Monthly Archive for February, 2010


Political comic strips around the Mississippi Bubble of the 1710s

I wish that I had time to read this paper by David Levy and Sandra Peart.

It’s about political comics (cartoons) drawn to depict John Law and the Mississippi Bubble of the early 1700s.  It also speaks to subtlely different meanings of the words “alchemy” and “occult” than we are used to today. Here is an early paragraph in the paper:

Non-transparency induces a hierarchy of knowledge. The most extreme form of that sort of hierarchy might be called the cult of expertise in which expertise is said to be accompanied by godlike powers, the ability to unbind scarcity of matter and time. The earliest debates over hierarchy focused on whether such claims are credible or not.

Here is the abstract:

Economists have occasionally noticed the appearance of economists in cartoons produced for public amusement during crises. Yet the message behind such images has been less than fully appreciated. This paper provides evidence of such inattention in the context of the eighteenth century speculation known as the Mississippi Bubble. A cartoon in The Great Mirror of Folly imagines John Law in a cart that flies through the air drawn by a pair of beasts, reportedly chickens. The cart is not drawn by chickens, however, but by a Biblical beast whose forefather spoke to Eve about the consequences of eating from the tree of the knowledge. The religious image signifies the danger associated with knowledge. The paper thus demonstrates how images of the Mississippi Bubble focused on the hierarchy of knowledge induced by non-transparency. Many of the images show madness caused by alchemy, the hidden or “occult.”

Hat tip: Tyler Cowen.


I didn’t even know I’d been nominated


Thinking about Human Rights (and UNICEF)

Before I begin:  UNICEF has a campaign in the UK at the moment to raise awareness of children being denied their rights around the world.  You can see the homepage for the campaign here.  You can donate here.

Here are some things to keep in mind when thinking about human rights:

  • A right is a particular form of liberty.  It is the freedom to do something.
  • An obligation or mandate is the opposite of a right.  A right involves a conscious choice; thus the phrase “to exercise one’s right.”  If there is no choice available, there is no right.
  • One person having a right often implies denying another right from a second person.  Suppose that you work for me.  If I have the right to fire you, you cannot have the right to a guaranteed job with me.  If you have the right to go on strike, I cannot have the right to fire you for going on strike.
  • Sometimes having a right does not impede the rights of others.  A right to make use of a non-rival good is the classic example.
  • Exercising a right is not necessarily in a person’s best interest.  I have the right to gamble all of my money at a casino, but it probably wouldn’t be wise to do so.
  • Every decision of consequence for everybody, everywhere, is subject to a constraint of some kind.  There are only 24 hours in a day, the resources at your disposal are finite and, eventually, you will die.
  • If a person, operating under a constraint, chooses to not do something, it does not imply that their right has been denied to them.

These last two points, while logical, create problems for many advocacy groups.  Consider the woman who, subject to constraints in her finances and the wages on offer for various jobs she can perform, chooses to become a prostitute.  Consider the subsistence-farming family that, subject to constraints in it’s finances and the wages on offer for alternative work, chooses to keep it’s children away from school and working on the farm.

It is largely for this reason that many people advocate what they call “economic rights”.  Although there are various versions of this (e.g. minimum wages, the welfare state, etc.), you can think of them as a government, on behalf of the entire population, instituting a guaranteed minimum income.

Now, while there are strong moral arguments for such a guarantee (which I fully support and agree with), this is not a right.  This is a mandated transfer of income from high-income citizens to low-income citizens.  For the rich, it is an obligation (the opposite of a right) and for the poor, it does not directly increase the range of choices available to them.  Instead, it indirectly increases that range by relaxing one of their constraints.

I say again:  I fully support providing a minimum income to all people by means of a welfare state; nobody should live in poverty.  But this is not a right.  It is a moral duty.  Calling this an “economic right” is a deliberate obfuscation for marketing purposes.  People pay more attention and money when a person’s “rights” are being denied than when they simply have a moral obligation to help.

I love the work done by UNICEF. I think they are just about the best NGO on the planet. My wife and I donate money to them. They make an express point of telling you how much of the money you give will go to administration costs or to more fundraising.

