Finance: Past, Present and Future

Eugene Fama  was recently awarded the Nobel Prize in Economics for his work on the efficient markets hypothesis .   Click here for a rap about the efficient markets hypothesis.

Richard Thaler and Cass Sunstein's book Nudge (see yesterday's post) has had a substantial impact on the current British government.  Apparently, the entire cabinet was given it as a summer reading assignment. The idea behind Nudge is that public policy should nudge people to make socially-optimal decisions by thinking cleverly about the choice architecture  facing citizens. The UK government now has a Behavioural Insights Team (or Nudge Unit) which apply the insights from behavioural economics to public policy in the UK. Their blog is available here  and a recent critique of the unit is here .  

The Federal Reserve Bank of Minneapolis has a great publication called The Review , which carries interviews with top economists. Click here to read an insightful and wide-ranging recent interview with Richard Thaler , one of the world's leading experts in behavioural finance and economics. Thaler is best known among the wider public for his book Nudge .

Neuroeconomics is an exciting area of research where neuroscience meet economics. Economics, at its heart, is about how and why we make economic decisions. As decisions are made in our brains, a better understanding of how our brains work will help us understand our decision making. Click here to read a recent op-ed by Robert Shiller on the promise and development of neuroeconomics and click here to read an op-ed which discusses how neuroscience might help us understand financial bubbles.   

What investment strategy should investors pursue? Should investors employ a buy-and-hold strategy whereby they buy stocks and hold on to them for a long period or should they be active investors constantly buying and selling stocks? The latter strategy implies that investors discern movements in the business cycle, whereas the former implies that investors ignore short-term fluctuations and are more interested in the long-term trend of economic growth. What my study of financial history has taught me is that over the long-run, a large proportion of portfolio returns come from dividends and reinvesting those dividends in your portfolio. Click here to read a piece by Tim Hartford which discusses the investment performance of Neil Woodford , someone who has taken a long view on stocks and been very successful.    

In the aftermath of the financial crisis, the UK government was criticized for engaging in austerity and not borrowing more. Click here and here to read a couple of op-ed pieces by Kenneth Rogoff which argue that the UK government did the right thing by not borrowing more. The UK is a heavily-indebted nation both in terms of it actual debts and its off-balance-sheet debts i.e., the liabilities of the UK banks for which it is responsible and its pension liabilities. Rogoff also argues that the UK's credit status and history is not as rosy as some would suggest.    

The short video below provides an excellent insight into the scale of wealth inequality in the UK (hat tip: Graham Brownlow).

Larry Summers, the former president of Harvard and all-round economic guru, has suggested that undergraduate education needs radically reformed to reflect changes in society.   Click here to read the things he wants to see change and why. His recommendations centre on what students learn as well as how they learn. Notably, he highlights three thing that we encourage at Queen's University Management School - collaboration in the classroom, active learning, and an ability to handle big data.

In a recent CEPR paper , Thomas Piketty and Gabriel Zucman trace the evolution of wealth-to-income ratios for several countries. Click here for VOX coverage of their article. They find that wealth-to-income ratios have increased since 1945 and that they are back to levels last seen two hundred years ago. What are the implications of this? Piketty and Zucman suggest that this really matters for the future of wealth inequality and of inherited wealth in particular. In other words, unless there is internationally-coordinated progressive capital and inheritance taxation, wealth inequality is here to stay and the top 1% will consist of the offspring of the current top 1%. In other words, a new aristocracy is on the way! 

Hot on the heels of yesterday's post , the Social Mobility and Child Poverty Commission , chaired by Alan Milburn, have released their first annual report . BBC coverage of the report is here . The findings are stark. First, real incomes have been flat-lining for a long time, meanwhile prices have been going up. Second, for the first time in over a century, the current generation of children are going to be worse off than their parents. Third, social mobility (i.e., the ability of people to better their lives and those of their offspring) is dying. For me, the big question is do politicians really care about this issue?  If so, what can they do about it?    

In the stage musical and film 'Evita' , Eva Peron sings "Screw the middle classes! I will never accept them." A recent study in the United States indicates that the middle classes are being screwed and squeezed as never before - click here to see NY Times coverage of the report. This squeezing of the middle classes is also happening in other economies - click here to see a recent Economist piece on the issue.  Three questions spring to mind. Why is this happening? Will the middle class disappear? What is the long-term effect of this squeezing of the middle classes? The squeezing of the middle classes is a worrying trend which has major consequences for the future of Western civilisation. 

