[HN Gopher] Pricing Money: A beginner's guide to money, bonds, f...
___________________________________________________________________
Pricing Money: A beginner's guide to money, bonds, futures and
swaps
Author : mhh__
Score : 778 points
Date : 2023-06-16 15:54 UTC (1 days ago)
(HTM) web link (www.jdawiseman.com)
(TXT) w3m dump (www.jdawiseman.com)
| jrockway wrote:
| This is really interesting. Very early in my career I worked on a
| team that supported the interest rate swaps desk at a large
| investment bank. Not one person told me to read this book. I
| still don't know what they are. Wish I read this back then!
| AYBABTME wrote:
| Is there an audiobook version of this?
| 12907835202 wrote:
| This looks great.
|
| One bit of feedback is that it seems quite difficult to read on a
| phone with small font requiring zooming and then horizontal
| scrolling. Both the website and the PDFs.
|
| Being so text heavy I imagine it should be fairly easy to add
| some CSS to make it more readable.
| bbno4 wrote:
| This is absolutely fantastic, it reminds me of Bits About
| Money[0]
|
| [0] https://www.bitsaboutmoney.com/
| henry2023 wrote:
| World government debt went from 5T at the beginning of the XXI
| century to about 305T today. Is this sustainable?
| DoingIsLearning wrote:
| Isn't this the same discussion of infinite growth versus the
| ceiling of finite resources.
|
| It is logically not possible might take 20 years or 700 years
| but eventually a ceiling is reached.
| logicchains wrote:
| Growth doesn't require more resources. If your barber finds a
| way to cut your hair 10% faster, that shows up in GDP growth.
| Increasing efficiency leads to increased GDP.
| aziaziazi wrote:
| How about industrie, craftsmanship and farming? Can they
| "grow" over a certain period of time while the required
| resources doesn't?
| less_less wrote:
| Yes, of course. The quantity and quality of the output
| can certainly grow for a given resource input --
| obviously with physical limits but we haven't generally
| reached those. It's possible to breed higher-yielding
| crops, design more efficient industrial processes, to
| craft with less waste, etc, and these have all been
| vastly improved over the past few centuries.
|
| The problem is that these industries have also been
| growing by increasing resource consumption along with
| output, to a level that isn't sustainable (even without
| more growth) beyond this century or so.
| anhner wrote:
| But there is still a limit that will be reached. If a
| barber cuts your hair in 0 seconds, there is no more room
| to improve.
| nabla9 wrote:
| Thinking in nominal values is rookie mistake.
|
| You must think in terms of ratios, or not think at all. Debt-
| to-GDP ratio is a good measure that takes into an account most
| other variables like changes in population, productivity etc.
| henry2023 wrote:
| Well, world debt went from 5T to 305T while world GDP went
| from 33T to 96T in the same period
|
| As ratio we went from to 16.5% to 317%.
|
| Same question. Is this sustainable?
| ayolisup wrote:
| Too bad it is not available in .epub format, I'd love to read it
| on my ereader.
| vacras wrote:
| If you download the html of the page, you can put it into
| Calibre and use Calibre's convert feature to generate an epub.
| I have not tried putting the generated file on my e-reader but
| it looks fine on desktop.
| dang wrote:
| (This comment is just a stub so I can bundle a bunch of obsolete
| subthreads about a former typo in the URL)
| politician wrote:
| @mhh__ Link 404's.
| AnimalMuppet wrote:
| 404.
|
| 9 upvotes for the post currently, though, which I have a hard
| time seeing with a bad URL. Maybe they removed it when traffic
| spiked?
| mhh__ wrote:
| I commented it elsewhere with the correct link (but it's good
| enough to deserve its own post so here it is but I posted the
| link on my phone so something got borked)
| turtleyacht wrote:
| 404
|
| The link had extra periods at the end. Edited, the page loads
| fine:
|
| http://www.jdawiseman.com/books/pricing-money/Pricing_Money_...
| dang wrote:
| Fixed now. Thanks!
| mhh__ wrote:
| Yes, my phone's clipboard has betrayed me. I've emailed dang
| mhh__ wrote:
| This link is right. Don't think I can edit the submission's URL
| (@dang ?) http://www.jdawiseman.com/books/pricing-
| money/Pricing_Money_...
| dang wrote:
| Fixed now. Thanks!
| tc313 wrote:
| It's hard to put a date on it, but surely it's no more recent
| than (2021).
| nologic01 wrote:
| > some things have changed since it was written; it cannot be
| your risk manager
|
| this is a fair warning. the book does a better job than the usual
| pre-crisis interest rate literature discussing credit risk.
|
| a lot of the more advanced treatments were too self-absorbed in
| their made-up mathematical universe.
| dizzydes wrote:
| I love it. That said, I'd love to see an updated version with QE
| as that has a gigantic effect in recent times.
|
| For simplicity it can be thought of as a proxy to interest rate
| adjustments but how it works is complex and can lead to strange
| side effects.
| dang wrote:
| Related ongoing thread:
|
| _Probability and Markets [pdf]_ -
| https://news.ycombinator.com/item?id=36354259 - June 2023 (60
| comments)
| nodesocket wrote:
| This looks like an amazing resource. The problem I have is
| digesting all the information and financial/mathematical data. I
| tend to get overwhelmed by densely rich books and sort of tune
| out as I read.
| malux85 wrote:
| Then read slower
| alecco wrote:
| All these Financial guides are very interesting. But beware of
| falling into the illusion of being a good-enough active investor.
| It's like entering the Pro league as an overconfident amateur.
| The other players are the best in the universe. And they have
| cybernetic extensions: algorithmic trading with virtually
| limitless amounts of resources and information. And sometimes
| they have "alpha" you'll never, ever get your hands on. They prey
| on "dumb money" like naive/retail investors and pension/mutual
| funds.
|
| And at these times of high rates and inflation, the only safe
| move seems to be money market accounts and take the delta
| inflation hit. Try to focus your time in more valuable things
| like your friends and family. And keeping your sources of income.
| jdaw1 wrote:
| Agreed, strongly. Which is why the online edition has some
| "Cautionary words":
|
| > Pricing Money is a beginner's guide: it says so in big
| letters on the front cover. I believe it to be an excellent
| beginner's guide -- presumably many authors believe their own
| books to be excellent -- but, being a beginner's guide, it will
| not immediately make you a world-renowned expert.
|
| > It was written around the turn of the pedant's millennium. In
| some parts it shows its age. It has been slightly freshened by
| the addition of green-boxed updates, but these have been
| written very concisely, more to point to developments than to
| explain them fully.
|
| > Please do learn from and be informed by Pricing Money. But
| also be cautious: it is not enough to make you a world-renowned
| expert; it does not list the many details that are both dull
| and necessary; some things have changed since it was written;
| it cannot be your risk manager.
| matheusmoreira wrote:
| Surely it must be possible to learn how to do whatever these so
| called "smart money" types are doing. Or at the very least
| learn how they operate so we can identify and avoid their
| attempts at predation.
| soVeryTired wrote:
| I'm not going to argue that asset managers and trading desks
| have plenty of resources and that they can transact very
| quickly and cheaply. But having been on the inside of small and
| large asset managers for almost ten years, I can say there's a
| lot of groupthink and rather brain dead behaviour to be seen on
| a trading floor.
|
| Call me jaded but I've worked with both systematic and
| discretionary traders. The algos I've seen tend to be heavily
| overfit, and stop working as soon as they hit production. The
| discretionary traders usually have a tonne of gambler's tics
| and have a bad habit of assigning narratives to market noise.
|
| Most institutional traders aren't the best in the universe.
| They just do dumb things faster and at bigger scale than day
| traders.
| polymathemagics wrote:
| Agree that people should not do active investing, although the
| solution would be passive investing (index funds), which allow
| you to focus on friends & family without missing out of the
| economy's long term gains.
| alecco wrote:
| This is a terrible moment for index funds.
| vecinu wrote:
| Hot take but I'll bite, what's your rationale? We're only
| ~9% down from VTI's ATH and what happens now doesn't matter
| when your investing horizon is 15+ years.
| hartator wrote:
| Would love to be able to buy a printed copy.
| 0xcafefood wrote:
| On a related note: does anyone have good recommendations for
| printing services that can print and bind an online PDF, etc?
| I've looked into lulu.com and printme1.com but haven't used
| either for this purpose.
|
| I've wanted to do something similar for some of Beej's guides
| that are not in regular print, and would definitely consider
| for this too.
| Nzen wrote:
| I looked at lulu for printing Scott Alexander's Unsong. Their
| terms of service declaim [0] anyone looking to print content
| that they do not have copyright or a license for. That's the
| entire point of copyright.
|
| I recommend that you contact beej directly.
|
| [0] https://www.lulu.com/terms-and-conditions section 3
| paragraph 3
| howard941 wrote:
| Most local printing places (places that do business cards,
| flyers, and the like) will gladly supply a quote for a single
| printed and bound PDF. Last time I did this only had to send
| the PDF for a complex flight sim. Shop local!
| SnooSux wrote:
| I had a college course use Lulu to print the notes into a
| textbook. The quality was good for a paperback. I think
| you're limited to black and white though. The formatting of
| the TeX notes could have been better, but that's probably on
| the professor to have fixed.
| Nzen wrote:
| Um, the second paragraph has a link [0] to Wiley's page for it,
| which only offers a paperback edition.
|
| [0] https://www.wiley.com/en-
| us/Pricing+Money:+A+Beginner's+Guid...
| robocat wrote:
| Para says (with links): While stocks last,
| hard copies of Pricing Money can still be purchased from
| Wiley, Waterstones, Amazon.co.uk, Amazon.com, Amazon.fr,
| Amazon.de, Amazon.co.jp, Abe books, as well as other
| bookshops: cite ISBN 0-471-48700-7
| dotBen wrote:
| I would love to buy an eBook version of it. That isn't the $75
| Kindle version on Amazon.
| gretch wrote:
| I read a couple of pages and it looks good. I'm not a complete
| beginner but it's still filling in some gaps in my knowledge. I
| appreciate the author's work and giving it away for free.
|
| That said I feel like it's skipping some explanation for what's
| supposed to be a beginner's guide. One thing that sticks out to
| me is that it jumps straight into talking about interest rates
| without explaining the time value of money and why interest
| exists.
|
| I wanted a book I could recommend and to others who knew even
| less than me, but I don't think this could be it.
|
| (And maybe interest is covered later on, but the ordering is
| important)
| urthor wrote:
| I deeply appreciate the green box. Thank you very much, look
| forward to the read.
| bullen wrote:
| The price of bad money is war.
| parpfish wrote:
| pricing money is easy. they usually print the price on both sides
| of the bill.
| jpmoral wrote:
| Question about the "Yields of Australian Commonwealth government
| bonds as of 21 January 2000" graph in Chapter 2 (page 13 of the
| A4 version):
|
| The y-axis (Yield in percent) values don't seem to match the data
| points. For example, the point for Feb '01 is labelled '7%' but
| the point is just above the 6% mark and well below the 6.5%. What
| am I not understanding?
| mhh__ wrote:
| That's the coupon, rather than the yield.
| jpmoral wrote:
| Ah, thank you!
| tech_ken wrote:
| This is an excellent resource and a great read, but DAMN do money
| markets seem stupid as all get out to me. Where is the productive
| output of all these arbitrage shell games? How is this more than
| an abysmal waste of time and resources simply to make a small
| handful of bankers richer?
| yieldcrv wrote:
| > How is this more than an abysmal waste of time and resources
| simply to make a small handful of bankers richer?
|
| Interesting observation given that your own wealth is managed
| this way.
|
| Whether its the simple bank deposit in a checking account, if
| you've ever chased an interest rate for a savings account, or
| had your earnings managed in a retirement account from your
| employer, or if you attempted to make money faster because a
| debt was coming due.
|
| Its all tied together and a product of this system.
|
| The goal is to keep money moving within the economy, as people
| also race to hoard it.
| MountainMan1312 wrote:
| I'm with you, but I apply the same logic to all rent-seekers
| and shareholders. We'd be a lot better off if we didn't have
| parasites and bottomless pits embedded in the economy by
| design.
| JackFr wrote:
| Not sure if you meant "money market" as it's understood to be
| the market lending/borrowing for terms of less than a year, or
| if you were referring to fixed income markets in general.
|
| Either way it's hardly a waste of time or money, and banks make
| money not from "arbitrage shell games" but by matching buyers
| with sellers. Some people have money to lend and sone people
| have enterprises they need to fund.
| lend000 wrote:
| The output (generally speaking, not specific to money markets)
| is better prices. There are large scale examples of economies
| in which prices were mismanaged either due to lack of
| information/technology or centrally planned prices, some of
| which resulted in failed states (e.g. Venezuela and the Soviet
| Union). While providing market information signals via prices
| is certainly an abstract concept that most people will never
| appreciate, it is important regardless.
|
| For complex instruments in money markets, the main effects are
| bridging mis-priced treasuries on different time frames and
| hedging against various outcomes for pensions, banks, and
| dealers in physical commodities.
|
| Most of the complex stuff either serves one of those purposes
| or becomes a zero sum game that doesn't affect non-
| participants. It's important to judge each instrument by its
| purpose and mechanism rather than bunch everything as a way to
| make bankers richer (e.g. a future vs. a CDO).
| mhh__ wrote:
| CDOs aren't particularly crazy until you start pricing them
| using completely fictitious numbers and reasoning (IMO at
| least).
