Life from a saint's perspective

Saturday, September 30, 2006

The Macroeconomics of Sport

"Ater he and his team successfully bid for the 2010 Commonwealth Games Indian Olympic Association President Suresh Kalmadi has now set his sights on bringing the 2016 Olympic Games to New Delhi.".... so blared the headlines one fine morning...

As always, it evoked mixed responses....A political party was screaming for his neck.. What was the need to spend so much on matters of trivial importance like Commonwealth Games and the Olympics, when millions are battling far more grave problems like hunger and poverty? Yet another group was buoyant... This will put our country on the world map! Millions of foreign tourists will visit our country and spend their money here, buying our products..

To confess, I was on the skeptical side. Forget the fact that it has been a long time since we won even a single Olympic gold..... Does the huge investment demanded by mega events like Olympics and Commonwealth actually make sense? We could conduct a simplistic event study to verify using emperical evidence whether hosting the Olympics has had any significant bearing on the GDP growth rate.

Event: Hosting the Olympics
Variable: GDP growth rate (pre-event vs post-event)
Time window: +/- 3 years

Here, we have taken the growth rate as the variable because it takes care of scale effects. Thus, while computing the average results across all hosting countries we can assign equal weightages to all of them.

The results of this study are startling!!! We see from the table that in fact, hosting the Olympics is a huge liability. It retards GDP growth rate by 0.07% We can observe from the table that this is in fact a conservative figure. By excluding the US from the table, the GDP growth actually slows down by a much larger rate of 0.76%.

We could also conduct a similar study for an event on a much smaller scale - The Cricket World Cup. The results we obtain in this case are totally contradictory. We can see a net benefit of 0.43% for the host country, on an average...

What are the causes for the above observations? I wouldnt dare to offer an explanation....
References : (Event Study)


Status Quo, the way to go?

A True Account...

From his office on the top floor, Jeff Paulson could see the sun setting over the skyline. It was symbolic of his life. For outsiders, Paulson owned the world. An MBA degree from one of the Ivy League bschools, an enviable track record, nice guy, happily settled down in life. But as the recently appointed CEO of a multinational tobacco corporation, he alone knew his problems. He was due to address his board in a couple of minutes…. A steely resolve gripped him as he took his steps towards his destiny. “If you do this, things will never be the same again. You will never know how things would have worked out…” Lauria’s words echoed in his mind….

In a brief period, this was the fifth company Paulson was taking charge of (or maybe sixth…no one keeps count..). He hated that. The first three at least were amicable, but the last one had been particularly ugly. After a period of two years, in one of which he made the cover of Business Week for the best CEO in town, his board had thrown him out in favor of a new superstar CEO. It hurt bad. Paulson was not the normal CEO you talk about in Principal Agent problems. He was a specimen who genuinely loved his company and its shareholders. When he was at the helm of a company, he’d never even consider looking at other options, however attractive they seemed to be. The job of the CEO was like marriage to Paulson, sacrosanct and above everything…..even himself….

US Tobacco seemed to be the perfect choice for Jeff. And they had just thrown out their CEO. If this wasn’t a symbiotic relationship, what could be? After months of pulling strings and playing the right cards, Jeff finally had the top job. He hit the books with a vengeance, looking for ways to improve the financials. Stock prices had been low, it was evident the company was undervalued. There was a huge stream of cash inflows. Jeff drew up a plan to diversify into the food business. For months, he and his dedicated team scoured for potential targets and drew up plans. It was after a board meeting on a sultry Thursday morning that the realization dawned on him. This board was not too bothered about shareholder interests. They were not even his board! Here was stonewalling at its best! Every proposal by Jeff was being shot down on the most ridiculous of grounds. Everyone from the sweeper to the chairman of the board seemed to think that change was a satanic verse! Status Quo would be the way to go…

It was then that Jeff ran to Lauria… She was married to his best friend from college, and Jeff couldn’t be happier for his friend. He adored and respected her. Now years later, he was seldom in touch with his friend, but he and Lauria caught up occasionally….. swapping stories and career advice… Lauria was the youngest vice president in the last decade in this part of the country. “Dude, I feel I am not in control of the whole thing, u know? I mean you’d think the CEO is the one who called the shots. But things are very difficult to change down there… Deep down, I know this would work…and it would be totally worth it…” He talked and talked…He never understood the vagaries of boards…They were fickle, and highly influenced by public opinion. Jeff had never been a conventional CEO. Neither funny, nor an extrovert…Jeff was more of the conservative, thinking type…Getting his point across to the other party was always a matter of concern to him… “Do your work and get on with your life!!! I’ve better things to do than crack silly jokes and indulge in orgies at stupid socializing parties….” He used to tell…Lauria disagreed, but understood him… “See Jeff, you gotta get a grip on yer life…Is this company that important to you?

