Markets only
misbehave
The other day I was at Niagara Falls. I found at least six
tall men of seven feet and a little over and more than twelve to fifteen women
of three and half feet width ( no accurate measurement but near approximation
of a statistician) in a visitor crowd of over fifty thousand on that sunny day.
As a traveler from India, such proportion of odd dimension figures is a rarity.
Their food intake would certainly be more than the average person. Wealth
follows a fat distribution meaning thereby that there are disproportionately
more very rich people than there are, say, very tall people. The reasons are
not hard to find why. Wealth has a tendency to gravitate to the wealthy through
self-reinforcing mechanism; the more you have of it, the more you acquire. The
fat tails of the bell curve of markets oft referred to as Gaussian distribution
based on fractals may imply a similar thing: the more they trend in one
direction, the more, the trend persists.
I distinctly recall the Economist survey of ‘The Frontiers
of Finance’ published nearly two decades ago wherein some such arguments led to
three hypotheses: (1) it undermines efficient markets theory – Mrs. Joan
Robinson long before emphatically proved that markets are imperfect; (2) it
rocks the capital-asset pricing model because that model depends on something
called standard deviation as a measure of risks; and (3) it reveals that
something is causing the stock market to be predictable. (The Economist: A
Survey of the Frontiers of Finance, October 9th 1993). The arguments
are used to prove that computerized models are leading to market predictions of
a different genre on the basis of a set of non-linearity (“Non-linearity simply
means that effect is not proportional to cause”). Non-linear statistics is
nothing but a child of the computer. Financial engineers emerged on the scene
to produce derivatives of student loans that generate more non-performing
assets quickly, mortgage loans where the underlying assets had no value over
the time due to fall in rentals and excessive initial rating of such assets (
the sub-prime loans) that led to the great recession of 2007 engulfing the
whole world. The trends have time dimension and the time zones differ across
the world. Prediction based on the trend obtaining in the US markets can
provide useful information to those working in Asian markets and such
information gets traded more than the data and the multi-national companies
stocks behave differently across the markets providing incentive or otherwise
for the investors. It is not as though that the GARCH theory (Generalised
Auto-Regressive Conditional Heteroskedacity) which simply means that the
volatility is clustered. Believers in this theory straddled securities. In the
late 1990s this theory went out of fashion due to embedding time in the
computer driven models.
The predictability of markets is like the prediction of the
almanac pundits of South India at the beginning of the year when the Chief
Minister and opposition leader listen to the sweet prediction of their
preferred persons who predict their win and they do win. But only one of the
parties they belonged to pick up the majority to stay in power for the next
five years. There are pre-election soothsayers on the TV channels whose
predictions are based on a survey of the miniscule of the electorate and yet
their prediction comes to close to the actual outcome. These are based on
computer manipulations.
The markets are
volatile in nature and the computers predict based on the manipulations of data
that the operator ingeniously does. Very many lose in the market and few only
gain like those playing in the Casino. The investors of Casino never lose while
most players lose. The few winners are like the broking firms who never lose. The
investors employ jobbers who manipulate the prices during the day.
How else do you describe the movement of prices of stocks
that move up in anticipation of the budget announcement of the Finance Minister
and as he starts reading the budget speech, the stock prices keep oscillating
with the up-end averages moving south or north and at the end of the speech,
one may find a huge drop in the stock index. Actually, no trading might take
place but the prices move. Similarly when there is a statement by the Governor
of the central bank that inflation decline is still to be reliable a couple of
days before the announcement of the mid-quarter monetary policy, the prices of
stocks rise or drop.
All this only demonstrate that the markets only misbehave
and not behave as you wish them to be. It is after all the individuals who play
on the computers dexterously to make the prices look what the powerful
investors like them to be. Changes in the balance sheets of firms like the
Wipro, Infosys, Tatas, Reliance etc., when released affect the prices of stock
index. The Index bases built by S&P based on fractal and chaos theories
have descended on markets and instruments based on such indices also entered
the markets. Whether these are signs of growth of the markets or the economy is
a big question as it is the few wealthy that determine them and minority
shareholders whose numbers may be large would have little voice in making or
breaking the volatility. The trade risks
are no better than the weather risks.