The Nobel Prize in Economics was awarded yesterday to Eugene Fama , Lars Peter Hansen and Robert Shiller for "their empirical analysis of asset prices". For some, Fama will be controversial pick. But for my money, Shiller deserves his prize for his work on irrational exuberance and animal spirits rather than his 1981 asset pricing paper .   Click here for a piece at Bloomberg, which briefly outlines the contribution of the three laureates.

See below two 5-minute FT interviews with Nassim Nicholas Taleb , where he talks about skin in the game and decentralisation in financial markets and political systems.

I got my allocation of Royal Mail shares during the night - 227 in total at a price of 330 pence. This morning, Royal Mail shares are up 38% in early morning trading ( story here ). This is good news for investors, but bad news for taxpayers because the shares have obviously been underpriced by the government. Taxpayers could have got more money from the privatisation of the Royal Mail - money has been left on the table!  One of the greatest puzzles in financial economics is why Initial Public Offerings (IPOs) are underpriced by about 15% on average.   Click here to read a NY Times piece on why IPOs are underpriced, here to see a survey paper on the same subject, and here to see Jay Ritter's IPO website.

Two nights ago, I chaired a panel discussion on global finance at Queen's University. The audience was full of students who want to work in well-paying jobs in the financial sector. But is it in society's interest that so much talent ends up in the financial sector? Robert Shiller argues in this op-ed that bright graduates who engage in speculation, deal-making and trading play a socially useful role in allocating funds to the best and most productive businesses. However, he also argues that many speculators, deal-makers and traders engage in pure rent-seeking activities, whereby they simply extract wealth from others rather than create wealth in the first instance. Such activity can actually be socially harmful. In other words, finance is socially useful, but up to a point.   

Do dividends matter? Should investors care whether their firm pays a high. low or no dividend? In a recent paper , I and my two co-authors suggest that they do matter because they communicate important information to investors. See below for a recent five-minute video by the Financial Times which argues that dividends do matter.

TED talks  make the work of academics and thinkers accessible to wide audiences. Why do we have economic prosperity? Why are some economies more prosperous than others? In the TED talk below, Niall Ferguson gives an entertaining and provocative 18-minute lecture where he identifies six "killer apps" which gave us economic prosperity. 

The Thatcher government privatised large parts of British industry in the 1980s ( click here for a short history of privatisation in the UK). But privatising  Royal Mail would have been a step too far back in the 1980s. However, this is not the case today as the letter market has contracted due to the advent of technology. Royal Mail is essentially a parcel delivery service and a deliverer of official (usually government) letters, and the former is a growth business thanks to internet shopping.  See below a video from MoneyWeek which argues that Royal Mail is a good investment.

Five years after the collapse of Lehman Brothers, economists are still picking over the corpse of the financial system in an attempt to understand why the financial crisis happened. Some simply blame capitalism. Such a view is naive at best. For others,and I include myself in this camp, there probably wasn't enough capitalism. In this op-ed , Roman Frydman and Michael Goldberg , extremely insightful economists, point the finger of blame elsewhere - the discipline of economics. Economists had totally the wrong economic models in their toolkit - they had models which assumed that the economy works in a mechanistic way, much like a complex piece of machinery. This reduces economics to an engineering problem. But at its heart, economics is a social and political science. The real issue for me is not whether economists had the wrong models (they quite obviously did), but why did they have the wrong models?  

See video below for an FT interview with Russell Napier , who is coming to speak at Queen's University in November.

I 've just tried to access the North Pole website of the U.S. National Oceanographic and Atmospheric Administrati on for my 5-year-old son to be told that the U.S. government has shutdown! T he U.S. has gone over the fiscal cliff.  Due to a lapse of funding, the U.S. federal government has shutdown - click here . Will anyone notice apart from a 5-year-old boy who is  obsessed  with the North Pole?

Many commentators have been predicting the death of the euro since the Eurozone crisis started over three years ago. But many commentators have underestimated the ability of the Eurozone to plod along and kick the problem into the future. The Eurozone is beset by problems, but politicians are playing for time - they are nursing weak economies (and their banks) along in the hope that economic growth will return, that asset prices will recover, and that economies will miraculously recover their former vim. How long can they do this for? Maybe a decade or more. However, if the PIIGS are still weak in several years time, the euro could well come to an end. Click here to read Barry Eichengreen's recent op-ed on the future of the Eurozone.