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This idea that things should be slowed down doesn't make much sense. What would be an acceptable time tic for the stock market? And why not half of that, or double that?

That's essentially a political decision. Liquidity contains an inherent tradeoff between the ability of investors to monetise their investment (lack of which ability acts as a disincentive to investing) on the one hand, and black-hat speculation on the other hand.

It seems reasonably obvious that nobody needs day-to-day liquidity in his investments, or even week-to-week, so the tradeoff here is fairly one-sided. When you get into several months, it becomes more iffy, because you get a larger downside (and possibly also a smaller upside).

Such tradeoffs are inherently political. And the fact that this decision is currently made by programmers and traders professional gamblers at Goldman rather than in democratically accountable parliaments does not make it any less political.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Jul 29th, 2009 at 10:49:00 AM EST
[ Parent ]
If it's merely a political decision, then politicians have spoken loud and clear for the last 30 years. Unfortunately, they haven't spoken on the side of longer time tics.

It seems reasonably obvious that nobody needs day-to-day liquidity in his investments, or even week-to-week, so the tradeoff here is fairly one-sided. When you get into several months, it becomes more iffy, because you get a larger downside (and possibly also a smaller upside).
I don't see it.

Firstly, there is the physical constraint from the volume flow of transactions. With millions of market participants performing one or two transactions every day or every week only, for example, the total number of transactions in a single day is still huge. So there has to be constant activity to balance the books, unless you can limit the number of market participants to a handful.

Secondly, modern replication strategies require frequent rebalancing of portfolios down to the smallest time interval possible. Whatever that time interval is chosen to be, expect millions of shares to be bought and sold during that interval market wide. The volume of transactions will not lessen if the time interval is increased, it will stay exactly the same at best and might probably even increase.

Such tradeoffs are inherently political. And the fact that this decision is currently made by programmers and [S:traders:S] professional gamblers at Goldman rather than in democratically accountable parliaments does not make it any less political.
I would say that there is a strong practical component involved. Politicians cannot legislate physical reality. Unfortunately, the one thing they should be doing, which is to allow the gamblers to lose their shirts and die, they do not wish to do.

--
$E(X_t|F_s) = X_s,\quad t > s$
by martingale on Wed Jul 29th, 2009 at 07:59:11 PM EST
[ Parent ]
If it's merely a political decision, then politicians have spoken loud and clear for the last 30 years. Unfortunately, they haven't spoken on the side of longer time tics.

I am quite comfortable with the fact that this is a political problem. Because, as I have noted elsewhere, political problems are somebody's fault, and can be rectified by removing the somebody whose fault it is and replacing him with someone who isn't a problem.

Firstly, there is the physical constraint from the volume flow of transactions. With millions of market participants performing one or two transactions every day or every week only, for example, the total number of transactions in a single day is still huge. So there has to be constant activity to balance the books, unless you can limit the number of market participants to a handful.

Not the regulator's problem.

Ban OTC transactions and enforce a Tobin tax on all on-exchange transactions. Then you don't have to care whether a transaction takes place to balance books or to shift ownership around.

Secondly, modern replication strategies require frequent rebalancing of portfolios down to the smallest time interval possible.

Modern replication strategies are a bug, not a feature.

But, again, not the regulator's problem. Under a Tobin Tax scheme, individual participants can have precisely the amount of liquidity that they are willing and able to pay for.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Jul 30th, 2009 at 01:53:57 PM EST
[ Parent ]
I am quite comfortable with the fact that this is a political problem. Because, as I have noted elsewhere, political problems are somebody's fault, and can be rectified by removing the somebody whose fault it is and replacing him with someone who isn't a problem.
Or not. That's the rub, isn't it? If it's purely a political problem, then to solve it one has to convince one's compatriots to vote in the way that one would like them to vote. How's that been working out for the last 30 years? For that matter, how did that work out in the years since 2000?

I continue to believe that a serious deterioration is first necessary to focus people's minds. I hope I'm wrong.

Ban OTC transactions and enforce a Tobin tax on all on-exchange transactions.
Ban OTC? How are you going to do that? Those are essentially private agreements between two parties. Would you like any two companies who wish to enter into any contract to ask the government regulator for permission first? You can shut down the OTC Bulletin Board and you could outlaw any contract which contains the words over-the-counter if you like, but what is that going to accomplish realistically? OTC is not the actual stock exchange, and the same can be accomplished by two people sitting in an office to sign a document, or two computers talking to each other directly. Worse, derivatives are not usually about trading stock directly, but about rights and obligations regarding the behaviour of people and companies owning stock. It's meta. It's an agreement about what the parties will do at particular event times.

