Areas of Interest and Research: (Subject & Primary question or applications)

Imprecise Mathematics; Decision making with imprecise probabilistic information.

The world is a very error-prone place, estimation is difficult and people tend to over-estimate things.  Some of my favorite quotes illustrating this are:  

 "All models are wrong, some are useful" -P. Kaufman.  

“Models, both financial and super are all idealizations of a perfect reality” S. Das

So how do we know what is useful and what is not?   This is what interests me.

Study of Variance; Interpretation of the term structure of implied volatility.  

Big, liquid options markets have a lot to say about the current perception of what the future holds.  Believe it or not, when people put money on the line to buy or sell a derivative, to me that is the ultimate expression of confidence in one’s perception- But perception and reality are different things.

In the words of the master: “I’m often wrong, but seldom in doubt.” – Norman Roberts.

Or the old Wall St saw: “Bulls and Bears make money, Pigs get slaughtered”

Understanding the current perception of the future to me is the only place to start in order have something to compare reality with.  I find that a very basic truth that is often overlooked, which is why it interests me.

Valuation of derivatives; calling "Bulls**t" on Wall St. Banks prices.

In the beginning, derivatives were priced using the “Straight-Face Model”, whereby the price was the maximum amount that a salesman could utter while maintaining a straight face due to the usurious nature of the transaction.  With the advent of e- mail, even this test went out the window.  The ability to effectively value a derivative is a skill which seems scant among their buyers.  I have taken a keen interest in informing people how much the people they golf with are ripping them off.

To me there are two things that can be easily monetized; Information and Time.  Broadly speaking I have found that many people who manage large piles of capital do not understand this, (perhaps they do understand this intellectually, but their actions are inconsistent with it) and they allow others to monetize the value of these things for their own benefit.  Whether we call it “Stealing,” or “Market-Making,” “Structuring” or “Management” it is one and the same.

The big buildings of the Manhattan skyline may have been built with the muscle of America, but they were paid for with the money siphoned from the unsuspecting and often gullible investing public.  Wall St. is a vast architecture designed to transfer wealth from the owner to the agent.

Investment Institutions can be the most gullible, as they are rife with conflicting interests and a sense of dissonance from the value of the money they manage.  I have found that people love to think they have something that they don’t, and Wall St. salesmen are truly talented at selling things that they aren’t. 

Derivatives are the epicenter of this.  Consider the Asian Institution who bought a the dreaded “Cashless Inverse Floating Currency Linked Arrears Reset Note” (a name for a derivative) in order to “hedge” their F/X risk very “cheaply”, the catch was that the ONLY way the note was worth anything mathematically was if time went backward, since the value of the note was inversely related to the square-root of time. (among other things).  Since squared-roots of negative numbers are imaginary, (like backward time is) it is fair to say that now prices are only limited by imagination and not just straight faces.

All of the above makes this area of great interest to me.

Agency Theory; Do you know who's capital your playing with?

Agency theory deals with how people behave when they are employed by someone to act as their agent.  The application I am interested in is capital markets and the behavior of agents in a corporate setting.  My view is that the fundamental definition of a corporation (or in the jargon a joint-stock company) is a structure utilized by a capital provider (owner) to control liability and to hire agents with specialized knowledge to undertake positive NPV projects on their behalf.  Sounds easy enough right?

A lesson I learned back in my early days investing in Russian companies is far more broadly applicable than I would have thought back then.   I used to chide Russian managers that there was a clear distinction between “Investment” and “Donation” (utilizing a convenient play-on-words in the Russki) It seems to me that the managements of many companies (small-cap ones in particular) in most countries have trouble with this differentiation.   I have often come across managers treating their company as their own fiefdom within which they are the Lord, Master, Mayor, Overseer and Maker of Rules.  My not-too-subtle reminder that they were employed at the pleasure of the shareholders is often met with the utterance of canned lipservice containing the words “shareholder value” in some order.

This 100% misses my message and only seeks to reinforce my conviction that hired (as opposed to owner) managers maintain a dissonance from the value of the capital they are employing to pay themselves.  In agency theory this is called an imperfect agent, and unfortunately our planet is infested with them.  I find that interesting.