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Did that course clinch your decision to pursue a career in the stock market

After I graduated, I moved to Dallas, which was the only big city I had ever visited, to look for a job as a stockbroker. I thought being a stockbroker meant that you got to manage other people's money and play the stock market all day long. I quickly found out that it was more of a sales job, and quite frankly, I'm a terrible salesperson. I picked up my largest client because his own broker wouldn't answer the phone on the day of the October 1987 stock market crash he couldn't face talking to his customers and 1 was the only one his client could reach. After I was there for about two years, I remember calling up my dad and saying, I don't like being a stockbroker. All 1 do is cold-call people all day, trying to sell them stuff they probably don't need in the first place. Verbalizing my feelings helped me decide to quit. I knew I really wanted to be a money manager. I moved to New York City to find a job more closely aligned with my goal.

Chapter The Stock Market the Theory of 7 Rational Expectations and the Efficient Market Hypothesis

PREVIEW Rarely does a day go by that the stock market isn't a major news item. We have wit nessed huge swings in the stock market in recent years. The 1990s were an extraordinary decade for stocks the Dow Jones and S& P 500 indexes increased more than 400 , while the tech-laden NASDAQ index rose more than 1,000 . By early 2000, both indexes had reached record highs. Unfortunately, the good times did not last, and many investors lost their shirts. Starting in early 2000, the stock market began to decline the NASDAQ crashed, falling by over 50 , while the Dow Jones and S& P 500 indexes fell by 30 through January 2003. Because so many people invest in the stock market and the price of stocks affects the ability of people to retire comfortably, the market for stocks is undoubtedly the financial market that receives the most attention and scrutiny. In this chapter, we look at how this important market works.

Computing the Price of Common Stock

Common stock is the principal way that corporations raise equity capital. Holders of common stock own an interest in the corporation consistent with the percentage of outstanding shares owned. This ownership interest gives stockholders those who hold stock in a corporation a bundle of rights. The most important are the right to vote and to be the residual claimant of all funds flowing into the firm (known as cash flows), meaning that the stockholder receives whatever remains after all other One basic principle of finance is that the value of any investment is found by computing the value today of all cash flows the investment will generate over its life. For example, a commercial building will sell for a price that reflects the net cash flows (rents - expenses) it is projected to have over its useful life. Similarly, we value common stock as the value in todays dollars of all future cash flows. The cash flows a stockholder might earn from stock are dividends, the sales price, or both.

Application Monetary Policy and Stock Prices

Stock market analysts tend to hang on every word that the Chairman of the Federal Reserve utters because they know that an important determinant of stock prices is monetary policy. But how does monetary policy affect stock prices The Gordon growth model in Equation 5 tells us how. Monetary policy can affect stock prices in two ways. First, when the Fed lowers interest rates, the return on bonds (an alternative asset to stocks) declines, and investors are likely to accept a lower required rate of return on an investment in equity (ke). The resulting decline in ke would lower the denominator in the Gordon growth model (Equation 5), lead to a higher value of P0, and raise stock prices. Furthermore, a lowering of interest rates is likely to stimulate the economy, so that the growth rate in dividends, g, is likely to be somewhat higher. This rise in g also causes the denominator in Equation 5 to fall, which also leads to a higher P0 and a rise in stock prices. As we will see in Chapter 26,...

New Information Is Not Always Immediately Incorporated into Stock Prices Although it

Is generally found that stock prices adjust rapidly to new information, as is suggested by the efficient market hypothesis, recent evidence suggests that, inconsistent with the efficient market hypothesis, stock prices do not instantaneously adjust to profit announcements. Instead, on average stock prices continue to rise for some time after the announcement of unexpectedly high profits, and they continue to fall after surprisingly low profit announcments.19

Practical Guide to Investing in the Stock Market

The efficient market hypothesis has numerous applications to the real world. It is especially valuable because it can be applied directly to an issue that concerns many of us how to get rich (or at least not get poor) in the stock market. (The Following the Financial News box shows how stock prices are reported daily.) A practical guide to investing in the stock market, which we develop here, provides a better understanding of the use and implications of the efficient market hypothesis. 18Evidence for mean reversion has been reported by James M. Poterba and Lawrence H. Summers, Mean Reversion in Stock Prices Evidence and Implications, Journal of Financial Economics 22 (1988) 27-59 Eugene F. Fama and Kenneth R. French, Permanent and Temporary Components of Stock Prices, Journal of Political Economy 96 (1988) 246-273 and Andrew W Lo and A. Craig MacKinlay, Stock Market Prices Do Not Follow Random Walks Evidence from a Simple Specification Test, Review of Financial Studies 1 (1988)...

Role of the Stock Market

The stock market plays a role similar to that of the insurance market in that it allows for risk spreading. Recall from Chapter 11 that we argued that the stock market allowed the original owners of firms to convert their stream of returns over time to a lump sum. Well, the stock market also allows them to convert their risky position of having all their wealth tied up in one enterprise to a situation where they have a lump sum that they can invest in a variety of assets. The original owners of the firm have an incentive to issue shares in their company so that they can spread the risk of that single company over a large number of shareholders. Similarly, the later shareholders of a company can use the stock market to reallocate their risks. If a company you hold shares in is adopting a policy that is too risky for your taste- or too conservative you can sell those shares and purchase others. In the case of the stock market, there is risk in the aggregate. One year the stock market as...

