Thursday, January 29, 2009

Defaults on government debt - starting now?

Economist Brad Delong has put together an excellent compendium of academic papers to illustrate the history and relevance of past financial crisis.

The one I found most interesting wasn't on the list "This time it's different - A panoramic view of 8 centuries of financial crisis."

This long (125 page) paper looks mainly at sovereign debt defaults. The following summarises my reading of it and it’s relevance for the current situation.

1. Very high default rates across all regions in all time periods apart from short lulls of a decade or two.
2. In situations were gov debt is domestic rather than external there is still default on external debt - this seems contrary with IMF views.
3. Defaults in countries happen in waves and generally flow big decreases in commodity prices that impact these "emerging
4. There are also peaks in defaults after there have been large financial flows from eh financial centers to the "emerging" economies. I.e. the money is spent then the flow stops and then the defaults occur.
5. There is particularly high inflation in the defaulting countries during and after defaults. I.e. the gov inflates to reduce indebtness
6. Inflation crises and exchange rate crisis go hand in hand.

To me, the current situation is a classic illustration of a typical scenario just before a large wave of defaults occur. I.e we have had the prerequisite large capital inflows (which are now rapidly drying up or reversing) and the collapse of commodity prices. The fact that much of the debt is local rather than external is no protection.

This also suggests we are going to have high inflation and big drops in exchange rates in the emerging commodities that have been impacted.

The difference this time seems to be that the largest capital flows have been into what most would consider the financial centre (US). This may change the dynamics of things but I don't think it will change the sovereign debt defaults in many emerging markets.

If this does occur this is going to cause:
1. Serious stresses on governments in non defaulting countries supporting bailout efforts in other countries through the IMF etc
2. Defaulting countries will be unable to support their own economies during the current downturn – indeed the usually proscribed austerity packages will exacerbate the issues given the global downturn and the difficulty of exporting your way out of the crisis when export markets are very weak.
3. Geopolitical tensions, due to the battle between debtors and creditors over repayment schedules, austerity packages etc.
4. Political instability in defaulting nations.
5. Further strains on the solvency of the banking systems in a wide range of countries (US Europe Asia etc) as more bad loans are written off.
6. A great deal of suffering in countries with high poverty levels.

Clearly a rather worrying picture on top of the current problems in private markets.

From a trading perspective the best options here would appear to be to short emerging currencies that have significant government debt and "commodity" exports over the coming few years. I'll talk more about the implications of this and any early signs of a wave of defaults occurring in a follow up blog.

Tuesday, January 27, 2009

Misconception 3 – Easy credit caused the housing boom

This one is more an oversimplification than a misconception.

There have been very similar credit conditions across all housing markets in the US. However vast differences in changes in price by city/ region. So while easy credit conditions during the boom certainly had a significant impact they are only one part the whole story. The economic literature and my 5 years experience studying speculative forces in housing markets suggest the following factors.
- Local economic growth rates
- Housing supply restrictions
- Expectations based on local past experience

Economic growth rates (and the associated changes in wages, economic migration, employment etc) make a significant difference in the demand for housing. We can see this most dramatically in looking at house price figures for a city like Detroit where house prices have been decreasing in real terms for many years due to a decline in their traditional industries and a subsequent migration out of the city. Fundamental economic factors are likely to have been at work to early in the booms in growth areas in the Sunbelt.

Supply restrictions on land and building are also likely to have resulted in the inability of the market to quickly supply relatively affordable housing and stop prices from increasing quickly as demand increased. See for a detailed international perspective. This study shows booms in prices across hundreds of cities worldwide overwhelmingly occurred only in cities with relatively tight planning restrictions.

Studies of what investors and home buyers expect to happen to house prices in a particular housing market indicate that most people project recent past prices changes (over the past year or two) into the foreseeable future. So once prices begin to discernibly rise potential buyers scramble to buy quickly before prices rise further. They are willing to buy at prices greater than similar homes have recently sold for as they believe prices will be higher still in the future. Without this factor house prices will generally appreciate only slowly as buyers and sellers are looking at prices of similar properties in deciding a reasonable price to buy and sell. Once prices stop rising potential buyers stop believing that prices are going to continue to rise in the short term and the bust begins.

How can this knowledge help policy makers? Clearly once a boom has run it is largely to late for policy makers to contain damage such as:
- builders having built houses that people do not want to buy
- investors/home owners financially overstretched
- banks and others find their loans are not being repaid and the loan is worth more than the collateral

1. As booms are local phenomenon the use of broad nationwide monetary instruments (e.g. interest rates) or fiscal policies (e.g. incentives to homeowners/builders) is not advisable.

