On the topic of algorithmic trading, I recently posted on some evidence documenting the benefits it brings to markets -- more liquidity, lower spreads and trading costs, etc. On a related topic, Ole Roleberg at Freakynomics has a nice post reviewing some of the evidence that automated decision tools actually make better decisions that real people when confronting many different kinds of problems. As he notes, There’s a host of studies showing that human judgment is poor at synthesizing and...

I had an opinion piece published today in Bloomberg Views looking at the relationship between market efficiency and stability, a topic which hasn't received much attention in the economics literature until recently. The point of the essay was to explore two distinct recent studies which suggest that adding more derivative instruments to markets tends to make them less stable, even if they do push markets toward the idea of market completeness and efficiency. I wanted to make available here...

From The Atlantic comes a chart showing an incredible rise in the level of student debt over the past decade or so. The total outstanding debt among US students has grown by a factor of more than five over this period.  Daniel Indiviglio brings out the crucial point to appreciating just how explosive this rise has been. The figure shows two curves, red for student loan debt, blue for overall household debt. The latter itself went through a rather explosive growth from 1999-2008, yet...

I was looking today for a paper -- allegedly published in Science earlier this year -- reporting the results of a re-run of the famous Robert Axelrod open competition for algorithms playing the Prisoner's Dilemma. In that competition, the simple TIT-FOR-TAT strategy -- start out the first time cooperating, and then afterward do whatever your opponent did in the preceding round -- won out easily over much more complex strategies. The twist on the new competition (as I've been told), is to...

By way of Moneyscience, Nicholas Bloom notes that the VIX -- the so-called fear index -- has spiked to the same level it reached just after 9/11 (not quite as high as during late 2008): What this means for the future is uncertain -- it is a measure of uncertainty, after all -- but Bloom suggests, by analyzing 16 previous episodes of similar spikes, that a short recession is very likely, as economic growth generally follows some level of coherent confidence, and that is obviously lacking:...

Writing at Salon.com, Yves Smith of Naked Capitalism offers a rather depressing but illuminating wrap up of the utter failure of the SEC or the US Justice Department to do almost anything to punish the perpetrators of massive fraud in the run up (and after) the financial crisis. It's a sobering analysis of the world we live in, which isn't (for most of us) the world we thought we lived in until a few years ago: For most citizens, one of the mysteries of life after the crisis is why such a...

In researching a forthcoming article, I happened upon this recent empirical study in the Journal of Finance looking at some of the benefits of algorithmic trading. I've written before about natural instabilities inherent to high-frequency trading, and I think we still know very little about the hazards presented by dynamical time-bombs linked to positive feed backs in the ecology of algorithmic traders. Still, it's important not to neglect some of the benefits algorithms and computer trading...

I'm traveling today and will probably have little posting time for several days, but here are two interesting links: 1. John Kay has an illuminating essay identifying a common pattern in many financial and economic problems and linking them (loosely) to the structure of one simple, if diabolical, auction-type game: The game theorist Martin Shubik invented an unpleasant economists’ party game called the dollar bill auction. The players agree to auction a dollar bill with...

Entering August 2011 we're still suffering through the aftermath of the financial crisis of 2007-2008. Indeed, we may not yet have seen the worst of it. Economies around the globe are suffering, millions are unemployed. Europe, the US, Japan seem to be competing to see who has the biggest problems. So I thought it might be interesting -- or at least perversely entertaining -- to look back to the rosy days, before the crisis, when our wise academic economists and bankers were telling us how...

A reader of my Bloomberg essay from last week (and related post here) on economic discounting emailed me to make a point that deserves some brief discussion. He asked me not to "ignore the psychology of discounting," i.e. the realistic aspects of human behaviour that really determine how we discount the future, whether or not that behaviour conforms to some "rational" paradigm. My view is that I couldn't agree more. I didn't mention psychology in the Bloomberg piece for two reasons. First,...