The Decision Process Of The Investor In Analysing And Selecting Stocks

It is important to start any analysis dealing with stocks by assessing the state of the economy which explicitly influences investors' everyday investment decisions. For example, if a recession is likely, or under way, stock prices will be heavily affected (they are likely to drop) at certain times during the contraction. Conversely, if a strong economic expansion is under way, stock prices will be heavily affected (they are likely to rise), again at particular times during the expansion. For instance, in 1997 when the world economy was performing exceptionally well, unprecedented rises were fuelled in stock markets all round the world.

Can Anyone Predict Stock Prices

Every day, financial news programs, such as Wall Street Week or CNBC's Squawk Box, offer stock market advice to millions of television viewers. The stock market analysts interviewed on these shows tell us that they have done some careful research, or that they have a secret formula, and that by following their advice, you'll earn more dividends and capital gains than you could hope to earn on your own. Of course, for the really good predictions, you'll have to pay a price, and subscribe to their private newsletter or use them as your stockbroker. It may surprise you to hear that the vast majority of economists don't believe them. Economists, as a rule, don't believe that anyone no matter how smart, no matter how much research they do can do much better than you, an introductory economics student, reading this book and finding out about the stock market for the first time. In fact, they don't believe that anyone can predict what will happen to stock prices much better than someone who...

Predicting Stock Prices Fundamental Analysis

One widely practiced method for predicting stock prices is fundamental analysis. As its name suggests, fundamental analysis focuses on the fundamental forces driving a firm's future earnings, and the value placed on those earnings by stock market participants. Fundamental analysts study data on overall economic conditions, on specific industries, and on individual firms. To try to predict what will happen to share prices for specific firms, they consider the products made by a company, the future demand for these products, and the strategic moves of current or future competitors to the firm in question. They will also study the firm's top management and try to assess how smart and creative they are.

Predicting Stock Prices Technical Analysis

Another method for predicting stock prices which seems to become more popular every year is technical analysis. The basic idea is that you can graph the recent behavior of a stock's price and, based on certain patterns, predict whether the stock is going to increase or decrease in value over the near future. Technical analysts believe that everything you need to know to predict a stock's future price changes is contained in the stock's past behavior. Many technical analysts recommend that their clients or employers buy and sell particular firms' stocks based on past price movements, without even knowing what the firm produces Many people find technical analysis appealing because there are, indeed, elements of strategic behavior in stock market investing. When you attempt to forecast what will happen to your 50 shares of General Motors during the next six months, it is not enough to understand GM's prospects and the demographic factors affecting the demand for automobiles. You also...

How did you first get involved in the stock market

I was always interested in finance and currencies. As a kid, I would read the sports page of the newspaper, just like my friends, but 1 also read the financial page. In 1986, they opened the Istanbul Stock Exchange. The newspapers didn't even have a stock market column until 1987. When they did start reporting stock prices, I noticed that the prices changed every day. It got my attention. I figured if you were smart, you could make money off of this because

How were you able to make even a small profit during the phase when the stock market was going down sharply

The stock market in Turkey is very speculative. The exchange has a 10 percent daily price limit. The maximum permissible daily price move (up or down) in each stock was limited to 10 percent. Typically, when a market reaches limit up, trading will virtually cease, as there will be many buyers, but few sellers. An analogous situation would apply when the market is limit down. Daily price limits are very common. I had a rule that I would buy a stock if it went down the daily limit three days in a row and then sell it on the first short-term bounce.

Profits and Stock Market Value

As we indicated above, most large firms are organized as corporations, which means that they are jointly owned by a number of individuals. The corporation issues stock certificates to represent ownership of shares in the corporation. At certain times the corporation issues dividends on these shares, which represent a share of the profits of the firm. The shares of ownership in the corporation are bought and sold in the stock market. The price of a share represents the present value of the stream of dividends that people expect to receive from the corporation. The total stock market value of a firm represents the present value of the stream of profits that the firm is expected to generate. Thus the objective of the firm maximizing the present value of the stream of profits the firm generates could also be described as the goal of maximizing stock market value. In a world of certainty, these two goals are the same thing. The owners of the firm will generally want the firm to choose...

Investment and the Stock Market

We noted above that in the largest developed economies, corporations finance most of their investment expenditure from internal resources ultimately this is shareholders' capital. The stock market valuation of companies' existing capital reflects the return that shareholders might earn on funds. So we should expect to see a link between levels of investment companies undertake and the stock market. In fact, the link was elegantly and formally set out many years ago by James Tobin, who developed the so-called q theory of investment. Tobin noted that if the value of a company on the stock market was substantially more than the replacement cost of the assets that the firm employs (most of which we will assume are some form of capital equipment), then in principle that company has a major incentive to increase investment. When we think about the replacement value of capital here, we mean the current cost of buying the sorts of machines that the company uses. If the ratio between the value...

The q theory of investment implies that we should expect to see a strong link between movements in the stock market

What about the cost of capital If a firm is generating just enough profits to satisfy its shareholders, we would expect that the ratio of profits to stock market value is equal to shareholders' required rate of return. So a measure of the cost of capital is profits stock market value of firm profit replacement cost of capital profit stock market value of firm stock market value of firm replacement cost of capital q The q theory of investment implies that there should be a positive link between stock market valuations (relative to the purchase cost of plant, machines, buildings, and so forth) and the level of investment. But empirical evidence suggests that there is not such a clear link. Figure 13.8 plots changes in the level of investment expenditure in the United States charted against the change in stock prices. While the two move roughly in line, the correlation between them is low. Similar pictures could be drawn for all the major economies. What are we to make of the relatively...