| consilient wrote:
| > lack of information/technology or centrally planned prices,
| some of which resulted in failed states (e.g. Venezuela and
| the Soviet Union)
|
| Venezuela has never had Soviet-style central planning. It's a
| market economy with a public sector only slightly larger than
| the OECD average. Their current situation is largely the
| result of excess social spending: first at the expense of
| investment and diversification away from oil prices were
| high, then at the expense of currency stability when oil
| prices crashed.
| lend000 wrote:
| While you're correct that high social spending that relied
| on high oil revenue was probably the primary cause of
| Venezuela's economic collapse, they had price controls on
| food starting back in 2003 and they began nationalizing
| major industries in addition to oil by 2008. From 2008, it
| was a full on centrally planned disaster.
| consilient wrote:
| Ownership and allocation mechanism are mostly independent
| axes. Consider for instance Norway (extensive state
| ownership but highly market-oriented; in certain respects
| more liberal than the US) contemporary China (state
| control of most major firms but mostly market-oriented),
| Gaullist France (nationalized infrastructure plus
| minority state shares in other sectors, markets
| supplemented with indicative planning and state-directed
| investment) or the US during WWII (almost entirely
| private, full-blown central planning).
|
| Venezuela's level of interventionism is unremarkable by
| the historical standards of the developed world. The
| problem is their poor choice of interventions.
| heywhatupboys wrote:
| > in certain respects more liberal than the US
|
| why would this be surprising? Don't believe for a second
| that the USA has a generally more liberal financial
| market than Scandinavia. Employment laws, trade,
| regulations, etc. are often wayyy less strict in
| Scandinavia.
| quickthrower2 wrote:
| While there are casinos, think: A farmer wants to get a fixed
| price for next years crop and insure against a bad harvest.
| Thats why you need these things.
|
| Ok the farmer example is a trope apparently. Any business where
| you need to hedge financial risk. Lending too many mortgages to
| self employed people? Sell that risk / revenue stream on to
| someone else and buy something different to diversify.
| novosel wrote:
| Great questions, but no reply will be coming at you.
|
| Except an apologetic nonsense-logic-it-is-obvious-it-works
| trope.
|
| Only product is the profit.
| scubbo wrote:
| Quite. The general response I get from questions like this to
| financial folks is that these markets and vehicles and
| products are important "for liquidity", but they can never
| quite tell me who liquidity benefits other than the system
| itself.
| NoboruWataya wrote:
| It benefits people who need to raise cash, because they can
| do it more quickly and generally with lower financing costs
| than in an illiquid market.
|
| It benefits people who have cash that they want to invest,
| because they have more opportunities to do it and more
| visibility over which investments are safe and which ones
| are risky.
|
| Therefore it benefits society by transferring cash from
| people who have it now but need it later, to people who
| will have it later but need it now. Enabling and
| facilitating actual socially good activity, like
| manufacturing goods, providing services, etc.
|
| So there are definitely benefits to people outside the
| finance industry. However, in order to accept any of that
| you do ultimately need to believe, to some extent, in the
| market as a means of allocating resources. You don't need
| to think it's perfect, or that it shouldn't be regulated,
| or even that it is the fairest system, but you need to
| accept that it is the system we use. In a totally state-
| planned economy, finance wouldn't work or even make sense.
| quickthrowman wrote:
| If you own equities (individual stocks, ETFs, mutual funds)
| then you benefit. More liquidity means lower bid/ask
| spreads which means lower transaction costs and higher
| returns (since you are paying lower transaction costs, more
| of your money is invested and it adds up over time) for
| every investor. The NYSE minimum tick size used to be 12.5
| cents, then 6.25 cents.
|
| Once HFT firms started becoming more widespread, the spread
| lowered significantly. SPY bid/ask spreads are 1 cent on a
| share that costs ~$450. Some assets even have sub-penny
| bid/ask spreads.
|
| The traders that create units of SPY get better spreads on
| the underlying stocks too, which benefits you as well by
| reducing asset fees and more accurately representing the
| NAV by lowering transaction costs. The S&P 500 is made up
| of 500 stocks, it is much more cost effective to assemble a
| basket of stocks with 1 cent spreads than 6.25 or 12.5 cent
| spreads.
|
| Liquidity does the same thing for every market, it
| increases the speed and accuracy of price discovery and
| lowers transaction costs.
| esotericimpl wrote:
| [dead]
| zzbn00 wrote:
| One example which is applicable to majority of the working
| population: in the UK at least the fixed-rate mortgages are
| priced off the Swap rates as that is how banks hedge them.
| bell-cot wrote:
| These days - figure that it is 1% "honest & productive uses",
| and 99% society-undermining casino.
| rcme wrote:
| Risk management is the product. Surely you agree that a product
| that reduces risk is worth something, right?
| ineptech wrote:
| This isn't false but it feels reductive. A financial
| instrument that allows one to bet on the corn harvest is
| obviously valuable to the corn farmer, as it allows them to
| use profits from good seasons to hedge against bad seasons.
| They're also valuable to people whose business is affected by
| the corn harvest - cereal manufacturers, say. The problem is
| that they can also be used by people with no exposure at all
| who simply want to bet on the corn harvest, and from the
| scale of the finance sector it seems like we are pouring a
| lot more of our resources and brainpower in to designing
| exotic new ways to bet on the corn harvest than we are on
| growing corn.
| quickthrowman wrote:
| The buyers and sellers of a futures contract are both
| trying to offload risk onto someone else. The risk profiles
| of both sides don't always offset exactly, so speculators
| are _necessary_ for functioning commodity futures markets
| (and markets in general). Also, price discovery is much
| more efficient with more liquidity, which is what
| speculators provide, in addition to risk assumption.
| ineptech wrote:
| Sure, I get this and agree, but price discovery and
| facilitating markets are subject to diminishing returns
| just like anything else, right? I don't think I would've
| been downvoted for saying something like, "It's a problem
| that it's more lucrative to speculate on existing housing
| than to build new housing, so we should make regulatory
| changes to address that" and this feels analogous to me.
| marcosdumay wrote:
| > as it allows them to use profits from good seasons to
| hedge against bad seasons
|
| It allows corn farmers to grow wheat instead, because he is
| selling it right now and wheat is more profitable right
| now.
|
| The main reason why it doesn't go astray and make people
| hungry is because people that isn't involved in any way can
| go, study the factors that make wheat more profitable to
| corn, do their predictions of what will be the case at the
| point of delivery, and if they predict correctly that the
| price is wrong they can go and adjust it making a lot of
| money on the process.
| ineptech wrote:
| I'm not sure how this is related to my post so perhaps I
| was unclear. I'm not talking about individual corn
| farmers and the choices they make, I'm talking about how
| we as a society and an economy allocate our resources.
| I'm saying that derivative financial instruments have
| value, for the reasons I suggested and the others
| described by sibling commenters, but that the finance
| sector is larger than that value warrants.
|
| I'm not sure why I'm being downvoted, as I didn't think
| this is all that controversial. Historically, finance was
| a much more boring and less lucrative field than it is
| now, and consequently much smaller. "I'm a super smart 18
| year old and I want to get rich, so obviously I should go
| into banking" is a relatively recent phenomenon. I agree
| with everyone else here that the industry has value, so
| presumably its recent explosion in size has brought some
| additional value, but it's very hard to believe that
| value is large enough to offset the opportunity cost of a
| generation of ambitious geniuses _not_ going in to
| science or industry or becoming entrepreneurs.
| tech_ken wrote:
| Sure I'm pro-risk management. So by arbing lending-rates
| which risks are mitigated?
| [deleted]
| tylerhou wrote:
| E.g. interest rate risk. Maybe I've sold a bunch of
| variable-rate bonds before. But now I am worried about
| interest rates rising. I can't call the bond for some
| reason (maybe not enough money, maybe some regulatory
| reason). So I buy an interest rate swap that pays out if
| interest rates rise.
| [deleted]
| cvalka wrote:
| Others have provided excellent answers. There's one thing I'd
| like to add. In order for the financial markets to provide more
| utility, a financial transaction tax needs to be introduced. It
| will indirectly kill unproductive or counterproductive
| financial activity such as high frequency trading.
| ulfw wrote:
| Same with the majority of tech companies. All you do is endless
| meetings, plannings, reviews and extremely little actual human
| brain is used for productive output.
| lordnacho wrote:
| The arbitrage game keeps the prices consistent with each other.
| It serves to create liquidity so that participants can get
| their business done without either waiting too long or paying
| too much.
| criddell wrote:
| Maybe this is a dumb question, but who are the participants?
| What is the business they need to get done? What are they
| waiting on?
| johngladtj wrote:
| Every single person in the world who has ever traded
| anything with anyone
| NoboruWataya wrote:
| Ultimately, they are governments, businesses and
| individuals. All of these actors regularly face situations
| where they need (or want) to expend money now that they
| will have eventually but do not have now. The financial
| markets are primarily about making it as efficient as
| possible to do that. (There is arguably another side of the
| financial markets that is about helping people manage risk,
| though they are somewhat related.)
|
| Most of the financial wizardry you read about in the linked
| article is related to that aim. It's not always obvious,
| because a lot of it is higher-order stuff: transactions
| between financial market participants where payouts are
| linked to other transactions (or aggregations of
| transactions) between financial market participants, etc.
| It can be hard to see the link to the participants I
| mentioned above. But a lot of it is a means to
| understanding, and spreading, the risks associated with
| financing those participants. It is a lot easier to lend
| people money to finance their wants and needs if you can
| (a) differentiate between people who will pay you back and
| people you won't; and (b) share the risk of not being paid
| back with others.
| lordnacho wrote:
| The participants are time-and-space separated buyers and
| sellers of
|
| - Commodities like wheat, barley, cows, coal, electricity
| and so on
|
| - Money itself, in which case we call this lending and
| borrowing
|
| - Money for other money, commonly called currency
| transaction
|
| - Ownership stakes in companies, aka shares
|
| - Contingent claims like options and futures on the above
|
| Say you want to build a factory to make cars. That's going
| to cost something, and you want to share the risk with the
| public.
|
| - When you IPO this company, you get a bunch of money from
| the buyers of your shares. The owners of the shares, why do
| they bother? They don't just get all the profits of the
| company like if they owned a restaurant. They don't control
| the car factory, they leave that to the management,
| including how much of the profits are paid out. What if
| they need the money, despite everyone thinking the company
| has good prospects? Enter the secondary market, what we
| normally call the stock market. Here you can find other
| people who want the shares you don't want, and will give
| you money today for your shares, even if the company hasn't
| made a dime yet.
|
| - You have plans with the 10B from the IPO, but not right
| this day. If there were a money market you could gather
| some interest until the bill for the factory comes. Some
| other business needs to make payroll with their receivables
| a couple of weeks later. You just need to match with them
| somehow.
|
| - When you start selling cars, you find that a lot of
| people don't have 50K in cash. Not to worry, you hand these
| people their cars anyway, and you make a financing plan
| where they pay for the car with money that they owe you.
| Now you have a bunch of loans from people, but you can't
| use the IOUs to expand your factory. What do you do? You
| find someone to forward you some actual cash on the
| expectation that the car buyer will eventually give you the
| money for the car. You just need a market to find this
| person with the opposite need to you.
|
| - You might sell cars in other countries. If your factory
| is not in that country, your expenses will be mismatched.
| If only there was someone out there willing to swap all the
| Euros you got from selling cars in Europe for your Dollars
| that you use to pay your workers. It happens that there are
| other companies in America expanding to Europe needing
| Euros for their local offices, and having only dollar
| income. How to find them?
|
| So what happens then? Who is going to match all these
| different interests? The answer is market makers. Basically
| people who know that there are clients whose interests
| match. Your basic middle man who stands there when the
| farmer comes in, buys the grain, and then waits for the
| restaurant guy to come in, and sells them. That way they
| don't need to meet at the same time and place, and they
| don't need to match exactly.
|
| Not matching exactly brings us to contingent claims. If
| everyone just transacted everything in the exact right
| quantities, that would be nice for the market maker. He'd
| just take a spread on everything and sleep comfortably. But
| that's not what happens and supply and demand change, and
| prices change. In fact prices can change a lot, and you
| might need some sort of deal where you can buy or sell
| something, but only if the price is at some particular
| level. Or you might want to buy or sell something
| definitely, but not right now, only at some time in the
| future. This whole derivative game allows people to move
| risks around in order to match their changing balance of
| buyers and sellers.
|
| I haven't even added speculators yet, but that's the start
| of a "who/why markets" answer.
|
| EDIT. I know people will ask next. What does any of this
| very nice sounding imaginary world of completely explicable
| financial needs have to do with arbitrage?
|
| The answer is liquidity aggregation on similar products,
| and liquidity spreading by interaction of participants.
|
| Let's say there's a market to borrow money for each year in
| the future, eg 2024, 2025, 2026, and so on. Some guy
| decides he needs to borrow money for 2025 to build a
| factory. As a market maker, that's fine, but hey wait a
| minute. There's nobody I know who wants to lend in 2025.
| What do I do? I have this guy who wants to lend in 2024 and
| a guy who wants to lend in 2026. Hey, maybe I can just do
| all these deals, paying me a spread? My books will be
| slightly off balance, but don't interest rates basically
| move up and down together? Let's do it and deal with the
| mismatch later. So now these related markets are connected.
| They are sort of one large pool of liquidity, but still
| their own separate pools since there is still some
| difference.
|
| This is a loose arbitrage. You're not guaranteed to make
| money on it, since rates can move the wrong way for you.
| But this is also the most common arbitrage, the one where
| you sort-of hedge your book against similar things and hope
| the imbalance falls out eventually.
