Macroeconomic principles: risk-return

I have been in email contact with some of my old professors, and I thought I would share some of the discussion between us, as it is direct;y pertinent to the situation at hand. My last posting was a near-copy of an email I sent my former economics professors. I was uncertain of my understanding of the situation, and I asked the macroeconomists among them to criticize my analysis. I don't really have that good a grasp of the current situation, and what I do know is from reading the Wall Street Journal.


Will Melick is Gensemer Professor of Economics at Kenyon College. A link to his biography is here. He has worked as a Research Associate at the FED, and from having taken classes with him, I can say he knows his stuff.


His response to me goes as follows:

...I think your analysis is pretty much spot on. However, we do not yet have any evidence that velocity is falling, nor is the money multiplier. At the end of 2007Q2, M2 velocity was 1.90. At the end of 2008Q2, M2 velocity was 1.86. Not a precipitous drop.


I am very disappointed with the rush to a bailout. There is no need to act so rashly. Bernanke and Paulson are underestimating the resiliency of markets. Everything is frozen because everyone is waiting to see if the government is a big enough chump to overpay for mortgages and mortgage backed assets. For crying out loud, we have not even seen a decline yet in commercial bank lending. We would be much better of waiting and letting firms fail and saving the $700 billion to hand to the FDIC in the event that commercial banks start to topple and we have to honor the explicit guarantee of deposits. I do not think this will happen. I hope the legislation that is passed is loaded with so many dopey provisions (caps on executive pay, etc) that no firm participates. We likely will get a recession, but so what, one of these comes along about every 10 years. The fate of the U.S. economy simply does not hang in the balance. Paulson and Bernanke only talk to financial types, of course those types think the world is ending because their livelihoods are at stake as the bloated financial sector starts to shrink. This is democracy at its worst. Congress should resist the "doomsday" gun that is being pointed at its head. The election year only compounds the problem. I am very disappointed.

Will Melick also has a podcast explaining the current economic situation, as well as possible solutions, explained in layman's terms. I can't recommend it enough.


Another economist-friend of mine sent me an article by Thomas Sowell, an influential economic and social theorist, which I'll repost here in case the link goes down:

SOWELL: A political 'solution': Part II

Thomas Sowell
Friday, September 26, 2008

COMMENTARY:
Estimates how much money a government program will cost are notoriously unreliable. Estimates of the cost of the current bailout in the financial markets run into the hundreds of billions of dollars, and some say it may reach or exceed a trillion.
Many people have trouble even forming some notion of what such numbers as billion and trillion mean. One way to get some idea of the magnitude of a trillion is to ask: How long ago was a trillion seconds?
A trillion seconds ago, no one on this planet could read and write. Neither the Roman Empire nor the ancient Chinese dynasties had yet come into existence. None of the founders of the world's great religions today had yet been born.
That's what a trillion means. Put a dollar sign in front of it and that's what the current bailout may cost.
Will that money be spent wisely? It is theoretically possible. But don't bet the rent money on it or you could end up among the homeless.
Whenever there is a lot of the taxpayers' money around, politicians are going to find ways to spend it that will increase their chances of getting re-elected by giving goodies to voters.
The longer it takes Congress to pass the bailout bill, the more of those goodies will find their way into the legislation. Speed is important, not just to protect the financial markets but to protect the taxpayers from having more of their hard-earned money squandered by politicians.
Regardless of what Sen. Barack Obama or Sen. John McCain may say they will do as president, after a trillion dollars has been taken off the top there will be a lot less in the federal treasury for them to do anything with.
Already Sen. Christopher Dodd, Connecticut Democrat, is talking about extending the bailout from the financial firms to homeowners facing mortgage foreclosures — as if the point of all this is to play Santa Claus. The huge federal debts we already have are the ghosts of Christmas past.

Senate Banking Committee Chairman Sen. Christopher Dodd, D-Conn., center, is followed by reporters as he returns to his office on Capitol Hill in Washington, Monday, Sept. 22, 2008. Associated Press.