Yes….It really is…I can feel it going somewhere meaningful, u know?

Ok, as I can see it… There are two options… You obviously cant go in and make sweeping changes.. There is no way that would work, with the employees and board totally comfortable with the status quo… So you could shelve your proposals for now.. Settle down, and maintain things the way they are now….

No way.. that’s insane… The board would think I’m not assertive enough… they wouldn’t feel my conviction in the whole idea… you get me? Everyone in the company would look at me as a new guy who wants to change things around just to get his kicks…

Hmmm…You are right…But the second option will be very painful to you.. Resign. That way, you maintain your views that the diversification is very important to the company, but you lose your company. You will never know how things would have worked out in the end… You don’t know in whose hands the company is finally going to end up in…do you want that?

Jeff hated to admit it, but deep down he knew Lauria was right… The first option seemed to be the lesser of the two evils… He promised her he’d take things slow, at the same time skeptical of whether it would work… His ability to screw things up with every company he’s ever handled surprised him, puzzled him… He was not sure where he was going wrong… He was hard working, he had the best interests at heart… He wanted to do what was best for the shareholders… But why were things going wrong at every step he took? At that instant, he’d have given away his right hand to know….

Now he sat in his office, smoking away at the company’s Premiere brand cigarette…watching the sun set… Two packs down, he wondered whether this would change his life for ever.. “Yes, I have to do this…”, he kept telling himself...Now, as he walked over to address the board, tucked in his left breast pocket was his resignation letter…

In the end, even if I lose the company I love, I can look back and tell myself that I always gave it what it wanted even if I did not believe that it was the best thing for the company…

Was he wrong? Who are we to tell? Was he right? Maybe, maybe not… But he sure gave up his personal wishes for the company that he loved…. Maybe he was just weak…?


Tuesday, September 26, 2006

Cognitivists……..the third gang of finance??

The world of finance is increasingly being gripped by gang wars….Their turf? Market efficiency…. Its probably the most brow-beaten research topic in the field of finance…My hunch is that more than 80% of the PhDs walking on the world today should say thanks to it…. But most of the work in this field is deductive in nature…In the sense that they process some empirical data and draw conclusions from it as to whether markets are efficient or not…But if we were to follow an inductive approach, some new ideas might crop up… So here, we’ll piece together small building blocks and construct the factors that explain how the market moves….

Yeah, lemme introduce the gangs to you…the first, well…. They don’t have a name, but we’ll call them the rationalists…. They are the people who love math…and equations… they attempt to find the logic and rationale in everything… they claim markets are efficient….so that they can keep themselves busy by doing a lot of research and finding many more models (of the mathematical variety, not the fashion one.. just to set the record straight)….

Anyways, the second gang has the behaviorists…. They claim the markets are not efficient…. Again, probably they are not good at math…hmm… I better fit into this…This school of thought has its roots in social psychology… and contends that well, external factors are responsible for the behavior of a person…and this behavior ultimately affects the market in a non-rational sort of sense… something like there is a bomb blast or a terrorist strike… this instills fear in people… this fear causes them to be skeptical of markets in general…they sell shares…and stock prices fall… in this case, the external environmental factor (bomb blast) determines the behavior of a person….

If we pause and study the evolution of behaviorism as a school of thought in psychology, it evolved because the psychologists of yore spent too much time brooding inwards, studying childhood experiences and attempting to rationalize the thought process…. This frustrated a lot of people because in this process, they never found the answers they were looking for….what motivates people to act the way they do? Championed by psychologists such as John B. Watson, Edward Thorndike, and B.F. Skinner, behaviorists argued that psychology should be a science of behavior, not the mind.

However, it became increasingly clear that although behaviorism had made some important discoveries, it was deficient as a guiding theory of human behavior. Noam Chomsky demonstrated that language could not purely be learned from conditioning, as people could produce sentences unique in structure and meaning that couldn't possibly be generated solely through experience of natural language, implying that there must be internal states of mind that behaviorism rejected as illusory. Similarly, work by Albert Bandura showed that children could learn by social observation, without any change in overt behavior, and so must be accounted for by internal representations.

This takes us to something that I’d like to name cognitive finance…. Put together the rationalists and the behaviorists…and throw in a new chota mota gang…and lo! We have a new school of thought!!! Lemme explain…. See, who make up the markets? It’s the people.. right? Now, when people determine the stock price in a free market, it makes sense for us to study their motivations…. Why they act in a certain way….for this we study their brains…

Human brain has 3 parts…first, the primal brain….which is present in all animals….this gives us our survival instincts…second, the emotional brain or the limbic brain… this explains why we act irrationally when we get emotional…and the last part is the neocortex, or the thinking brain…the behaviorist school of thought contends that man’s behavior is driven by external factors…yes, but this is a highly incomplete view…the way the human brain perceives and process these external stimuli is equally important…. The rationalists seem to think that the neocortex is the sole driver of human actions…but men are not robots… there are two more brains that drive human behavior which need to be taken into consideration…here comes in the cognitive school of thought…

Finance is an art…studying it will be a lot more fun if we were to adopt this integrated model, rather than just focus on one of the factors which drive the market….
1. Brealey Myers - The Principles of Corporate Finance (7th ed) Pg 347 for market efficiency
2. for the evolution of behaviorism
3. Daniel Goleman - Emotional Intelligence Pg 10-14 for the structure of the human brain


Monday, September 25, 2006

The Joke called Bschool interviews...

