High Frequency Trading: The Rise of the Machines

As a professional trader, you are confronted daily with all kinds of dynamics and situations that require a flexible and adaptive mind. You are faced with multiple variables constantly interacting with each other and your task is to process ever-changing information quickly and profitably. Valuations arbitrage, reflexive supply-and-demand dynamics, and structural changes are recurrent landmines in the typical day of traders and money managers.

We accept this “dangerous” line of work for only two reasons: monetary compensation and pride in being part of capital markets, that transmission mechanism without which innovation and creativity would be prisoners of their own ethereal state.

As a society, we are ready to strike compromises in return for a system that will allow the ethereal state of our creativity to turn into reality. We allow market insiders like market makers, broker-dealers, and others to have small advantages over us mortal investors in order to have them create the positive externalities that help us build a more sophisticated economic system. We give market makers and specialists a privileged look at the order flow (the supply and demand of stocks) in exchange for their commitment to maintaining orderly markets whenever an imbalance occurs.

We give systemic firms like JP Morgan and Goldman Sachs privileged access to liquidity via the Federal Reserve so that the banking system and capital markets can continue to serve us in our quest to invent, produce, and distribute new products. But sometimes things turn out more like a bad inland casino rather than a better market… We may still be reeling from the systemic economic collapse of last year, but new structural changes with potential negative externalities are already at our door.

For months I have witnessed strange dynamics in the way markets behaved: liquidity issues, intra-day volatility, and a constant disconnection between technical, sentiment and fundamental inputs. Markets often go through periods of irrationality, but this time it felt different.

As a professional trader and an educator on markets, my sensitivity level is higher than normal and I immediately began conducting research to make sense of my discomfort. This process pointed consistently to one element: high frequency trading or as I like to call it “the rise of the machines.”

What is High Frequency Trading?

High frequency trading (HFT) was, until recently, a topic confined to Wall Street insiders. Only in the last few weeks has it become a mainstream subject of debate via articles on theNew York Times, the Washington Post, and interviews on CNBC (yes even CNBC’s clueless anchors can now spell HFT).

The reason for this foray into the mainstream media is the potential negative ramifications HFT can have for all of us: investors, entrepreneurs, and just plain hopeful citizens.

But first, let’s define HFT as it is a very technical classification that, nonetheless, encompasses many different things. Generally speaking, HFT is high velocity trading based on mathematical algorithms that create huge daily volume on different electronic exchanges and platforms. It is machine against machine—endless trading in order to capture fractions of pennies in profits. But, so far so good: the machines provide liquidity to all of us. The owners of the machines (financial institutions) make an all-American profit and the liquidity aggregators (electronic exchanges) provide competition to other exchanges in the most capitalistic way.

But what happens if we scratch the surface? Like Michel de Montaigne, the famed Renaissance scholar, once said: “There is no man so good, who, were he to submit all his thoughts and actions to the law would not deserve hanging ten times over.”

High frequency algorithmic trading is ridden with issues:

Volume. Machine-driven trading is over 60% of trading volume on a daily basis and in some confined cases it can be as high as 90%.

Adaptability. Machines are unthinking units that do not adapt to human reactions. HFT algorithms are based on correlations and historical relationships, which are great guidelines for trading and investing but by no means they can be used blindly (see: 1987 portfolio insurance, long-term capital management 1998, credit default swaps 2008, mortgage-backed securities 2008…the list of quant-related disasters is a sad one).

Exclusivity. HFT can only work by using incredibly fast and powerful computers that also must be placed in the exchanges as proximity helps the speed. Few people can afford the computers and/or the co-location fees charged by the electronic exchanges.

Flash quotes. Some brokers have access to quotes of orders before anyone else. By exploiting the speed of their machines, they can either arbitrage price differentials or potentially front-run clients. Another abuse of flash quotes (called flash because they last one–to-three milliseconds) is that they can be used as teaser quotes to gauge supply and demand without the risk of being hit due to their quickness.

Rebates. Many high frequency traders trade not for profit but for rebates paid by the electronic platforms to attract liquidity. This escamotage incentivizes useless and toxic volume.

While these are only the most immediate concerns about HFT, they have a potentially disproportionate influence on the cost of running our capital markets. The HFT lobby pushes the argument that they create positive externalities by exploiting improving technology—but there is a difference between volume and liquidity.

If over 60% of trading is toxic, it will go away in a nanosecond and most likely it will dissipate right when investors and money managers need it the most. This could cause a huge liquidity vacuum and a 1987-type of event. Liquidity is created by market players with a stake in the game, not by casino-like machines. Flash quotes and “predatory algorithms” also raise the cost of execution for the necessarily slower institutions like pension funds and mutual funds. Additionally, the surreal tempo of machine trading makes trading for all more expensive as we now have to prepare for the irrational moves and volatility of markets when executing our trades.

I love this business and I love technology, but checks and balances are needed to preserve our capital markets. Little adjustments can be made to reduce systemic risk, like re-instating circuit breakers that cut off program trading when price changes accelerate beyond certain parameters, like investigation or stopping flash quotes that drive front running, like making good on teaser quotes for longer than just three milliseconds, and so on. In the end, we need to understand that capital markets are here not to destabilize our economy, but to serve us as a society and help us make better lives.

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Source:

http://gbr.pepperdine.edu/blog/index.php/2009/08/10/1341/

Russian, Ukrainian Tug of War Over History

Russian historians widely recognize June 27, 1709 as the date their country became a great power. Russia that day defeated an invading Swedish army at Poltava in Ukraine, where Ukrainian forces allied with Sweden were also vanquished. The Battle of Poltava is not just history, but another source of ongoing friction between Moscow and Kyiv.