| pwatsonwailes wrote:
| Not dumb at all. The participants are basically everyone in
| the market. Everyone buying and selling and speculating on
| the thing in question.
|
| What they might be waiting on - imagine you have a business
| wanting to invest in something - new equipment maybe, or
| opening a new office. That requires capital expenditure.
| You might not have the free capital to be able to do that.
| However, if you can improve your cash position, that might
| be something which becomes available sooner, allowing you
| to grow more rapidly.
|
| That requires that you're able to secure finance, which
| means you need someone to either buy something from you
| now, or to buy the promise of something for the future. In
| either case, you now have increased cash at bank, which
| lets you invest to generate returns (hopefully).
|
| This is deeply rooted in the idea that money you have now
| is worth more than money you may have in the future.
| mhh__ wrote:
| Meaningful prices for the rest of us
| pwatsonwailes wrote:
| Whilst arbitrage is certainly something which exists in the
| financial markets, the vast majority of what's done isn't
| arbitrage. Arbitrage assumes differing views on valuation of an
| asset _today_. So I can buy something from person A, which they
| believe to be worth value x, and sell it to person B, who
| believes it to be worth y, where y > x. That's arbitrage in
| its simplest form - the market has priced something
| incorrectly, and I can buy it from willing sellers, and sell it
| to willing buyers at different values at the same time.
|
| The vast majority of financial transactions aren't this -
| they're speculative. They bank on the idea that money now is
| worth more than money in the future, and the future value of an
| asset (using the definition of an asset that it's a sequence of
| cashflows) is both variable and uncertain. So therefore the
| promise of future money is inherently tied to the concept of
| risk. The majority of financial markets trading is based around
| this concept of risk, and the management of it.
|
| There's vastly more complexity under the hood, but that's
| roughly speaking, accurate.
| raincom wrote:
| Commodities, homes, lands, water, minerals, etc (let's call
| them real assets) can not inflated as freely as possible, the
| way money can be expanded/inflated. That's the large source
| of speculation. This is why people borrow in order to acquire
| real assets.
|
| Third world countries want to issue debt in American dollars,
| because no one wants to buy their bonds in their home
| currencies.
| tech_ken wrote:
| Gotcha gotcha, that makes sense, thanks for the clear
| explanation! So I can see how the arbitrage (thusly defined)
| has the risk mitigation benefits other people talk about, can
| the same be said about speculation?
| ls612 wrote:
| Speculation is fundamental to price discovery.
|
| Think about it this way, actors in financial markets all
| have various beliefs about the future, and all of these
| beliefs are on a scale of accurate to inaccurate.
| Speculation allows these beliefs to be aggregated into a
| single market price (which btw implies no arbitrage) for
| various types of contingencies and risks, and the price
| will rapidly update to reflect updates to reality and thus
| updates to everyone's beliefs.
| pwatsonwailes wrote:
| Sure. You mitigate risk on speculation by hedging. I'll try
| and give a similarly simple (if not perfectly accurate and
| far more lengthy) explanation. Someone mentioned farming
| financials in the comments around this, so we'll use that.
| It's also something I know well, as I know a lot of
| farmers.
|
| Let's imagine that a commercial farmer, whom we'll call
| Jeremy plants 100 acres of wheat on a farm. Market values
| for wheat (and everything else you can farm, from livestock
| to grains and so on) vary and move constantly, as a
| function of supply and demand. We saw this in an extreme
| form with the invasion of the Ukraine, and the droughts in
| Italy last year.
|
| Now the problem with farming is your timescales are long
| compared to the movements of values for your product in the
| market, so you've no real idea as to what what you're
| planting will be worth by the time the bloody thing has
| actually grown and you've got it harvested and into barns
| to be sold. And once the seed is in the ground, you can't
| exactly just plough it all over and plant something else
| (not strictly accurate, but you don't want to go down that
| route).
|
| So now let's fast forward. Jeremy now harvests his wheat,
| and let's say the price has moved up a lot between planting
| and harvest. Jeremy is a happy man, who's going to have a
| bumper time, even if his crop doesn't produce as much per
| acre as he might like at the minute, because it's not
| raining enough. Or conditions are perfect, and the price
| has gone up, and he makes a huge amount and can reinvest.
| Jeremy is a happy camper.
|
| However, if the price falls, Jeremy is not going to be
| quite so chipper. As such, Jeremy can move his risk,
| through the use of a hedge. Let's say Jeremy hunts around
| to find someone to buy his wheat at the start of the
| season. He might sign a contract with a flour producer,
| stating that they will promise to buy x tonnes of his grain
| at PSy per tonne. Jeremy now has a fixed price, which has
| hedged his risk profile. Now his risk has moved from
| financial to productive - he has to be able to provide the
| x tonnes. If he can't produce it all on the farm, he needs
| to source the difference. On the other hand, if he's a good
| farmer, and the farm produces well, and he doesn't over-
| extend his risk on what he's committing to, he now has a
| fixed price contract for his goods, _which isn 't going to
| fluctuate based on time_ (assuming the contract is honoured
| - if he's worried about that, Jeremy could then buy
| insurance on the risk of a default on the contract, but
| that then gets complex). This is a very good thing, but
| means if the market prices his wheat vastly higher than he
| expected, he'll miss out on that upside.
|
| This is called a forward contract. There's other types of
| contract which can be used to do similar things (futures,
| derivatives...) but that gets a bit more complex.
| Utkarsh_Mood wrote:
| > On the other hand, if he's a good farmer, and the farm
| produces well, and he doesn't over-extend his risk on
| what he's committing to, he now has a fixed price
| contract for his goods, which isn't going to fluctuate
| based on time (assuming the contract is honoured - if
| he's worried about that, Jeremy could then buy insurance
| on the risk of a default on the contract
|
| So basically a third party would step in to assure him
| that he'd be paid the fixed price for a small fee? Are
| there no repercussions if the contract isnt honored?
| pravus wrote:
| > Are there no repercussions if the contract isnt
| honored?
|
| Basically the entire point of futures markets is to
| standardize the contracts and process by which these
| contracts are fulfilled to the point where all of that is
| just part of the pricing mechanism.
| pwatsonwailes wrote:
| I mean, shit is still going to hit the fan if the
| contract isn't honoured, but in the simplest terms, yes,
| he'll still get paid by the insurer if the contract party
| defaults on the contract. (As a massive scale version of
| this, see 2007/2008 financial crash. That's basically
| what happens when counterparties default at scale and
| insurance contracts have to pay out everywhere, to the
| level that the insurers themselves have to be rescued.)
|
| Simple example - let's say the contract is for 100 tonnes
| of wheat at PS175 a tonne. So Jeremy should get PS17,500
| for the wheat he's contracted to deliver. Now let's say
| that Jeremy has the 100 tonnes ready to go, but the flour
| merchant can't/won't pay up. Maybe he's in financial
| troubles, maybe Jeremy ran off with his wife, who knows.
| But for whatever reason, he refuses to pay.
|
| Now let's also imagine two scenarios - one in which the
| price of wheat has gone up, and one where it's gone down.
| In the former, Jeremy is actually happy with this, as he
| can now sell his grain on the open market for more than
| the contract, and claim the insurance payout on the
| contract. On the other hand, if the price went down,
| Jeremy still has to sell his grain, but he might only get
| PS100 a tonne, which is going to result in a loss of
| PS7,500. At this point Jeremy is very glad of the
| insurance.
|
| Now the interesting bit is the insurer has the estimate
| the risk of default, and the likely movement on the
| market, to be able to offer a sensible insurance product
| to Jeremy. So Jeremy might pay PS1,000 for an insurance
| product which pays out PS10,000 on the default of the
| purchaser, for example. Obviously the numbers involved
| here are fictional (apart from the price of wheat per
| tonne, which is probably around the mark given at the
| moment), but the principle is accurate.
| TuringTest wrote:
| No, that's purely destructive greed.
|
| Ancient civilizations invented the jubilee (loans should be
| repaid in 7 years) to prevent speculation on them. But
| unfortunately, preventing extreme concentration of wealth
| has fallen out of favour
| e-master wrote:
| Generally speaking you can group large financial institutions
| into two groups: sell side and buy side. I'm no expert, but
| afaik, these firms either SELL liquidity (e.g. investment
| banks, market makers etc.) or BUY liquidity (for example
| pension funds, certain hedge funds). Liquidity is the key here
| - that is (if any) the benefit they bring to society. I can
| buy/sell pretty much any financial product/risk with reasonable
| spreads because there's always someone on the other side of the
| trade ready to be my counterparty.
|
| Not that I want to defend some of these institutions, though
| some are better than others, but it's important to keep in mind
| that they do take on risk in order to provide us liquidity, and
| most of them specialize in managing the risk, some of them are
| even good at it. Their infrastructure and connectivity and the
| price they charge you to provide liquidity allows them to make
| profits, but they do lose money sometimes. Also, compared to 20
| years ago, there's fierce competition now in pretty much every
| aaset class - if you work in one of the buy/sell side firms,
| you'll very often hear terms such as spread compression etc
| (except the Covid years of course - people just wanted to
| trade, nobody cared about the price of liquidity (e.g. spreads
| or sales credit etc.) they had to pay)
| tel wrote:
| Arbitrage and it's various squishier more stochastic cousins
| are the vehicle by which information flows through markets.
| Markets exist as a global network of interactions and
| persistent imbalances anywhere in the system can have massive
| consequences. Generally, these consequences rhyme with "two
| counterparties which don't interact with one another directly
| all that often suddenly discover grave disagreements in the
| desired price and quantity of something they'd like to trade".
| Economic wreckage is the result, at least, but also imagine
| what would happen if corn farmers produced only half the crop
| that their buyers would have liked to purchase.
|
| So, markets work pretty hard to make sure that information from
| one area of the global economy can flow to all of the rest of
| the system with relative efficiency. This works a lot like a
| game of telephone where changes in one market venue propagate
| through related instruments to other venues crossing space,
| species, and even time. Much like telephone, each pair of
| neighbors wants to do a good job sharing information without
| loss and, also, over long distances minor errors add up.
|
| Arbitrage is the glue which prevents this from happening.
| Arbitrage says that any time _anyone_ discovers some level of
| disconnection occurring, they can make money at very low risk
| by voting to shift markets to better align with one another.
|
| Arbitrageurs are getting paid to provide a service to the
| market and subsequently the entire world. Their actions ensure
| that information flows throughout the global financial system
| quickly and without relying on centralized planning. Without
| them, markets could become disconnected and wander out of
| agreement.
| tech_ken wrote:
| >Arbitrage and it's various squishier more stochastic cousins
| are the vehicle by which information flows through markets.
|
| >This works a lot like a game of telephone where changes in
| one market venue propagate through related instruments to
| other venues crossing space, species, and even time.
|
| Hell yeah I'm not sure where I fall on accepting this way of
| thinking about things, but the line of
| poetics/skeuomorphics/analogy is very cool to me.
|
| >Economic wreckage is the result, at least, but also imagine
| what would happen if corn farmers produced only half the crop
| that their buyers would have liked to purchase.
|
| This is kind of my sticking point because on direction of
| that risk is like an actual hazard to my biology and the
| other is the consequence of allocating food by market. Not
| saying it's 'wrong' per se, but it does stand out that we're
| resolving market problems with like market^2
| lolpython wrote:
| Farmers use futures contracts to protect against price risks
| [0]. As do energy suppliers [1].
|
| [0]
| https://www.ers.usda.gov/webdocs/publications/99518/eib-219....
|
| [1] https://emp.lbl.gov/publications/primer-electricity-
| futures-...
| panarchy wrote:
| Why is it that every time someone mentions futures trading
| someone comes along to drop the farmer's crops example, do
| y'all really have no other examples?
|
| What percentage of futures trading is on farmers crops?
|
| What about the crops they destroy because they would be less
| profitable? Does the protection against monetary risk
| outweigh starving people to death?
|
| How well will it work if we create unsustainable land that
| the farmers can no longer grow crops on?
| marcosdumay wrote:
| The one goal of future contracts is for producers and
| consumers to be able to make deals before that production
| and consumption happens. Those are the primary dealers
| there, and I don't really remember where I got statistics,
| but AFAIK, they are about 10% of the volume.
|
| On top of those primary deals, a lot of people pile up
| making bets on secondary deals. Those are the people going
| for "hey, a lot more farms are growing rice this year, I
| bet its price will fall". They are very welcome because
| they not only stabilize the prices on those markets, but
| they also provide short-term money to make the deals flow
| more homogeneously. Without them, making deals on those
| markets would be a profession by itself (as it was).
|
| Now, there exist people making bets on the results of the
| bets of the secondary market. That is a different market.
| At some point it's clear that this becomes toxic, but
| nobody seems to agree on what point exactly.
|
| > What about the crops they destroy because they would be
| less profitable?
|
| You mean farmers getting bankrupt? You seem to be
| misunderstand, because the main reason farmers love the
| futures market is because it lowers their risks.
|
| > How well will it work if we create unsustainable land
| that the farmers can no longer grow crops on?
|
| Well, surely if you go and kill everybody, there will be
| nobody losing money on those markets.
| droffel wrote:
| > What about the crops they destroy because they would be
| less profitable?
|
| To clarify this point specifically, food self sufficiency
| is considered a national security issue.
|
| Consider the situation where a hostile country floods
| your market with cheap food products (below cost) until
| your country's farms go bankrupt due to an inability to
| compete. Once you stop producing food of your own, you
| give significant power to whoever controls your food
| supply.
|
| This is a large part of why agricultural subsidies exist.