The elusive call from that prestegious bschool changed my life... overnight, the nobody that i was transformed into this celebrity.... giving speeches on how to crack CAT and inspiring hundreds of juniors... an average joe in the top 40 among 60 students in an engg college whose claim to fame was nothing more glamorous than paying fine for lack of attendance in all his 8 sems..... suddenly catapulted to limelight by the vagaries of CAT patterns...

A year has passed since then...and today, on the other side of the bschool campus wall i begin to wonder whether this is indeed worth all the fuss!!! Back then we had these wonderful notions about bschool interviews... "they pick only the best!!! one mistake and u can kiss your chances goodbye…u know, they tape your interviews and study it with a microscopic lens before they pick u!!! when u join, u can be rest assured that the profs will know your life history!!!”

Oh yeah? I certainly dint get that impression from any of MY interviews… the bschool, touted as the Harvard of India…. When I walked up to them, the first question that they ask me is some shit about finding the radius and height of a goddamned cylinder!!! Excuse me??? Is this some kinda IIT interview??? Forgive my ignorance, but I thought I was joining a management school… what has marketing gotta do with cylinders??? Or perhaps, they don’t believe that their entrance test can indeed identify the IQ level of a candidate!!! Strike one!!! The next…. Supposed to be the first n foremost destination for finance in india!!! “rishi, do u know what is KKK???” of course I did… but what I did not know was the connection of a cult that operated during the American civil war and a bschool education in the 21st century… I’ll explain… I had put my hobby as “music” in my cv… that led to a discussion on kishore kumar, my fav singer… and lo! In a stroke of genius, KK was transformed to KKK….what a perfect interview question!!!!

I’ll list some of the questions I was asked in my interviews…no doubt they are all relevant to a bschool education…
  • What is the distance of railway line between Thane and Mumbai?
  • Do you have a girlfriend? Are you planning to elope with her?
  • If you get an admission in this bschool and in another one X, where will u join? Why?
  • How did your interview with bschool Y go?
  • You are from Kerala.. why is it such a lousy state? (he seemed pretty pissed off when I differed and gave him statistics that supported my views)
  • You have 60% in engineering. You are a bad engineer. Why should I take you? (Inference: bad engineer = bad manager)

As a parting shot..i don’t know whether any bschool prof is gonna read this… but candidates work really hard to get that elusive call… those 15 minutes can alter the course of their life…. Please take this as seriously as they do…it is the least way you can reward their hard work…and as for me, well.. I’m now in a bschool that offers two courses… and I never knew the difference until the profs told me during the interview… even so, here I am… catapulted to fortune by the vagaries of bschool interview processes…


Culture - The sculptor of Financial Structure?

USA and Japan are the two largest economies in the world today. Have you ever wondered why one has a predominant market centric economy and why the other is dominated by its banks? Why do countries differ so drastically in the configuration of their financial systems? Read on…

In modern economies, financial systems play a major role in allocating scarce resources. They help channel household savings to the corporate sector and allocate investment funds among companies. When these companies make profits, the system also helps funnel some of the returns back to the individual savers. But financial systems in different countries have evolved in different ways in serving this function in the nation’s economy. My contention here is that the culture prevalent in the country plays a major role in this evolution.

Culture is the software of the mind, shaped and reinforced by our daily interactions, education, friends, upbringing, religious beliefs and other factors. Philosophers like Aristotle and Descartes have believed in the concept that every individual has patterns of thinking, the software of the mind, which he picks up during the course of his lifetime. This explains for example, the differences in behavior of a Chinese man and an American woman at a party. Based on a study conducted for IBM in 72 different countries, Geert Hoefstede has identified five dimensions, or differences in mental programming. For want of a quantifiable measure of culture, I will be falling back on this model particularly the Uncertainty Avoidance dimension. I conjecture that countries with stronger uncertainty avoidance as a cultural dimension are more likely to be associated with a bank-based financial system.