Poltava is recognized as the pivotal battle in the Great Northern War, a 21-year struggle, in which Russia replaced Sweden as the great power of Northern Europe in the early 18th century. Poltava also ended Ukrainian aspirations for independence from Russia.

"Traitor Mazepa"

The leader of the Ukrainian forces, Ivan Mazepa, remains a source of controversy between Moscow and Kyiv. Mazepa was Ukraine's so-called Hetman, or leader of its Cossack military forces.

In Russia he is considered a traitor who betrayed an oath of allegiance to Czar Peter the Great, the victorious commander at Poltava. The term "traitor Mazepa" remains a common Russian term. He was cast as a villain in works by Russian poet Alexander Pushkin and composer Peter Tchaikovsky, and also excommunicated by the Russian Orthodox Church. That decision is still in effect, despite recent high level requests from Ukrainian political and church leaders to rescind the move.

But Ukrainians say the Hetman was forced to side with Sweden, because Russian ruler Peter the Great failed to honor a 1654 treaty to protect their land against Polish attacks. But until the collapse of the Soviet Union, Russia considered the same treaty to have been an agreement by Ukraine for an everlasting union with its northern neighbor.

Ukrainians also consider Mazepa to have been a great reformer, who built schools and publishing houses, expanded higher learning, and supported the arts, including a distinctly Ukrainian style of church architecture that dominates the modern skyline of Kyiv.

Mazepa's portrait appears on Ukraine's 10-hryvna currency note, and the country will soon unveil a monument to him in Poltava. Last month, the Russian Foreign Ministry issued a statement condemning the statue as divisive. At a recent Poltava conference in Moscow, Vladimir Artamonov of the Russian Academy of Sciences told fellow historians the battle liberated Ukraine from Swedish invaders.

Artamanov says Poltava was not a tragedy for Ukraine, but rather a tragedy for Mazepa and his followers who sought to subordinate "Little Russia" to Poland. Russians often use the term "Little Russia" as a synonym for Ukraine. Many Ukrainians resent it as demeaning.

Genocide issues

Speaking at the same Moscow conference, Ukrainian historian Serhiy Poltavets said it is important to consider why Mazepa allied himself with Sweden. Poltavets says documentary evidence indicates that Mazepa's goal was to create an independent Ukraine; that his goal contradicted the political and geopolitical aims of the Russian state is something, which cannot be denied.

Moscow and Kyiv are also at odds over historic assessments of an artificial famine during the period of Soviet land collectivization in the early 1930's that claimed the lives of millions, particularly in Ukraine, Russia and Kazakhstan. Ukrainians consider it an act of genocide. The Kremlin says food was intentionally withheld from peasants as a class, but not any ethnic group, and therefore cannot be considered a violation of the United Nations Genocide Convention, which does not mention class.

Another point of contention is Ukraine's World War II guerillas, who fought Soviets and Nazis after mistakenly welcoming Germans as liberators. They are seen as freedom fighters by Ukrainian President Viktor Yushchenko and as fascist collaborators by his Russian counterpart, Dmitri Medvedev.

Last month, Mr. Medvedev announced creation of a government commission to help prevent what he said was falsification of history that harms the interests of Russia. Mr. Medvedev says Russians are increasingly being confronted with what is known as historic falsification, and perhaps many have noticed that these attempts are becoming increasingly harsh, mean, and aggressive.

In Ukraine, President Viktor Yushchenko condemned foreign and domestic attempts to brand Ivan Mazepa as a traitor. Mr. Yushchenko says enough to looking at history through foreign eyes. He calls on Ukrainians to look at Mazepa with their own eyes, with Ukrainian eyes.

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Source:

http://www.voanews.com/english/2009-06-25-voa33.cfm

Tags:

Viktor Yushchenko, Dmitri Medvedev, Russian history, Ukrainian history, Ivan Mazepa, Serhiy poltavets, Soviet Union, Nazi Germany, Genocide, World War II, United Nations Genocide Convention, Kyiv, Moscow, Kremlin, Global Development News,

Posted via email from Global Business News

A Reclusive Billionaire Gives Away His Fortune

One by one, speakers rose to toast the elderly gent with baggy pants and a shy, gaptoothed smile.

"Of course, he didn't wear a tie tonight," teased one. Another called attention to the honoree's cheap watch and the plastic bag that serves as his briefcase. The joshing at a Manhattan gathering would have been nothing out of the ordinary except that the man pulling a worn blue blazer over his head in mock modesty was none other than the onetime billionaire, Chuck Feeney.

Never heard of him? No surprise there.

Over the years, the frugal 76-year-old has made a fetish out of anonymity. He declined to name his foundation, Atlantic Philanthropies, after himself, registering the $8-billion behemoth in Bermuda to avoid U.S. disclosure laws. He lavishes hundreds of millions of dollars on universities and hospitals but won't allow even a small plaque identifying him as a donor.

"We just didn't want to be blowing our horn," he explains in a rare interview at his daughter's Upper East Side apartment. The party was to celebrate a biography of the elusive tycoon by Irish journalist Conor O'Clery, titled "The Billionaire Who Wasn't: How Chuck Feeney Secretly Made and Gave Away a Fortune," published last fall.

Feeney said he cooperated with the book and submitted to an interview because he is driven by a new public mission: nudging hedge fund heavies and silicon scions into "giving while living." It is the latest trend in philanthropy and one that he, more than anyone, jump-started several years before billionaires like Bill Gates and Warren E. Buffett followed suit.

Feeney, a founder of the conglomerate Duty Free Shoppers, said he wants to "set an example" to address "that layer up there of people," the ones, as he puts it, who have "a jillion dollars. . . . I mean, honestly, if you ask them, 'Tell me what you're doing with your money this week?' they couldn't spend a fraction of what they're accruing." Most foundations, set up after the donor's death, dribble out barely more than 5% of their assets each year, the legal minimum.

