Re: I DESERVE RESPECT
[ QUOTE ]
i see what you're trying to say here but it is literally just semantics in terms of profit vs. value maximizing.
profit maximizing = the individual placing the order is concerned with his/her/its bottom line (in terms of that specific order/market). however they trade, be it value, technicals or whatever, their goal is to maximize their bottom line profits.
your argument makes a very good point though in that since equity markets have such a large dollar weighted percentage of rational profit maximizing entities doing VERY DIFFERENT types of trading, the inefficiency is quite likely higher. if they were all doing the same type of trading, i'd venture to guess the market would be less inefficient.
[/ QUOTE ]
I'm not sure if I quite understand your last paragraph but it's not just semantics. Entities that try to buy when value > price and sell when price > value lead to discovery of efficient prices. No other form of profit-maximizing activity leads to any sort of efficiency other than increase in trading volume and corresponding reduction in bid-ask spreads. Most of speculative trading in equity markets is almost certainly not value-driven. Thus there's nothing inherently efficiency-maximizing about greater levels of speculative activity.
Another way to look at it is from a game-theoeretical perspective. Play between best profit-maximizing poker players doesn't approach Nash equilibrium as the best players get better, as long as there's implicit understanding that there may be at least one sucker.
[ QUOTE ]
[ QUOTE ]
I also don't get this notion that markets driven by need are necessarily inefficient (more specifically, the notion is that speculators are more successfully value-driven than natural actors). People allocating to international equity without hedging are not making currency markets any more inefficient, unless you feel that their decision making is flawed, in which case their "irrationality" has an effect on the corresponding equity market as well.
[/ QUOTE ]
if you are placing a currency bet simply to gain on the underlying equity without factoring in the currency (what virtually all foreign investors in equity markets do), you are not concerned with your profit as it relates to the currency market. you are just using the currecny market as a tool.
[/ QUOTE ]
[ QUOTE ]
more precisely, the view that an individual cannot affect the rationality of the currency market without affecting the rationality of the equity market (in the case of a domestic investor allocating to int'l equity markets w/o hedging) is wrong. their decision in the equity market has unintended and irrational consequences in teh currency markets.
look at it this way. is it rational to add volatility to your portfolio without adding any return?? developed world currencies don't yield any return over the long run and add a ton of volatility. rational actors in the currency market would hedge some amount (less than 100% given transaction costs) in order to reduce that volatility. the fact that probably over 95% of dollar weighted int'l investors hedge 0% shows that given all the above, they are irrational in the currency market even if they are being rational in the equity markets.
[/ QUOTE ]
Investment in foreign equity isn't comprised of two bets, one of which he understands and undertakes voluntarily and the other of which he's forced to make. It is a single investment. The empirical observation that the price of a stock in its currency and the price of the currency may be de-linked in a way that reduces volatility is somewhat irrelevant to the fact that if whoever is making the investment isn't looking at the price of his investment, he isn't looking at the price for either component. (As a side note that the observation itself speaks volumes about how inefficiency in one market can transfer to another - if the equity markets, even in aggregates, were efficient but the forex wasn't, then equity market indices in nominal terms would have negative correlation with the currency in which they are denominated, removing, partially, the need for currency overlay management).
Furthermore, the investor does not end up holding any currency but rather a piece of the business he's investing in. He is neither long, nor short, the currency - the currency he initially purchased to buy the security has been returned to somebody else. It's now that entity's choice whether to sell the currency because it's overpriced or keep it because it's underpriced.
Also, while we're talking about unsophisticated investors, I'll say that just about every single individual investor appears to look at positive short-term past performance as a positive (in other words, they are not just price-insensitive, but their demand curve has negative price elasticity!)
[ QUOTE ]
much like central banks (that hold pegs) do. look at every single peg ever. they all break down eventually. this is a HUUUUGE inefficiency. central banks that peg don't care about their profit/fundamentals/technicals whatever. they simply are willing to spend as much as necessary to hold down/up the value of their currency relative to another.
that is a very clear source of market inefficiency.
[/ QUOTE ]
Well, I thought we were largely talking about currencies without pegs.
[ QUOTE ]
Finally, let me take this exact statement and prove it wrong:
[ QUOTE ]
I also don't get this notion that markets driven by need are necessarily inefficient (more specifically, the notion is that speculators are more successfully value-driven than natural actors).