Financial institutions are not being bailed out as a favor to them or their stockholders. In fact, stockholders have come out worse off after some bailouts.
The real point is to avoid a major contraction of credit that could cause major downturns in output and employment, ruining millions of people, far beyond the financial institutions involved. If it was just a question of the financial institutions themselves, they could be left to sink or swim. But it is not.
We do not need a replay of the Great Depression of the 1930s, when the failure of thousands of banks meant a drastic reduction of credit — and therefore a drastic reduction of the demand needed to keep production going and millions of people employed.
But bailing out people who made ill-advised mortgages makes no more sense that bailing out people who lost their life savings in Las Vegas casinos. It makes political sense only to people like Mr. Dodd, who are among the reasons for the financial mess in the first place.
People usually stop making ill-advised decisions when forced to face the consequences of those decisions, not when politicians come to their rescue and make the taxpayers pay for decisions the taxpayers had nothing to do with.
The Wall Street Journal, which has for years been sounding the alarm about the riskiness of Fannie Mae and Freddie Mac, recently cited Mr. Dodd along with New York Sen. Charles Schumer and Massachusetts Rep. Barney Frank, also Democrats, among those on Capitol Hill who have been "shilling" for these financial institutions, downplaying the risks and opposing attempts to restrict their free-wheeling in the mortgage market.
As recently as July of this year, Mr. Dodd declared Fannie Mae and Freddie "fundamentally strong" and said there is no need for "panicking" about them. But now that the chickens have come home to roost, Mr. Dodd wants to be sure to get some goodies from the rescue legislation to pass out to people likely to vote for him.
Don't make any bets on how this situation will turn out - except that we can predict politicians will blame the "greed"of other people. You can bet the rent money on that.
Thomas Sowell is a nationally syndicated columnist.

This clairvoyant and concise column pretty much sums up my opinion of the situation. My only question is whether a bailout is necessary at all. After all, if we use unemployment or economic growth as indicators, the situation is nothing like the Great Depression. Furthermore, the FED is loosening the money supply, while at the beginning of the Great Depression they actually contracted the money supply severely in order to curb speculation. In either event, I find it ridiculous that we are contemplating helping out the idiots who obtained adjustable-rate mortgages when the interest rate was low, expecting it to stay that way forever. The entire model for macroeconomic activity, boiled down to only its most fundamental part, is the dichotomy of risk-return. These people took a big risk, and the decision bit them in the ass. They should be made to suffer the consequences.

Collapse? Not quite...

It's been quite awhile since I wrote anything, because I've been trying to wrap my head around the financial crisis taking place.  The following is my understanding of what has been happening the past few months...

My impression of the situation is that the FED set a somewhat dangerous precedent when it bailed out the investment bank Bear-Stearns, essentially establishing the public perception that gains from taking risks are private, while the losses are public.  This would, naturally, increase moral hazard.  If the FED is perceived as being only a little bit more likely to bail a failing firm out, a firm will be marginally more likely to make risky business-decisions.  Which is especially bad in troubled economic times...

Fannie and Freddie failed because they agreed to underwrite risky subprime mortgages after the government, in 1992, essentially mandated that the two organizations underwrite subprime mortgages so that low-income bad-credit home buyers could have a chance at a part of the American dream.  Lo and behold, when the interest rate shot up last summer, and subprime mortgage dependent home-buyers started defaulting left and right, these securities they had underwritten became essentially worthless.  Bye-bye, Fannie and Freddie.

The FED wasn't going to make the same mistake with Lehman Brothers, and it (wisely, I believe) allowed that investment bank to fail.  Everything would have been peachy, except that money markets started essentially drying up because investors were scared.  For instance, the LIBOR doubled overnight, which is historically unprecedented, and banks actually stopped lending to each other, which is unheard-of.  AIG insurance had previously issued many credit-default swaps (or subprime mortgages), and as a result was having to pay the collateral in massive amounts because they were losing their bets in massive amounts.  AIG started frantically borrowing money in the hope of paying off their debts from the credit-default swaps, to such an extent that its credit-worthiness rating was downgraded.  Remember commercial paper?  A substantial portion of the commercial paper held was issues by AIG, and thus a whole lot of people ran the risk of getting screwed if AIG became financially insolvent.  Money markets would have dried up  So the financial markets froze up, because a lot of people were invested in AIG's debt, and as a result the velocity of money plummeted.  Bernanke and Paulson concluded that it was a better option to loan AIG massive quantities of money at a high interest rate (making a pretty penny if AIG pulled through) than have the economy potentially collapse, and that pretty much leaves us where we are today.  Whew.