| And yes, sometimes it means paying farmers to let crops
| rot on the vine in order to not cause market gluts. That
| is an entirely different situation from futures and
| hedging, which in any sane market match supply and demand
| (with the result of minimizing waste).
| nostrademons wrote:
| "floods your market with cheap food products (below
| cost)"
|
| The hostile country will eventually go bankrupt because
| they are producing products below cost.
| ikekkdcjkfke wrote:
| Dump and pump?
| hllooo wrote:
| Not necessarily, if they can produce the crops more
| cheaply. Since each country ideally wants to secure it's
| own food supply, it's inevitable that many countries will
| find themselves subsidizing local production that would
| otherwise disappear in a competitive international
| market.
|
| Additionally, hostile countries do not need to flood
| markets sustainably if the goal is simply to hollow out
| food production in the target country before taking more
| overtly hostile (i.e. military) actions.
| tedunangst wrote:
| Ask for an example. Get an example. "That's not the example
| I wanted." Every time.
| OJFord wrote:
| Because that's the origin story.
|
| Other examples are _all_ commodities markets like mining,
| logging, etc.
|
| Of course public company share futures are inherently
| abstract, but they serve similar purposes, just not to a
| particularly similar party, depending on your perspective
| (of ownership, operation).
| cscurmudgeon wrote:
| > Why is it that every time someone mentions futures
| trading
|
| They didn't just mentioned, they had an outsider negative
| take on it.
|
| The best way is to respond with simple examples.
|
| > What about the crops they destroy because they would be
| less profitable? Does the protection against monetary risk
| outweigh starving people to death? How well will it work if
| we create unsustainable land that the farmers can no longer
| grow crops on?
|
| How does futures trading cause these negatives? If
| anything, trading reduces these risks. Countries with
| markets have large bounties as opposed to those that don't.
|
| It is not a zero sum game.
| rawgabbit wrote:
| The website gives the gold mine example. Farmers and gold
| miners often have to weigh taking on a loan to get them
| through next season. They want a fixed rate of return to
| determine if the loan is worthwhile.
| dmbche wrote:
| Not sure why this person is getting downvoted, these seems
| like fair questions.
|
| Edit: Now get why it is downvoted, but it's fair to note
| that farmers represent a small (10% from what I gather
| here) portion of futures, so I don't know how
| reprensentative they are.
| pwatsonwailes wrote:
| They don't have anything to do with hedging. Good
| questions, just off-topic, which isn't something HN tends
| to like.
| NoboruWataya wrote:
| I don't have a percentage for you but agriculture-related
| futures make up a non-negligible amount of overall trading.
| It's not just some artificial example. Agricultural futures
| were also the _first_ futures, and much of today 's trading
| infrastructure was built around agricultural futures. So
| that's probably part of why it is such a common example.
|
| They are far from the only example. Airlines use futures to
| hedge against fluctuations in fuel prices. Manufacturers
| use futures to hedge against fluctuations in the price of
| input materials. International businesses use FX swaps to
| hedge against currency fluctuations. Borrowers use interest
| rate swaps to hedge against interest rate rises. Investment
| funds (including pension funds and sovereign wealth funds)
| use options to hedge against drastic movements in asset
| prices.
|
| I don't really understand your other questions. The use of
| derivatives in agriculture does not, on balance, result in
| fewer crops being produced. On the contrary, by allowing
| farmers to protect themselves against various risk,
| derivatives markets allow farmers to safely invest more
| money in production, and reduces the risk of farmers going
| bankrupt (bankrupt farmers don't produce many crops). Food
| would almost certainly be more scarce and more expensive if
| farmers did not have access to the financial markets.
| koolba wrote:
| It's not just farmers. It's useful for anything that
| involves future delivery of a good that could have a
| variable price or production.
|
| A mining company would sell gold futures under the
| expectation that they will mine a known quantity of gold.
| They trade the risk of price fluctuations to match against
| their known liabilities (e.g. labor or depreciation of
| equipment costs).
|
| Now replace "gold" with lithium (for electric car
| batteries) and you can create the greenwashed story that
| you want to hear.
| pdntspa wrote:
| Well, pretty much everybody buying commodities at an
| institutional level are using futures contracts to smooth
| over price risk.
|
| Oil, gas, lithium, corn....
| opportune wrote:
| Because that's what futures are for? Consumers and
| producers of commodities want to lock in prices to lower
| the risk of price fluctuations in the future.
|
| >what about the crops they destroy
|
| This has nothing to do with the discussion
| MR4D wrote:
| Because farmers have been using futures contracts (traded
| on an exchange) since 1859.
|
| And technically, futures are a more standardized tool than
| forwards are, hence the talk about futures all the time.
| [1] For reference, forwards have been used forever, and
| used for all sorts of commerce. [2]
|
| We take for granted that you can pull out an iPhone and buy
| your favorite stock in seconds, but for most of history,
| nobody could even imagine that. That the modern world even
| exists is because of forwards and futures. The ancient
| world was able to grow and expand because of forwards.
|
| [0] - https://www.cftc.gov/About/HistoryoftheCFTC/history_p
| recftc....
|
| [1] - https://www.investopedia.com/ask/answers/06/forwardsa
| ndfutur...
|
| [2] - https://www.encyclopedia.com/social-sciences/applied-
| and-soc...
| Quarrel wrote:
| Or since the 18th Century in Japan (and I'm sure other
| places before 1859).
|
| https://en.wikipedia.org/wiki/D%C5%8Djima_Rice_Exchange
| pwatsonwailes wrote:
| Because it's an example you can use to explain a forward
| contract, which is easily understandable as a form of
| hedging risk. Vast amounts of the value of crops are
| hedged, either through forwards, futures or derivatives.
| Crops aren't destroyed because of hedges (in the financial
| sense). Indeed, the whole point is to ensure you don't need
| to, because you've hedged the value of your crop.
|
| I get where you're coming from, and there's a lot which is
| not great in farming, but hedging values isn't one of those
| areas.
| gabereiser wrote:
| >Why is it that every time someone mentions futures trading
| someone comes along to drop the farmer's crops example, do
| y'all really have no other examples?
|
| Because it was created by them, for that very purpose?
| Futures Contracts. Chicago Mercantile Exchange. Up until
| 1971 future contracts were ONLY for agricultural goods.
| Quarrel wrote:
| Metal futures have been traded on the London Metal
| Exchange since 1877, and before that at other venues on
| Threadneedle St.
|
| The Dutch (and after the idea had crossed the Channel,
| the English) were trading debt from the invention of
| exchanges.
|
| The CME might have started with FX futures in 1971, but
| they're hardly the first non-agricultural use.
| astrange wrote:
| Although none of them are for onions, because we were so
| annoyed at two guys cornering the market we banned that
| and then forgot to ever undo it.
|
| https://en.wikipedia.org/wiki/Onion_Futures_Act
| dataflow wrote:
| I get why farmers do it but what's the societal benefit of
| letting a rando like me buy and sell (i.e. make bets on) such
| contracts? Do farmers really prefer that random people do
| this?
| jacobr1 wrote:
| They prefer a liquid market
| anon291 wrote:
| Many 'randos' like you have lots of money and would happily
| buy the contract in the hope that they win out, and would
| be not bummed out completely if they lose, unlike the
| farmer, for whom such events could be existential.
| choeger wrote:
| It creates the market and should thus create the best
| possible price. Think of any speculation as a voting system
| with proof of stake.
|
| Problems always appear when market participants try to
| affect reality to increase their odds, like shorting a
| position and then releasing some ugly news.
| charlieyu1 wrote:
| Provide liquidity. Speculators are trying to make profit,
| but their existence is important to make sure the farmers
| are correctly priced.
|
| Do farmers prefer that? Yes, the larger the futures market,
| the price of selling futures will be closer to optimal. If
| the market is illiquid, farmers often have to sell futures
| at a lower prices to market makers.
| jdaw1 wrote:
| Society allows the people to trade futures, but makes it
| difficult. US brokers seem to make it very easy for
| "randos" to own equities, but difficult to trade futures.
| Recently, when I wanted to trade a one-by-one call spread
| on a commodity future (not saying which) via Interactive
| Brokers, the required initial margin would have been eight
| times my maximum possible loss. Bonkers! Hence trade not
| done.
|
| And what would you rather happen? That you were prohibited?
|
| As others have said, your counterparty won't know who you
| are: hedge fund; commercial hedger; rando -- unknown.
| OJFord wrote:
| In general/basics/origins, farmers only want to sell
| futures, because they actually have (intend to have) the
| commodity for physical delivery, and do want to physically
| deliver it.
|
| So who is on the buy-side? Exclusively
| supermarkets/distributors, while exclusively farmers sell?
| I suppose that could work, but I assume it would quickly
| regress into tight relationships like we have (probably
| regionally variable) for smaller market's, like most
| vegetables (vs grain) where as I understand it it's largely
| a direct relationship with the buyer - you probably still
| sell a future contract, but it's not via a central market
| and it is 'farm x will deliver to buyer y', i.e. a pre-
| order if you will, not really a commodity.
|
| And as others say, price discovery, liquidity. What harm
| does completely open (no obligation) do? And maybe you eat
| a lot of potatoes and want to lock in the price today. (Or
| more seriously maybe you're a big baker, but not big enough
| to be buying direct from farm, your miller is. So grain
| price affects you, but ypu can't directly control/choose
| when to take it. Secondary grain futures allow you to hedge
| risk of it moving against you. In turn this means lower
| prices or lower risk of shock price increase to your
| consumers.)
| jdaw1 wrote:
| Farmer agrees to sell an agricultural commodity to a
| grocer, for a price fixed now, with delivery after the
| harvest. Assume price falls a lot, and then the grocer
| goes bust. Ouch! Then the farmer must instead sell on the
| open market, at the lower price, and so becomes unable to
| make the payments on the mortgage on the tractor. Ouch
| ouch!
|
| The farmer did want the price certainty that allows the
| risk of being more leveraged (tractor mortgage). But the
| farmer was not the optimal person to hold the credit risk
| of the grocer.
|
| And the farmer might have sold without the intent to
| deliver. It might be that the delivery specification, or
| location, or whatever, isn't perfect for the farmer. But
| if the farmer is confident that the prices will move
| together, then it still works.
| HWR_14 wrote:
| Theoretically, the societal benefit of lettings randos buy
| and sell contracts is that there is (a) better price
| discovery and (b) better liquidity. There are probably
| theoretical counterarguments to both of those points, but
| it's hard to see alternative systems that provide either or
| both those features.
|
| At a basic level, obviously thee needs to be someone
| assuming the price risk from the farmers, and those people
| will obviously need to be compensated.
| dataflow wrote:
| I buy that there's some benefit, but I don't buy that
| it's significant. And I don't see any reason why I should
| believe this provides a net benefit to society. Sure it
| saves the original parties some money, but then a bunch
| of unrelated parties come in and siphoning money from the
| existing parties. Why should I believe this is net-
| benefiting society?
| HWR_14 wrote:
| If it "saves the original parties some money" than how is
| it "unrelated parties... siphoning money from the
| existing parties"?
| solumunus wrote:
| But what's the negative to society? You seem really
| bothered about this and it's not clear why.
| lbotos wrote:
| Your viewpoint here is kinda weird?
|
| The more something trades, the more likely we will have
| _the right price_. When things don 't trade as much, we
| don't actually know what that thing is worth.
|
| This concept is a benefit to society as many things are
| interconnected and correlated, so the more accurate we
| can quickly find the current price (and expected future
| price) the more we can evaluate _value_.
|
| (Also, they aren't "siphoning money" really it's "value"
| because the contract isn't actually _money_ )
| dataflow wrote:
| Just because you've improved the accuracy of a price for
| something, that doesn't mean whatever you're doing to
| achieve this is a net benefit to society, right? Surely
| the idea that this logic doesn't follow isn't weird?
|
| Is the idea that society gets a net benefit from price
| distortions like minimum wage, subsidies, taxes, etc.
| also "weird"? These also make it hard to discover the
| "right price" for goods, therefore it's... weird to have
| them?
| lbotos wrote:
| My point about being "weird" was related to this bit:
|
| > but then a bunch of unrelated parties come in and
| siphoning money from the existing parties.
|
| I think you are trying to argue that markets mean that
| the value of a purchased contract changes, and that's
| _only if you want to sell the contract again_. If you buy
| the contract you 'll get delivery of what you bought at
| that price? the market moving only affects you if you
| want to sell again. If I buy a 2009 used dodge charger
| with 100k miles for 10k, and then the next day someone
| sells another 2009 dodge charger with 100k miles for 9k,
| are those unrelated parties siphoning money away from me?
|
| You could go straight to your local wheat farmer and cut
| a deal directly with them, but they are gonna say "what's
| the going rate for wheat" and call some friends and look
| at market data to determine if they want to accept your
| deal or not.
|
| ----
|
| If you believe that futures markets are harming society,
| then what is your proposed solution as to how a buyer and
| seller should agree on a fair price for wheat?
| skybrian wrote:
| It's doubtful that farmers care about you in particular.
| However, in general, the societal benefit should be like a
| loan, like insurance, or both, depending on what it is.
|
| Loans are useful and necessary because businesses need to
| buy things before they get paid. It can't all be done using
| Kickstarter! Farming works this way.
|
| Insurance is useful because you get paid when something bad
| happens to you. On a day when you're glad that you had
| insurance, it means someone else lost a bet.
|
| Buying insurance you don't actually need is kind of dumb
| because you'll lose on average, but people do sometimes win
| in casinos, too. Selling insurance when you can't afford to
| lose is risking disaster, but sometimes people get away
| with that too.