A quick literature review throws up two broad alternate explanations for the disparity of financial systems across countries: legal-system (Rajan & Zingales 1998, Boot & Thakor 1997) and risk-reduction (Allen & Gale 1997). However, these two explanations are not mutually exclusive. The former theory contends that markets require supporting enforcement mechanisms in the form of strong laws. Where laws are weak, banks arise to internalize the transactions because they can enforce contracts extra judicially via their market standing. The latter theory argues that bank-based systems may have a comparative advantage in providing a better mechanism in smoothing financial risks over time. This article takes off from here by putting forward the idea that the culture of a country determines the extent to which people want their risks to be smoothened. Businesses emerge to satisfy people’s needs. Thus, it is but natural that in countries where there is a compelling need to smoothen financial risks, there is a lot of business opportunity for banks.

We can proceed to conduct a regression analysis of the Equity Market Capitalization / GDP ratio of the country with its UAI index. We take the EMC/GDP ratio in order to nullify the differences in the scale of the GDP. We note a significant standard error in this analysis. This indicates that there are other factors in addition to risk-reduction that explain the differences in financial structure. This supplements the existence of legal-based theories.We can now use this regression model to nullify the cultural aspects and then proceed to judge the legal climate of countries and its impact on the financial structure. We do this by estimating the best-fitting regression line. It was found to be

Equity Market Capitalization = { UAI * -0.004792991 + 0.912064436 } * GDP

Using this regression line, we can proceed to calculate the estimated market capitalization of each country using its UAI index. This estimation takes into account the cultural differences among countries. Hence, whatever discrepancy remains can be attributed solely to the legal climate of the country.

To take an example, our analysis shows that currently Japan has a EMC/GDP ratio of 0.66 and US has a ratio of 1.22. The discrepancy is to the extent of 0.56. After standardizing for cultural effects, the corresponding ratios are calculated to be 0.5 and 0.7. The discrepancy here is to the extent of 0.2. We contend that this 0.2 difference is on account of differences in legal climate of the two countries and the remaining 0.36 is on account of cultural factors.

In countries where the UAI index is high, the people are more risk averse and prefer to invest in safe avenues like fixed deposits. This leads to a higher lending to the industry. On the other hand, in countries like US where the UAI index is low, investors demand high returns and save in riskier assets like stocks. This leads to very well-developed markets, around which the entire financial system is structured.

We can observe these factors in India’s brief history. In the 1960’s, India was largely pro-Russia which has a UAI score of 95. India’s key industries were nationalized, and the nationalized banks dominated the financial landscape of the country. Compare that to the situation now, when India has very high economic and strategic alliances with the US. This cultural orientation has played a major part in the India that we see today, one where several key industries have opened up to FDI and one where investors flock to the stock markets. In fact, recently a research by Morgan Stanley has put forward the idea that reducing risk premiums have largely been responsible for the bull runs that we’ve witnessed in the recent past. Cultural factors??? Could be!!!
this blog is based on some amount of quantitative data crunching.. dint put that here for fear of boring ppl out of this page... interested ppl can mail me for that....


My experiences with God...

u will not believe this, but religion was created as a means of achieving political stability. for maintaining law and order. all these scriptures and culture is programmed in our subconscious mind so that we will never "sin"... if a person were to realize that he could do something bad (like kill another person..) and get away with it, that wud have been the end of law and order in the early world. so smart ppl invented the concept of god to instil a fear in people...(something similar to mom saying eat fast, or else gabbar singh will come...) religion evolved subsequently to reinforce these beliefs. i do not disagree that all the scriptures (bible, gita, vedas, upanishads, quran) all recommend good actions... but thts like the lowest form of awareness. the goal is not to get u to believe in "god". the goal is to get u to believe in "good".

subsequently, two schools of political philosophy emerged in the cambridge university in the early 19th century. ppl who saw this through. ppl who refused to believe in god and religion. they were divided into "the intuitionists" and "the utilitarians"... the former group believed that even if religion were not there, ppl wud still continue doing good bcos they intuitively know that is the right thing to do. the latter group feels that everyone has a selfish motive. bcos of this, ppl will see the utility in a better world and so will do good. modern concepts like economics is premised on this utilitarian concept.

so if u ask me....
1. the least level of awareness is lack of belief in god. this level of hierarchy is characterised by criminals and the like.
2. next level is being religious - the illusion that one's religion and beliefs are far superior to anyone else's.
3. third level is being spiritual - belief in god, but blurring boundaries between religions.. a feeling that religion is irrelevant, its god and his teachings that are important... this happens when u read all the scriptures from all religions.. ppl like akbar were in this category...
4. the last category is the philosophy of existentialism. the realization that the whole point is in the teachings that these books and their authors are trying to convey and that god is but an illusory medium to communicate it to the illiterate. such ppl do not believe in god, they believe in themselves, and their ability and motivation to do good to society.

finally, this is not designed to provoke a controversy or anythin... everyone is totally entitled to have their own personalized views of god and religion... just sharing mine with u guys....