Arguments and counterarguments

In response to my previous posting, a fb friend said this:

The reason looking at historical voting records of each party doesn't really work is because the parties have changed greatly in the past century. Where once democrats generally included slave owners in the deep south (founded as it was by jefferson, madison, etc), that demographic has pretty much been swept away since the civil rights movement. And where once an intellectual from illinois could comfortably call himself a republican, it is safe to say that that, too, has changed. The current republican party, and this administration in particular, upholds few, if any, of the many moral prinicples it uses to get votes, demonstrating a startling level of hypocrisy. Smaller government? They've gone out of their way to put the unitary executive theory into work, trying their best (as many of them did during the nixon administration) to make the president a quasi-monarch, while tapping our phones for freedom, altering well defined laws of torture and habeas corpus, and putting our country into greater and greater debt. Gay marriage? While Karl Rove and Dick Cheney were openly opposing gay marriage, making it a huge national issue during election election years to distract their homophobic base from any real issues, they consistently asked for 'privacy' when it came to their own families. While everyone knows that Cheney's daughter, Alan Keye's daughter, Newt Gingrich's daughter, etc are open lesbians quietly loved and supported by their families, few know that Karl Rove, while trying to put a gay marriage ban in the constitution, often visited his gay stepfather (who he always called dad) and his stepfather's partner in Palm Springs. Family values? One can only imagine the unholy hate-filled shit storm that would have spewed from the right had a democrat announced a female vp with 5 kids, a six month old with downs syndrome, and a pregnant 17yr old. In short, the republican party of today stands for nothing and just wants power, nothing else.

I figured it was a shame typing up a long, politically-intelligent response and not posting it to my blog, so here is my response, in full:

Why so partisan? The whole purpose of political debate is to further the discourse, ultimately developing a policy that is acceptable to most representatives of both parties, The whole reason I wrote this was that Mr. Herbert's arguments are so blatantly partisan that anybody with half a brain could poke holes in them. Which I proceeded to do. Now, I am neither a Republican nor a Democrat. Bigger government scares the shit out of me, as does God in government, as does the nanny state, as do countless other things about both parties. Your point about the evolution of the parties is valid, and I agree wholeheartedly that neither party today is the same as it was 25, 50, or 100 years ago. I found the argument that long-past conduct is a justification for present political control to be ludicrous. Thus Mr. Herbert's insistence that Liberals have a track record to be proud of is not quite true; the modern parties bear no resemblance to those of 40 years ago. Republicans have co-opted the JFK-style Liberalism, and the old-Democrats have evolved (or regressed, depending upon how you feel about it) to Progressivism. It is ridiculous to claim that the modern Democratic party should be proud of FDR's accomplishments, just as it is pointless to suggest that modern Republicans bear any similarity to those of Lincoln's day. If you want to term the evolution of party ideals as hypocrisy, that is fine by me, but I would ask that you recognize that the Democrats are just as guilty of this hypocrisy as the Republicans, and that you consider which is more likely top be successful: a party that stays stagnant, never changing its ideals, or a party that evolves to meet its constituents' wants. I agree that the current administration has been awfully hypocritical, saying one thing and then doing another. However, I invite you to consider the complexities of the issue: would the Democrats have attacked Bush as lax on security if he had not taken precautions, like wiretapping? Although the courts have ruled that habeas corpus extends to enemy combatants, (a bad decision in my view), before that ruling the law only extended to citizens within their own country; enemy combatants without a country were not protected. Historically, in times of war the president has always had the power to curtail certain civil liberties for the sake of security. The courts have taken a new stand, hurting Bush a lot, but restrictions on freedom such as wiretapping are nothing new. Remember that the government rounded up Japanese during WWII and interned them. These restrictions of freedom by the Federal government are nothing new. Although I agree that unbridled executive power is extremely dangerous, speaking as an individual, it's ok with me if they wiretap my phone and subject the tapes to computer analysis to make sure I'm not a terrorist. Just a personal opinion, and I completely see how that wouldn't be ok with you. Debt? Look at the government's fiscal deficit over the past 75 years. We were in debt most of the time. Clinton's surplus was the happy result of increased taxes and a new, flourishing economic sector. I agree that the current debt is bad, (lots of crowding out), but it's nothing new nor particular to the Republican party. Lastly, regarding gay marriage, abortion, and what people do with their genitals in general: I think it's an awful shame people care about this so much. John Edwards had to drop out of the race because it was revealed he had cheated on his wife. If Bill Clinton hadn't lied under oath, I wouldn't care one hoot about his infidelities. Giuliani would have been a great president, I think, but his past spouses reflected poorly upon him. I think that in general, we should all care a whole lot less about what politicians do in their spare time, and instead focus on their policies.

