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Wednesday, January 17, 2018

What's The Hedge Ratio (Inflation-Linked Edition)?

Most investment analysis aimed at retail investors are for directional trades: how much money do you make (or sadly, lose) if something happens (such as a yield change)? Directional trades are fun to talk about -- and easy to analyse -- but unless you have an amazing forecasting record, not a great way to make money in the short term. In order to control your risk, you need to do relative value trades -- buy one or more instruments, and sell one or more others.

In particular, if we are interested in breakeven inflation, we are interested in a relative value trade (unless you enter into an inflation swap). As soon as we no longer just buying (or selling) one instrument, we run into the oft-repeated question: what is the hedging ratio? (The hedging ratio is the relative sizes of the instrument positions involved in the trade.) The correct answer to this question is: what are you trying to accomplish? For relative value trades involving linkers and nominal instruments, we could have either a larger or smaller position in the linker, depending upon what you are trying to do.

Sunday, January 14, 2018

Bitcoin Valuation Part II(b): What Might Work

This article concludes my series on Bitcoin valuation techniques. There appear to be three broad techniques that are not entirely psychological. The first would rely on the use of the crypto currency as an intermediary; it needs to have a large enough market capitalisation for transfers through the currency to work. The second relies on the portfolio allocation decisions of the large holders: at what point does it become irresistible to allocate towards other assets? Finally, there is the slim possibility that it is possible to hire labour or buy commodities at a fixed bitcoin price, allowing purchasing power parity (arbitrage) to work.

Thursday, January 11, 2018

Bitcoin Valuation Part II(a): What Might Work

We need to distinguish between a fair value and what price an instrument trades at. Economic and financial theory is almost invariably about the first part, and the second is not viewed as respectable. However, Bitcoin as an instrument is an excellent example how observed prices are actually determined by the actions of human beings, and not mathematical models. If we wanted to have a more formal approach, we need to look at the valuation of Bitcoin on a macro basis, and not arguments about the valuation of one Bitcoin on the margin.

Wednesday, January 10, 2018

Bitcoin Valuation Part I: The Wrong Answers

The rise of Bitcoin (and other crypto-currencies) appears that it will have a negative net effect for most law-abiding citizens, but it has provided us with a rather wonderful teaching opportunity. It underlines the weaknesses of existing analytical techniques. (I discussed Bitcoin in a previous article, but I used it to take a sideswipe at DSGE models, and I didn't bother giving the correct answer.)

Due to article length, this article will discuss incorrect valuation techniques. Part II will give the correct methodology.... 

Monday, January 8, 2018

The Death of Mainstream Macro

The American Economic Association's big conference - ASSA - was the occasion for a limited amount of introspection about the state of economics. On the surface, it looks like mainstream economists congratulating themselves on what a great job they are doing. However, my interpretation is that my views were confirmed: mainstream macro is essentially a dead body of theory. Anyone hoping to advance our state of knowledge of the macro-economy needs to look elsewhere.

Sunday, January 7, 2018

How To Build A Supply Curve?

I did a bit of the software plumbing for my economic/financial agent-based simulator over the holidays. I got a lot of the key architecture in place, I just need to start the hard part -- adding in agent behaviour. I am first working on a stripped-down economic model, and need to figure out how to set up a supply curve. Suggestions are welcome...

Saturday, January 6, 2018

MMT Is Not Just "Theory X"

I keep running into arguments of the form: "Modern Monetary Theory (MMT) is just {mainstream theory X} with {qualifier Y}." (The loopiest recent variant of this was that "MMT is just the Quantity Theory with bonds as part of the money supply." My head hurts just thinking about that assertion.) I believe that such characterisations are largely inevitable, and it is not obvious how to deal with them.