Or, to put it differently, the people who actually trade in dollars are less sure about further drops than the people who write about trade in dollars. The trade deficit you mention has been like that for years, or to some extent it will already be incorporated in the price.
O a side note, you compare a drop of 4% in dollar values to 4% securities. Of course, people who expect a 4% drop in the next year, and buy 1-year securities are apparently willing tolose money. But people who buy longer duration securities might still consider it a good, safe investment, even if they expect a further 4% drop in the coming year but nothing afterwards.
A pleasure I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude
the current price of anything in a liquid market is the best estimate for its future price.Or, to put it differently, the people who actually trade in dollars are less sure about further drops than the people who write about trade in dollars
Or, to put it differently, the people who actually trade in dollars are less sure about further drops than the people who write about trade in dollars
You mean that people buying US securities do not think that the dolar is going to fall
Again: the market expectation is not necessarily a good estimate of the future price. This is so important that entire chapters of financial mathematics books are devoted to it. In technical terms, there are two probability measures. One is the "actual" or "physical" probability measure, and the other is the "market" or "risk-neutral" probability measure. "Financial engineering" is concerned with the "market expectation", while "risk management" is concerned with the "actual expectation". Too bad the "actual expectation" is not observable from market prices, by definition.
You need the assumptions of general equilibrium, market efficiency, and lack of arbitrage in order to make the "actual" and "market" measures coincide. But that begs the question, doesn't it? Money is actually made exploiting deviations from equilibrium, market inefficiencies and arbitrage opportunities. But if you believe that's impossible because you know too much economics you just try to be a market maker and make money from commissions on the volume that is traded. We have met the enemy, and he is us — Pogo
I encountered this 'risk-free probability' once before, when I accidentally visited an 'Introduction to Black-Scholes' talk by a French guy who I thought would be talking about shape optimization. But he said, very dryly, something along the lines of "Nowadays, all my students want to become rich. So I decided to study something about money. I'll tell you about it, it is actually not as boring as you would think." I am afraid I missed the finer points of his talk.
Now, I understand why you could observe the risk-free expectation from the market prices, if the risk-free assumption were correct. It was my impression the Black-Scholes model at least used risk-free probabilities because it made calculations easier, not because it really was a good assumption.
But your post suggests that more intrinsically you can derive the risk-free expectation (or at least the market's opinion of it?) from current prices but not the actual expectation, nor other people's opinion on this. I definitely do not understand this.
On another note, how would these concepts translate to the practical case of the current dollar? More concrete, to return to kcurie's question, why would people who expect a further slide of the dollar be willing to buy American investments without an increase in the interest rate?
Let's look at this probability of a single event in a little more detail... We have a single event, the result of a single football game. RogueTrooper:
The miserable 3-2 defeat by Croatia at Wembley saw England finish in third place in qualifying Group E and led to the Football Association terminating the contract of head coach Steve McClaren after just 18 games.
£2bn of domestic spending lost according to some estimates.
England's spectacular crash out of Euro 2008 on Wednesday night drove Sports Direct to warn that it was unlikely to meet expectations for profits in the current year. The boot of Mladen Petric, who scored a late strike to lead Croatia to victory against England, also dented the prospects at Umbro.
England's spectacular crash out of Euro 2008 on Wednesday night drove Sports Direct to warn that it was unlikely to meet expectations for profits in the current year.
The boot of Mladen Petric, who scored a late strike to lead Croatia to victory against England, also dented the prospects at Umbro.
Assume for the sake of argument that the "true" probability (objective-probability-interpretation alert!) of an England win (Achtung! single-event-probability alert!) was 2/3. That is, England was a priori twice as likely as Croatia to win the game. Now, how you would know this is beyond me, but let's assume that God rolled a die with 1-2 giving a Croatia win and 3-6 an England win. But we don't know this.
Now suppose that you're a bookmaker offering fixed odds which you adjust daily so as to make sure you don't lose money, and up to a certain point, 37846 pounds have been bet on an England win and 17364 pounds have been bet on a Croatia win, and you have been continually adjusting the odds as people place bets. How do you set the odds at this point? Note that you're the bookmaker: you're not in the business of betting on the outcome of the match so your opinion of the odds of an Englan win are immaterial to the odds you will offer. Note also that the amount of money bet on either side gives odds of 2.18:1 which overestimates the "true" (unknown by you or anyone) odds of 2:1 (this is presumably the English punters getting moderately carried away by patriotic fervour). So, what odds will you offer?
Using the ratio of money people have already bet with you, and given the fact that 2:1 < 2.18 < 11:5 (continued fractions under the hood, here) you could offer 1:2 odds for Croatia bets and 11:5 odds for England bets. The implied probabilities of 1/3 and 11/16 add up to 49/48 so you're making a profit of 1/48 no matter what. Indeed, if Croatia wins, you have to pay off 17364 * 3 = 52092 and if England wins you have to pay off 37846 * 11/16 = 55049, but people have bet 55230 in total, so if Croatia wins you make 3138 and if England wins you make 181. There is an implicit bet, but you never lose money.