But Feeney, raised in a blue-collar Irish Catholic family in New Jersey, quietly transferred the bulk of his fortune to his foundation when he was 53. Then, eight years ago, he instructed his board to pay out every last dollar by 2016. So far: $4 billion down, $4 billion to go. Atlantic Philanthropies is spreading its wealth at the rate of more than $400 million a year, more than any U.S.-based family foundation apart from Bill & Melinda Gates and Ford.

As Feeney sees it, there is too much misery in the world to justify delay. "I'm not going to die until I can spend it," he vows with a merry chuckle. Feeney's biggest beneficiary has been Cornell University, which he attended on the GI Bill, earning spending money by selling sandwiches to fraternities. Over four decades, he has donated an astonishing $588 million to the Ithaca, N.Y., campus, almost all of it anonymously.

Many of Feeney's grants are still directed to traditional bricks and mortar -- $60 million for a Stanford biomedical center and $125 million for a UC San Francisco cardiovascular complex. But others are iconoclastic: Fighting homophobia among South African Muslims. Lobbying against the death penalty in New Jersey. Buying medical supplies for Cuban-trained doctors. Funding a Washington office for Sinn Fein during the Irish peace negotiations.

Feeney built his global enterprise through cutthroat competition and uncanny business intuition. He speaks fluent French and Japanese. And he still hop-scotches from Dublin to Da Nang seeding new projects.

But his demeanor is affable and unprepossessing and his conversational style is hesitant. He is allergic to introspection. Direct questions send him into vague digressions leavened with humorous asides. In the tiny world of stratospheric wealth, Feeney is a man of yin and yang: extravagant charity coupled with personal penny-pinching. "It's the intelligent thing to be frugal," says the erstwhile billionaire, who jokingly refers to himself as "the shabby philanthropist."

He once owned six luxurious homes from the French Riviera to Mayfair to Park Avenue. These days, he owns none, instead hunkering down in a cramped one-bedroom rental in San Francisco with his second wife, Helga, his former secretary. He raked in billions selling duty-free cognac, perfume and designer labels. But you won't catch Feeney in a Hermes tie or Gucci loafers. He once met the prime minister of Ireland with his drugstore glasses held together by a paper clip.

Feeney doesn't own a car and prefers buses to taxis. Until he turned 75, he flew coach. Now, making excuses for wobbly knees, he upgrades with frequent flier miles. Fine dining? "There are restaurants you can go in and pay $100 a person for a meal," he muses. "I get as much satisfaction out of paying $25. I happen to enjoy grilled cheese and tomato sandwiches."

Niall O'Dowd, a friend of Feeney and editor of Irish-America magazine, reflects: "The way he copes with his wealth is to never remove himself from his working-class persona. He keeps grounded by acting like it hasn't happened to him -- like basically he is still the same guy." At the book party, most of the guests were bused in from the Garden State: former classmates from St. Mary's of the Assumption High School and an extended clan of Feeney-Fitzpatricks, including two of his five children.

Feeney joked about his "rent-a-crowd" but, amid the toasts and roasts, seemed moved: "Who was it who said, 'My cup runneth over?' " He planted a kiss on the head of his 21-year old great-nephew, Dennis Fitzpatrick, who has cerebral palsy and uses a wheelchair. He autographed copies of the book while seated at a small table with Dennis by his side.

"He'd send my parents $50,000 for our college educations," nephew Daniel Fitzpatrick, 50, recalled. "But if you went out to have a beer with him, he'd check the bar bill. . . . If I left the light on in a bedroom, he'd say, 'By the way, you left a light on.' And I knew I'd better go up and turn it off."

O'Clery, former international business editor of the Irish Times, spent two years traveling with Feeney and investigating a financial empire that had been sheathed for decades in obsessive secrecy. He unfolds a story of ferocious entrepreneurship that operated, he concluded, "on the edge of legality but was never corrupt." Shortly after graduating from college, Feeney, who had served in the U.S. Air Force in Japan during the Korean War, moved to Europe. With a partner he knew from Cornell, Robert Miller, he began peddling duty-free liquor to sailors.

The two went on to sell cars to American soldiers based in Europe and Asia. Eventually, profiting from a postwar boom in tourism, they built Duty Free Shoppers into the biggest retailer of liquor and cigarettes in the world and a global purveyor of luxury goods. Their ingenious schemes stretched the limits of the duty-free concept. As O'Clery explains, Duty Free Shoppers allowed a tourist in Mexico, for instance, to peruse a catalog and choose a cashmere sweater to be shipped from Amsterdam to his home in the U.S. Leaving Mexico, he could declare the faraway sweater as "unaccompanied baggage" and avoid paying duty. Feeney and Miller operated with Swiss bank accounts and offshore headquarters in Lichtenstein, Monaco and the Netherlands Antilles. They registered assets in the names of Danielle, Feeney's French wife, and Miller's Ecuadorean wife, Chantal, as a precaution against the long arm of the U.S. Internal Revenue Service.

Today, Feeney makes no apologies. "Most large companies structure their affairs so that they minimize their tax payments," he says, rocking back on an armchair in his daughter's apartment. "As long as you do it within the law, it's OK." For Duty Free Shoppers, publicity was to be avoided at all cost, to ward off not just tax collectors but also competitors. "If you had a machine to make money, you wouldn't blow your horn and say copy me, copy me," says Feeney, whose annual share of dividends from the business reached $155 million in 1988, making him richer at the time than Rupert Murdoch, David Rockefeller or Donald Trump.

