One of the first models covered in game theory is the Prisoner’s Dilemma. I’m sure you’ve heard of it or at least recognize it from episodes of Law and Order. Let’s look at the simple model with 2 individual players so we can eliminate mixed strategy equilibria and focus strictly on pure strategies. The two strategies for each player are “productive” and “exploitive”. The payoffs for the two players can be summarized on the usual grid. Employee Productive...

This morning I ran through the Dunkin Donuts to pick up two donuts for me and two donuts for my wife. Four donuts cost $3.85 while 6 donuts cost a little over $4.00. The cashier tried to convince me that buying 6 donuts would be cheaper. Understandably, the cashier would not know that I was ordering for only two people or that we prefer not to stuff ourselves with more than two donuts each. Still, I feel like the cashier never quite believes that I understand the cost per donut is lower with an...

A particular insurance company’s investment department measures stock performance against the S&P500 index on an annual basis. The portfolio is long only with no derivatives. The portfolio manager eases into new positions and takes smaller positions outside of the index. The department operates on a monthly trading schedule where all trades for the next month are set within the last week of the current month. Regardless of how much the portfolio outperforms its benchmark, full bonuses...

The quantmod package is great for grabbing various financial data series from online sources like Google, Yahoo, Oanda, and the Federal Reserve. It also has some nifty technical charts that look very nice but are rather difficult to modify. One such problem is charting multiple data series. In quantmod, you could do this: library(quantmod) variables=c(“INDPRO”,”TCU”); names=c(“Industrial Production”,”Capacity Utilization SA”)...

I hear a lot of opinions on how economic value is created. Some of these opinions are supported by secondhand anecdotal evidence and most of them are used to support various political or social positions. Some of the most absurd theories on value creation even come from wealthy and/or successful people so someone without a business education may be forgiven for believing that this is a philosophical question that can only be answered through a belief in some set of principles. I would like to...

Earlier this week, I saw a message in my Twitter feed talking about an unusual correlation pattern between the S&P 500 and the Dow. Unfortunately, the graph produced by the Greg Mankiw recommended site AssetCorrelation.com was grossly inaccurate showing periods of zero correlation between the indices. A few lines of code using the Quantmod package in R can easily replicate the functionality of the site and a prudent analyst can simply load a more reliable data source before arriving at any...

Introduction Highland Capital and Tallwood Venture Capital represent two strategies of venture capital investing. Highland represents the traditional diversified portfolio strategy where many unrelated investments are made and little operational support is provided by the investor. Tallwood represents the focused portfolio strategy where fewer investments are made in a specific industry and investors are able to provide a greater amount of time and operational support to their firms. Neither of...

The Economist recently reported on a study conducted by Rob Nelissen and Marijn Meijers from Tilburg University in the Netherlands on how brands change our personal interactions. Through a series of experiments, the researchers showed that a well-known designer brand alone confers a higher perceived status and wealth on the wearer that alters how others interact with him or her. The positive effect from the label allowed a subject to get more people to take a survey, solicit donations, obtain a...

In operations management, co-production is the use of a business’ customers to assist in creating a good or service. Obvious examples are assembling Ikea furniture, self checkout, and using an ATM. Social media is also co-production. The value of Facebook, Twitter, or the rest is not the platform; it is the network and content that we create using the tools provided by the company. Unlike assembling furniture or replacing people with machines, the majority of social media’s value is...

In Part 1, I discussed some of the structural reasons why it is easy to beat the market that stem from the incompleteness of markets. The investment policy statement limits most market participants to specific assets and factors such as liquidity, bid-ask spreads, and risk management limit the remaining market participants from maintaining constant market efficiency. If we look at the largest market participants, they are typically long only institutional investors with relatively low portfolio...