BD Interpreting Typical Stock Market Betas

The market beta is the best measure of diversification help for an investor who holds the stock market portfolio and considers adding just a little of your firm's project. From your perspective as a manager seeking to attract investors from everywhere in the market, this is a reasonable assumption. Recall that we assume that your investors are diversified, holding the stock market portfolio. To get your market investors to like a S10 million project, you just need the average investor to want to buy S10 million divided by about S10 trillion the stock market capitalization , which is 1 1,000,000 of their portfolios. For your investors, your corporate project is just a tiny addition to their market portfolios.

The Impact of Privatization on Stock Market Liquidity

In an attempt to measure what part of the increased liquidity of world stock markets is driven by privatization, Boutchkova and Megginson (2000 henceforth BM) generate the turnover ratios for individual markets and regress these on the number of privatization deals for each country in a particular year. BM specifically pick the turnover ratio, defined as the total value of trading divided by prior year-end total market capitalization, as their measure of stock market liquidity because it reflects increases in both the value of shares traded and the stock market capitalization measures rather than just measuring absolute growth in trading volume. In other words, it is a conservative measure of the growth in liquidity. Furthermore, as Levine and Zervos (1998) point out, turnover is one of the few robust stock market-based predictors of long-run economic growth. The Privatization International Electronic Database is used to obtain the number of privatization deals (share offerings plus...

Case Study Why The Fed Watches The Stock Market And Vice Versa

That was how Federal Reserve Chairman Alan Greenspan once described the booming stock market of the late 1990s. He is right that the market was exuberant Average stock prices increased about fourfold during this decade. Whether this rise was irrational, however, is more open to debate. Regardless of how we view the booming market, it does raise an important question How should the Fed respond to stock-market fluctuations The Fed has no reason to care about stock prices in themselves, but it does have the job of monitoring and responding to developments in the overall economy, and the stock market is a piece of that puzzle. When the stock market booms, households become wealthier, and this increased wealth stimulates consumer spending. In addition, a rise in stock prices makes it more attractive for firms to sell new shares of stock, and this stimulates investment spending. For both reasons, a booming stock market expands the aggregate demand for goods and...

When Firms Publicize Energy Management Projects Their Stock Prices Go Up

Frequently, these projects are perceived to be superior to EMPs, even though they may yield the same increased profit and present value. A justification is that revenue-enhancing projects are more likely to attract publicity and investor attention. Investor speculation and reaction to announcements can increase the firm's stock price. Most EMPs do not generate as much publicity as joint ventures or new product lines. selected over an EMP. But is this a fair comparison There has not been any research to determine if an EMP announcement increases a firm's stock price. In theory, it should because most EMPs increase profits (via cost reduction instead of increased revenues). From a cash flow perspective, an EMP is equivalent to any other profit-enhancing project. This article seeks to determine whether an EMP announcement correlates with an abnormal increase in a firm's stock price. If such announcements positively impact stock price, then the firm has one more incentive to implement...

The Stock Market And The Macroeconomy

Tracking the Stock Market Explaining Stock Prices The Stock Market and the Macroeconomy How the Stock Market Affects the Economy How the Economy Affects the Stock Market A Shock to the Economy and the Stock Market The 1990s Greenspan was referring to the rapid rise in stock prices that had occurred over the previous several years. By one broad measure, the average stock's price had doubled over this period a very rapid rise by historical standards. But when the markets opened for trading at 9 30 a.m. on the morning after Greenspan's speech, stock prices dropped by about 2 percent almost immediately. That evening, on Larry King Live and ABC News Nightline and CNN Money-line, pundits debated the meaning and wisdom of Greenspan's remarks. Everyone agreed that the purpose of Greenspan's remarks was to bring down stock prices, and that he had succeeded somewhat. But there were two opposing reactions to what the Fed chair had done. One group of commentators believed that Greenspan was...

Tracking The Stock Market

In the United States, financial markets are so important that stock and bond prices are monitored on a continuous basis. If you wish to know the value of a stock, you can find out instantly by checking with a broker or logging onto a Web site (such as,, or In addition, stock prices and other information are reported daily in local newspapers and in specialized financial publications such as the Wall Street Journal and the Financial Times. In addition to monitoring individual stocks, the media keep a close watch on many stock market indices or averages. These averages track movements in stock prices as a whole, or movements in particular types of stocks. The oldest and most popular average is the Dow Jones Industrial Average (DJIA), which tracks the prices of 30 of the largest companies in the United States, including AT& T, IBM, and Wal-Mart. Another popular average is the much broader Standard & Poor's 500 (S& P 500), which...

Explaining Stock Prices

Why do stock prices change And why do they change so often single corporation's shares. That is, we'll view the stock market as a collection of we'll view the stock market as a collection of individual, perfectly competitive markets for particular corporations' shares. In each market for shares, the buyers and sellers are both individuals and institutions (money market funds, insurance companies, and retirement funds). In either case, a high rate of return is a primary goal. Since most of the return on stocks comes from capital gains, we can state this goal very simply Buyers will want to buy and hold shares in a company when they believe the stock price will rise, and sell shares in a company when they believe the price will fall. Like all prices in competitive markets, stock prices are determined by supply and demand. However, in stock markets, our supply and demand curves require careful interpretations.

How The Economy Affects The Stock Market

Now that we've explored how the stock market affects the economy, let's look at the other side of the two-way relationship how the economy affects stock prices. Actually, many different types of changes in the overall economy can affect the stock market. Some like the revolution in telecommunications that took place in the 1990s are rare, happening once or twice a century. Others like the impact of macroeconomic fluctuations happen much more frequently. In this section, we'll focus on the more frequent scenario how the stock market responds as the economy goes through expansions and recessions in the short run. Let's start by looking at the typical expansion, in which real GDP rises rapidly over several years. In the typical expansion, profits will rise along with GDP. Higher profits are themselves enough to make stocks look more attractive. But the process is further helped by another factor an improvement in investor psychology. In an expansion, not only are corporate profits...

