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put your money where your mouth is

Few days ago the Wall Street Journal reported that the hedge-fund Universa Investments LP, advised by Nassim Nicholas Taleb, author of the Black Swan, was betting that despite the Fed’s best effort things will go terribly wrong (again) and we will end up in deflation or hyperinflation (here, see also Bloomberg here).  Universa’s investment strategy is based, among other things, on buying deep out-of-the money options, with the assumption that the market is underestimating the probability of extreme events. So, for instance, in September 2008, Universa was purchasing out-of-the money options on the S&P 500 index at 90 cents, and when the market crashed they were selling them at around $50. Needless to say they have been quite successful with the crisis.

Taleb is not the only scholar putting his money where is mouth is. Behavioral economists Dick Thaler (Chicago) and Daniel Kahneman (Princeton), are on the board of Fuller & Thaler Asset Management, Inc.,  and leverage their research on behavioral biases to assess market reactions to news and identify mispriced assets.

After reading about these ventures I started wondering: what would an “Economic Sociology” fund look like?

Our field has been studying markets for a few years now, and maybe we already know a things or two that could be “translated” in investment strategies.  Zuckerman’s  “illegitimacy discount” and “structural incoherence“, for instance, might be an interesting starting point to develop an investment strategy on volatility.  Rao, Greve and Davis‘ work on security analysts’ coverage initiation and abandonment, and the literature on social influence among analysts, might help predict analysts’ behavior and stock reactions. Yuval Millo, Daniel Beunza and the Socializing Finance crowd must have discussed this problem, and I bet they will launch a “Performativity fund” one day: what would that fund look like?

I am sure that the “translation” of theoretical insights into investment strategies is a complicated task, but we can learn a lot about our theories and their limits with this thought experiment.

And who knows, maybe in a few years one of you will be profiled in Bloomberg, or GQ, as the new Taleb, hopefully with a better attitude!

Written by Fabrizio Ferraro

June 6, 2009 at 4:18 pm

5 Responses

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  1. How about a self-fulfilling prophecy fund, whereby false bank profits (based on mark to model valuation of distressed assets and mark to market valuation of bond issuances) can trigger a market rally, even though they have no basis in ‘reality’? For instance, the price of Citigroup’s bonds decreased – when they mark to market, they profit from a hypothetical buyback, adding the difference between the initial price and the market value to revenue. Of course, they do not have the liquidity to do this and the lower bond price indicates that it will be harder for them to raise capital at a reasonable interest rate. Nonetheless, their stock has increased 235% since March when they released these results. As such, I think sticking to fundamentals is problematic in such a volatile market environment, perhaps favoring a behavioral approach.

    As far as economic soc. models go, I think Burt’s paper on structural constraint would also make a good input, especially if one could construct an index that measures marginal QoQ movements. I have some ideas of my own as well, but given an abundance of coursework, I haven’t had adequate time to test them out yet.

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    Craig

    June 6, 2009 at 9:32 pm

  2. […] 6, 2009 Over at Orgtheory, Fabrizio Ferraro has been posing a fascinating question. If we agree that economists perform […]

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  3. […] 6, 2009 Over at Orgtheory, Fabrizio Ferraro has been posing a fascinating question. If we agree that economists perform […]

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  4. And do not be fooled the market volatility is far from over for quite some time.

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    Mike

    October 13, 2009 at 7:38 pm

  5. […] put your money where your mouth is […]

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    Monday Links | Alea

    December 22, 2010 at 9:47 am


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