Palin's actions can all be framed in her belief in the right to life and the wrongness of abortion. That is her in a nutshell. She appeals to a lot of people because, well, a lot of people think abortion is wrong. Very wrong. Most Democrats would say they don't think abortion is a walk in the park, I think. What could they do if elected to overturn Roe v. Wade? Nothing, in practical terms, because that was a Supreme Court decision. Personal views, in this case, aren't worth a hoot. As for Republicans trying to define marriage as between a man and a woman, while at the same time having gay children, isn't the simplest reason because they really, really believe in it? Enough to put it above family? I'd like to think that they wouldn't hurt their children just to get votes, but it could just be me. As for a hate-filled shit-storm, as you so-eloquently put it, I don't myself know, but I find it likely that the Republicans could use that as a political leverage device, just as the Democrats are currently doing so wholeheartedly. Again, just a hypothesis.

The whole point of this email is not to support Republicans, because many of the things they do are not supportable. I am merely trying to keep you from demonizing the opposition party. Aside from the political spin in an election year, a crime of which both parties are guilty, their views are founded upon real principles, just as are the Democrats. While I don't agree with all the arguments I have made here, at least I am able to remove myself from the discourse sufficiently to approach the discourse compassionately.

In response to Mr. Herbert

A facebook friend of mine, who shall remain anaoymous, posted an article that so too me back that I felt compelled to respond.  The article is Hold Your Heads Up, by Bob Herbert, and it's so monumentally stupid that I have to quote it here, in full, before offerng refutations.  These refutations, I would like to believe, are common sensical, and at times I will refer to econometric studies that I have read and read about.  So without further ado, here is the article as quoted by my friend:

Hold Your Heads Up 

By BOB HERBERT

Ignorance must really be bliss. How else, over so many years, could the G.O.P. get away with ridiculing all things liberal?

Troglodytes on the right are no respecters of reality. They say the most absurd things and hardly anyone calls them on it. Evolution? Don’t you believe it. Global warming? A figment of the liberal imagination.

Liberals have been so cowed by the pummeling they’ve taken from the right that they’ve tried to shed their own identity, calling themselves everything but liberal and hoping to pass conservative muster by presenting themselves as hyper-religious and lifelong lovers of rifles, handguns, whatever.

So there was Hillary Clinton, of all people, sponsoring legislation to ban flag-burning; and Barack Obama, who once opposed the death penalty, morphing into someone who not only supports it, but supports it in cases that don’t even involve a homicide.

Anyway, the Republicans were back at it last week at their convention. Mitt Romney wasn’t content to insist that he personally knows that “liberals don’t have a clue.” He complained loudly that the federal government right now is too liberal.

“We need change, all right,” he said. “Change from a liberal Washington to a conservative Washington.”

Why liberals don’t stand up to this garbage, I don’t know. Without the extraordinary contribution of liberals — from the mightiest presidents to the most unheralded protesters and organizers — the United States would be a much, much worse place than it is today.

There would be absolutely no chance that a Barack Obama or Hillary Clinton or Sarah Palin could make a credible run for the highest offices in the land. Conservatives would never have allowed it.

Civil rights? Women’s rights? Liberals went to the mat for them time and again against ugly, vicious and sometimes murderous opposition. They should be forever proud.

The liberals who didn’t have a clue gave us Social Security and unemployment insurance, both of which were contained in the original Social Security Act. Most conservatives despised the very idea of this assistance to struggling Americans. Republicans hated Social Security, but most were afraid to give full throat to their opposition in public at the height of the Depression.