Why did he decide to give it away, leaving himself with a net worth then that dipped below $1 million? "I'm an easygoing guy," he shrugs. "I like to eat my grilled cheese and tomato sandwiches quietly. I don't like people to say, 'Look over there; he's eating a grilled cheese and tomato sandwich.' " In 1990, Feeney had separated from Danielle. And, in the divorce, she retained their mansions and luxury apartments, along with $100 million. "The wealth got to him," recalls his nephew, Fitzpatrick. "He got disgusted by it, in my opinion. He said, 'This expensive heavy-duty lifestyle doesn't fit me.' "

Feeney gave his children, friends and colleagues copies of Andrew Carnegie's 1889 essay "The Gospel of Wealth," in which the robber baron-turned-philanthropist admonishes rich men to use their fortunes to help others and "to set an example of modest unostentatious living, shunning display." In the realm of modesty, Feeney tended to extremes. For years, Atlantic Philanthropies staff couldn't tell their families where they worked. Beneficiaries, few of whom knew the origin of their grants, signed agreements acknowledging that the funding would halt if its source were revealed.

It was only in 1997 that the existence of Atlantic Philanthropies became public during the sale of Duty Free Shoppers to French luxury goods magnate Bernard Arnault. Court papers revealed that Feeney's share of the company had been transferred to a foundation. The news that a huge donor had surfaced -- bigger than renowned charitable institutions founded by the Pew, Lilly, MacArthur, Rockefeller and Mellon families -- rocked the philanthropic world, although many had long suspected something was afoot.

Today, though Atlantic Philanthropies lists its grants on its website, it still won't issue news releases touting accomplishments. Black tie thank-you dinners, along with plaques, remain verboten. Feeney's practical reason for not plastering his moniker on buildings is to attract matching donors who would want naming rights -- as was the case at Stanford with high-tech tycoon Jim Clark and at a UC San Francisco cancer facility with venture capitalist Arthur Rock.

Does Feeney have no ego, then? "It doesn't matter who put the building up," he says. "The important thing is that it happens." In Vietnam, he recounts with a chuckle, "the people at the Da Nang General Hospital felt so bad that we wouldn't put our name on the hospital that they painted it green" -- shamrock green. He pauses, adding, "Which used up a lot of paint."

Although his parents were American-born, Feeney's attachment to the land of his ancestors runs deep. The Republic of Ireland in the 1980s was plagued by high unemployment, a brain drain and the festering guerrilla war to the north. Anonymously, Feeney began pouring money into renovating Ireland's seven universities, along with two in Northern Ireland.

He offered $125 million for postgraduate research if the Irish government would match the amount, nearly 20 times what the Republic was spending a year. Soon, Ireland's best and brightest flocked to the new research institutes. In all, Atlantic Philanthropies has spent more than $1 billion in Ireland.

In 1993, O'Dowd, who had worked with Feeney to promote U.S. naturalization for Irish immigrants, asked him to join in what would become the Connolly House Group, named after the Belfast headquarters of Sinn Fein, the political arm of the Irish Republican Army. The small, secret group of Irish Americans offered the newly elected Clinton administration a back-channel to negotiate a cease fire between Britain and the Irish Republican Army.

"At the time, it was risky business to be seen 'talking to terrorists'--that was the label," said former Rep. Bruce Morrison, one of the group. Feeney was intensely involved in the negotiations that led Clinton to grant a visa to Sinn Fein leader Gerry Adams, and he funded a Washington office for Sinn Fein to the tune of $750,000.

"It was New Jersey working class meets Belfast working class," O'Dowd recalled of a secret meeting between Feeney and Adams in a Dublin safe house. "These two guys understood each other right away." The peace process was ultimately successful, and Feeney has since funneled millions into reconciliation programs in Northern Ireland. "The only way you're going to solve things with your friends or enemies is to sit down and talk to them," he says today. "It didn't seem right to me that Irish people were killing Irish people."

On the coffee table in his daughter's living room, Feeney opens Bill Clinton's recent bestseller "Giving." He turns to the chapter "How Much Should You Give and Why?" and reads from statistics derived from U.S. income tax data showing that if the top 14,400 taxpayers gave a third of their income, the total would be about $61 billion.

Feeney shakes his head. "People who wouldn't miss it," he muses. "Sixty-one billion in one year!" And why isn't it happening? "People traditionally collect money. I guess there is an attraction to be known as a wealthy person," he says. "It's not my role in life to tell them what they should be doing. . . . I'm just convinced if people gave money to things they've identified as being in the public interest, they'd get great satisfaction out of it."

Feeney mentions one of his favorite charities, Operation Smile, which sponsors surgeons to operate on children with cleft palates in developing countries. He tells of watching a little girl in a waiting room sitting with her hands covering her mouth. "I kept an eye on her," he recalls. "After she had the operation and she was smiling [like], 'It's not the ugly me you knew before. It's the new me.' "

On another occasion, he says, a man in a restaurant called him over and said, "Do you realize you educated me in this business? I had one of your scholarships . . . and here I am now, the general manager of this chain. " O'Clery, who hung out with Feeney for several years at P.J. Clarke's, the Manhattan pub, before broaching the topic of a book, attributes Feeney's generosity to growing up with charitable parents and in a neighborhood where people helped one another.

He calls his subject an "enigma. . . . He likes to make money, but he doesn't like to have it. He travels all over the world, but in a way, he's never left Elizabeth, N.J." Feeney suggests with a cryptic smile, "There's a thin line between sanity and the other side. Some people might even say the idea of giving money away is crazy."

For those folks, Feeney has a Gaelic proverb: "There are no pockets in a shroud."