Random Sample Of 10 Stock Market Mutual Funds Was Taken

Monthly rates of return on the shares of a particular common stock are independent of one another and normally distributed with a standard deviation of 1.7 A sample of 12 months is taken. 43. A random sample of ten stock market mutual funds was taken. Suppose that rates of returns on the population of all stock market mutual funds follow a normal distribution.

How The Stock Market Affects The Economy

Stock Market The link between stock prices and consumer spending is an important one, so economists have given it a name the wealth effect. And the wealth effect works in both directions Just as an increase in stock prices increases autonomous consumption, so will a drop in stock prices which decreases household wealth cause autonomous consumption spending to fall. the wealth effect tells us that autonomous consumption spending tends to move in the same direction as stock prices. When stock prices rise, autonomous consumption spending rises when stock prices fall, autonomous consumption spending falls with it. The Wealth Effect and Equilibrium GDP. As you learned when you studied the short-run macroeconomic model, autonomous consumption is a component of total spending. And an increase in total spending tends to increase equilibrium real GDP, as shown in panel (a) of Figure 4. There, when stock prices rise, the increase in real wealth causes the aggregate expenditure line to shift...

The Enron Scandal and the Stock Market

In 2001, two big shocks hit the stock market the September 11 terrorist attacks and the Enron scandal. Our analysis of stock price evaluation, again using the Gordon growth model, can help us understand how these events affected stock prices. The September 11 terrorist attacks raised the possibility that terrorism against the United States would paralyze the country. These fears led to a downward revision of the growth prospects for U.S. companies, thus lowering the dividend growth rate (g) in the Gordon model. The resulting rise in the denominator in Equation 5 would lead to a decline in P0 and hence a decline in stock prices. Increased uncertainty for the U.S. economy would also raise the required return on investment in equity. A higher ke also leads to a rise in the denominator in Equation 5, a decline in P0, and a general fall in stock prices. As the Gordon model predicts, the stock market fell by over 10 immediately after September 11. Subsequently, the U.S. successes against...

Ramsey and Zhang Approach of Stock Market Crises by Matching Pursuit with Time Frequency Atom Dictionaries High

It would be interesting to test this method on a stock market index offering a continuity throughout the twentieth century and compare this series and its decomposition with the historical events which impacted this financial index and the economy. The French index does not allow probably this experiment, indeed, it would be necessary to study the continuity between the French index before and after 1988, since in 1988 a new index has been created (i.e. Cac40). The Ramsey and Zhang work (using the Mallat and Zhang algorithm) is based on the S& P500 index of the United States which seems to have a better structural continuity. If one evokes the growth rate of the index, it is possible to observe that the very dense signal is traversed by fast oscillations with localized bursts of very large amplitude. This type of behavior favors the use of analysis tools such as the waveform dictionaries, i.e. the time-frequency J.B. Ramsey and Z. Zhang distinguish for a signal between isolated...

Why The Fed Watches The Stock Market And Vice Versa exuberance.' was how Federal Reserve Chairman Alan Greenspan once described the booming stock market of the late 1990s. He was right that the market was exuberant Average tuck prices increased about fourfold during this decade And perhaps it was even irrational In the first few years of the following decade, the stock market took back some of these large gains, as stock prices experienced a pronounced decline, falling by about 40 percent from 20(10 to 2003. How should the Fed respond to stock-market fluctuations The Fed has no reason to care about stock prices in themselves, but it does have the job of monitoring and responding to developments in the overall economy, and the stock market is a pieceof that puzzle. When the stock market booms, households become wealthier, and this increased wealth stimulates consumer spending. In addition, a rise in stock prices makes it more attractive for firms to se-ll new shares of Stock, and this stimulates investment spending....

Are Stock Prices Forecastable

Belief in efficient (or rational) stock market pricing has taken big blows over the last 20 years. Robert Shiller led the intellectual assault on belief in stock market efficiency in a series of papers written more than 20 years ago.10 In 1981 Shiller argued that stock prices in the United States over the 100-year period starting in 1870 were far too volatile to be consistent with a rational evaluation of the fundamental value of the corporate sector.11 Shiller wanted to compare the volatility of stock prices observed in practice with the volatility of share prices if they are based on rational forecasts of future dividends. However, we cannot recreate now what rational forecasts of future dividends were in 1870. Therefore, Shiller focused instead on the volatility of share prices assuming that the investor had perfect foresight about future dividends. If you had known in 1870 what dividends U.S. companies would pay over the next 100 years, then using the logic of Figure 17.7, you...

Future dividends should influence todays stock price

However, note that while the current stock price reflects information about all future dividends, all dividends are not equally important. Because of discounting, current dividends influence the current stock price more than dividends in the far future. The discounting works as follows. The current stock price depends on the discounted expected price and dividends next period, P(0) P(1) + D(1) (1 + r). We also know that next period's price equals the discounted value of expected prices and dividends in period 2. Therefore, in influencing today's stock price, current dividends are discounted only once, D(1) (1 + r), but dividends expected in period 2 are discounted twice. That is because we have to discount P(1) when considering its influence on P(0) and because P(1) itself depends on discounted dividends in period 2. Therefore, the influence of period 2 dividends on the current stock price is twice discounted, D(2) (1 + r)2. Because (1 + r)2 is greater than (1 + r), future dividends...