2. Supply side restrictions need to be decreased as much as possible so affordable housing enters the market in a timely manner.

3. Decrease unrealistic expectations about future house prices. This requires the provision of strong public education through all available channels to dampen down unwarranted speculation based on unrealistic expectations. Channels could include media, industry groups, investment advisers etc. Furthermore a government pre commitment to take credible actions to decrease prices in speculative bubbles would send a message that the boom will swiftly end and make the educational message more credible. Such commitment could include temporarily increased taxes on capital gains from housing, or swift decreases in restrictions on supply in the case of increased prices.

4. However, perhaps the most effective deterrent to future housing bubbles is simply to let this bubble deflate without the kind of support which will stop prices from returning to more realistic and normal levels. House prices in many markets are still far above pre boom levels and well above historical levels when compared with incomes or rents. To stop house prices from returning to economically sustainable levels would be:

- expensive

- unfair to those who have not benefited from the previous boom and

- counter productive; as without expensive and ongoing artificial support prices will still fall at a later date and the lessons of the boom and bust would not have been learnt thoroughly enough to prevent a repeat.

How can this knowledge help homeowner and investors?

1. If you live/own in a market that has had a large boom and have equity in your home and selling is an option you would consider then it's probably better to sell now then wait for a few years and sell at lower prices. this is particularly so if you currently have some equity in your home but might be forced into foreclosure (and hence loose all your equity in the house) at a later date.

2. If you're renting and looking to buy in a city that has boomed and boom prices are well above what they were before the boom began then there is no hurry as houses will probably be significantly cheaper in the coming years.

3. If in the future you see people making a lot of money by investing in housing (or anything else) during a boom time - don't be panicked into buying or think this is the way to make easy money . The boom will end and those that made a lot of money will probably loose a lot of money. In the long term the price of housing will remain in line with rents and prices. We don't' know who long it will take this to happen -sometimes prices zoom back down in two years and sometimes it takes 15 years of house prices standing still while inflation and increases in real wages catch up.

For an excellent source of both insight and data from an international perceptive see

Misconception 2 – Housing market inventory

Misconception 2 – Housing markets won’t recover until the inventory is gone

Once we accept the idea that there are lots of separate housing markets rather than one market (see my blog "Misconception 1 - One Housing Market") it’s clear that the huge amount of inventory of unsold homes in one market doesn’t mean much for another market. So there could still be a huge backlog of inventory in many markets while other markets may need new supply. i.e. those with reasonable economic growth, no huge backlog of inventory and affordable housing.

This is good news for builders and residential housing market investors in these areas. For stock market traders/investors this suggests it will be highly profitable in the coming year or two to buy beaten down builders who are active in stabilising housing markets. Don't be put off by headlines about inventory gluts and falling prices in "the housing market".

However there is bad news for investors in markets with a big overhang of inventory and for holders of CDO’s and other housing market debt that was issued based on these markets. The real value of these (either in an auction or on a “hold to maturity basis) will most likely continue to drop as prices continue to fall and as foreclosures continue to mount. This bad news for the solvency of the financial system in the year ahead.

Misconception 1 – One housing market

I spent 5 years writing a thesis on speculative forces in residential housing markets and will do a series of blogs on misconception and reality in the US housing markets.

The mainstream media and politicians often talks about the housing market as if it’s one single market. While for some purposes there is a grain of truth in this, for most purposes this is downright misleading.

Let's start by thinking about what a "market" is. A market is made up of goods that are reasonably close substitutes for one another. However while houses are similar in some ways (they all have walls, roofs, provide shelter etc) houses in one city/region are not generally substitutes for those in another city/region and often even within a particular city it can be more useful to think of a lot of loosely connected separate markets than one market. This range of local markets is primarily due to three things: location, housing type and housing quality.

Location - If I’m looking for a house in New York a house in LA isn’t much good to me no matter how much the price falls.
Type - If I’m looking for suburban house for myself, my wife, three kids and a dog a condo probably isn’t for me.
Quality – if I can afford a house in the price range $175-200K a house worth $500 K isn’t relevant to me.

What we see at the moment is a some similarity among housing markets across the US (i.e. prices are generally going down) and then significant differences between cities/regions and even within cities/regions between housing types and housing quality.