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Source:

http://articles.latimes.com/2008/mar/08/local/me-feeney8

Tags:

LA Times, Atlantic Philanthropies, Duty Free Shoppers, Chuck Feeney, Bill Gates, Warren E. Buffett, founder of the conglomerate Duty Free Shoppers, Irish Catholic, Cornell University, Bernard Arnault, IRA, Sinn Fein, Korea, Japan, Vietnam, Global Best Practice,

Posted via email from Global Business News

What Can Replace Efficient Markets Theory?

The most interesting thing about the efficient markets hypothesis is not whether it is valid or not – clearly it is not – but how it has managed to remain so influential for so long. At a recent conference in London on the subject, organised by the CFA Institute, Professor Andrew Lo of Massachusetts Institute of Technology offered the audience a simple explanation: “physics envy”.

This was a reference back to the early inspiration of the Nobel economics laureate Paul Samuelson, who set out to find for economics a set of fundamental laws that would do for the dismal science what Newton’s laws of thermodynamics had done for physics, and from which a rigorous general theory with practical uses could subsequently be developed.

Using such building blocks as utility theory, equilibrium and the principle of no arbitrage (“no free lunches”), this led Mr Samuelson and his many successors to develop what we have come to know as the discipline of microeconomics that is universally taught to every finance and economics student at university and business school. The efficient markets hypothesis and the notion that stock prices follow a random walk are offshoots of this approach.

The attempt to bring order and an overarching theoretical framework into analysis of the seemingly unruly behaviour of financial markets was a temptation that has for years proved too great for academics (and many market participants) to resist, but it has turned out to be a long and largely fruitless journey. The problem of course, as Prof Lo has helped to demonstrate with his empirical studies of the random walk, is that the financial markets simply don’t lend themselves to deductive theory as well as the physical world.

If a theoretical approach is not firmly grounded, it is not surprising that the predicted consequences that flow from it should fail to show up consistently in the way that investors and markets actually behave. Behavioural finance has grown to become a popular alternative approach precisely because it does appear to explain more clearly how investors, individually and collectively, appear to act. In Prof Lo’s words: “Economic systems involve human interactions, which almost by definition are more complex than interactions of inanimate objects governed by fixed and known laws of motion.”

The real beauty of the efficient markets hypothesis, and the explanation for its longevity in the face of consistent empirical evidence that it is invalid, surely lies in its beguiling simplicity. As the future is uncertain and many of the key variables that concern investors cannot be predicted with confidence, a theoretical structure that appears to offer a way to live with uncomfortable reality has obvious attractions.

Prof Lo’s own response has been to develop what he calls the adaptive market hypothesis, which seeks to draw on the insights of neuroscience and evolutionary biology. The hypothesis aims to create a framework that seeks to relate the behaviour of financial markets to a number of different factors, including the emotional condition of market participants at different points in time and the current balance of advantage between competing groups of market participants.

“Market efficiency,” he says “cannot be evaluated in a vacuum, but is highly context-dependent and dynamic, just as insect populations advance and decline as a function of the seasons, the number of predators and prey they face, and their abilities to adapt to an ever-changing environment.”

What is at work in financial markets, he believes, is a Darwinian process of “survival of the richest”. The implications of this approach are interesting. One is that the relationship between risk and return will not be stable over time, which seems right both intuitively and empirically. Another is that, rather than markets becoming steadily more efficient over time, as early proponents of the EMH proclaimed, this world is one in which new profit opportunities will continue to emerge at a constant rate.

This is the engine that provides the continuing incentive for active managers to remain in the market. But they will need to be innovative and adaptive to changing market conditions if they are to remain successful, Prof Lo argues. One-trick ponies risk going out of business before their kind of market next comes around. Most important of all, investors cannot rely on the comforting message of the efficient market hypothesis that all you need to do to obtain an expected return is to take the appropriate level of risk.

The biggest problem with this new approach, as with all alternatives to EMH, including behavioural finance, is that it doesn’t give investors a simple metric for understanding what to do. Its great merit, however, is that it appears to relate to the complex and uncertain world that we all actually inhabit, something the efficient markets hypothesis has never done.

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http://globaleconomicnews.blogspot.com/2009/07/greenspan-fears-inflation.html

http://globaleconomicnews.blogspot.com/2009/05/good-news-in-music-business-no-really.html

Source: http://www.ft.com/cms/s/0/cf6d096a-6d7a-11de-8b19-00144feabdc0.html

Tags:

CFA Institute, Professor Andrew Lo, Massachusetts Institute of Technology, MIT, “physics envy”, behavioural finance, Global Economic News, Darwinian process, “survival of the richest”, “Market efficiency”, financial markets,

Posted via email from Global Business News

The New Great Game: Iran, China and the New Silk Road

Does it make sense to talk about a Beijing-Tehran axis? Apparently no, when one learns that Iran's application to become a full member of the Shanghai Cooperation Organization (SCO) was flatly denied at the 2008 summit in Tajikistan.

Apparently yes, when one sees how the military dictatorship of the mullahtariat in Tehran and the collective leadership in Beijing have dealt with their recent turmoil - the "green revolution" in Tehran and the Uighur riots in Urumqi - reawakening in the West the ghostly mythology of "Asian despotism".

The Iran-China relationship is like a game of Chinese boxes. Amid the turbulence, glorious or terrifying, of their equally millenarian histories, when one sees an Islamic Republic that now reveals itself as a militarized theocracy and a Popular Republic that is in fact a capitalist oligarchy, things are not what they seem to be.

No matter what recently happened in Iran, consolidating the power the Khamenei-Ahmadinejad-IRGC axis, the relationship will continue to develop within the framework of a clash between US hyperpower - declining as it may be - and the aspiring Chinese big power, allied with the re-emergent Russian big power.