| dataflow wrote:
| I don't follow. If the goal is insurance then why not
| just have... something more like insurance? Like when you
| buy insurance for your car or home? We don't let randos
| buy options on the average Joe's mortgage or car loan and
| claim it helps price discovery or liquidity, right? Or is
| it the case that even I can do that and I'm just out of
| the loop?
| solumunus wrote:
| > I don't follow. If the goal is insurance then why not
| just have... something more like insurance?
|
| Because this is more efficient and useful.
| skybrian wrote:
| I don't know, but one reason might be history. Modern
| insurance companies are pretty recent. Before the 1920's,
| there were mutual-aid societies. Commodities trading is
| ancient.
|
| But they also do different things:
|
| You need insurance companies for one-off risks. Someone
| has to go see the house and say, "yep, it burned down."
| Also, we don't let people bet on other people's houses
| burning down for good reason.
|
| Other risks are more impersonal, like "what if this
| company I bought a bond from goes bankrupt" or "what if
| the price of corn drops in half" or "what if the price of
| oil doubles." There are lots of people and companies who
| might want to hedge against those, not just the owner of
| the property.
| tomatocracy wrote:
| To answer your question directly, there are active
| markets where insurance policies are effectively "traded"
| like this (reinsurance and retrocession and the Lloyds
| market). A single policy with sufficient limits
| absolutely does get syndicated out and bought like this.
| For smaller policies they get bundled up. But they're
| professional markets where participants must be regulated
| because insurance regulation is how we mitigate
| counterparty credit risk on insurance policies.
|
| But "like insurance" I think was meant as a broader term.
| Traditional insurance contracts look a bit like options.
| But forward purchases or sales are also often used as
| "insurance". The big gain is that purely cash settled
| contracts (or contracts where cash settlement is possible
| as a result of sufficient market liquidity existing to
| allow closing a position before physical settlement) can
| be used for risk mitigation in other ways which offer
| much better liquidity and better cost-efficiency in the
| right markets.
|
| A good real world example is oil price hedging. An
| airline might want to mitigate the risk that their future
| cost of jet A-1 goes up. On the other hand, an oil
| producer might want to mitigate the risk that their
| future sale price of a particular blend of their crude
| goes down. Instead of using insurance or entering into
| bilateral forward contracts, both can trade futures or
| options on a standardised crude (which neither of them is
| ever planning to physically deliver or take delivery
| of[0]). _The contract they are trading will not be a
| perfect hedge for either of them, but it will mitigate
| their risk significantly._ In fact if they are both large
| enough, bilaterally the liquidity available to them would
| likely be insufficient to mitigate the same amount of
| risk.
|
| Having a "single", transparent price also brings some
| other benefits beyond simple liquidity. For example, it
| enables several ways to manage counterparty credit risk
| which would otherwise be unavailable (daily margining,
| use of central counterparties or clearing, etc).
|
| [0] although the contract might enable an oil producer to
| make physical delivery of their own blend with a price
| adjustment
| gmd63 wrote:
| There is a societal benefit that comes with individuals
| internalizing their own costs of risk. Treating society like
| it's in an economic womb while Mother Finance shields it from
| the world of worries rewards ignorance and in my opinion
| accelerates us toward the world depicted in Idiocracy.
|
| It is nice as a purchaser of such securities that you can
| build things more quickly than usual and transfer worry to
| someone who is willing to be worried for you. However I don't
| believe the SEC financial highway patrol has enough cruisers
| or sophistication to pull over enough abusers to deter the
| disproportionate fraud that increasingly arcane financial
| instruments create.
|
| The costs of a few bad actors building piles of money
| illegitimately do not show themselves immediately. They pop
| up slowly, in dark money investments in destabilizing
| elections, funding of war criminals, market manipulation,
| etc. The societal cost of a charlatan having several
| lifetimes worth of an honest person's influence are grave and
| not to be laughed off.
| yesbut wrote:
| > accelerates us toward the world depicted in Idiocracy.
|
| We're already there, brother.
| mo_42 wrote:
| > Where is the productive output of all these arbitrage shell
| games? How is this more than an abysmal waste of time and
| resources simply to make a small handful of bankers richer?
|
| If shares of companies are valued at fair prices it means that
| the finance departments for that companies can raise more
| capital. So companies that bring value to society should be
| able to expand their business.
|
| At the same time, regular people can invest in such companies
| at somewhat fair prices without doing much analysis. Basically,
| because the profits above the market average have been taken by
| smarter investors already. But it's still good to always be
| able to put money somewhere and receive avg. market returns.
| HWR_14 wrote:
| > If shares of companies are valued at fair prices it means
| that the finance departments for that companies can raise
| more capital.
|
| This only true of companies that were underpriced. Overpriced
| companies, either because of hype (Pets.com), fraud (Enron)
| or other reasons (maybe Jim Cramer issued a buy) do not
| benefit from a fairer price.
| mo_42 wrote:
| I guess this could go in both directions. There are also
| underpriced companies.
|
| I know that some people knew that something was wrong with
| Wirecard and they short sold the stock.
| chii wrote:
| >> companies can raise more capital. > This only true of
| companies that were underpriced.
|
| You mean over-priced?
|
| because if a company is underpriced, they cannot raise
| capital as easily, since each share they raise would be
| underpriced, and thus the existing shareholders actually
| _lose_ value.
|
| An overpriced company is one where raising capital (via
| equity offering) is worth doing. If a company was under-
| priced, it would actually make more sense to do buybacks
| instead.
| HWR_14 wrote:
| I agree with your point, but you misread my statement. We
| were talking about whether a company would have an easier
| time raising money _once they were correctly priced_.
|
| For the reasons you listed, it was hard for the
| underpriced company to raise capital and too easy for the
| overpriced company. But those distortions go away once it
| is fairly priced.
| H8crilA wrote:
| Yeah, exactly. There is absolutely no way you could have ETFs
| if the "quick games" were forbidden. Not only because it's
| the HFTs that essentially run the fund on a day to day basis
| (see Authorized Participant for details).
|
| One famous example with a completely extinguished price
| discovery is the Soviet Union. I think this is what killed it
| more than any internal or international political problems.
| pavlov wrote:
| Sibling comments have provided good explanations of why modern
| economies need finance: risk management, capital allocation,
| enabling ventures, and so forth.
|
| At the same time, it's worth asking the question of why the
| financial sector just keeps growing and whether that's
| desirable. Shouldn't improved efficiency with digital systems
| make this intermediation layer thinner, less labor-intensive,
| more competitive? Instead it seems to be capturing an ever
| larger share of the economy's output to itself.
|
| In my opinion regulators should try deploying some blunt tools
| like transaction taxes and hard salary caps, and see if we'd be
| any worse off with a smaller and poorer financial sector.
| [deleted]
| rocho wrote:
| Futures and options were born from commercial needs.
|
| Suppose you produce oranges. It'll take a few months for the
| harvest, and while costs are generally well understood and
| stable, at what price will you sell those oranges? What if by
| then the price of oranges tanks and you find out you're not
| turning a profit? This is where futures come in. The producer
| can sell a number of futures contract to lock in a future
| selling price, making cash flows much clearer and predictable.
|
| Conversely, there's the case of a factory that needs to buy
| oranges for its products. They have the opposite problem and
| would like to make costs more predictable. Then they'd buy
| futures to lock in a future buying price.
| alphanullmeric wrote:
| Sounds like you worry too much about what other people do with
| their own time and money.
| scubbo wrote:
| When it results in a concentration of wealth in the hands of
| people who can abuse it for political ends, or results in
| market crashes that cause knock-on impact to real humans -
| then yes, worrying about it is reasonable and justified.
| alphanullmeric wrote:
| Feel free to not trade in this market then. "Mom they won't
| share" is also not a particularly convincing way to justify
| the right to other people's money.
| diordiderot wrote:
| Why is it their money? Your're starting at the wrong
| point in time friend.
|
| You need mommy just as much.
|
| E.g. Chad Ungabunga sees alphanumeric living on fertile
| soil with an attractive woman so he's going to bonk him
| over the head with a club and take his stuff because he's
| bigger and stronger.
| alphanullmeric wrote:
| It's their money if you follow the "force is only
| justified in response to force" principle. They didn't
| obtain their money by force, so you can't take it by
| force from them.
|
| I believe that principle should be enforced by the
| government, that's the only thing I need mommy for. Given
| that you also believe in police, military and courts, on
| top of a bunch of other shit (like stopping consenting
| individuals from trading their own money), no I don't
| need mommy "just as much".
| refurb wrote:
| The value add is offering financial products that consumers
| want.
|
| Businesses and people need to loan or borrow money, offering a
| wide variety of products that suit different needs supports
| economic growth.
|
| A good example of this are all the foreign companies that
| decide to go public on the NASDAQ. They aren't doing it in
| their home country because of a weak (or non-existant) equities
| market, or burdensome regulation.
| jdaw1 wrote:
| I'm the author. Thank you for saying it is an excellent read --
| that was no small amount of work.
|
| You ask "Where is the productive output of all these arbitrage
| shell games?", which is a very fair question. The purpose of
| financial markets, sometimes but not always wholly achieved, is
| to transfer risks to those best able to hold them. E.g., you
| are not the optimal person to hold the risk that, through no
| fault of your own, your house burns down. That risk exists, and
| you are not the optimal holder of it. Hence insurance. A
| Lincolnshire farmer -- and yes, I like the non-abstract solidly
| of the example -- is not the optimal holder of the 'risk' that
| the Australian and Kansas wheat harvests are super-bountiful.
| Markets allow that risk to be transferred to a non-farmer
| better able to hold the risk.
|
| Of course, with markets come some 'unproductive' stuff.
| Likewise, democracy is good, but that is not necessarily
| praising the optimality of all parts of campaign finance
| legislation.
|
| Let me also mention that I am the author of the definitive
| reference book on old Vintage Port: Port Vintages (and
| seemingly the board disallows a link).
| nostrademons wrote:
| Note also that in some cases you _might_ be the optimal
| person to hold the risk that your house burns down, if, for
| example, your liquid net worth is 100x the replacement cost
| of your home. And that 's illustrative of the value of
| markets: you can _choose_ to transact in them, depending on
| your personal circumstances. The insurance market exists
| because for the vast majority of people, rebuilding their
| home is not feasible with their current net worth. But for a
| small number of people it might be, and for a small number of
| firms it 's probably worth it to insure many thousands of
| people, and then you can even slice up the shares of those
| insurance firms and sell them on the stock market so that the
| risk of your house burning down gets socialized across all
| the other shareholders but at the same time you have a stake
| in the profits.
| nullindividual wrote:
| It's not a choice to be part of the insurance market for
| the vast majority of American homeowners. What you describe
| is choice in name only.
| rfrey wrote:
| Your parent literally said if, for
| example, your liquid net worth is 100x the replacement
| cost of your home.
|
| and for the vast majority of people,
| rebuilding their home is not feasible with their
| current net worth.
| ezconnect wrote:
| He's saying you are required by law to buy insurance for
| your house because of government regulation. There's no
| way of saying no.
| borski wrote:
| Please point me to this law. Unless you are in a
| mortgage, no law requires you to hold homeowner's
| insurance, and you can absolutely self-insure, to my
| knowledge.
|
| The same is not true for auto insurance in most states,
| though most also have an option to self-insure by putting
| up collateral.
| h2odragon wrote:
| There may not be a law explicitly stating you have to
| have homeowner's insurance. But.
|
| Without such insurance, specifically the "injury
| liability type" with its limits; then if someone gets
| injured on your property there may _be_ no limit to your
| liability.
|
| So even people who could afford the loss buy insurance
| because it is the best method of limiting intangible
| risks.
| borski wrote:
| People who can afford the loss buy insurance because it
| is simpler peace of mind to do so, not because it is the
| law.
| robocat wrote:
| > there may be no limit to your liability.
|
| You can put the house into a limited liability company,
| which theory should limit the liability to the value of
| the house.
|
| Depending on whether director negligence was involved
| etcetera.
| MechanicalTim wrote:
| My understanding is that for an LLC to provide protection
| the house would have to be used for purely business
| purposes and that there can be no co-mingling of personal
| finances. the concept is called "piercing the corporate
| veil". IANAL but I looked into this pretty extensively
| when choosing how to protect myself with investment
| properties.
| im3w1l wrote:
| Rebuilding a shitty house is quite possible for a person.
| Like people can literally build simple shelters in a time
| frame of hours. It's only because of so many regulations
| and rules that you have to go into multi-decade debt.
|
| For instance, apparently the EU is currently considering a
| regulation that houses must be energy efficient. Getting a
| current house into compliance would cost on average $50k.
| That kinda stuff adds up.
| Folcon wrote:
| Do you mean this[0] when you wanted to link to `the
| definitive reference book on old Vintage Port: Port
| Vintages`?
|
| Also, welcome!
|
| - [0]: https://www.portvintages.com/
| hbarka wrote:
| I would love to hear your opinion on Silicon Valley Bank and
| First Republic Bank. Did they deserve their fate on equal
| terms and also in retrospect who should have been the optimal
| holder of their risks?
| chii wrote:
| > who should have been the optimal holder of their risks?
|
| they _produced_ more risk (by holding long maturity bonds
| that lose value as interest rate grows). This risk was not
| something that is inherent - they could've chosen not to do
| that with the large deposits from the pandemic money
| growth.
|
| There's noone who can be the optimal holder of the risk
| that is produced this way, because there's no value on the
| other end - SVB is taking the full value already (the
| interest payments on said long bonds).
|
| If someone were to hold that risk, SVB would have to pay
| out premiums that would surpass the interest income they
| receive.