Looking at house price by city/region. Those that went up the most generally coming down the most. For example, prices in LA and Miami boomed around 175% between 2000 and mid 2006 and are now down nearly 40% from their peak while in cities like Denver, Charlotte and Dallas prices only rose 25-40% during that same period and have only come down 5-10%. For detailed data,0,0,0,0,0,0,0,0,1,1,0,0,0,0,0.html It appears houses prices are steadily coming back to historically "normal" levels compared to incomes and rents. So probably some considerable way to fall in the boom cities.

Even within the same city/region there are wide discrepancies in how properties in different price ranges (quality) or type are selling. While reliable statistics for these are harder to come by (due to small sample sizes) the real estate agents and buyers and sellers on the ground are well aware of this.

Brett Steenbarger looks at months of housing inventory/sales for three different price ranges in the city he lives in (Naperville, IL). He concludes “There is little inventory problem at the lower end of the housing spectrum; speculation in that market had centered on the luxury end, where there is more than 3 years of inventory…. In my looks at other suburban communities, from Washington to Florida, I have seen similar lumpiness in inventory.”

Here Brett looks at a wider view across both cities and housing types
Again, there is huge variation across different types of housing in the same city and also obviously between cities.

For a more comprehensive view based on the Case Shiller housing market indices see:
They show that prices changes for different types of houses (condo's versus single family homes) and price levels (i.e. quality) have varied significantly. Again markets

There are a large number of investors on housing market blogs who are saying “all markets are local” and they are right. However they area also saying “my market is fine”. Obviously for some of them this is the case but given the state of most markets this is probably more the exception than the rule.

At the same time politicians and their advisers are in the midst of a trying out and planning a wide range of actions to stabilise "the housing market". If these policies are based on the idea of a single market they are bound to have some very unsatisfactory and unwanted results.

In the case of both investors and politicians it appears that self delusion is a powerful force.

Tuesday, January 20, 2009

Risk, Uncertainty and the Financial Crisis

The concept of reflexivity (see blog on reflexivity and finance for explanation) has an important implication for theories about financial markets in general and also for the current financial crisis.

This implication is that markets exist in historical time where events and situations are to some extent unique and not simply part of some timeless economic machine in which financial outcomes (e.g. the probability distribution of returns in markets) are unchanging and fixed. So there exists not only risk (the range of probabilities of outcomes indicated by past events) but also genuine uncertainty (the impossibility of knowing what the future holds even in a probabilistic sense). This is important for the formation and testing of economic/finance theories because it means:

1. The expectations and actions of markets must be conceived to rely on something other than the accurate calculation of probabilities about the future. e.g. social convention, personal experience, expert opinion.

2. That theories about economics and finance may be more relevant for some segments of historical time than others.

Uncertainty is important for practitioners in financial markets because players in these markets need to be aware that calculations of probabilities based on past history maybe radically inaccurate. Failure to understand this contributed to the proliferation of financial instruments that investment banks and other produced in the belief that the data on which their models of risk and return would remain stable over time. As taught by standard approaches to finance. Sadly practitioners did not recognise uncertainty and as the the dynamics of the economic situation turned their calculations proved to be disastrously inaccurate and lead to the technical insolvency of much of the global finance system. This episode will surely go down in history as one of the most disastrous misconceptions of the last fifty years. The ironic thing is that this mistake was made by thousands of the most intelligent people on the planet. Such are the dangers of building an edifice of knowledge on an inaccurate assumption and then leveraging your bets.

Reflexivity in financial markets: its meaning and implications

Reflexivity is an idea that has a long history and has been applied in many social sciences.

However in the finance areas the term reflexivity has been popularised largely by one man, George Soros.

The basic idea is that:

1. The market is made up of people.

2. People have a conception of the economic reality (which is inevitably false or incomplete) and base their actions on these conceptions.

3. These conceptions then have a feedback loop with "economic fundamentals"..

4. In certain historical circumstances this feedback loop leads to outcomes that are initially self fulfilling but inevitably self defeating in a boom/bust sequence.

5. Generally this reflexive boom/bust sequence initially builds on a pre-existing trend based on sound economic fundamentals.

Examples of factors that may give rise to this the feedback loop in point 4 include

(a) increasing lending against appreciating assets without understanding that one of the main reasons for the increased asset price is the increased lending.

(b) the trend-following habits of investors or speculators (including adaptive expectations formation).