I just wish they could raise those funds without confusing things by saying that Aklima’s right to education is being denied to her.  I recognise that they have to.  I just wish that they didn’t.


I am Britralian

… being both British and Australian.  It only took seven and a half years of living in Ol’ Blighty to do it.  The ceremony took place in the chambers of the Camden Council Hall — all dark timber and green leather.  There were about 30 of us in the ceremony.  Roughly half chose to swear their allegence by God, and half to affirm it without any religious reference.  Now I get to wait six weeks before getting my British passport.


Double-yolk eggs, clustering and the financial crisis

I happened to be listening when Radio 4’s “Today Show” had a little debate about the probability of getting a pack of six double-yolk eggs.  Tim Harford, who they called to help them sort it out, relates the story here.

So there are two thinking styles here. One is to solve the probability problem as posed. The other is to apply some common sense to figure out whether the probability problem makes any sense. We need both. Common sense can be misleading, but so can precise-sounding misspecifications of real world problems.

There are lessons here for the credit crunch. When the quants calculate that Goldman Sachs had seen 25 standard deviation events, several days in a row, we must conclude not that Goldman Sachs was unlucky, but that the models weren’t accurate depictions of reality.

One listener later solved the two-yolk problem. Apparently workers in egg-packing plants sort out twin-yolk eggs for themselves. If there are too many, they pack the leftovers into cartons. In other words, twin-yolk eggs cluster together. No wonder so many Today listeners have experienced bountiful cartons.

Mortgage backed securities experienced clustered losses in much the same unexpected way. If only more bankers had pondered the fable of the eggs.

The link Tim gives in the middle of my quote is to this piece, also by Tim, at the FT.  Here’s the bit that Tim is referring to (emphasis at the end is mine):

What really screws up a forecast is a “structural break”, which means that some underlying parameter has changed in a way that wasn’t anticipated in the forecaster’s model.

These breaks happen with alarming frequency, but the real problem is that conventional forecasting approaches do not recognise them even after they have happened. [Snip some examples]

In all these cases, the forecasts were wrong because they had an inbuilt view of the “equilibrium” … In each case, the equilibrium changed to something new, and in each case, the forecasters wrongly predicted a return to business as usual, again and again. The lesson is that a forecasting technique that cannot deal with structural breaks is a forecasting technique that can misfire almost indefinitely.

Hendry’s ultimate goal is to forecast structural breaks. That is almost impossible: it requires a parallel model (or models) of external forces – anything from a technological breakthrough to a legislative change to a war.

Some of these structural breaks will never be predictable, although Hendry believes forecasters can and should do more to try to anticipate them.

But even if structural breaks cannot be predicted, that is no excuse for nihilism. Hendry’s methodology has already produced something worth having: the ability to spot structural breaks as they are happening. Even if Hendry cannot predict when the world will change, his computer-automated techniques can quickly spot the change after the fact.

That might sound pointless.

In fact, given that traditional economic forecasts miss structural breaks all the time, it is both difficult to achieve and useful.

Talking to Hendry, I was reminded of one of the most famous laments to be heard when the credit crisis broke in the summer. “We were seeing things that were 25-standard deviation moves, several days in a row,” said Goldman Sachs’ chief financial officer. One day should have been enough to realise that the world had changed.

That’s pretty hard-core.  Imagine if under your maintained hypothesis, what just happened was a 25-standard deviation event.  That’s a “holy fuck” moment.  David Viniar, the GS CFO, then suggests that they occurred for several days in a row.  A variety of people (for example, Brad DeLong, Felix Salmon and Chris Dillow) have pointed out that a 25-standard deviation event is so staggeringly unlikely that the universe isn’t old enough for us to seriously believe that one has ever occurred.  It is therefore absurd to propose that even a single such event occurred.   The idea that several of them happened in the space of a few days is beyond imagining.

Which is why Tim Harford pointed out that even after the first day where, according to their models, it appeared as though a 25-standard deviation event had just occurred, it should have been obvious to anyone with the slightest understanding of probability and statistics that they were staring at a structural break.

In particular, as we now know, asset returns have thicker tails than previously thought and, possibly more importantly, the correlation of asset returns varies with the magnitude of that return.  For exceptionally bad outcomes, asset returns are significantly correlated.