|
| The alternative is for society (aka, the central bank) to
| hold that risk. But this just means socializing the losses
| but privatizing the gains - something i'm very much
| against.
|
| In the end, SVB was the optimal holder of the risk (that
| they produced for themselves). And they can't actually hold
| that risk - thus their failure.
| hbarka wrote:
| What about First Republic Bank?
| chii wrote:
| I know less about FRB's failure. It was likely due to a
| domino effect from SVB's - specifically, FRB has a high
| uninsured ratio of deposits (they service rich people).
|
| The FDIC has announced that they will not do a repeat of
| what they did for SVB - insure the full deposit amount
| rather than just the $250k. Therefore, anyone with a
| large deposit in a small bank is going to want to move
| their money out into a "too big to fail" bank.
|
| Unfortunately for FRB, this is what happened to them. No
| bank can survive a real run, no matter how carefully
| balanced they are with risk (after all, they _do_ take on
| some risks in order to make a profit).
|
| In my opinion, the FDIC's announcement of what they will
| not do (insure the full deposit, even if above the $250k
| limit) after doing it for SVB, while have good
| intentions, is what backfired.
|
| They should've just lied, and said that they'd do it for
| another bank, if there's a need to; this would've stopped
| any fear of a run, and thus stop the run before any more
| dominos collapse.
| flagrant_taco wrote:
| > They should've just lied, and said that they'd do it
| for another bank, if there's a need to; this would've
| stopped any fear of a run, and thus stop the run before
| any more dominos collapse.
|
| While this _may_ have prevented FRB, that 's a very
| dangerous game to play should the bluff get called.
|
| I'm strongly opposed to the idea that those given the
| power and authority to control or markets, as best they
| can, should world that power by lying to us. Lying
| because they think it's the best thing for us or because
| they don't think we can handle the truth is a slap in the
| face to the very trust that empowered them to begin with.
| Our leaders do this often and it's such a slippery slope
| - it either works and you feel emboldened to lie again or
| it backfires and we're all worse off.
| chii wrote:
| The thing is, this white lie is what keeps confidence
| levels high, which is what prevents the run.
|
| By merely suggesting that a bank can fail, and that the
| FDIC is not going to bail out high depositors, they
| paradoxically _cause_ the run. After all, the people who
| took the money out just merely redeposited it back
| elsewhere (that they trusted more).
|
| The white lie is better than a loss of trust which lead
| to an actual problem. And the FDIC could actually lie
| without lying by putting in vague words and misdirect
| people - such as saying things like "if necessary". In
| fact, people in society today believe plenty of white
| lies already - what's one more?
| flagrant_taco wrote:
| While I totally agree that is how the system is designed,
| that's also the fundamental issue I have with it.
|
| If we have such a fragile banking system that those in
| charge are expected to lie to us to keep people from
| seeing the fragility, we have to rethink the system.
|
| > In fact, people in society today believe plenty of
| white lies already - what's one more?
|
| That feels like a bit of a slippery slope, selling people
| on one lie shouldn't justify telling another. It also
| means first defining what a white lie is, and who gets to
| know the truth to decide whether it's acceptable or not.
| jeron wrote:
| I like how this guy has written two books on completely
| different subjects - Money and Wine
| borski wrote:
| One could easily make the argument these are actually
| extremely closely linked.
| rytill wrote:
| As someone with little knowledge of wine, how are wine
| and money closely linked?
| chishaku wrote:
| Money and wine are closely related.
| kqr wrote:
| > A Lincolnshire farmer -- and yes, I like the non-abstract
| solidly of the example -- is not the optimal holder of the
| 'risk' that the Australian and Kansas wheat harvests are
| super-bountiful. Markets allow that risk to be transferred to
| a non-farmer better able to hold the risk.
|
| Are you familiar with the arguments of (more popularly) Aaron
| Brown and (transitively) Jeffrey Williams?
|
| Essentially, the idea that a farmer would be an active
| participant in a futures market is quaint, but the vast
| majority of activity is speculation. This is not a
| contradiction of your point, but an elaboration of a counter-
| intuitive part of it.
|
| One might look at a futures market and see that well over 98
| % of the activity is buying and selling by people who never
| have any reason to care about wheat other than for the
| possibility of its price going up or down. But this large-
| scale speculation is precisely the thing that makes it
| possible for a farmer to hedge (by providing liquidity and a
| motive for the counterpart of the hedge) or, as Williams'
| points out, perhaps more commonly "take out loans in
| commodities" for their convenience yield.
|
| Essentially, the Lincolnshire farmer can lock in a price with
| a plain forward contract. However, that does take a double
| coincidence of demands (or whatever the phrase is) and the
| standardised nature of futures contracts help avoid that
| problem.
|
| But! The most common use of futures contracts (aside from
| speculation) is not (or at least was not, when Williams wrote
| his book) hedging, but effectively borrowing and lending in
| commodities.
| lxgr wrote:
| > the vast majority of activity is speculation
|
| Where do you draw the line between (useful) arbitrage and
| "pure speculation"?
|
| Much of what is commonly known as speculation is actually
| an important mechanism for price quality or liquidity.
|
| Obviously there are limits, and there are ample
| opportunities for making a one-sided profit without
| regulations, but people often seem to miss the value that
| arbitrageurs tangibly provide to them: Being able to
| exchange foreign currency at very tight spreads almost
| 24/7; being able to buy and sell even not commonly traded
| stocks etc. are often a function of that.
| kqr wrote:
| I think you and I are saying the same thing! What's
| counter-intuitive about many well-functioning markets is
| that the vast majority of what happens is superfluous in
| one sense, but its side effects are desirable by most!
| [deleted]
| RyEgswuCsn wrote:
| Except that is not exactly "productive", isn't it? After all,
| risk was not eliminated, only redistributed. Productive
| output, e.g., would be something that reduces the chance of
| your house catching fire.
| burntwater wrote:
| Risk, for many things, will never be eliminated. They can
| only be reduced and/or redistributed.
|
| For example, having fire sprinklers greatly reduces the
| risks from fire. However even the reduced risks are still
| too great for your typical homeowner, so therefore those
| risks are distributed (and the reduced risks are reflected
| in lower premiums for the homeowner).
| ummonk wrote:
| People can be more productive by engaging in ventures they
| would otherwise not have due to prohibitive risk.
|
| (Likewise with credit allowing people to finance ventures
| that they would otherwise be unable to)
| FabHK wrote:
| Sure, but without insurance, everyone would have to have
| enough cash available to build a second home in case the
| first burns down (ie, provision for the worst case loss).
| With insurance, just need to have extra cash corresponding
| to the expected loss (ie, worst case loss times probability
| it happens) plus some cost for administering the insurance.
|
| So, effectively [1], with insurance everyone can build a
| house nearly twice as big as without. That strikes me as
| productive.
|
| [1] if the probability of a fire is sufficiently small
| photonbucket wrote:
| People would just live with the risk, if their house
| burns down they're just homeless
| vineyardmike wrote:
| How terribly _unproductive_
| nimithryn wrote:
| The redistribution _is_ productive, because by
| redistributing risk (not just among people, but also across
| time), some ventures that were otherwise not feasible
| become feasible. For example, you want to build a house -
| but you don't have the cash. A bank gives you a loan. They
| take the risk that you won't pay them back, you get a
| house, and return they get a premium. This benefits many
| stakeholders (you, the bank, the builders, etc). If the
| bank has too much risk, they can off board it to someone
| with deeper pockets and a more diversified portfolio.
| fsckboy wrote:
| > _If the bank has too much risk, they can off board it
| to someone with deeper pockets and a more diversified
| portfolio_
|
| ... or especially to somebody who happens to bear the
| reverse risk.
|
| For example, a wheat farmer doesn't want the risk that
| wheat prices might collapse by harvest time due to
| windfall harvests somewhere else in the world; and the
| spaghetti maker doesn't want the risk that wheat prices
| might be soaring due to crop failures somewhere else-
| else. They make a deal now so they don't need to worry
| about the future, but they don't need to make the deal
| directly, they can each buy or sell wheat futures.
| RyEgswuCsn wrote:
| I am not saying that the redistribution of risk is not
| useful ---- it certainly is, and I agree with what you
| said. But let us suppose we would like to reverse climate
| change at a global scale in a short time without further
| damaging the environment, right now; I don't see how it
| would be possible with our current technologies, even if
| every possible risk redistribution options are exhausted.
| alex_smart wrote:
| This is exactly the why and how of "travel broadens the
| mind". You only have to visit countries and socities that
| do not have well-developed financial markets to directly
| see and appreciate the value financial markets bring to
| your own society.
|
| Visit a part of the world where most people do not have
| access to home loans, health insurance etc. and you will
| not have to ask how mere redistribution of risk and capital
| adds to productivity ever again. (I happen to have been
| born one such part of the world.)
| boppo1 wrote:
| > (I happen to have been born one such part of the
| world.)
|
| Care to elaborate for those of us who never made it out
| of middle-america?
| chii wrote:
| > socities that do not have well-developed financial
| markets to directly see and appreciate the value
| financial markets
|
| Which is true, but there's another angle that needs
| discussing - that of a high-trust society vs low-trust
| society.
|
| In all places where there are well functioning financial
| markets, there exists a high trust society. This trust is
| the foundation on which the financial markets exist.
|
| So in poorer countries where such financial markets don't
| exist (or don't serve the people), it's not because
| they've chose not to have it, but that individual actors
| cannot trust that the system is fair and is rules based.
| So the problem isn't the lack of financial markets (which
| is a symptom), but that of a lack of good governance (bad
| or non-existant laws, corruption etc).
| alex_smart wrote:
| Rural India (unlike urban India) is relatively high trust
| environment. Everybody knows each other and there are
| lots of shared ethical values. But they still have to
| build their houses one brick wall at a time (lack of
| access to home loans) and be at the risk of financial
| ruin due to unpredictable life events (lack of access to
| insurance).
|
| Urban India is a very low trust environment, but people
| still have access to things like home loans, insurance
| and capital markets (equity and loans).
|
| > lack of good governance (bad or non-existant laws,
| corruption etc)
|
| I agree that good governance is a necessity for
| development of financial markets, but not sure what it
| has to do with being a high trust or low trust society.
| usefulcat wrote:
| Maybe 'productive' is mot the best word on which to focus.
| Insurance doesn't eliminate risk but it can still be very
| useful.
| rfrey wrote:
| Many businesses would behave much more conservatively --
| making much smaller bets, conserving cash instead of
| investing it -- if they could not offload certain risks. So
| that ability does increase overall productivity IMO.
| User23 wrote:
| It is an interesting reframe to think of insurance as a,
| roughly, ATM put.
|
| Having some experience with both trading derivatives and
| gambling though, I'm fairly confident saying that it's a
| distinction without a difference. In both cases a little guy
| with an understanding of risk and bankroll management and
| some aptitude for the game, which for trading is a Keynesian
| beauty pageant, can scrape up a few bucks. But most people
| are going to be fish for the house. The derivative markets
| are providing exactly the same service as casinos, albeit
| with considerably higher limits and opportunities for
| crafting complex bets.
| FabHK wrote:
| Some derivatives can be fairly consistently good bets,
| because you can take real-world probabilities, while your
| counterparty (the bank) deals with "risk-neutral"
| probabilities implied by their hedging, which can differ
| quite substantially and persistently from the real-world
| probabilities.
| fsckboy wrote:
| casinos are based on pure chance which nobody cares about
| (what does it matter to the outside world if a coin came up
| head or tails?) and the house still takes a cut.
|
| financial markets are based on stochastic events which do
| matter very much, such that paying a broker is worth it. If
| it's not worth it to somebody, they should not participate,
| but in that sense they shouldn't participate in casinos
| either.
| bombcar wrote:
| The derivatives market is like if they let you buy
| insurance on anyone without ah insurable risk.
|
| So I could decide that I think _your_ house is likely to
| burn down, so I buy insurance on it.
|
| That's what enables the gambling. If the only people who
| could buy puts or calls were people who had insurable risks
| in the underlying; it would be a lot smaller market and
| less gambling.
| chii wrote:
| > So I could decide that I think your house is likely to
| burn down, so I buy insurance on it.
|
| which makes the insurance premium grow higher, reflecting
| the information that such a house has a high risk of
| burning down.
|
| It doesn't matter that the buyer of the insurance has no
| material connection to the house. I can't see why such
| "gambling" shouldn't be allowed to happen, provided that
| there's enough regulation and monitoring so that you
| cannot then go and burn down someone's house to collect
| the insurance!
| perpocet wrote:
| Regulating participants to only those who have a purpose
| and meaningful reasons, would mean higher bid-ask
| spreads, less liquidity and less turnover, which then
| means those markets would probably cease to exist.
| Gamblers in these special markets are a net-positive,
| non-gamblers are happy to give some gamblers a payday or
| some drink money, since it allows non-gamblers to focus
| on their main activity, instead of doing their activity
| and gamble that everything turns out fine.
| bombcar wrote:
| Of course they're happy to have the gamblers! Almost by
| definition the gamblers are _subsidizing_ their risk
| management strategies!
| dnadler wrote:
| Good point. The flip side is that allowing anyone to
| transact in options makes the pricing far more efficient.
| boppo1 wrote:
| The book is from 2001; are there any substantial changes in
| the landscape a motivated finance student should be aware of?
| beefield wrote:
| As a beginner book, no there are no substantial changes on
| what a beginner should read.