A current example of reflexivity in modern financial markets is that of the debt and equity of housing markets. I would argue that both the factors (a) and (b) above contributed to this damaging boom bust cycle in the following way.

a. Lenders began to make more money available to more people in the 1990s to buy houses. More people bought houses with this larger amount of money, thus increasing the prices of these houses. Lenders looked at their balance sheets which not only showed that they had made more loans, but that their equity backing the loans - the value of the houses, had gone up (because more money was chasing almost the same amount of housing). Thus they lent out more money because their balance sheets looked good, and prices went up more, and they lent more, etc. Prices increased rapidly, and lending standards were relaxed.

b. Ever larger numbers of potential investors in housing markets grew increasingly confident that house prices would continue to increase based on their past experience (i.e. adaptive expectations) and thus scrambled to bid up the prices of houses.

Reflexivity in simply an inescapable fact of life in all arenas of social action. The reflexive boom/bust sequence is one consequence of this and only occurs in certain historical settings. In this conception financial markets are not necessarily in, or indeed close to, equilibrium.

Soros perspective is that the housing boom and bust has been superimposed on a larger global "super bubble" for that last 25-30 years. This super bubble is base on so called global "market fundamentalism" regarding financial markets. i.e the belief that free financial markets work well and when left to their own devices tend towards equilibrium. This belief lead to three main trends: (a) unchecked credit expansion, (b) an explosion in the value and type of unregulated financial instruments (derivatives, leveraged instruments, securitised instruments, synthetic instruments etc.), (c) globalization of financial markets with the financing of US consumption (private and government) by foreign lenders (China etc). This bubble has now burst and we are now in the beginning of the bust phase. Given that the boom took 25 years to unfold I would not be surprised if the bust lasts more than a year or two.

For more information on the broad idea of reflexivity see the follows chapter from a book on the reflexivity

For more information on George Soros and his thoughts on reflexivity and the current financial crisis see

Monday, January 19, 2009

Is this an unusually bad US recession?

The above following chart present an interesting comparison of our current U.S. recession’s percent change in employment with those of the 10 previous recessions that have occurred since 1946.

Thanks to Michael Guzzo from for bringing this data to my attention.

So on face value it looks like this U.S. recession is pretty well a median type recession so far. Until you look more closely.

Clearly employment has shrunk very slowly in the first months of this recession meaning, from this perspective, it looks much like a “median” recession. However, look at the rate of change in employment in the last 6 months - its rate of fall is much faster than earlier and this rate is accelerating.

Also worth bearing in mind that employment is probably a 3-6 month lagging indicator compared to say real GDP or retail sales and that retail sales have been decreasing 2-3% a month (yes a month!) for the last three months and that this rate of decrease is also accelerating. For more detail on retail sales see So given employment’s lag we should expect the employment to keep falling at the current rate or faster for at least 3-6 months even if retail sales turned around in January. Given that that rate of change in retail sales or real GDP is inevitably not going to turn positive in the next 3 months and probably not for at least 6 months (and possibly much longer though stimulus will give some positive bumps) we’re looking at a that employment graph heading south at the current rate of decline for 6 to 12 months. That will take the current decline in employment to worse than the harshest recessions on this graph in terms of total loss of employment. It will also mean the length of time from the start of recession until it begins to sustainably turn around (maybe somewhere between months 21 and 27 on that graph) would be much longer than longest post war recession.
In the two most recent recessions the unemployment rate actually peaked around 15 months behind real GDP so if that pattern continues it's even worse. So employment held up well early but it’s going to get uglier than in living memory and looks like living up to the “worst post war recession” hype. Having said this anyone suggesting this is great depression number II is merely speculating rather than looking at the facts . The great depression was 4 years long and involved a massive 50% decrease in GDP and was simply a bigger beast altogether than either the recessions since the WWII or the 15 contractions in real GDP that occurred from 1840 to 1920. Indeed the fact that we had the great depression has meant that policy makers and economists have to some extent learned from it. So what happens from here it will be ugly but it will have a somewhat different dynamic that the great depression.

Sunday, January 18, 2009

International stock markets markets - where to from here

Many countries around the world are in a recession (one that will most likely get a lot uglier in terms unemployment, poverty and social unrest) and we've had major stock markets busts in every major market. I summarise what past studies and current data tell us about how things are likely to play out in stock markets around the globe. Given economic data and economic theories and forecasts are always flawed (inaccurate, incomplete, irrelevant etc) I find the best way is to take a wide range of perspectives to get an overview and avoid basing my thoughts on one shaking bit of data or one perspective.

