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Archive for November 2004

Bretton Woods II and ASEAN summit

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WSJ: Meeting on the sidelines of a regional gathering in Laos, the leaders of South Korea, Japan and China agreed on the need for exchange-rate stability, according to a statement issued by the South Korean presidential office. A separate meeting of finance-ministry officials from the three countries to discuss the dollar’s decline led to an “understanding,” though no agreement on any concerted action, South Korean Deputy Finance and Economy Minister Chin Dong Soo told reporters in Seoul.

…South Korean President Roh Moo Hyun met with his counterparts, Prime Minister Junichiro Koizumi of Japan and China’s Mr. Wen, on the sidelines of the Asean summit yesterday. A statement from Mr. Roh’s office quoted the Korean president as telling Messrs. Koizumi and Wen that “a dramatic change in exchange rates is not appropriate” and that “currency stabilization is important for the economies in this region.” According to the statement, Messrs. Koizumi and Wen agreed. The statement paraphrased Mr. Koizumi as saying there should be cooperation and joint efforts among the three countries to stabilize the currencies.

See previous discussion of Bretton Woods II.

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Written by infoproc

November 30, 2004 at 9:01 am

Posted in Uncategorized

VIX and Black-Scholes

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OK, humor me here as I continue to think about volatility. Looking at the CBOE white paper on VIX, I see a plot (page 13) indicating very strong correlation between movements in the SP and the implied vol. A change in the SP of about 1% causes a 4% shift in the VIX, but with the opposite sign. Now, SP500 options are widely traded and liquid. They should provide one of the best tests of options pricing theory. But in the usual Black-Scholes model the volatility of the underlying security is a fixed input parameter – it certainly isn’t supposed to be path (history) dependent. The simple log normal random walk model has its limitations – for example, there is no reason the vol shouldn’t change in time (hopefully slowly) – but I’m surprised to see such clear path dependence. Of course, it’s possible that the actual volatility (as opposed to implied volatility) doesn’t exhibit the correlations we are discussing. But if so, there is an inefficiency in the behavior of options traders that should be arbed away!

…I’ve been informed that these issues are addressed using more sophisticated GARCH models. (GARCH = Generalised Autoregressive Conditional Heteroskedastic!)

This paper seems to conclude that implied vol is a good predictor of realized vol, so the correlation between market movements and vol is not a behavioral quirk of options traders (indeed, it is a quirk of the market itself).

Written by infoproc

November 30, 2004 at 9:00 am

Posted in Uncategorized

VIX thoughts

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The VIX index tracks implied volatility, using a basket of options with expirations closest to +30 days to compute an implied probability distribution for values of the SP500 30 days hence. The VIX is often referred to as a “fear gauge” because it is anticorrelated with market performance: when the SP goes up the implied vol goes down, and vice versa.

To characterize the prob. dist. with a single volatility value, one fits to a Gaussian. Historically we know that outlier events are much more likely than implied by a log normal distribution. Deep out of the money options are included in the VIX computation as long as there are nonzero bids (and no intervening zero bids at more probable strikes). Looking at the current prices I see this only goes out about 2 sigma into the tail, so the distortion from mispricing of rare events is small. I know Nassim Taleb (author of Fooled By Randomness) makes his living buying mispriced deep out of the money options – I assume he has to buy these directly by calling up market makers, since the widely traded options don’t go too far out on the tail.

Why is the VIX anticorrelated with market moves? I can understand why options traders might be psychologically disposed to expect more vol in a down market, but does the observed, historical vol exhibit this anticorrelation? We could check by crunching the data looking for up/down moves to see if the variation in the following 30 days is correlated with the sign of the move. To put it very simply, are downward moves of the market choppier than upward moves? If not, can’t I arbitrage by selling vol when the market goes down and buying it when the market moves up?

Written by infoproc

November 29, 2004 at 9:00 am

Posted in Uncategorized

Inflation: goods vs services

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If you break the CPI into components, you can see an interesting divergence in the behavior of goods vs services. The former have exhibited deflation over the last 4 years (exported from China?), while services costs have continued to go up. When will outsourcing become widespread enough to affect the rate of inflation in services? Evidently labor still has some pricing power.

(Graph from BusinessWeek.)

Written by infoproc

November 28, 2004 at 9:20 pm

Posted in Uncategorized

BusinessWeek on US-China trade

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I picked up the latest issue of BusinessWeek on the flight home, which is largely devoted to US-China trade. The cover story is on the “China Price” that manufacturers are now forced to match.

Meanwhile, U.S. companies are no longer investing in much new capacity at home, and the ranks of U.S. engineers are thinning. In contrast, China is emerging as the most competitive manufacturing platform ever. Chief among its formidable assets is its cheap labor, from $120-a-month production workers to $2,000-a-month chip designers. Even in sophisticated electronics industries, where direct labor is less than 10% of costs, China’s low wages are reflected in the entire supply chain — components, office workers, cargo handling — you name it.

China is also propelled by an enormous domestic market that brings economies of scale, feverish local rivalry that keeps prices low, an army of engineers that is growing by 350,000 annually, young workers and managers willing to put in 12-hour days and work weekends, an unparalleled component and material base in electronics and light industry, and an entrepreneurial zeal to do whatever it takes to please big retailers such as Wal-Mart Stores (WMT ), Target (TGT ), Best Buy (BBY ), and J.C. Penney (JCP ). “The reason practically all home furnishings are now made in China factories is that they simply are better suppliers,” says Janet E. Fox, vice-president for international procurement at J.C. Penny Co. “American manufacturers aren’t even in the same game.”

An interesting statistic from the article: the US is still the world’s largest manufacturer, and 75% of goods consumed in the US (presumably by value) are made here (this is down from 90% as late as the mid-90’s). So, very roughly speaking, a 4% trade-weighted decline in the dollar would lead to a 1% increase in inflation, assuming there is no resulting substitution of goods.

Written by infoproc

November 28, 2004 at 9:44 am

Posted in Uncategorized

Japan, China, UK and hedge funds(?)

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…are the largest holders of US Treasury debt, in order of holdings. Note Japan still dominates all others.

Is it plausible that hedge funds hold $100B in US Treasury debt? A recent JP Morgan report concludes that hedge funds currently account for $900B in capital, out of a world total capitalization of $74 Trillion in equity and fixed income. So, the notes held by secretive Caribbean entities account for only 10% of hedge fund capital.

Written by infoproc

November 27, 2004 at 5:39 am

Posted in globalization

Sino-French TTE largest producer of TVs

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WSJ covers TTE, created from the takeover of French TV maker Thomson by Chinese company TCL. This may be the first example of a major western technology company and prominent brand (RCA) taken over by a Chinese firm. TTE produces 20M televisions a year, in a dozen factories worldwide (China, France, Mexico, Poland, Thailand and Vietnam).

The agreement between Thomson and TCL was highly ambitious and seemed to be clearly necessary. TCL, with just 11 years in the TV-making business at the time, produced more sets than Thomson and was profitable as well. But the company was virtually unknown outside China and had little expertise in global marketing. Thomson, keeper of the 85-year-old RCA brand, was being squeezed by cost pressures in developed markets and posting losses in North America. It also had only dabbled in China, which two years ago passed the U.S. as the world’s biggest TV-set market in terms of unit sales.

One of the obvious difficulties, covered briefly in the article, is the huge salary differential between TTE employees (including top executives) in China and France.

Written by infoproc

November 26, 2004 at 9:00 pm

Posted in Uncategorized