Stock Market Value

Other times, especially if the time frame in which the value must be realized is short, the stock market method may be the best of several poor alternatives. Consider the valuation of an investment company. In mid-1990 the Schaefer Value Trust, Inc., a closed-end mutual fund, scheduled a vote of its shareholders to consider liquidation. The most relevant measure of the liquidation value of Schaefer was its stock market value, the value that its holdings would bring when sold at once in the stock market. No other valuation method would have been appropriate. Stock market value applies in other situations as well. In attempting to value a company's interest in an unrelated subsidiary or joint venture, for example, investors would certainly consider the discounted anticipated future cash flow stream (net present value), the valuation of comparable businesses in transactions (private-market value), and the value of tangible assets net of liabilities...

What drove the stock so high

I challenge you to defend the valuations of those companies that account for the largest holdings in the most prominent mutual funds in this country. You may tell me they are great companies. That is one of the biggest misconceptions in this business. With all due respect to Warren Buffet, this business is not about investing in great companies it's about profiting from inefficiently priced stocks. At this point, an assistant brings in the fund holding statistics for

Your list of stock selection factors can you explain why you consider AOL so extremely overpriced

If a stock routinely has daily trading ranges of 20 percent or more, without any substantive news, you know that the market has no idea how to value it. It's all driven by flow of funds, and if the flow of funds into the highest capitalization stocks diminishes, then AOL will certainly suffer disproportionately. It is interesting how rational money managers become in a bear market. Only then do they begin to question the underlying valuations.

What made you decide to make the transition from analyst to money manager

I had done well trading my own account for many years, and I wanted to devote full time to stock picking, which had always been my passion. As a sell-sider, nearly 80 percent of my time was spent on marketing, and the research was often too oriented on maintenance. Another attraction was that, as a portfolio manager, my universe of potential ideas would expand dramatically. Also, although I certainly wasn't underpaid as an analyst, I was well aware of the economic potential implied by the remuneration-for-performance structure of a hedge fund. Finally and I hesitate to say this because I don't want to

She didnt know that you took out a homeequity loan

Maybe you have to put yourself in the position to be lucky, but I think we all get our fair share of luck both good and bad. We just have to take it as it comes. That Commodore trade saved me. You might think my attitude would have been That tip worked, so I'm going to listen to other tips. But at the time, I recognized the luck involved. I realized that I was being bailed out by the stock market gods. I did learn my lesson. From that point on, 1 traded so much better.

Where did you get out

Companies whose stock price is very vulnerable because of weak fundamentals will often attract a lot of short selling. Sometimes these companies will encourage their investors to request their stock certificates in their name, in the hopes of forcing shorts to cover their positions when the loaned stock is recalled. Sometimes a few firms will buy up a large portion of the shares in a stock with a heavy short interest and then call in the shares, forcing the shorts to cover at a higher price. Then they will liquidate the stock for a quick profit. Do most stocks that are squeezed eventually come down

Were you profitable when you resumed trading

The tick became very negative, the market would tend to snap back on the upside. Conversely, strongly positive tick readings seemed to be followed by sell-offs. I asked a broker who had been in the business for thirty years what it meant when the tick got very positive or negative. He said, A negative tick means the stock market is going down, and a positive tick means it is going up. Yeah, I know that, I said, but what do I do when the tick is very positive or negative Well, if it's a high plus, you buy, and if it's a high minus, you sell, he answered. I asked a number of other brokers the same question, and they gave me the same advice. Since this advice contradicted my observations, I did just the opposite When the tick went above plus 400, I would sell, and when it went below minus 400, I would buy. I recorded the results in my diary and confirmed that this strategy was making money. I noticed, however, that the more minus the tick became, the more the market would snap back, and...

How long did it take you to recover the 350000 trading deficit that was left over from the Cities Service trade

At that time I wasn't day trading yet. In May 1987 I saw what I believed was a phenomenal buying opportunity in stock index call options. Two factors had converged my cumulative tick indicator was giving extremely bullish readings, and the decline in volatility had made the option premiums very cheap. My grandfather used to tell me, Buy things when people don't want them, and sell things when people want them. I put 55,000 into long-term, out-of-the-money stock index calls that were trading at 2 to 5 s. In this type of option position, the trader can make multiples of the initial outlay if there is a huge price advance, but lose the entire investment in any other price scenario. I bought well over a thousand options. During the next few months, stock prices exploded and the volatility shot up a combination that caused the value of my options to soar. Ever since the Cities Service disaster in 1982, I had wanted to demonstrate to my parents that I wasn't a failure. On August 7, 1987, I...

What happened last year

At the start of the month, 1 was up 30 percent for the year. I thought the rise in Internet stocks was a mania. Valuations had risen to levels we had never seen before. For example, Schwab has been publicly traded for over ten years. At the time I went short, the ratios of the stock price to the valuation measures sales per share, earnings

Oh about ten times bigger than this office [translation extremely small How long did you watch the market before you

At the time, there was no market research whatsoever. I started doing my own research. The Istanbul Stock Exchange published sheets that showed current and previous year revenues, earnings, debt, and a few other statistics. No one paid any attention to these numbers. Since there were no books or articles available on the stock market, I just tried to interpret the statistics logically.

