Perpetual Motion
markets are never solved
People were trading options for a long time before the Black-Scholes-Merton (BSM) model came along in the early 1970s. And the traders came pretty close where the model would price things.
We conclude that option prices were closer to their BSM theoretical values. Furthermore, we find that interwar option prices were no more mispriced than in modern times and were as sensitive to changes in volatility—the key valuation parameter in the BSM model.
David Chambers, Rasheed Saleuddin, Commodity option pricing efficiency before Black, Scholes, and Merton (wiley)
The market is great at sniffing out idiots with money and parting them of it. It is highly unlikely that you and you alone found a mispricing that only you get to exploit. What made the BSM Nobel-worthy was that it was closed-form solution that anyone with a calculator could use. This ease-of-use combined with it being “sciency” resulted in an explosion of option trading activity. However, like all models, it is a small sliver of the map of the world and not the world itself.
Hence, the option smirk. Something that we wrote about this week: The Smirk
Markets this Week
US markets got squeezed and took other markets up with it…
More here: country ETFs, fixed income, currencies and commodities.
Crypto continued its uptrend with spot ETF hopes…
Links
Research
When Generating Income Undermines Investment Returns
Do high derivative income covered calls tend to deliver higher total returns? No. In fact, the relationship goes the other way. We demonstrate a strong negative mechanical relationship between expected total return and derivative income for covered call strategies.
Pricing Power Everywhere
Pricing power or a company’s ability to raise prices and maintain profit margins amidst increasing costs or competition is one of the most important dimensions for evaluating the value of a business. We find that companies with pricing power tend to be high quality, lower risk (beta) companies that compound returns steadily over the long run. They tend to be hard-to-replace suppliers of key inputs for consumers and businesses alike. We propose such a measure for capturing corporate pricing power.
Goods That People Buy But Wish Did Not Exist
People buy some goods that they do not enjoy and wish did not exist. They might even be willing to pay a great deal for such goods, whether the currency involves time or money. Efforts to measure people’s willingness to pay for goods of this kind will suggest a welfare gain, and possibly a substantial one, even though the existence of such goods produces a welfare loss, and possibly a substantial one.
Dirty Air and Green Investments
We show that retail investors' investments in "brown" stocks are negatively related to local air pollution after a monitoring station appears nearby, with particularly pronounced effects on “alert” dates when air quality is listed as harmful to the general population.
The Topography of Nations
How does the interplay of geography and political-economic forces affect the shape of nations? This paper presents a quantitative framework for characterizing the equilibrium evolution of national boundaries in a world with a rich geography.
Economy
China’s plausible long-term growth projections agree on several factors that imply significant deceleration, but disagree on distant, future policies. These commonalities and differences explain a 2%-5% range in GDP growth rates to 2050. If results fall in this range, China will neither dominate nor disappear from global economic leadership, but outcomes at the lower end would represent large shortfalls relative to its economic potential.
Peak China (brookings)
Investing
With only a third of active U.S. stock funds beating their index before fees over the average 10-year period and with the average fund outperforming by just 0.26% p.a. (excluding dead funds), one thing seems pretty clear: Active U.S. stock funds charge too much. (thread)
What if the fancy “quant” hedge fund you invested just traded based on the vibes of the manager?
There was no grand system, no artificial intelligence of any substance, no holy grail. There was just Mr. Dalio, in person, over the phone, from his yacht, or for a few weeks many summers from his villa in Spain, calling the shots.
The rise and collapse of bond markets for developing countries (findevlab)
Auto insurers have rapidly boosted prices for electric vehicle cover in the past year, much more than for fossil fuel cars. Average electric car insurance costs rose 72% in the year to September, compared with 29% for petrol and diesel models (ft)
A.I.
AI Has a Hotness Problem (theatlantic)
Attenuating Innovation (stratechery)
Meme of the Week