A. Let's start by thinking at which equity markets matter and if it's really meaningful to talk about a global equity market, as opposed to a whole lot of country specific equity markets. In recessions most equity markets around the world tend to have much higher correlations with each other than they usually do (i.e especially when there are in sync recessions as is the case at the moment). So at the moment and in the medium term we can meaningfully talk about a global equity market. This means that any question about who a stock market will perform in one market is tied up to the question of how the whole current global crisis will play out. The US is the largest economy in the world and also leading the pack in terms of timing of real impacts on the economy so is probably the most relevant place to study. At the moment it seems the initial crisis stage in the debt markets have passed due to actions by the Federal reserve and others in propping up the debt markets. For relevant indicators see ttp://

However in most vital areas of the USA real economy (e.g. housing markets, retail sales, and unemployment) things are not only getting worse but the rate of deterioration is increasing. Indexes of leading indicators are also pointing down. Before things actually get better in the real economy the chronological steps we have to go through are:
  1. Stop increasing the speed of deterioration
  2. Continue to get worse but at a slower pace
  3. Stabilise
  4. Start to improve.

It's hard to see all these steps occurring within a time frame of less than a year . Indeed to may take it may take a number of years and be an L shaped recession. i.e. a protracted period of economic stagnation like the one experienced by Japan in the 1990s after the bursting of its housing and equity bubble So as far as the real economy in the USA is concerned it's going to be a while before things turn around. Other countries are just now entering in recessions so they may even come out of recessions after the USA.

B. The scope of government action. The decrease in real GDP has occurred despite large stimulus and bank bailout measures and unprecedented monetary policy action. So there is not too so much more the governments can do without causing themselves significant long term problems (i.e. government deficits become to large for markets to believe they will be serviced and the Fed ends up lacking creditworthiness due to holding assists worth less than amounts lent).

OK so that's the real economy but hasn't the stock market already fallen a lot and discounted these problems meaning we might have seen the bottom?

C. When in the economic cycle are equity returns usually strong? Research indicates that returns in stock markets are very high for 6 months starting in the last 6 months of recession or at the end of recession. So given we're very likely more than 6 months away from the end, and possibly years away, this suggests we should be vigilant for a possible stabilisation in the recession (particularly if its' not related to one off government stimulus responses which will have a temporary impact) but we shouldn't be too hopeful about strong equity returns from this point.

D. Are stocks cheap compared to earnings? Aggregation of earnings forecasts suggests that when looking at individual companies USA equity market earnings forecasts are way too optimistic given the bleak macro economic outlook. i.e. analysts forecasts are suggesting earnings will zoom up over the next year when clearly the economy looks tougher this year than last. Earning disappointments will lead to disillusion with the market and create strong downward pressure on prices.

E. Are equity prices cheap compared to the asset values of the companies? Compared to valuation during the last few years yes prices are cheap compared to asset value. But historical standards during recessions equity prices are not cheap. Tobin's Q - The measure of equity prices to prices on assets on the books - is currently around 0.7 this typically bottom's at 0.3 during recessions. This suggests there is a long way to fall. i.e. over 50%.

F. Are longer term technical indicators basing in preparation for a sustained rebound? Primary long term trends in all major stock markets are clearly down.

G. What is driving equity term markets on a daily basis and does this gives us hope? Looking at the past 9 months the pattern in movement in daily stock prices is astoundingly consistent. Equity markets are rebounding based on possible government actions and falling on the reality of earnings and broader economic data. There is no other "story" of substance out there in the market. Given the size of the economic problem, governments cannot have an overwhelming impact. So once the reality of this hits the primarily stimulus in this market of this "Obama bounce" will be gone and traders will be focused on the bleak macro economic data and the bleak earnings data.

H. Will the new administration in the US make a difference? Sure they can take actions that will have positive impacts but they are still politicians in the same political, social, cultural and economic system and political/equity cycles suggest bad times ahead. Basically "on average" equity markets in the US perform well in the third and forth years of a presidential term and poorly in the first and the second years. My understanding of this is that in the third and forth years most presidents (and congress and the senate) worry about being elected next time so they need to get out there and sell a positive picture of the economy. However during the first two years they face the reality of not being able to fund all their promises and the opportunity to talk down things and blame their predecessor. No doubt Obama will "discover" things are a lot worse than he thought and he will not be able to follow through with campaign promises.