Now, if you happen to have a personal estimate of the odds of the game that falls between 2:1 and 11:5 you won't bet, as the bet is not favourable. But if you believe that the true odds should be 3:1 because you're English or 1:1 because you're Croatian or you have some sort of grudge against the FA or MacLaren, you'll place a bet because it is favourable to you. It is, in fact, highly unlikely anyone will have so precise a bet as to fall betweeen 2:1 and 11:5 so everyone who is inclined to betting is pretty much guaranteed to find the odds advantageous (despite the 1/48 commission that the bookmaker is taking).
In this case, coincidentally, the 2:1 odds offered on one side match the "true" odds that nobody knows about. But note that the calculation of odds and payoffs at no point involves an estimate of the true odds, just an analysis of the market expectation, which is driven in part by irrational considerations and is not very precise (let alone accurate).
Now replace the football match results with the dividends to be given out by a company at the end of the financial year, the bets with buying and selling stocks, the bookmaker with a stock broker (or a "market maker") and the 2:1 and 11:5 odds with the bid and offer for the particular stock. Replace the patriotism or the grudges of the bettors with various cognitive biases of investors big and small, and you'll see the difference between the "market expectation" and the "true valuation" of securities.
The thing is, if you want to get a good estimate of the "true valuation" you need to pay through the nose for computers, analysts, data, and even then either you have to rely on the judgement of an fundamental analyst or on having good technical analysts, or a good computer "expert system", and half the time you're estimating not fundamentals but the herd instinct of the market participants.
So, if you think you know about the fundamentals you're likely to find a few investment opportunities because the conventional wisdom is not very wise. We have met the enemy, and he is us — Pogo
And, as we know at least since Keynes (who put them at the center of his macroeconomic theory), expectations drive the economy...
But do they?
Sure, my expectation that house prices will keep rising is a principal factor behind my decision to borrow as much as I can so I can flip it at a quick profit etc etc.
So, yes expectations drive asset prices upwards, which affects the amount of money in issue, and some leaks out into circulation.
But retail prices are different IMHO.
I don't believe yer average Joe Blow thinks:
"In my view, petrol, cornflakes, cigarettes and booze are going to rise 10% in the next year, therefore I want a pay rise".
I believe he thinks:
"Shit: petrol, cornflakes and booze have all gone up in the last year, therefore I want a pay rise."
And the JoeBlowCo Plc management think:
"Shit: our staff costs have gone up, and so have those pesky interest rates, (which the Central Bank has just raised in order to control inflation), never mind energy costs and the rest.
I must maintain my profit margin, and therefore I'll try and increase my prices."
Result, if they succeed: inflation.
ie maybe profits are de facto the principal component of inflation.
In other words, I think that retail price inflation is driven less by inflationary expectations, and rather more by past experience.
On the demand side, consumer confidence influences which fraction of disposable income mill be saved and which will be spend, that is, the savings rate, and what Keynes called the propensity to consume. Also the propensity to take on debt. And consumer confidence is all about expectations, though not about expectations of future retail prices. We have met the enemy, and he is us — Pogo
Which means I don't understand the risk-neutral measure. Give it a couple of days.
Watch this space. We have met the enemy, and he is us — Pogo
You mean that people buying US securities do not think that the dolar is going to fall.. or that they are not sure... but if they are not sure and they are foreigners.. why not going elsewhere?
And do they really believe that the dollar is not going to fall further?
That's not exactly an easy thing to define, but I'm pretty sure it has something to do with it.
I would write more, but I've run out of energy for the evening.
my rule of thumb, which is shared I think by people who do know about the fine print, is that the current price of anything in a liquid market is the best estimate for its future price.
European Tribune: A very murky crystal ball by Colman on May 19th, 2006
A lot of people seem to think that oil futures give a good indication of future oil prices, apparently believing in the "wisdom of crowds". Menzie Chinn (who is a real economist) on Econbrowser looked at that idea: ... So they're not very good at predicting prices. In fact, he goes on to say that they're not much better than a random walk would be.
...
So they're not very good at predicting prices. In fact, he goes on to say that they're not much better than a random walk would be.
Jerome a Paris:
Futures are the opinion of the market as to where prices will be in the more or less distant future. Usually, there are fairly precise bets for the first year or two, and then it drifts towards what is seen as the long term expectation. For twenty years, that long term expectation was extraordinarily stable. It is just as remarkable how quickly that long term expectation has changed in the past 3 years. This is truly the market absorbing new information. <...>
For twenty years, that long term expectation was extraordinarily stable. It is just as remarkable how quickly that long term expectation has changed in the past 3 years. This is truly the market absorbing new information. <...>
HiD:
keep in mind what may have changed is the character of the market. <...> Now the hedge funds are big, big players. Buffett/Munger was on the phone daily to the guy sitting across from me back in 1996. (Ditto Tiger.) Buffett was an early adopter. Many, many more are involved in commods now and there is much more money in hedge funds overall. So now you have a more realistic market. That overlays the obvious supply/demand tightening.
<...>
Now the hedge funds are big, big players. Buffett/Munger was on the phone daily to the guy sitting across from me back in 1996. (Ditto Tiger.) Buffett was an early adopter. Many, many more are involved in commods now and there is much more money in hedge funds overall.
So now you have a more realistic market. That overlays the obvious supply/demand tightening.