|
| However, while the simple discounting formulas described
| (likely, haven't read other than the list of contents) in
| the book were at the time actually used more or less as-is
| to value instruments in the derivative markets, nowadays
| they are seldomly used on their own. Two major developments
| there are multi curve discounting taking collateralization
| into account and different valuation adjustments,
| collectively known as XVAs.
|
| That is not to say you do not need to understand the
| beginner basics, vice versa, iys just that nowadays there
| is much more nuance in actual valuation.
|
| Edit: to add, I'm not sure if its useful to study these
| nuances in detail, unless you are going to actually work on
| the markets. In the big picture their details are likely
| not worth it, but of course it is good to try to understand
| why these developments have been needed/wanted by market
| participants.
| jdaw1 wrote:
| There's a free HTML version on my website, which has some
| green-boxed updates. But even without those, the book is an
| excellent beginner's guide to the interest rate markets. (I
| am the author, so might be thought not to have a NPoV.)
| k__ wrote:
| Thanks for the book.
|
| I started with blockchain development, but noticed a huge gap
| in knowledge when it came to economics.
|
| Hopefully, this book can give me some insights on tokens that
| resemble "money".
| dmurray wrote:
| I think you did a great job of explaining why someone might
| want each of these products, starting from first principles
| of "a company borrows some money from its bank". To still ask
| GP's question is either to not have understood the book, or
| to not understand any scenario where one might want to lend
| or borrow money.
| FabHK wrote:
| > The purpose of financial markets, sometimes but not always
| wholly achieved, is to transfer risks to those best able to
| hold them.
|
| That is just one of the purposes; others are:
|
| - time-shifting of consumption: borrow when you study or
| build a house, then invest and save during work years, then
| live of retirement portfolio
|
| - maturity transformation enabling investment: extra cash
| goes in the bank (and can be redeemed on demand), is bundled
| and lent (long-term) to fund construction or businesses [1]
|
| - allocative function: send capital to its most productive
| use. For that, you need accurate prices, supported by equity
| research and markets.
|
| So, in real financial markets, all the arbitrage games etc.
| [2] at least support actual productive purposes.
|
| In crypto, it's just a pure cargo cult copy of financial
| markets without any underlying productive purpose.
|
| [1] that whole banking business is somewhat precarious, but
| reasonably well understood (since Bagehot) and
| regulated/insured, though in recent times obviously hasn't
| worked great. Alternative models (narrow banks + private
| credit) are conceivable.
|
| [2] and to be clear: the amount finance skims of the economy
| is way too large. Similarly, building a somewhat straighter
| fibre (and then microwave towers) from Chicago to NY has no
| societal benefit I can discern. (But the solution to that is
| fintech and regulation, not crypto.)
| agentgumshoe wrote:
| > So, in real financial markets, all the arbitrage games
| etc. [2] at least support actual productive purposes.
|
| So without all those games, what would be substantially
| different?
| lxgr wrote:
| You'd probably see much larger spreads and lower
| liquidity when buying and selling stocks or
| commodities/currencies; you'd often overpay on insurance
| etc.
|
| (All assuming a properly working market without
| collusion, illegal usage of non-public information etc. -
| which is unfortunately not always the case.)
| MrMan wrote:
| [dead]
| pembrook wrote:
| By referring to arbitrage as "games" OP's comment has
| poisoned the well for this entire chain of responses. So
| to get an understanding, first we need to fix.
|
| A "game" implies non-productive or zero sum.
|
| By definition, an arbitrage is not that. Any arbitrage is
| the result of an inefficiency in prices or the economy.
|
| When someone arbitrages prices back to where they should
| be, they are performing a service that everyone else
| benefits from, and are rightly compensated for this. Now,
| are finance people compensated too much for correcting
| price discrepancies? If yes, then that's another
| arbitrage opportunity!
|
| But the question of what would be substantially different
| is easy. No arbitrage = no markets = top-down command
| economy. Check out North Korea, Cuba, USSR, the former
| Yugoslavia, etc. for what would be different.
| vinay_ys wrote:
| Most of the pricing inefficiency comes from information
| asymmetry. It might have made sense a 100 years ago when
| information traveled slowly. But in today's world, it
| travels fast. But still there is asymmetry due to
| purposeful obfuscation and complex packaging.
| less_less wrote:
| > When someone arbitrages prices back to where they
| should be, they are performing a service that everyone
| else benefits from, and are rightly compensated for this.
| Now, are finance people compensated too much for
| correcting price discrepancies? If yes, then that's
| another arbitrage opportunity!
|
| While I agree that finance serves a useful purpose, I
| don't understand this bit. Suppose hypothetically that
| arbitrage gives some social utility, but not in
| proportion to the amount of money it makes for
| arbitrageurs, and thus not in proportion to the effort
| put into it. Suppose that society is overproducing
| finance -- that most people would be better off if the
| world had slightly worse pricing information, fewer
| financial datacenters and low-latency microwave links,
| less human effort devoted to banking, and more of
| something else that could be built with those resources
| and that effort.
|
| Maybe this creates another arbitrage opportunity -- maybe
| in an idealized free market (where there are no barriers
| to entry) more people would work in finance, and their
| competition would reduce profits. But it seems to me that
| this would only worsen the overproduction problem.
|
| Or is there something I'm missing here? Why isn't this
| really an "opportunity" to (carefully) increase taxes on
| finance, so that it won't be overproduced by as much?
| nsvd wrote:
| I don't think it's the case that finance is over
| produced. If it were, then the value of financial
| services would drop.
|
| Rather, because the gain produced by financial
| instruments is proportional to the wealth someone has,
| the returns of finance disproportionately benefit those
| with large amounts of wealth. One man can only make so
| much plumbing or being a mechanic, but can make an
| arbitrary about by investing in ETFs.
|
| In other words, if the financial sector was largely a
| collection of small businesses run by middle class
| people, no one would think it was a problem that they
| make money. That would be great! But in reality it's a
| smaller amount of companies and smaller amount of wealthy
| people that benefit from it.
|
| That problem isn't unique to finance, it affects many
| parts of our society.
| berniedurfee wrote:
| I think regulatory capture needs to be considered as
| well.
|
| At some point those that amass large amounts of wealth
| are disproportionately able to influence government
| regulation to 'game' the system itself in their favor.
|
| It seems in the realm of finance, it's much easier to
| obscure regulatory capture than in other domains, where
| anti-competitive practices are much easier to suss out.
| less_less wrote:
| > I don't think it's the case that finance is over
| produced. If it were, then the value of financial
| services would drop.
|
| I don't think this follows for all financial services.
| Overproduction leads to a drop in value if the market is
| efficient, but real-life markets are not perfectly
| efficient. For arbitrage in particular, the whole point
| is that the market isn't efficient. Arbitrage makes it
| more efficient after the arbitrageurs have taken their
| cut, but the value of that service isn't necessarily
| determined efficiently. (At least as far as I know: I'm
| not an expert.)
|
| > Rather, because the gain produced by financial
| instruments is proportional to the wealth someone has,
| the returns of finance disproportionately benefit those
| with large amounts of wealth. One man can only make so
| much plumbing or being a mechanic, but can make an
| arbitrary about by investing in ETFs.
|
| > In other words, if the financial sector was largely a
| collection of small businesses run by middle class
| people, no one would think it was a problem that they
| make money. That would be great! But in reality it's a
| smaller amount of companies and smaller amount of wealthy
| people that benefit from it.
|
| > That problem isn't unique to finance, it affects many
| parts of our society.
|
| ... but I do almost entirely agree with this.
| wavemode wrote:
| It's much simpler than that. The utility provided by
| arbitrage is that a given security is no longer under- or
| over-priced in one market relative to other markets. Any
| buyer/seller of that security will then always be
| buying/selling for the best available price (rather than
| losing out on money by not buying/selling in a different
| market).
|
| The price discrepancy which was corrected by arbitrage
| is, itself, the compensation the arbitrageur receives. If
| it weren't, that inherently also means that there still
| exists a price discrepancy, and thus an arbitrage
| opportunity.
|
| This is all separate from the question of public policy.
| Should taxes on income from arbitrage be increased?
| Perhaps they should. Though that doesn't affect the
| mechanics of how arbitrage works, it simply decreases the
| net profit of the firm doing the arbitrage.
|
| Conceivably, you could increase the
| taxes/regulations/restrictions on such firms to such a
| degree that they are either no longer allowed to perform
| arbitrage at all and/or can no longer justify the cost of
| the high-speed equipment involved. The end result of this
| would be that the markets become less efficient (there
| would be greater price discrepancies and they would arise
| more frequently).
|
| How much does that matter? Well, that's more of a
| philosophical question. How much does it matter to you
| that you're buying something for the best possible price
| (versus knowing it might be available cheaper elsewhere)?
| Depends on the person.
| norswap wrote:
| I understood it as it's an arbitrage because it enables
| the creation of a new system that reward arbitrageurs
| less (but still enough that they would perform the
| arbitrage).
|
| Though this is only true in a system where you don't face
| tons of hurdles to deploy these new systems, which is not
| the case in the current financial system.
| norswap wrote:
| I was nodding my head along (fantastic answer) until the
| stab at crypto.
|
| Let me offer a (partial) defense of crypto if I can:
|
| Broadly, crypto is divided into crypto-currencies and
| applications.
|
| Let's tackled currencies first, some of which some are
| reputable and some of which are grifts, but which viewed in
| their most favorable light attempt to be a form of currency
| or asset that is decentralized. This means that no single
| party may unilateraly devalue them, or restrict their trade
| in any way.
|
| (No I understand if that doesn't excite a lot of people,
| but this is clearly valued by some people!)
|
| As may be obvious, crypto-currencies are too volatile to
| serve as actual "currencies", so they are at best "assets".
| But it is possible to use these assets as collateral for
| the minting of stablecoins. I'm not sure this is quite risk
| transfer, but it essentially relies on the willingness of
| some to hold speculative assets to enable the creation of a
| stable assets.
|
| In turn, these assets are not typically useless -- they
| hold value because there is demand for them to pay for
| transaction costs on blockchain.
|
| Blockchains themselves are not useless. We may not think
| much of the difficulties of transferring money, but it is a
| real challenge in LARGE swaths of the world, where people
| are unbanked or live under tyrannical governments. I would
| argue that even in the west, the need becomes is becoming
| more pressing (Trudeau freezing trucker supporter bank
| accounts, banks imposing tons of restriction on cash
| withdrawals and "large" bank transfers).
|
| Beyond transfer, they also serve to run decentralized
| applications. People are quick to dismiss those, and true
| it doesn't enable to do anything dazzingly new. It simply
| enables you to do things you could already do, but in a way
| where no single party (or even colluding parties) can shut
| it down. This may seem silly, but I think the world would
| truly be better if we for instance had a YouTube where
| copyright trolls couldn't strike down / demonetize legimate
| content.
|
| Applications then. In reality, we're still far from
| decentralized YouTube (but we will get there). Most
| applications today are financial. And I think they're quite
| useful. The financial infrastructure being built is
| genuinely novel and useful.
|
| The problem is that it is navel-gazing at the moment: that
| infrastructure is mostly used to perform financial
| operations on crypto tokens themselves. But there is no
| reason that they couldn't be used for other assets.
|
| In fact this is starting to happen: you can now invest in
| real estate and US treasuries on the blockchain. We're
| still a way from mainstream adoption, and that has mostly
| to do with legal uncertainties that prevents established
| players from diving in (though many of them are
| experimenting). There are also entrenched interests there,
| it must be said.
|
| So if anything else, crypto helps build a better financial
| infrastructure.
|
| It's somewhat ridiculous that when you buy some stock, the
| trade is routed through three intermediaries and is only
| really settled 7 days later. The abstraction on top of this
| is actually leaky, with each intermediary coming with some
| risk and some agency to throw a wrench in the works. As in
| fact happened between Robinhood and its clearinghouse (or
| some such intermediary) during the GameStop frenzy.
| pcdoodle wrote:
| Another useful aspect:
|
| Heat pumps will take a long time to reach every
| application that needs heating. EG: drying grain.
| Sometime heat pumps are not the answer (-21F for
| instance). Bitcoins resistive heating properties are
| almost 100% efficient.
|
| With bitcoin mining: Money In = Heat + Air Flow = Money
| Out.
|
| Electrical energy now has an opportunity to not be
| waisted where it normally would be. Think renewables
| where line loss / demand doesn't make a perfect system.
| Bitcoin can act as a storage device with near free
| movement allowing flexibility in these systems.
|
| This monetary recovery can also be used to move
| money/energy to other places without the line loss.
| rprospero wrote:
| It's that last step I've never understood. I get that
| some guy in Iceland has excess power generation and can
| use that to mine bitcoin. I can then buy those bitcoins
| from him. However, I've never heard an explanation for
| how I then recover the energy from the bitcoin?
|
| The closest I've heard is that I could use the bitcoins
| to buy electricity from someone else, but I could have
| just paid that guy in the first first place and cut out
| the guy in Iceland. Also, it feels like we now have two
| power plants involved in charging my laptop, which feels
| like a lot of overhead.
|
| I've heard this explanation enough that there must be
| something obvious that I'm missing.
| pcdoodle wrote:
| You could take the bitcoin from excess hydro generation
| in a northern climate and deploy solar panels in a
| climate where solar has great ROI for instance.
| MrPatan wrote:
| > But the solution to that is fintech and regulation, not
| crypto
|
| Why? Now we have a trustless, decentralized, tech solution,
| why do you still want the "guys with guns" solution?
| croes wrote:
| There is no such thing as trustless
| MrPatan wrote:
| Where's the trust in a bitcoin tx?