I. Buffet is buying so if I'm a long term investor isn't now the time to snap up some bargains? Yes Buffet has been buying (but generally getting a special deal rather than buying at market price as you would be). His interviews suggest he's buying based on his view that this is largely similar recession to the ones he has experienced since he started in 1954. There are two points here. One - this recession looks different in terms of the: possible insolvency of the banking system, the debt levels of the USA consumers and government and the massive bubble in house prices that still has a long way to bust . Two - Buffet doesn't try to time the market, he readily admits he usually buys in too early when the market falls and he buys stocks with very specific characteristics rather than the whole market (often at prices unavailable to others).

So in summary, the all the balance of probabilities is for more downside in stock markets all over the world for at least the next 6 months and possibly considerably longer.

In a word if you're a trader - short . If you're an investor I would dump companies that have a lot of debt (even if prices are fire sale it's better than holding on while they go bust) and stay away from the banks and finance companies, commercial property and builders that are directly exposed to the largest problem areas. Personally I'm short the SP500 index in the US and 85% cash and only 15 % invested in stocks in (this is my primary home market Australia). Most of these stocks are held based on a strategy of buying stocks that are trading at a 30% plus discount to their marked-to-market net asset value (a Buffet type strategy) and have no debt. Generally I try to to be 90% invested in the stock market so here actions speak louder than words.

Why this blog?

I want to connect with people who have overlapping interests with me. For example those who have an interest in the approaches of George Soros, or behavioural economics, or who simply have practical insights from their experience of trading financial markets. Ultimately I aim to work with George Soros and Robert Shiller. So if you've got an interest please contact me, reference me in your blogs, comment and/or direct me to others who maybe interested!

I want to connect with with people who are interested in the study of financial markets because I believe there is a better way for academics, regulators and finance industry participants to understand and study financial markets then the standards methods based around the efficient markets hypothesis. I call this approach "Evidence Based Finance Economics". It means that approaches to financial markets should seek to encompass as much evidence as possible. This evidence includes both the currently studied macro level changes in prices and volumes and as well as the currently ignored micro based evidence on market participants portfolio allocations and decision making processes. This vastly broader set of evidence enables us to both come up with insights that are relevant to individual market participants (as opposed to "the market") as well as continually improve our macro theories and understand the limits to our theories. i.e. understand where our theories apply, how accurate they can be, what aspects of reality are more or less stable over time and which ones may change over time etc.

I believe that because the current approach restricts it's approach to "The Market" is a theoretical dead end that provides little scope for improvement in current theories. The lack of progress in the mainstream study of financial markets over the past 25 years and the complete surprise of economists at the occurrence current financial crisis bears this out.

How did I come to my beliefs?

In a sense this blog begins to complete a circle in my study of financial economics from theory to practical experience and now back to theory. From 12 years from the age of 18 I comprehensively studied the academic and professional literature on financial economics, as well as what I took to be relevant in psychology, philosophy and sociology. During this time I wrote a 250 page long masters thesis that looked at theoretical approaches to expectations formation in asset markets and at the evidence for expectations formation in housing markets. This evidence strongly suggested to me that peoples expectations about future house prices are generally trend following based on the recent (1-3 years) of changes in house prices in the areas in which they live. I was surprised that my approach (looking at a wide range of evidence and seeking to evaluate how various economists insights about expectations formation apply to housing markets) was met with an angry reaction by most academic economists. I was admonished to use the standard and approach and restrict the evidence I looked at to the standard macro economic evidence. The head of my department at the university finally explained to me that academics were not really interested in original research from master students they wanted you to follow the standard recipes. Had he told me this at the start of my thesis it may have saved me 5 years of working on an approach that was never going to be accepted.

I concluded that despite my strong desire to contribute to the study of financial markets a career as an academic economist at this point was virtually impossible unless I simply conformed to the standard methods that I believed to be deeply flawed. So at this point I decided the only way to really show people that I had insights into financial markets was to take my own money and speculate successfully in these markets. This I have now done successfully for ten years.

Why do theories about financial markets matter?

At the broad level they matter if you want the world to be a better place to live where people can make sensible financial decisions that are likely to lead to prosperity rather than disaster and where regulators have a good enough understanding of these markets to enable appropriate regulation. Given the current financial crisis, it's unfolding impact on people's lives and the past and present actions of regulators there is great scope for improvement..

Where to from here?

To paraphrase a private detective movie character. If you're looking for one particular thing it's hard to find it - because of all the things in the world. But if you're looking for anything interesting you will find it - because of all the things in the world.

So approach here is simply to blog about things that I believe are interesting about financial markets and how they are studied. Some of this will be drawn from the academic literature, some of it from other interesting commentators and some of it from my own study of financial markets.

I'll blog about once a week and look forward to hearing from you!