Then are all the stocks you buy at or near recent lows

Receives a premium for the obligation to buy a stock at a price called the strike price during the life span of the option. This obligation is activated if the option is exercised by the buyer, which will happen if the stock price is below the strike price at the option expiration. For example, assume that a stock is trading at 13 and that a put option on the stock with a 10 strike price is trading at 1. If the stock is trading above 10 when the option expires, the seller will have a 1 profit per share (a 100 profit per option contract, which represents 100 shares). If the stock is trading below 10 at the option expiration, the option will presumably be exercised, and the seller of the option will be required to buy the stock at 10, no matter how low the stock is trading. Okumus, who typically sells puts with strike prices below the current market price (called out-of-the-money puts), will earn a profit equal to the option premium paid by the option buyer if the stock For example,...

What are some of the common denominators of stocks that share this rapid price gain characteristic

More than 80 percent of the stocks are less than ten years old. Although many of these stocks are newer companies, I avoid low-priced stocks. Stocks that are low are usually low for a reason. Typically, the stocks I buy are 20 or higher, and I never buy stocks under 12. My basic philosophy is Expose your portfolio to the best stocks the market has to offer and cut your losses very quickly when you're wrong. That one sentence essentially describes my strategy.

Losses at 10 percent Youre specifying that the list has to be preselected in some wayin your example the stocks with

I was only using an extreme example to illustrate a point Containing your losses is 90 percent of the battle, regardless of the strategy. In addition, if you put yourself in a position to buy stocks that have the potential to go up a lot, your odds will be better. In other words, the odds will be better if you buy stronger stocks. The odds will be better that you will buy stocks that go up a lot. Of course, the odds may also be better that you will buy stocks that go down a lot. But you don't have to worry about that do you since you are cutting your losses.

What gave you that conviction It certainly wasnt your trading results

I don't give up very easily. Perhaps the single most important factor was that I had a great passion for the game. I think almost anyone can be net profitable in the stock market given enough time and effort, but to be a great trader, you have to have a passion for it. You have to love trading. Michael Jordan didn't become

What happened after that

The other big influence for me were my uncles, Uncle Louie and Uncle Larry, who both traded stocks. When I was little, we would have family gatherings. Uncle Louie would be seated on one side, Uncle Larry on the other, and my dad across the table, and they would all be talking about the stock market. I was the only son, and I thought that's what men did. When I got into the business, Uncle Louie and Uncle Larry were accounts of mine, and I learned a lot from them.

Was that difficult to do

I also did cold-call visits with one of the other trainees. We knocked on doors in the neighborhood, trying to get people to open accounts. One time we went into a grocery store, and it turned out that the owner's brother-in-law had lost all his money in the stock market. The grocery owner chased us out of his store, swinging a big loaf of bread at us, and yelling, I don't want to

It doesnt sound like you have a very high regard for Wall Street analysts

One of the basic tenets of option theory is that the probabilities of different prices on a future date can be described by a normal curve. * Many traders have tweaked this model in various ways. For example, many option market participants have realized that rare events (very large price increases and decreases, such as the October 19, 1987, stock market crash) were far more common in reality than predicted by a normal curve and have adjusted the curve accordingly. (They made the tails of the curve fatter.) Bender, however, has gone much further. He has questioned the very premise of using a normal curve as the starting point for describing prices. He has also questioned the convention of using a single model to describe the price behavior and by implication option prices of different markets and stocks. By ditching the concept that price movements behave in the random fashion implicitly assumed by a normal distribution and by dropping the assumption of a universal model, Bender was...

So even if the company stock is 10 when you make the deal and it goes down to 5 you still make a minimum return

Why would a company raise money by doing a guaranteed deal with you instead of borrowing money from a bank at a fixed rate We compete with banks all the time, but there are many reasons why companies come to us. Sometimes a bank may be willing to give a company a partial loan but want them to raise an equity cushion elsewhere. For example, one of the companies we invested in is a consolidator in the home alarm industry. They needed 22 million to *Preferred stock takes precedence over common stock in respect to dividend payments and asset distribution in the event of liquidation.

David Shaw The Quantitative Edge

In offices Situated on the upper floors of a Midtown Manhattan skyscraper, Shaw has assembled scores of the country's most brilliant mathematicians, physicists, and computer scientists with one purpose in mind to combine their quantitative skills to consistently extract profits from the world's financial markets. Employing a myriad of interrelated, complex mathematical models, the firm, D. E. Shaw, trades thousands of stocks in more than ten countries, as well as financial instruments linked to these stock markets (warrants, options, and convertible bonds). The company seeks to profit strictly from pricing discrepancies among different securities, rigorously avoiding risks associated with directional moves in the stock market or other financial markets (currencies and interest rates). Shaw's secretiveness regarding his firm's trading strategies is legendary. Employees sign nondisclosure agreements, and even within the firm, knowledge about the trading methodology is on a need-to-know...

Up to that point had you given any thought to a career in the financial markets

I had read that your stepfather was a financial economist who first introduced you to the efficient market hypothesis.* Did that bias you as to the feasibility of developing strategies that could beat the market Also, given your own lengthy track record, does your stepfather still believe in the efficient market hypothesis Although it's true that my stepfather was the first one to expose me to the idea that most, if not all, publicly available information about a given company is already reflected in its current market price, I'm not sure that he ever believed it was impossible to beat the market. The things I learned from him probably led me to be more skeptical than most people about the existence of a free lunch in the stock market, but he never claimed that the absence of evidence refuting the efficient market hypothesis proved that the markets are, in fact, efficient.

How much of what you do is gut feel

When did you first become aware that there was a stock market When I was about thirteen years old. My father used to bring home the New York Post every evening. I always checked the sports pages. I noticed that there were all these other pages filled with numbers. I was fascinated when I found out that these numbers were prices, which were changing every day.

