Tuesday, July 8, 2008

Worthless Money

Ever wondered what a bank note from Zimbabwe looks like?

Check it out

Note the expiration date !

Save for your retirement

Everyone should save for their retirement. Here's a nice story from India.

As a side, the story notes that coins in India are smuggled to Bangladesh to be melted down into razor blades. The metal content of the coin exceeds the face value of the currency. In the US we're getting close to that point with the 1 cent.

Monday, July 7, 2008

Inflation and stock prices

Stocks should be a good hedge against inflation - they are claims on real cash flows. Bonds on the other hand should do terribly when inflation increases - they are claims on nominal cash flows that cannot adjust. In reality though, stocks do pretty poorly when inflation increases. This article in the Economist offers an explanation - that earnings decline during periods of inflation.

An alternative explanation, and a better one I think, is that investors don't understand how to value stocks in the presence of inflation. They discount real cash flows using nominal rates and they fail to realize that the reduction in earnings due to higher interest costs is merely illusory. In essence, investors suffer from money or inflation illusion. My 2002 Journal of Financial and Quantitative Analysis paper with Jay Ritter discusses this, and several others (here here and here) provide further evidence.

Some thoughts about oil prices

An article in Fortune says that it is unlikely that higher oil prices are due to futures trading. There are two basic reasons for this. First, these futures traders are not building inventories of oil, in fact oil inventories are down. Second, for every futures contract, there has to be a long and a short. If the longs are paying too much - the shorts should stand to make a killing. As usual, congress is blaming speculators for high oil prices and proposing legislation to reign in these "speculators". A similar article is in the Economist

On a related note, Newmark's door has an article about how the onion market is more volatile than the oil market, perhaps because there is not a futures market for onions. This finding is supported by my own work that shows that Single Stock Futures reduce volatility in the spot market for stocks. In fact most evidence shows that futures markets have a stabilizing effect on the underlying spot asset.

Finally, on NPR this weekend I heard a story about people trying to trade in their SUVs for more fuel efficient vehicles. In the story, one person brought a 2007 Escalade to a CarMax dealership. The truck was a year old, and cost over $70K. The owner was making $1400 a month payments on it. The CarMax buyer offered him about $30K for it. Here's what I don't get. You buy a 70 grand SUV a year ago when gas prices are $3 a gallon, but when gas prices hit $4 a gallon, you can't afford to run it? What's more, the owner said he would have sold it for $40,000 to the dealer - basically taking a $30,000 loss to save the pain of an extra $1 per gallon of gas. In behavioral finance this is called "mental accounting".

Wednesday, July 2, 2008

Finance Salaries

From Craig Newmark. An article saying that many Harvard grads go into finance because that's where the $$ are.


The article discusses whether we are seeing a "finance bubble" - I doubt it, but I am sure that finance jobs are not going to be quite as plentiful and high paying in the near term.