On the road
Iran and China are all about the New Silk Road - or routes - in Eurasia. Both are among the most venerable and ancient of (on the road) partners. The first encounter between the Parthian empire and the Han dynasty was in 140 BC, when Zhang Qian was sent to Bactria (in today's Afghanistan) to strike deals with nomad populations. This eventually led to Chinese expansion in Central Asia and interchange with India.

Trading exploded via the fabled Silk Road - silk, porcelain, horses, amber, ivory, incense. As a serial traveler across the Silk Road over the years, I ended up learning on the spot how the Persians controlled the Silk Road by mastering the art of making oases, thus becoming in the process the middlemen between China, India and the West.

Parallel to the land route there was also a naval route - from the Persian Gulf to Canton (today's Guangzhou). And there was of course a religious route - with Persians translating Buddhist texts and with Persian villages in the desert serving as springboards to Chinese pilgrims visiting India.

Zoroastrianism - the official religion of the Sassanid empire - was imported to China by Persians at the end of the 6th century, and Manichaeism during the 7th. Diplomacy followed: the son of the last Sassanid emperor - fleeing the Arabs in 670 AD - found refuge in the Tang court. During the Mongol period, Islam spread into China.

Iran has never been colonized. But it was a privileged theater of the original Great Game between the British Empire and Russia in the 19th century and then during the Cold War between the US and the Soviet Union in the 20th. The Islamic Revolution may at first imply Khomeini's official policy of "neither East nor West". In fact, Iran dreams of bridging both.

That brings us to Iran's key, inescapable geopolitical role at the epicenter of Eurasia. The New Silk Road translates into an energy corridor - the Asian Energy Security Grid - in which the Caspian Sea is an essential node, linked to the Persian Gulf, from where oil is to be transported to Asia. And as far as gas is concerned, the name of the game is Pipelineistan - as in the recently agreed Iran-Pakistan (IP) pipeline and the interconnection between Iran and Turkmenistan, whose end result is a direct link between Iran and China.

Then there's the hyper-ambitious, so-called "North-South corridor" - a projected road and rail link between Europe and India, through Russia, Central Asia, Iran and the Persian Gulf. And the ultimate New Silk Road dream - an actual land route between China and the Persian Gulf via Central Asia (Afghanistan, Tajikistan, Uzbekistan).

The width of the circle

As the bastion of Shi'ite faith, encircled by Sunnis, Iran under what is now a de facto theocratic dictatorship still desperately needs to break out from its isolation. Talk about a turbulent environment: Iraq still under US occupation to the west, the ultra-unstable Caucasus in the northwest, fragile Central Asian "stans" in the northeast, basket cases Afghanistan and Pakistan to the east, not to mention the nuclear neighborhood -Israel, Russia, China, Pakistan and India.

Technological advancement for Iran means fully mastering a civilian nuclear program - which contains the added benefit of turning it into a sanctuary via the possibility of building a nuclear device. Officially, Tehran has declared ad infinitum it has no intention of possessing an "un-Islamic" bomb. Beijing understands Tehran's delicate position and supports its right to the peaceful use of nuclear energy. Beijing would have loved to see Tehran adopt the plan proposed by Russia, the US, Western Europe and, of course, China. Carefully evaluating its vital energy and national security interests, the last thing Beijing wants is for Washington to clench its fist again.

What happened to the George W Bush-declared, post-9/11 "global war on terror" (GWOT), now remixed by Obama as "overseas contingency operations" (OCO)? GWOT's key, shadowy aim was for Washington to firmly plant the flag in Central Asia. For those sorry neo-cons, China was the ultimate geopolitical enemy, so nothing was more enticing than to try to sway a batch of Asian countries against China. Easier dreamed of than done.

China's counter-power was to turn the whole game around in Central Asia, with Iran as its key peon. Beijing was quick to grasp that Iran is a matter of national security, in terms of assuring its vast energy needs.

Of course China also needs Russia - for energy and technology. This is arguably more of an alliance of circumstance - for all the ambitious targets embodied by the SCO - than a long-term strategic partnership. Russia, invoking a series of geopolitical reasons, considers its relationship with Iran as exclusive. China says slow down, we're also in the picture. And as Iran remains under pressure at different levels from both the US and Russia, what better "savior" than China?

Enter Pipelineistan. At first sight, Iranian energy and Chinese technology is a match made in heaven. But it's more complicated than that.

Still the victim of US sanctions, Iran has turned to China to modernize itself. Once again, the Bush/Dick Cheney years and the invasion of Iraq sent an unmistakable message to the collective leadership in Beijing. A push to control Iraq oil plus troops in Afghanistan, a stone's throw from the Caspian, added to the Pentagon's self-defined "arc of instability" from the Middle East to Central Asia - this was more than enough to imprint the message: the less dependent China is on US-subjugated Arab Middle East energy, the better.

The Arab Middle East used to account for 50% of China's oil imports. Soon China became the second-largest oil importer from Iran, after Japan. And since fateful 2003, China also has mastered the full cycle of prospection/exploitation/refining - thus Chinese companies are investing heavily in Iran's oil sector, whose refining capacity, for instance, is risible. Without urgent investment, some projections point to Iran possibly cutting off oil exports by 2020. Iran also needs everything else China can provide in areas like transportation systems, telecom, electricity and naval construction.

Iran needs China to develop its gas production in the gigantic north Pars and south Pars fields - which it shares with Qatar - in the Persian Gulf. So no wonder a "stable" Iran had to become a matter of Chinese national security.

Multipolar we go
So why the stalemate at the SCO? As China is always meticulously seeking to improve its global credibility, it had to be considering the pros and cons of admitting Iran, for which the SCO and its slogan of mutual cooperation for the stability of Central Asia, as well as economic and security benefits, are priceless. The SCO fights against Islamic terrorism and "separatism" in general - but now has also developed as an economic body, with a development fund and a multilateral economic council. The whole idea of it is to curb American influence in Central Asia.