Great Traders Are Marked by Their Flexibility

Walton, for example, started out by selling powerhouse stocks and buying bargain stocks. When his empirical observations of what actually worked in the market contradicted this original inclination, he was flexible enough to completely reverse his approach. As another example, when Minervini was a novice trader he favored buying low-priced stocks that were making new lows, an approach that was almost precisely the opposite of the methodology he ended up using. stocks in one year and a buyer of value stocks in another. My philosophy he says, is to float like a jellyfish, and let the market push me where it wants to go.

You Cant Be Afraid of Risk

Limiting the Downside by Focusing on Undervalued Stocks A number of the traders interviewed restrict their stock selection to the universe of undervalued securities. Watson focuses on the stocks with relatively low price earnings ratios (8 to 12). Lauer will look for stocks that have witnessed market-adjusted declines of at least 50 percent. Okumus buys stocks that have declined 60 percent or more off their highs and are trading at price earnings ratios under 12. He also prefers to buy stocks with prices as close as possible to book value.

Countertoanticipated market behavior See item 21 Portfolio considerations See item

For example, the use of stops to limit losses is essential to Minervini, who uses a timing-based methodology, but is contradictory to the approach used by Lauer, Okumus, and Watson, who tend to buy undervalued stocks after very sharp declines. (The latter traders, however, would still use stop-loss strategies for short positions, which are subject to open-ended losses.) As another example, profit objectives, which are an integral part of some traders' methodologies, could be detrimental to other traders and investors by limiting profit potential.

This Time Is Never Different

Every time there is a market mania, the refrain is heard, This time is different, followed by some explanation of why the particular bull market will continue, despite already stratospheric prices. When gold soared to near 1,000 an ounce in 1980, the explanation was that gold was different from every other commodity. Supposedly, the ordinary laws of supply and demand did not apply to gold because of its special role as a store of value in an increasingly inflationary world. (Remember doubledigit inflation ) When the Japanese stock market soared in the 1980s, with price earnings ratios often five to ten times as high as corresponding levels for U.S. companies, the bulls were ready with a reassuring explanation The Japanese stock market is different because companies hold large blocks of one another's shares, and they rarely sell these holdings. As this book was being written, there was an explosive rally in technology stocks, particularly Internet issues. Stocks with no earnings, or...

Successful Investing and Trading Mas Nothing to Do with Forecasting

Lescarbeau, for example, emphasized that he never made any predictions and scoffed at those who claimed to have such abilities. When asked why he laughed when the subject of market forecasting came up, he replied I'm laughing about the people who do make predictions about the stock market. They don't know. Nobody knows.

Use Common Sense in Investing

Buy Stocks That Are Difficult to Buy Walton says, One of the things I like to see when I'm trying to buy stocks is that they become very difficult to buy. I put an order in to buy Dell at 42, and I got a fill back at 45. I love that. Minervini says, Stocks that are ready to blast off are usually very difficult to buy without pushing the market higher. He says that one of the mistakes less skilled traders make is waiting to buy these stocks on a pullback, which never comes.

Popularity Can Destroy a Sound Approach

A classic example of this principle was provided by the 1980s experience with portfolio insurance (the systematic sale of stock index futures as the value of a stock portfolio declines in order to reduce risk exposure). In Index funds may well provide a current example of this principle. As Lauer explained, index funds originally made a lot of sense for the investor, providing the opportunity to own a representative piece of the market, with presumably lower risk due to the index's diversification, and a low cost structure and favorable tax treatment (due to low turnover). As index funds outperformed the majority of actively managed funds, however, they attracted steadily expanding investment flows. This investment shift, in turn, created more buying for the stocks in the index at the expense of the rest of the market, which helped the index funds outperform the vast majority of individual stocks, attracting still more assets, and so on. As a result of this process, what started out...

Like a Coin the Market Has Two Sidesbut the Coin Is Unfair Just as you can bet

Heads or tails on a coin, you can go long or short a stock. Unlike a normal coin, however, the odds for each side are not equal The long-term uptrend in stock prices results in a strong negative bias in short-selling trades. As Lescarbeau says, Shorting stocks is dumb because the odds are stacked against you. The stock market has been rising by over 10 percent a year for many decades. Why would you want to go against that trend (Actually, there is a good reason why, which we will get to shortly.)

The Confidence Chickenand Egg Question

To cite only a few of the many possible examples A When Watson was asked what gave him the confidence to pursue a career in money management when he had no prior success picking stocks, he replied, Once I decide 1 am going to do something, I become determined to succeed, regardless of the obstacles. If 1 didn't have that attitude, I never would have made it.' - Bender not only spends a full day trading in the U. S. markets, but then is up half the night trading the Japanese stock market.

Youve been pretty specific about how you select your stocks How do you decide when to get out When and why did you get

In our typical long position, we are looking to buy stocks that are grossly undervalued, and we are prepared to hold those positions for twelve months, or even longer. In contrast, in our short positions, we are looking for stocks that will experience a shortfall relative to Wall Street's expectations in the near term, and our anticipated exposure period is, at most, a couple of weeks. On the long side, you only buy stocks that your analysis tells you have very limited risk. On the short side, you will stop yourself out before a stock goes very far against you. Did your risk control strategy ever fail Was there ever a situation where you took a large loss I sustained a terrific loss in my personal account during the October 1987 crash. All the stocks that I owned at the time were very cheap, using the same criteria we talked about earlier. However, there was a technical breakdown in the market. In one day, the Dow was down over 25 percent, and the small caps small capitalization...

