in exogenous information. The reaction could be due to uncertainty about what information is being displayed in the price. A reaction to price behavior independent of exogenous information is an endogenous reaction. Investors react to prices rather than to any other information. This can lead to extremes and explain most of the price movement during the day. One of the most important tasks for an investor is understanding the difference between these price moves and appreciating the action that stems from the distinction between exogenous and endogenous moves. 

Neoliberals and the fight between dominium and imperium

 Quin Slobodian’s book Globalists: The End of Empire and the Birth of NeoLiberalism was written before the pandemic and before the uproar about Davos and the World Economic Forum. Yet it is truly relevant to anyone considering the current world order between some form of global government and nationalism. Globalist does a good job of describing the origins and rise of neoliberalism and helps readers understand the differences from national movements or a national focus. 

What I found most interesting was the focus on differences between dominium and imperium capitalism. Dominium refers to the rights of owners to control their property, which is a key feature of capitalist private property. The imperium or public power refers to the sovereign power of the state to rule, tax, and regulate. The intersection between these two forms of capitalism is the crux of how neoliberalism bears on the issue.  

For Slobodian, neopliberalism is not a simple version of laissez-faire capitalism, but a project to, as he terms it, “encase” the market within legal and institutional frameworks to ensure that dominium is protected over imperium. Global capital is protected from democratic pressures, nationalism, and social redistribution that seek to take property away from owners. Thus, dominium is given a higher priority over imperium, and the right to rule by nations is constrained by international institutions. Capitalism is not left to self-regulate but needs oversight and active management to protect the dominium. Neoliberals believe there is a need to constrain democracy in a pure form that will subvert property rights in an effort to redistribute wealth. Neoliberals want an active legal framework to protect property rights and allow the freedom of capital to move and be controlled by owners.  

Sorkin's 1929 - A tale of personality

 

I finally got around to reading Andrew Ross Sorkin’s 1929: Inside the Greatest Crash in Wall Street History - and How it Shattered a Nation. His narrative style is compelling for those who do not want to read dry financial history. The characters come alive with his writing, but I did not come away with any new insights into the stock market crash. There were signs before the October crash, so it was not a total surprise. Excess leverage, margins that were too low, excess greed, and herd mentality, but we already knew that. While I liked reading about the characters, I kept asking why we didn’t hear more about the central bankers. What about some of the surviving brokers? How about some of the businessmen outside of Wall Street? 

Do I better understand the psychology of bubbles and the 1929 crash? I don't think so. Perhaps I am jaded by all my reading on the topic, but did I learn anything new beyond the fact that the same tropes of greed and leverage are always with us?

What does 1929 tell us about markets today? Not much. There is significant leverage, crowd behavior, misinformation on policy choices, and fear of taking action. Perhaps that is the message. Things don't change.

Words have uncertainty - The enemy of precision for investors

 

With the evolution of LLM and natural language processing, there is a closer connection between the discretionary and quantitative world, yet the two are not perfectly linked. There is uncertainty in both worlds. For the quant, there is model and parameter uncertainty. For the discretionary trader or non-quant, the problem is the precision in words. What you say may not be precise by you as the sender and by the receiver. 

We have discussed this issue of precision in language in the past, yet most investors still seem to be at risk from word uncertainty. Just think of all the Twitter words and Substack posts driven by language. Are these words given any quality control? If you look at the research, the answer is no. If you look at the range of meaning for these words of estimative probability, you will have to agree that there is ambiguity concerning the words often used by any decision-maker. Ask for specifics. Ask for the actual probabilities. Close the range of uncertainty.

See "Variability in the interpretation of probability phrases used in Dutch news articles — a risk for miscommunication."

Words of Estimative Probability (WEP) - Words matter and poor precision leads to decision failures

Imprecise language - The big problem with investment analysis

Language, perception, and numbers - The translation problem

Sherman Kent - the godfather of precision in forecasting language

Sherman Kent - My guy for precision in forecasting language

Sherman Kent - The analyst's analyst - Be precise with your forecasts

Sherman Kent and the problem between warner and warnee