Iran has been an observer since 2005. Next year may be crucial. The race is on to beat the clock, before a desperate Israeli strike, and have Iran accepted by the SCO while negotiating some sort of stability pact with the Barack Obama administration. For all this to happen relatively smoothly, Iran needs China - that is, to sell as much oil and gas as China needs below market prices, while accepting Chinese - and Russian - investment in the exploration and production of Caspian oil.

All this while Iran also courts India. Both Iran and India are focused on Central Asia. In Afghanistan, India is financing the construction of a US$250 million road between Zaranj, at the Iranian border, and Delaram - which is in the Afghan ring road linking Kabul, Kandahar, Herat and Mazar-i-Sharif. New Delhi sees in Iran a very important market. India is actively involved in the construction of a deep water port in Chabahar - that would be a twin for the Gwadar port built in southern Balochistan by China, and would be very helpful to landlocked Afghanistan (freeing it from Pakistani interference).

Iran also needs its doors to the north - the Caucasus and Turkey - to channel its energy production towards Europe. It's an uphill struggle. Iran has to fight fierce regional competition in the Caucasus; the US-Turkey alliance framed by the North Atlantic Treaty Organization; the perpetual US-Russian Cold War in the region; and last but not least Russia's own energy policy, which simply does not contemplate sharing the European energy market with Iran.

But energy agreements with Turkey are now part of the picture - after the moderate Islamists of the AKP took power in Ankara in 2002. Now it's not that far-fetched to imagine the possibility of Iran in the near future supplying much-needed gas for the ultra-expensive, US-supported Turkey-to-Austria Nabucco pipeline.

But the fact remains that for both Tehran and Beijing, the American thrust in the "arc of instability" from the Middle East to Central Asia is anathema. They're both anti-US hegemony and US unilateralism, Bush/Cheney style. As emerging powers, they're both pro multipolar. And as they're not Western-style liberal democracies, the empathy is even stronger.

Few failed to notice the stark similarities in the degree of repression of the "green revolution" in Tehran and the Uighurs in Xinjiang. For China, a strategic alliance with Iran is above all about Pipelineistan, the Asian Energy Security Grid and the New Silk Road. For China, a peaceful solution to the Iranian nuclear dossier is imperative. This would lead to Iran being fully opened to (eager) European investment. Washington may be reluctant to admit it, but in the New Great Game in Eurasia, the Tehran-Beijing axis spells out the future: multipolarity.

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Source:

http://www.atimes.com/atimes/China/KG26Ad02.html

Tags:

Beijing-Tehran axis, Iran's application, Shanghai Cooperation Organization (SCO), 2008 summit in Tajikistan, Uighur riots in Urumqi , mythology of "Asian despotism", Eurasia, Bactria, silk, porcelain, horses, amber, ivory, incense, Asian Energy Security Grid, Caspian Sea,

Posted via email from Global Business News

Russia and the US: An Uncertain Reset

Predictably, both Russia and the United States have portrayed the recent summit in Moscow as a success. Indeed, the summit did produce some positive signs: a resumption of serious arms control negotiations after years of neglect, an agreement on U.S. military overflights of Russian territory to Afghanistan, and the creation of the U.S.-Russia Bilateral Presidential Commission, a structure that could give the relationship a high-level institutional focus.

But much more is needed for the "reset" to be real. Most important, the United States must overcome what I first described in an essay from October/November 2007 as "the unmistakable impression that making Russia a strategic partner has never been a major priority." This will require not only new vocabulary -- such as "reset" -- but a new sense of priority toward Russia from the Obama administration.

Such an approach need not come at a cost to U.S. interests or values. But it will require an honest recognition that, since U.S. and Russian interests are not identical, Moscow is unlikely to accommodate Washington's concerns unless it sees something for itself in return.

The United States' priorities with respect to Russia are Afghanistan, Iran, and North Korea. Regarding Iran, neither Washington nor Moscow wants to see the clerical regime develop nuclear weapons. However, Iran is a major Russian trading partner and -- unlike Turkey, a U.S. ally -- offered no encouragement to separatist movements in the North Caucasus or support for pipelines that bypass Russia. Some in the Russian government fear that a Western rapprochement with Iran could disadvantage Moscow if Iranian gas were to become available for export to Europe.

Although Russian officials strongly oppose any military strike against Iran's nuclear installations, they privately acknowledge that such an attack could benefit Russia by increasing energy prices and creating a global backlash against the United States.

As for Afghanistan, Russia does not want to see the Taliban defeat U.S. and NATO forces and the country descend into chaos. Nevertheless, it is frustrated at being shut out of the Afghanistan after then President Vladimir Putin supported U.S. military intervention and encouraged the Northern Alliance to provide muscle to unseat the Taliban in 2001.

Moscow's priorities are different from Washington's: curbing NATO expansion, preventing the establishment of U.S. missile defense sites in Poland and the Czech Republic, and maintaining and enhancing Russia's influence in the post-Soviet region. At times, Moscow can sound like its own worst enemy, when, for example, it makes inflated claims that any expansion of NATO is unacceptable or demands privileged interests in its "near abroad."

However, notwithstanding the August 2008 war against Georgia, Moscow's practical ambitions are fairly limited -- especially in comparison with suspicions that Russia is seeking to reestablish the Soviet Union by coercion and force. It is hard to take Russian statements about dominance in the post-Soviet space seriously when even Russia's closest allies in the region -- Armenia and, particularly, Belarus -- are regularly defiant of Moscow's wishes. As for the Caucasus, although Russia did invade Georgia proper, it did so after its own forces in South Ossetia came under attack by Georgian troops. The Russian army then ultimately stopped short of entering Tbilisi and directly challenging the rule of Georgian President Mikheil Saakashvili. Even after the war, most of Russia's neighbors feel free to ignore its preferences and have not expressed fear of a Russian attack.