Modern replication strategies are a bug, not a feature.
Why? A replication strategy is only a sequence of trades, such as any person might do. The difference is in the player's mind. Whereas a casual investor has no idea what the end result of his investment strategy will be, beyond a nebulous hope of increasing his wealth, the replication strategy is designed to create a specified function of the underlying stock. That's all.

Any sequence of trades over time generates some function of the underlying stocks, bonds, etc. If you can write down what function you would like to get, then it is a matter of solving an engineering style control problem to get an approximation of this function within the feasibility constraints represented by the number of allowed trades and asset classes. In other words, you could have a stock market that allows a single time tic per day, or any number of silly constraints, and you could replicate regardless.

How do you control what's in a person's mind? How do you argue politically that companies cannot choose what to buy or sell when they want to? How do you convince your compatriots to vote for somebody who will impose those restrictions? It doesn't sound easy to me.

Under a Tobin Tax scheme, individual participants can have precisely the amount of liquidity that they are willing and able to pay for.
And Tobin concerns exchange trades only, right? What private companies agree between each other about what they will or will not do on the exchange is not covered, right?



--
$E(X_t|F_s) = X_s,\quad t > s$

by martingale on Thu Jul 30th, 2009 at 10:15:12 PM EST
[ Parent ]
Ban OTC? How are you going to do that?

Same way you do with gambling, price fixing cartells or any other contract the government wants to get rid off. Ban the action and give it suitable punishments, make it possible for government to seize assets if the action is revealed, and refuse to let the criminals use the governments resources to uphold the contracts.

Illegal activities will always still happen, but it will be riskier and less profitable. And thus probably less common.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Jul 31st, 2009 at 04:44:14 AM EST
[ Parent ]
Ban OTC? How are you going to do that?

Simple. You cannot legally change ownership of anything that is traded on an exchange without notifying the exchange and paying the Tobin Tax.

The same way that you cannot legally change ownership of a house without notifying the local zoning authority and paying stamp duty.

Private agreements that, at some future point in time, securities that are traded on exchange will change hands should be similarly unenforceable, unless they are registered with the exchange. Precisely the same way that I cannot hold you to a promise you make to sell me your house at some agreed-upon time at some agreed-upon price, unless the contract has been signed and notarised.

Contracts between private third parties require the government to enforce them. So if the government ceases to enforce certain kinds of contracts, they cease to have meaning as contracts and become much vaguer kinds of promises. Private enforcement of such promises is what's known as "blackmail" and it is usually frowned upon in polite society.

Why? A replication strategy is only a sequence of trades, such as any person might do. The difference is in the player's mind. Whereas a casual investor has no idea what the end result of his investment strategy will be, beyond a nebulous hope of increasing his wealth, the replication strategy is designed to create a specified function of the underlying stock.

Yes, and that's the problem. It works on the stock price to generate revenue, rather than the underlying cash flow.

Which is a bug, not a feature.

And Tobin concerns exchange trades only, right? What private companies agree between each other about what they will or will not do on the exchange is not covered, right?

Correct. But if such agreements are not enforced by the state, the first time any party finds itself in a losing bet he can simply walk out without further discussion.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Jul 31st, 2009 at 05:27:28 AM EST
[ Parent ]
Simple. You cannot legally change ownership of anything that is traded on an exchange without notifying the exchange and paying the Tobin Tax.

Exchanges? Who needs exchanges?

Where's the exchange in the world of FX?

Exchange trading would disappear into "dark pools" of liquidity in five minutes. A lot already has.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Jul 31st, 2009 at 07:10:20 AM EST
[ Parent ]
Where's the exchange in the world of FX?

Basel.

It's not a very effective exchange, as a number of SE Asian countries will attest, but it's there.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Jul 31st, 2009 at 07:24:55 AM EST
[ Parent ]
Basel??

CLS Bank is the closest thing there is and it's not even remotely possible to operate at the requisite level of granularity.

There is not a cat in hell's chance of a Tobin Tax without a new clearing network created - or evolving - from the ground up.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Jul 31st, 2009 at 07:40:14 AM EST
[ Parent ]
Because existing exchanges would resist?  Because capital would flee to "dark pools" and engage in legally unenforceable transactions?  Well, various mafia's do seem to be able to do business, but...

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Jul 31st, 2009 at 01:49:07 PM EST
[ Parent ]

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