| croes wrote:
| That Bitcoins still have a value when you sell them
| MrPatan wrote:
| 1 BTC = 1 BTC
| croes wrote:
| https://www.coinopsy.com/dead-coins/abandoned/
| notahacker wrote:
| sure, and 1 UST = 1 UST, but it turns out that people who
| thought they didn't need to trust the asset held its
| value are considerably poorer than they were before.
| earnesti wrote:
| But there is varying degrees of trust required. Also the
| quality of trust.
| notahacker wrote:
| Because whilst crypto provides an excellent solution for
| the "how to skim money from the economy by persuading
| less skilled investors to give you money" part of
| finance, it doesn't address the actual problems finance
| purports to solve like sending capital to its most
| productive use, maturity transformation, insurance,
| pensions etc.
| MrPatan wrote:
| It's the same application layer just running in a
| different tech and social stack.
|
| It's clear why the current gatekeepers don't like
| permissionless alternatives, but why do _you_ agree with
| them?
| notahacker wrote:
| The "social stack" is what actually makes finance's
| "application layer" happen, because it turns out that
| blockchains can't actually enforce delivery of barrels of
| oil or sue ICO recipient for spending their proceeds on
| coke and hookers, and things like hiring and receiving
| goods and valuing insurance losses all involve
| counterparties.
|
| Much as you would like to personalise this debate, it's
| not about my level of agreement with straw gatekeepers.
| It's about the simple fact the "application layer"
| doesn't exist. You're not getting your mortgage or
| pension from a blockchain.
| MrPatan wrote:
| Nobody is saying delivery of assets is done on chain.
|
| That's a strawman you've skewered twice already, well
| done.
|
| What we're saying is: a lot of the low level
| infrastructure used now in finance (brokers! Dealers!
| Clearinghouses!) is easily replaced by some code, once
| you have trustless decentralized computers. Which we do
| now.
|
| Then your oil barrel market is just some code nobody
| needs to trust, and yes, the "last mile" of it still
| needs "guys with guns" infra. So what? We made a part of
| that market freer and fairer.
|
| Cool, isn't it?
| notahacker wrote:
| You started off asking "why do you still want the guys
| with guns solution" and insisting that blockchain
| provided a "trustless, decentralized" solution to the
| problems financial markets purport to solve.
|
| So I don't think it's a "straw man" to point out the
| answer to your question is _market participants want
| promises actually delivered upon_ which you now admit is
| entirely dependent on the "guys with guns" (and/or
| trust). By extension, blockchains don't actually provide
| a trustless or decentralized solution to the actual
| problems of finance. _Actually knowing that your
| counterparty will send you oil_ isn 't some unimportant
| detail of the oil barrel market which can be handwaved
| away, it's considerably more important than the
| implementation detail of the transaction record updates
| or whether brokers are involved.
|
| You've moved more goalposts in this discussion than
| crypto has moved in the useful bits of finance.
| [deleted]
| kenniskrag wrote:
| Is https://www.portvintages.com/ the book?
| tech_ken wrote:
| >that was no small amount of work.
|
| It definitely shows, thank you for publishing it freely
|
| >The purpose of financial markets, sometimes but not always
| wholly achieved, is to transfer risks to those best able to
| hold them.
|
| This makes a sense to me, thanks for explaining. I can
| definitely understand how insurance collectivizes and smooths
| individual risks, and from this and other examples I can see
| why a lending institution might seek something similar to
| enable them to keep cash moving. It does seem a little
| epicyclic to me that a farmer faces a glut as a result of
| organizing food production through a market economy, and then
| we resort to like a second-order market trick to resolve that
| problem. Presumably it would be simpler to just dump all the
| food in the middle of the table and then hand it out evenly,
| but I've heard this runs into its own set of difficulties.
|
| >Let me also mention that I am the author of the definitive
| reference book on old Vintage Port: Port Vintages
|
| Very welcomed, I may not buy the book but I will definitely
| go buy some port. TGIF!
| asdff wrote:
| Why have them privately controlled at all? The fed prints the
| money. The fed could be the bank and insurer as well, and
| obviate the middle men skimming the pot.
| anon291 wrote:
| I think the question should be 'why not'? The default
| should be the government doesn't do things and only does
| things that it is uniquely able to do.
| asdff wrote:
| I think that just invites parasitic loss into the system
| through profit seeking, but maybe this is in fact by
| design, and us laborers are merely a means to another's
| greatly yielding end.
| Matl wrote:
| > The default should be the government doesn't do things
|
| Right, but taking this in the opposite direction then,
| why for public interest things should the default of
| 'people who just want to buy the next yacht' run them
| good?
| chii wrote:
| because they can only buy that yacht _if_ they ran it
| good!
| Matl wrote:
| [flagged]
| asdff wrote:
| Unfortunately "running it good" might also mean things
| like bain capitalism where they part out anything of
| value and leave the customer base high and dry.
| totallywrong wrote:
| Yeah, capitalism 101, good in theory but terrible for
| most people in practice. Look at e.g. the health system,
| where a major issue means total bankruptcy and life debt.
| A somewhat balanced system where governments protect
| basic needs and have some control over the markets is the
| ideal imo.
| toast0 wrote:
| > total bankruptcy and life debt
|
| Those are two different things. Bankruptcy isn't fun, but
| it clears your debt.
| tacocataco wrote:
| What about student's loans?
| conradev wrote:
| It's a valid question!
|
| There are people advocating for "public banking":
| https://publicbankinginstitute.org/
|
| and credit unions also exist, which are nonprofits
| xyzzyz wrote:
| Because private insurers have incentive to accurately price
| risks. If they price them too low, they will go bankrupt.
| If they price them too high, the competition will steal
| their customers with lower rates for the same coverage.
|
| The governments, on the other hand, don't go bankrupt, so
| when they price the risks too low, the public will be
| forced to bail it out anyway, either through taxes or
| through inflation.
|
| This very much is real and serious problem: consider, for
| example, National Flood Insurance Program, which is exactly
| the kind of publicly controlled insurance you asked for. It
| was $25B in the red by August 2017, and would have gone
| bankrupt if it was private. However, you (and other
| taxpayers) bailed it out in October 2017 to the tune of
| $16B. It continues to accumulate debt, and is more than
| $20B in debt right now. You will bail it out again, and
| keep subsidizing people who build their houses on flood
| prone areas, knowing that you will pay for their losses.
| chii wrote:
| This is exactly what moral hazzard is.
|
| It's no different from the GFC, where the risk (of those
| mortgages) are mis-priced, and in the end, someone is
| left holding the bag.
|
| A functioning market to redistribute risk needs
| transparent pricing, and proper bankruptcy (so in other
| words, the risk taker must not be bailed out, even if it
| hurts in the short term).
| tacocataco wrote:
| I'd love to make the post office my bank. One location to
| do two of the errands on my todo list for today!
| [deleted]
| plandis wrote:
| The thing that I've always found wild is that the money people
| make on markets seems to be so much higher than the money
| people who actually make goods/services.
|
| Why has the global economy put such a high benefit from
| investment bankers compared to, for example, family doctors?
| thelamest wrote:
| For one, finance is a macro force multiplier; it can make or
| break entire other industries. There's also a bit of
| selection (global top) and survivorship (plenty of less
| visible non-success stories) in the wild money stories you
| can see out there.
| chii wrote:
| > family doctors
|
| they can only scale at most linearly, with the number of
| hours they work.
|
| A financier can scale multiplicatively, because the amount of
| the monies they deal with can increase without "extra work".
| The multiplicative nature means the more capital you have
| access to, the more money you get to make, which approaches
| exponential at some point.
|
| And in the end, the financier speculating on the markets can
| affect many more people than the doctor ever can in their
| life.
| nostrademons wrote:
| Prices and financial markets in general exist solely for
| information transmission. The central problem of economics is
| "How do you produce the things that your population needs, in
| the quantity and at the time they need them, as efficiently as
| possible?" This is why every centrally-planned economy
| eventually fails, and why we were stuck in the feudal middle
| ages for a millennia. Information (and _incentives_ ) about
| what to produce and how to produce it efficiently weren't
| getting to the population at large, which caught us in a local
| subsistence minima. Financial markets give all the players an
| incentive (in the form of profit) to transmit information (in
| the form of prices) from people who want goods to people who
| can supply them.
|
| This is also behind the theory of why certain forms of
| financial transactions are legal and others are illegal.
| Arbitrage = legal, because it converges prices in two separate
| markets in a way that gives producers in both those markets
| better information about true demand. Futures markets = legal,
| because they smooth out temporal fluctuations in demand so that
| producers only have to worry about producing, while also
| incentivizing the construction of just enough storage &
| buffering to hold that product. Pump & dump schemes = illegal,
| because they distort price information in the market in an
| unsustainable way and then leave later participants to bear the
| cost of this. Same with Ponzi schemes. Equities markets =
| legal, because they transmit information about the overall cost
| of capital within the economy to firms, which can then use it
| to decide the profitability or unprofitability of various
| investments.
| panarky wrote:
| _> solely for information transmission_
|
| Certainly one function of financial markets and prices is to
| convey information, but that's not "solely" their purpose.
| They also provide a mechanism for resource allocation, risk
| management, wealth generation and collective action, among
| other things.
|
| Your point about centrally planned economies, while
| historically corroborated in cases like the Soviet Union,
| might be an overgeneralization. The effectiveness of an
| economic system depends on numerous factors, including its
| degree of flexibility, the effectiveness of its institutions,
| and its ability to adapt to changing circumstances.
|
| Not all centrally planned economies are doomed to failure;
| some have been quite successful, notably in East Asia where
| countries like China and Vietnam have managed a mixed economy
| with elements of central planning and market mechanisms.
|
| Many capitalist corporations are centrally planned economies
| larger than many nation states. While everything fails
| eventually, these centrally planned organizations can last
| multiple human generations, and can be more durable than many
| markets and market-oriented economies.
|
| The assertion about the feudal Middle Ages also needs some
| nuance. The Middle Ages, and the feudal system in particular,
| had complexities beyond simple information and incentive
| problems. Numerous sociopolitical factors were at play,
| including a rigid class structure, the influence of the
| Church, and the lack of certain technological innovations.
| Ascribing the issues of a historical period mainly to its
| economic structure oversimplifies the multitude of factors
| that influenced societal development.
|
| Moreover, while financial markets do help in transmitting
| information from consumers to producers, they are not
| infallible. They can, and often do, suffer from issues like
| information asymmetry, where one party in a transaction has
| more or better information than the other. This can lead to
| problems like adverse selection and moral hazard. Financial
| markets can also be subject to speculation, which can distort
| the "signal" provided by prices.
|
| The focus on profit as the sole incentive in the market might
| be somewhat limited. People's decisions to buy, sell, and
| produce are influenced by a host of factors beyond profit,
| including societal and environmental concerns, personal
| values, and ethical considerations. Financial systems, to be
| truly effective, need to take into account this wide range of
| motivations.
| nostrademons wrote:
| Resource allocation, risk management, and collective action
| are all information transmission problems. It's arguable
| whether wealth is being generated by the people who
| actually _do the work_ or the people who decide _what work
| is being done_ , but that's the subject of this thread.
|
| China isn't really centrally planned. They call themselves
| that so that the government and previous communist ideology
| can avoid losing face, but anyone who's visited there or
| done business with Chinese companies will say that it's
| intensely capitalistic, just with the potential for random
| state interference at a whim. I suspect the same is true
| for Vietnam, but know less about the country.
|
| Information asymmetry issues are exactly why certain types
| of financial transactions are illegal - that's why we have
| things like SEC disclosure and insider trading laws.
| nazka wrote:
| Without them we wouldn't have McNuggets.
|
| McDonald's is known to have almost invented and streamlined
| cooking to industrial level. But McNuggets were made possible
| only through financial engineering:
|
| https://tackletrading.com/tackle-today-the-rise-of-chicken-m...
|
| I just finished some McNuggets so it's even more funny to me
| right now.
| tech_ken wrote:
| > Without them we wouldn't have McNuggets.
|
| youtube.com/watch?v=uG3uea-Hvy4
| WFHRenaissance wrote:
| I just want to say thank you to the author for writing this. It's
| very easy to read, and it's something I've sent to many close
| friends after reading.
| marcrosoft wrote:
| I love classic hypertext. I miss some of the old internet.
| arbitrary_code wrote:
| is there a version of this not presented in a timecube format?
| hotpockets wrote:
| I am interested in this, but already confused on page 1. The book
| describes a bank needing to borrow swiss francs, but that doesn't
| make sense to me. Why not just borrow the money in their native
| currency? Does the book ever go into this?
| acover wrote:
| If you borrow in a different currency than your assets then you
| introduce currency risk. For example, if I make a loan of 100
| CAD by borrowing 100 USD, then when the loan finishes I might
| only be able to convert 100 CAD to 50 USD.
| Sherl wrote:
| I am always amazed by Finance. But the engineer in me somehow
| always failed to grapple after few trenches deep into the realm
| of terminologies. I am strongly considering the MITx Finance
| specialization, but this resource is a great stop gap.
| consultSKI wrote:
| Interesting insights... it is going to take me a couple of reads
| to comprehend all the value here. Thx JDAW
|
| P.S. Thx for the PDF version
| zjmil wrote:
| If you want something related in video form, the lectures[0] from
| MIT 15.401 Finance Theory I [1] by professor Andrew Lo are great.
|
| [0]
| https://www.youtube.com/playlist?list=PLUl4u3cNGP63B2lDhyKOs...
|
| [1] https://ocw.mit.edu/courses/15-401-finance-theory-i-
| fall-200...
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