“In the procedural motions that preceded final passage,” wrote historian Jean Edward Smith in his biography, “FDR,” “House Republicans voted almost unanimously against Social Security. But when the final up-or-down vote came on April 19 [1935], fewer than half were prepared to go on record against.”

Liberals who didn’t have a clue gave us Medicare and Medicaid. Quick, how many of you (or your loved ones) are benefiting mightily from these programs, even as we speak. The idea that Republicans are proud of Ronald Reagan, who saw Medicare as “the advance wave of socialism,” while Democrats are ashamed of Lyndon Johnson, whose legislative genius made this wonderful, life-saving concept real, is insane.

When Johnson signed the Medicare bill into law in the presence of Harry Truman in 1965, he said: “No longer will older Americans be denied the healing miracle of modern medicine.”

Reagan, on the other hand, according to Johnson biographer Robert Dallek, “predicted that Medicare would compel Americans to spend their ‘sunset years telling our children and our children’s children what it was like in America when men were free.’ ”

Scary.

Without the many great and noble deeds of liberals over the past six or seven decades, America would hardly be recognizable to today’s young people. Liberals (including liberal Republicans, who have since been mostly drummed out of the party) ended legalized racial segregation and gender discrimination.

Humiliation imposed by custom and enforced by government had been the order of the day for blacks and women before men and women of good will and liberal persuasion stepped up their long (and not yet ended) campaign to change things. Liberals gave this country Head Start and legal services and the food stamp program. They fought for cleaner air (there was a time when you could barely see Los Angeles) and cleaner water (there were rivers in America that actually caught fire).

Liberals. Your food is safer because of them, and so are your children’s clothing and toys. Your workplace is safer. Your ability (or that of your children or grandchildren) to go to college is manifestly easier.

It would take volumes to adequately cover the enhancements to the quality of American lives and the greatness of American society that have been wrought by people whose politics were unabashedly liberal. It is a track record that deserves to be celebrated, not ridiculed or scorned.

Self-hatred is a terrible thing. Just ask that arch-conservative Clarence Thomas.

Liberals need to get over it.

Aside from the blanket statement about Republicans, which do nothing to further the American political discourse, Mr. Herbert speaks of the second Amendment as if its negativity were a foregone conclusion.  It is a fact that gun ownership saves lives every year that might not be saved if the would-be victims of crime were forced to resort to calling the police.  It is a fact that in countries in which guns are banned, like Britain, deaths by stabbing have increased dramatically.  (Fancy that -- some people will kill others, regardless of whether the government steps in and bans their method of choice.)  Personally, were I robbed, I'd prefer to be able to equalize the level of force-potential with a gun than have to worry about my personal strength in a gun- or knife fight.  But I disgress.

And fancy a liberal, changing his or her status to support the death penalty?  Wonder of wonders!  It's apparant that Mr. Herbert didn't bother actually researching the issue.  In studies of this issue, the death-penalty has been found to be a statistically significant reducer of crime (fancy that!  Criminals are worried that they'll get killed!).  Though it is a morally contentious issue where one could make grounded arguments on either side of the issue, by making a blanket statement and deriding his opponents Mr. Herbert only shows the weakness of his own views.

Mitt Romney made an insulting statement about Democrats at the Republican convention?  The surprises just keep coming!  I can't believe that he would do such a thing, in a ceremony that 99% fluff and 1% actual politics.  Well, at least the Democrats didn't do anything of that sort...

Civil rights?  Yes, liberals fought for equality among races, against other Democrats.  While there were Republicans opposed to the Civil Rights Act, a quick examination of the percentages of Democratic and Republican support reveals:

"The original House version:^[9]

• Democratic Party: 152-96   (61%-39%)
• Republican Party: 138-34   (80%-20%)

The Senate version:^[9]

• Democratic Party: 46-21   (69%-31%)
• Republican Party: 27-6   (82%-18%)

The Senate version, voted on by the House:^[9]

• Democratic Party: 153-91   (63%-37%)
• Republican Party: 136-35   (80%-20%)"

As can be clearly seen from a quick examination of these percentages, the Republicans were more for the Civil Rights Act than the Democrats.  And let's not forget which party Abe Lincoln was from.  Nor ought we to forget that the Southern Democrats were the ones largely responsible for the Civil War;  those same Dixiecrats voted in droves against the Civil Rights Act.

