Early Starts

I get to head in to work early both Thursday and Friday, so I really ought to be going to bed rather than updating my blog right now. Besides, very little happened today that would be worth my typing out and your reading.

Oh yes: it appears that my coworkers came in just under the wire (or, rather, the wire was repositioned slightly), and so made their bonus.

I heard on the TV yesterday morning that the Department of Defense spent $750,000 to prepare a “terror futures” market. This market would allow people to, uh, “invest” money in various possible terrorist attacks (“King of Jordan assassinated,” “Third Old Man Drives into Farmers Market crowd,” etc.) to try and profit if that event actually happened. [In some ways, this parallels the “buy DJIA put options to profit if another terrorist attack strikes the U.S.” strategy that I invented/implemented in my Risk Management class—but writ much more large.]

Their logic behind the creation of this market? The statement given on CNBC went something along the lines of “well, markets are efficient [meaning that, e.g., the price of a stock contains all information (be it public or private) known about that company] and so if we create a terror market, it too will be efficient and give us a clue as to when and what attacks might occur.” In other words, if “Maui Golf Cart Rampage” suddenly starts trading for $50,000 instead of its average $0.005, there’s a good probability that someone in Maui might use their golf cart for evil in the near future.

Soooo stupid! (Thankfully, Congress universally saw fit to axe the project before another $8 million got spent on it.) Just for fun, two thoughts (though note that my finance theory is a bit rusty, so I might get some of the details wrong):

First: the Efficient Market Hypothesis of finance has three forms: weak (“all past prices are considered in the current price”), semi-strong (“all past prices, as well as all publicly known information, are considered in the current price”), and strong (“everything that anyone knows about this stock is considered in its current price”) The DOD seems to have selected the strong form (the most likely to be wrong form) of the hypothesis to support its theory. The strong form would only hold true, as far as I can imagine, if the people who have insider information somehow act on that information (be it by illegally buying/shorting stock, or by passing that information on to others, who act on it). If those people don’t always act, then I don’t see how the strong form could hold.

Second: a market isn’t efficient simply because you call it a market! One prerequisite is a whole lot of people actively trading in the market—liquidity, in other words. The reason the U.S. stock markets are relatively efficient is because people buy good deals and sell bad deals, and therein settle on an overall price. Any arbitrage (riskless profit) situations that exist in the market quickly disappear because there are a good number of people out there looking for them, and once they’re found they’re exploited until the situation no longer exists. [For similar reasons, other less-active stock exchanges might really not be efficient.] I doubt this terror futures market would have truly been efficient, ’cause I don’t think that many people would have used them.

If this actually interests you, here’s what CNBC had to say about the story. Then again, maybe I don’t have a clue what I’m talking about: The Washington Post (you may need to forge your name and age) has an article by Stanford economics professors with a different perspective.

Damn. I really should have just gone to bed. FWIW, “Brent Drinks Mountain Dew Tomorrow Morning” futures have gone up 50% in the last half-hour of trading.


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