The United States would be wise, therefore, to make a distinction between Russia's nostalgia and bravado, on the one hand, and its actions and capabilities on the other. This would leave several options for developing common ground. The United States already recognizes that neither Georgia nor Ukraine is ready for NATO membership. (This will not change anytime soon, and few NATO members support accelerating the process.) On the question of missile defense in Europe, President Barack Obama and his advisers do not share the almost religious commitment of the Bush administration -- suggesting that a joint system may be possible, as is providing Russia with guarantees that if the Polish and Czech sites are eventually operational, they could not be used against Russian interests.

Given all this, Russia's immediate concerns can be addressed fairly easily without sacrificing anything of real importance to the United States. The modest results of the summit are less a function of U.S. interests or even Russian conduct -- which too often is counterproductive and provides good cause for those skeptical of cooperation -- and more due to the Obama administration's failure to make the "reset" a priority. In this respect, U.S. policy has not changed much since the Bush and Clinton administrations.

Before the summit, Washington promised a "reset" but sent a series of mixed messages. In May, NATO conducted military maneuvers in Georgia despite strong objections from Russia. Although there were good reasons to proceed with the exercises -- they were small-scale, planned before Russia's war with Georgia, and included an invitation to Russia to participate -- the Obama administration could have made a stronger effort to convince the Russians that the maneuvers were not directed against them. A good use of Obama's political capital would have been a presidential or cabinet-level conversation with Moscow to discuss U.S. motives and interests.

Then, days before the summit, Obama criticized Russian Prime Minister Vladimir Putin for having "one foot in the old ways of doing business and one foot in the new." Considering that Putin continues to influence Russian national security, it was predictable that Russia's political elite would interpret Obama's statement as endorsing the allegedly more liberal Russian president, Dmitry Medvedev, against Putin. This could hardly have been helpful to Medvedev, whose political legitimacy still depends on Putin's support and approval.

Meanwhile, Russian questions about Obama's intent only intensified when Michael McFaul, a top Russia specialist at the National Security Council, said, "We're not going to reassure or give or trade, you know, anything with the Russians regarding NATO expansion or missile defense." He went on to align U.S. "national interest" on these questions with "the interests of our allies in Europe." This statement was seen within Russia as a sign that the Obama administration was not prepared to negotiate on the issues most important to Russia and would instead settle these questions without regard to Russia's perspective and with input from new NATO member states considered antagonistic toward Russia.

In Moscow, however, this is not quite how Obama acted. All issues were on the table and -- to Russia's satisfaction -- the two presidents signed a statement affirming the link between strategic offensive and defensive weapons. This linkage was vague, but Medvedev cited it as an acknowledgement that Russian views counted. Then, to compensate for his earlier criticism of Putin, Obama praised the prime minister's "extraordinary work" while president. Still, this did not overcome the resentment of some on the Russian side over Obama choosing to spend one of his two nights in Moscow at a nightclub with his family rather than with his Russian hosts.

From Moscow's perspective, Russia offered a significant goodwill gesture in allowing U.S. military planes to fly over Russian territory on their way to Afghanistan -- but it did not receive a goodwill gesture in return. In fact, on the question of repealing the Jackson-Vanik amendment -- a move promised by the Obama administration and three preceding administrations -- U.S. Secretary of Commerce Gary Locke said in Moscow that Russia must remove restrictions on U.S. poultry and pork imports as "a significant first step" toward persuading Congress to repeal the act.

The Moscow summit was a useful step and certainly did no damage. However, it did not send a clear signal that Obama has decided to make the U.S.-Russian relationship a personal priority. Without such clarity about the president's commitment, the relationship is unlikely to progress significantly. The Bilateral Presidential Commission is helpful as an expression of presidential commitment but cannot be a substitute for it.

More fundamentally, the United States needs to think more strategically about what is required to turn Russia into a responsible stakeholder in international security. Early last century, the Treaty of Versailles excluded Germany and Russia from European security architecture and thereby contributed to a chain of events that led to the outbreak of World War II. Now, more than 20 years after the end of the Cold War, Russia remains outside this NATO-dominated structure.

Most officials in the United States and Europe were dismissive of Medvedev's call for a new European security treaty that would include Russia as a full partner. It is understandable that Western leaders are reluctant to do anything that might weaken NATO's mandate, especially when the alliance continues to play a role in providing security in places such as Afghanistan and Kosovo, but this should not obscure the fact that marginalizing a great power such as Russia could push it into seeking partners outside Europe, such as in China or Iran, to the detriment of U.S. interests.

Estrangement from the West would cost Russia dearly, but it would not be without costs to the United States either. An isolated Russia could make it harder to use such international institutions as the UN to advance U.S. interests, as well as provide the hint of an alternative to U.S. primacy, potentially emboldening other U.S. competitors and rivals. Pursuing a partnership with Moscow is difficult and frustrating, but neglecting Russia could severely compromise the pursuit of vital U.S. national interests tomorrow and in the years to come.

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Source:

http://www.foreignaffairs.com/articles/65203/dimitri-k-simes/an-uncertain-reset

Tags:

Russia, USA, Medvedev, Putin, Obama, Russia-US Summit, U.S.-Russia Bilateral Presidential Commission, Treaty of Versailles, NATO, Taliban, Iran, North Korea, Georgia, UN, Afghanistan, Kosovo, Germany, Global Development News, Europe, Ukraine, CFR, Armenia, Belarus,

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