Social Security, Unemployment Insurance, Medicare and Medicaid were all Democratic endeavours, true, and were all fiercly opposed by Republicans.  And such programs unambiguously decrease the incentive to work, and increase adverse selection and moral hazard amongst the 'insured'.  It has been proven -- proven -- that unemployment insurance, like Welfare, decreases the incentive to work, thereby prolonging the very unemployment it seeks to relieve.  Remember Welfare reform in 1996?  That was a Republican initiative.  Social security is a benefit to society only in that it forces present-consumption-biased consumers to save a lttle -- a very little -- for the future.  Let's remember that the real value of the money a citizen puts into Social Security over a lifetime actually decreases.  Significantly.  All of Mr. Herbert's social programs are net detriments to society, and all have had consequences far beyond their original reach.  Google Medicare / Social Security / Welfare deficit, if you want to teach yourself something.

I agree with one point the author makes, that "[w]ithout the many great and noble deeds of liberals...  America would hardly be recognizable to today's young people".  But in my view, the author has failed to mention a singal significant accomplishment that liberals can be proud of, aside from part of the Democratic party's noble support of the Civil Rights Act.  All of his examples follow a simple formula:  restrict basic liberties and rights, and attempt to legislate around the consequences, with an ultimate 'solution' that is worse than the problem it was originally trying to fix.

I could go on.  In fact, I think I will.  Head Start was a noble cause, for certain, aside from the fact that it has been econometrically demonstrated to be a failure.  Food Stamps restrict the freedom to purchase of the poor, forcing them to spend their handouts on food rather than what they really want.  I have a feeling legal services were provided in this country with the advent not of Liberals, but of lawyers.  I have no idea how Liberal government has made children's toys safer.  The workplace is safer, yes, but with the cost of a restriction of individual freedom.  (For the record, this is one thing that I think Liberals can be proud of, but I'm on a rol, and just wanted to point out the two sides to this issue.)

As a last point, I would like to say that there are many, many things modern of which Liberals (or more rightly termed Progressives) can be proud.  I am not a Republican, though I'll admit that of late I vote like one.  The reason this article so infuriated me is that it actually weakens Liberals' position on issues where they have a lot to contribute towards a bipartisan conslusion.  Far from helping his party I believe Mr. Herbert has pushed undecided voters away from the Democratic party.

Should I stay or should I go?

Now comes the big question for me: should I stay in the political market, or should I cash out and reap my sweet reward? McCain futures were currently selling at 51.5-52, which is their lifetime high. It's also pretty high considering that McCain and Obama do not split this market 50-50 (their prices do not add up to 100) -- a small discount exists for unlikely possibilities, like Hillary somehow getting the nomination, or McCain dying. If I cash out now, closing my positions and having a check mailed to me, I win; I have made about 60% of my original investment, which is damned good considering the short time I've been involved in the market. If McCain is selling at an even 50.0, with each share worth $5, I would gross $4.95 per share, because the trading fee is only $0.05. Good returns by any measure.


Another option is to try to make marginal gains from short-term fluctuations in price between McCain and Obama. This is an inherently dangerous strategy, but it has its merits. If this price changes by as little as 0.6 (or $0.06) I stand to make a small gain. But there is a whole lot of information that I cannot know that is being taken into consideration by this market; by my reasoning, using a short-trading strategy, I stand to lose as much if not more than I do to gain.


There is also the fact that the debates are fast approaching, and I think the Republicans are going to get trounced, to put it bluntly. Obama is a far more elegant speaker than McCain, policy questions aside, and I think that despite Palin's energy her lack of experience is really going to hurt her in the VP debate. Which again, is telling me that I should sell McCain now, possibly even more than I have, in the expectation that the price will drop by a few points during the debates. This strategy is very attractive, to me, but the reality is that it is far more short-term and far less certain than the strategy I have adopted thus far. Which fills me with a nervous excitement.

Convergence

First, a quick update on the prediction markets. Lo and behold, my thinking a few months back seems correct; $3.20 / $10 = 32% was far too low a value for the McCain stock contracts. The appreciation I am seeing on my assets is the reward for my clairvoyance. Since a picture is worth a thousand words, I'll give you the latest intrade charts, and say that Palin is energizing the Republican party, or at least the markets.







