Economics 2.0

Economics 2.0, Norbert Haring and Olaf Storbeck, First Edition, 2009, ISBN 0-230-61234-1
This book is a summary of a large number of studies in the field of economics, and other fields where researched touch on economic issues. The book is presented in fourteen chapters.

Man: An Economic Animal

The Pursuit of Happiness

The Enigma of Labour Market

The Almost-Forgotten Small Differences

It’s All About Culture

Economics by Scales and Measures

The Logic of Globalization

Financial Markets

In this chapter, the authors dispel the myth of efficient markets which relies havily on Homo Oeconomicus, supposedly a cold, calculated and rational person making decisions purely for personal economic gain.
According to research by two Italian economists (Luigi Guiso and Tullio Jappelli) spending time researching financial information does not yield better investment performance. In order to measure investment returns, they used ‘Sharpe ratio’ which is an indication of level of risk an investor is taking on for respective level of return. Their research of Italian investment bank customers found that those that spent two to four hours a week doing research had investment performance that was 25% lower than those that did no research. The researchers also found a positive correlation in the number of hours spent on research and a number of trades done by an investor.
Other researchers have found that most of the investment analysts stay close to the recommendations of other analysts for the fear alienating prospective companies. Investment analysts were also found to be more accurate when their advice was meant for institutional investors (investment companies) than it was for advice meant for retail investors (ordinary persons).
Investors are not only investing based on the financial performance of a company, but are focusing a lot of their tactics on how anticipating and preempting other investors’ moves.
If you had missed 10 most profitable trading days since 1900, they you would have missed out on 65% of the gains of the 20th century. It is really important to be in the market, but it is really hard to time it right. Therefore, it is better to be in it continuously.
It has also been noted that market swings do not behave like a normal distribution. This is important to note as most stock market models and predictions are based on normal distribution assumption.
The authors end the chapter by commenting that Ilia Dichev, from University of Michigan, has found that stock returns in the stock market are lower than advertised. Ilia had found that even though market gains on NASDAQ from 1973 to 2002 were 9.2% a year, effective returns due to varying market capitalization were 4.3%.

Subprime Surprises

Managers are People,Too

  • If he thought of it, it can’t be good – Studies have shown that there is a preference for “external knowledge” which is information and advice provided by outside consultants or sources. Excellent ideas generated internally will not be acted upon, until an external company or source makes a point of using this same idea. Other studies have shown that while an outside company was copied, as soon as that ‘innovative’ company was acquired, its innovation were not acted on because of the preference for ‘external knowledge.’
  • Beware of aggressive managers – Excessively self-confident senior managers make decisions regarding company’s investment activities based on the company’s current cash-flow situation, instead of basing those decisions on need and market outlook.
  • Good managers, bad decisions When good managers make bad decisions, they often have no incentive to correct them. If they correct them, then they make it look like they made a mistake. If they don’t correct them, then there is a chance that conditions will improve and decision will right itself eventually.
  • It pays to work with the same team – Heart surgeons in America are often contracted by various different hospitals. Their success rate was found to be higher if they have been working in the same hospital with the same team, then if they had worked in different hospitals (and therefore with different teams). Even those that had a higher success rate overall, had a lower success rate when working at a hospital where they performed few surgeries.
  • Rewarding with financial resources – Researchers have found that when an intellectual task was ‘incentivised’ with cash, the subjects performed worse, than if there were no cash reward. The opposite was true for a mechanical/physical type of task. Another aspect of rewards that was interesting is that sometimes a reward was sufficient enough until someone else received a similar type of reward. We don’t always care about how much we get, but how much we get in relation to others.
  • Communication matters, too – Studies have found that workplaces with only cash rewards, performed worse than places with cash rewards AND where management communicated frequently and effectively with its employees.
  • The reason for high CEO salaries – Studies into the reasons for extra large CEO pay packages have used a “matching theory” to explain the reasons for this oversized pay. The thinking is that large companies spend a lot of money on marketing, research and investments, so the best CEOs will be able to put all that investment to proper use. Another point in the theory explains that CEO pay is correlated to the market capitalization of the company. This would mean that large companies pay proportionally more than smaller companies. One interesting point in the study is that corporations find differences in managerial talent to be marginal, which means the TOP CEO is not much better than other CEOs. (Gabaix and Landier)

The High Art of Buying and Selling

  • Winner’s Curse – By winning an auction on Ebay you are pretty much saying that you had overpaid for a certain item, as no one else was willing to pay as much as you. Studies have found that shoppers on Ebay have been bidding more for an item than you would have paid by choosing “Buy it now” feature. It was found that only about 12% of Ebay shoppers overpay for items, but they do skew the statistics by their high bidding.
  • Snipers buy cheaper – Sniping on Ebay (the act of putting in a bid in the last few minutes of bidding) appears to be an effective way to win auctions and not overpay for an item where a value of an item is not easily discernible (antiques, collectibles, etc.) If a sniper puts in his bid too early, he risks letting others know how much he thinks the item is worth. By waiting until the end, he does not allow the item’s price to be bid up too high.
  • What’s Psychology Worth – An interesting study in South Africa studied a loan company that sent out fifty thousand offers for a loan to existing customer. The loans varied between 3% and 11%. The study found that when the brochure for a new loan included a picture of a female and the addressee was male, the loans accepted were on average 4.5% higher than in other user groups! Sex does sell. Other findings were: offering only one option for a loan instead of providing two or three different options increased acceptance rate. Describing possible uses for the loan also increased acceptance rate of loans.
  • The Athlete as Guinea Pig

    • Football – David Romer from UC Berkley studied strategic decisions by NFL teams on their fourth down. As you may know, on their fourth down, teams have an option to go for it, punt or go for a field goal. The study found that coaches played too defensively and passed up too many opportunities for taking advantage of the fourth down.
    • Side effect of incentives – Research on soccer teams had determined that large discrepancies in income on teams is highly counterproductive to teams performance. The larger the difference in income was on the team, the lower the performance of the team. This confirms a theory that people’s absolute salary is not as important as their relative standing to others.
    • New coach, same difference – Studies on performance of soccer teams after their coaches have changed show that the new coach does not make a long lasting difference in the performance of the team. There is a small effect for the first four games, but after that the effect is gone.
    • Slowing down others – Since the introduction of the new FIFA rule where a winner gets 3 points while a tie gets a team only 1 point, it has been shown that the games have become more physical. The rationale is that as soon as one team is in the lead, the number of fouls and yellow cards they take on increases. This happens because they take on a more defensive posture, trying to prevent the other team from scoring in order to keep their lead.

    In the Dark Recesses of Market Economy

    A Final Warning