[/ QUOTE ]
look at commodity markets. the returns from backwardation have been to speculators, paid by for "natural actors" or hedgers. they are using the market in order to reduce volatlity of their underlying product so as not to be exposed entirely to future price movements of that product.
in other words, that market (to the extent it is used by the hedgers) is based on need. speculators DIRECTLY gain from that. this is studied, proven, etc. the hedgers pay speculators to hedge their future revenue streams.
they are basically paying insurance. they are consciously losing money in the commodities market to insure their revenues for their business. they are making efficient business decisions, yes. but within that, they are making inefficient decisions in terms of the commodities market.
i.e. they are not placing bets on price changes to derive profit from that market. they do not add to efficiency in that market. they subtract it by the way that act to secure their overall bottom line (which is rational for them overall) vis a vis the commodity market.
[/ QUOTE ]
I'm not getting what you're saying - speculators making money is not a proof of them adding efficiency. The right question is: what would the prices look like if there was less speculative activity? Are you saying that hedging commodity producers are price-insensitive? That's far from the truth. Are you saying that hedging commodity consumers don't exist? That's also far from the truth. Are you saying that by having fewer producers and fewer consumers trade commodities and more speculators trade, prices will be closer to fundamentals? Aren't what natural actors are willing to pay for, in essence, fundamentals?
And anecdotes don't really prove anything - there appears, for instance, to be a correlation between mispricing in the housing market and high levels of speculative trading. As in, when most people are buying houses to live, prices appear to track rents much better than when more people buy houses as a speculative holding. One important reason is that almost any reasonable need can be expressed in terms of value, hence price willing to be paid. The speculator, however, doesn't care about price paid, as long as investment returns sufficiently exceed his cost of capital.
[ QUOTE ]
[ QUOTE ]
Besides, most of the trading in currencies, whether directly or indirectly, is done by banks and large corporations with international exposure.
[/ QUOTE ]
that is most likely hedging and can be argued as definitely rational from the opint of view of a bank with a large amount of exposure to something that they cannot control or accurately predict and thus cover some of their exposure...but, as stated above, that rational action by a business can lead to inefficiencies in another market.
[ QUOTE ]
To me, it seems that these are the exact entities whose views reflect the fundamentals.
[/ QUOTE ]
no. they are not concerned with the value they get from the currency market by itself. they only care about how their trading profits correlate and offset their underlying large exposure. volatility of profit streams to them is likely to be a huge cost and they want to reduce that cost via hedging (trading in teh currency markets).
so while it may reflect the fundamentals of their business, it doesn't have to have anything to do with the fundamentals fo the currency market (i.e. interest rate differencitals, CA balances, momentrum etc.)
[/ QUOTE ]
How are banks' assets and liabilities in different currencies NOT part of the fundmentals? Demand for dollars is demand for dollars, whether it is used to pay US taxes, pay off dollar-denominated liabilities or interests thereof, pay wages of US-based operations, import US products or simply to travel to the US. Multinationals also have a lot of discretion in where they choose to expand or contract and also where to shift manufacturing to and etc. All of these activities reflect fundamentals and are undertaken in a price-sensitive way. In fact the least-price sensitive class of participants in the currency market may be investors of financial assets. Currency markets also don't suffer from the asymmetry between long and short positions that asset markets have (it's easier in general to borrow money than borrow specific securities).
[ QUOTE ]
[ QUOTE ]
unlike stock markets, where most of the trading is certainly not done by those whose views reflect the fundamentals (insiders) but rather by those who are far removed from businesses and are either 1) trained to trade on technicals or 2) momentum-driven asset-allocators (almost all large funds, individual investors).
[/ QUOTE ]
can you rephrase this, i can't tell if you're saying that 1) and 2) relate to currency markets or stock markets.
thanks,
Barron
[/ QUOTE ]
Stock markets. I meant most of the trading in equity are done by people who have nothing whatsoever to do with the businesses that the shares represent, have no real use for the shares and have no real ability to price the shares. Another way of saying that forex markets are less efficient than stock markets is basically saying that individual equities are priced more efficiently than aggregates of goods and services denominted in that currency.
|