The prices of the two contracts -- and therefore the relative probabilities that each candidate will win, as assessed by the market -- are converging. The media's opinions -- read educated spin -- are giving way to market participants' experiences of the candidates, their platforms, and the implications of the policies they would enact if elected. When I started drafting this piece a few days ago, what I said was: "My prediction, based purely on instinct and a coin flip, is the McCain will edge closer to the 50% line as the weeks pass. Bottom line: I think this contract is undervalued, resulting in a long-selling opportunity that is greater than the trading fee, at least as of today". Oh well. I guess the market outpaced me.


What is particularly interesting is the performance of the markets over the past week. I haven't actually examined those charts with any scrutiny yet, but if I had to make an educated guess, (and I do), it's that Obama will have slipped a couple of points after some gaffes he made that have riled the Repiblican party, and women in general, at least according to the media. Something about comparing Palin to a pig, though I don't follow these things closely...






Fancy that, right again! I amaze myself sometimes. Though I dare say that anyone should have been able to see that a selling price of 32/100 for McCain was substantially undervalued, unless he was giving undue weight to say the probability that McCain would have to drop out due to health issues (let's face it -- he is pretty old). I predict Obama won't climb more than approximately five points over McCain for the foreseeable future, assuming that no one in the McCain camp makes a political faux pas.

A few notes...

I've been away for a while, so for my 3.5 readers, um, sorry? A lot has happened this week, including the DNC / RNC, as well as some interesting occurrences on the prediction markets. So let's take a look at past week or so, and try to disentangle the facts from the fictions.


The big no-brainer was that Obama secured his party's nomination, and that, as far as these things go, the outcome of the convention was as the markets predicted. Now, I say that in lieu of the gloomy commentary of the right-wing pundits, who are claiming that the Clintons didn't endorse Obama wholeheartedly enough, and that Obama's wife was the only one who seemed to have any affection for him. (Methinks the audience was pretty excited...) Underneath this rhetoric hides a larger point: Obama does not have as many political allies as McCain does, and he will have to woo a significant number of moderate voters that heretofore supported Hillary if he wants to stand a chance come November.


On the Republican side, McCain chose Palin as his VP. Palin is unknown, unlike Biden, and has some spots on her candidacy that will be hard to get out. Most significant is that her illegitimate grandchild has already been the target of many attacks that ask, essentially, how will Pailn help run the country if she can't even keep her daughter in check? When you frame the issue in light of Palin's belief in life over abortion, which presumably extends to her family, the issue can be used to attract fundamentalist Christians, which I think is the best way to turn an assuredly-bad outcome into a potentially-good one. Other notable qualities of Palin include her union-husband, her previous membership in an Alaskan-secession group, and her Regeanesque attitude towards business and government. The left-wing pundits are having a field-day with her, naturally, and though I feel somewhat sorry for the Palins as a family, it's to be expected. Political campaign ads this season have been dirty enough on both sides of the aisle, and any imperfection in one's personal life seems, sadly enough, fair game.


I am struck by a couple of interesting points regarding Palin. Those on the left are assaulting her lack of experience, which is rather amusing considering Obama's roughly-equal level of political practice. Hypocrisy is a powerful tool in politics, especially when one believes in it himself. Palin is going to snag a lot of ex-Hillary voters, because she is a woman, a feminist, and because her husband is a big union-man. At the same time. it seems probable that her strong conservative convictions will help the Republicans keep right-wingers going to the polls.


What have the markets thought of these recent developments? An examination of the prediction markets over the past two weeks reveals that Obama has gained overall, with a notable drop over the past few hours. McCain's price has dropped over the past three days, although the overall trend is up.



A look at the futures markets over the past 100 days shows the overall trend. McCain has been steadily gaining value, and Obama losing value.





Now, the question is, who will win? Although I can fit a trend to the data according to the previous data-points, it will not be that reliable an indicator of the future, because this prediction market is influenced not so much by the past price as by what market participants think the future will be, now.


Footnote: For those wondering, the green bars at the bottom represent the volume traded on a particular day. As you can see, the volume of each security increased dramatically during the lead-up to the respective party conventions. This makes sense -- people get excited.