Successful years

I became very concerned about the rise in interest rates. In the past, higher interest rates had always led to lower stock prices, and I assumed the same pattern would repeat this year. The market, however, chose to look at other factors. 1 didn't wait for the market to confirm the fear of higher interest rates, and I lost money very quickly. I was down 7 percent in March, which is a pretty big one-month drop for me.

Any final words

Any investment approach that is dependent on stock market direction for profitability is doomed to mediocrity. Any investment approach that is heavily reliant on accurate forecasting or involves the purchase of high-expectation stocks is inherently risky. Market supply and demand forces create spectacular pricing inefficiencies. All that is required for successful investing is the commonsense analysis of today's facts and the courage to act on your convictions. Michael Lauer's market philosophy is perhaps best summarized by his comment that this business is not about investing in great companies, it's about profiting from inefficiently priced stocks. The crucial point is that fundamentals are not bullish or bearish in a vacuum they are bullish or bearish only relative to price. The greatest company in the world could be a terrible investment if its price rise has already more than discounted the bullish fundamentals. Conversely, a company that has been bombarded with negative news...

Jack D Schwager

Copyright 2001 by Jack D. Schwager. All rights reserved. Printed in the United States of America. Designed lay Fearn Cutler Library of Congress Cataloging-in-Publication Data Schwager, Jack D., 1948-Stock market wizards interviews with America's top stock traders by Jack D.

What restrictions

The environment wasn't very conducive to running a hedge fund. One of the rules was that you couldn't short any stock that the company owned. Since the firm held at least a thousand different stocks at any time, the universe of potential shorts was drastically limited. They also had a very negative attitude toward the idea of shorting any stocks. When Jim Levitt quit, I was on vacation in Lake Tahoe. Mark called me and told me that I would be taking over the hedge fund because Jim had left the firm. Mark's philosophy was that anyone could short stocks. He ran computer screens ranking stocks based on relative strength price change in the stock relative to the broad market index and earnings growth. He would then buy the stocks at the top of the list and sell the stocks at the bottom of the list. The problem was that by the time stocks were at the bottom of his list, they were usually strong value candidates. Essentially you ended up long growth stocks and short value stocks that...

What are your goals

Okumus's bread-and-butter trade is buying a stock with sound fundamentals at a bargain price. He looks for stocks with good growth in earnings, revenues, and cash flow, and significant insider buying or ownership. Strong fundamentals, however, are only half the picture. A stock must also be very attractively priced. Typically, the stocks Okumus buys have declined 60 percent or more off their highs and are trading at price earnings ratios under 12. He also prefers to buy stocks with prices as close as possible to book value. Very few stocks meet Okumus's combination of fundamental and price criteria. The majority of the stocks that fulfil his fundamental requirements never decline to his buying price. Out of the universe of ten thousand stocks Okumus surveys, he holds only about ten in his portfolio at any given time. One element of market success frequently cited by Market Wizards, both in this volume and its two predecessors, is the age-old trading adage Cut your losses short. Yet...

Preface to the second edition

Extensive reading of economics journals and monographs, as well as newspapers, has produced over a thousand new entries. The organisation of the Dictionary has also been changed. The newer version of the subject classification employed by the Journal of Economic Literature and The Economic Journal has been applied to previous and new entries. There is now a separate listing of abbreviations and acronyms, together with tables for currencies and stock market indexes.

Thomas B Fomby and Dek Terrell

The editors are pleased to offer the following papers to the reader in recognition and appreciation of the contributions to our literature made by Robert Engle and Sir Clive Granger, winners of the 2003 Nobel Prize in Economics. Please see the previous dedication page of this volume. The basic themes of this part of Volume 20 of Advances in Econometrics are time-varying betas of the capital asset pricing model, analysis of predictive densities of nonlinear models of stock returns, modeling multivariate dynamic correlations, flexible seasonal time series models, estimation of long-memory time series models, the application of the technique of boosting in volatility forecasting, the use of different time scales in Generalized Auto-Regressive Conditional Heteroskedasticity (GARCH) modeling, out-of-sample evaluation of the 'Fed Model' in stock price valuation, structural change as an alternative to long memory, the use of smooth transition autoregressions in stochastic volatility...

Investment Objectives

Deliver a return that will exceed the inflation rate over the investment period, so that the real purchasing power of the investment will increase over time. Some funds are more aggressive than others, some are more tolerant of volatility than others, but the basic idea is to make the investors' assets grow. Equity mutual funds do this by investing in the stock market, which has an upward bias over long time periods.

Financing Energy Management Projects

Most facility managers agree that energy management projects (EMPs) are good investments. Generally, EMPs reduce operational costs, have a low risk reward ratio, usually improve productivity and even have been shown to improve a firm's stock price.1 Despite these benefits, many cost-effective EMPs are not implemented due to financial constraints. A study of manufacturing facilities revealed that first-cost and capital constraints represented over 35 of the reasons cost-effective EMPs were not implemented.2 Often, the facility manager does not have enough cash to allocate funding, or can not get budget approval to cover initial costs. Financial arrangements can mitigate a facility's funding constraints,3 allowing additional energy savings to be reaped.

Aligning the interests of managers and shareholders

Critics of such schemes argue that senior managers may be motivated by nonmonetary rewards and that it is difficult to devise incentive schemes that only reward superior performance. A survey by Gregg et al. (1993) explored the relationship between the direct remuneration (pay plus bonuses) of the highest paid director and the performance of around 300 companies in the 1980s and early 1990s. They found that almost all large UK companies had bonus schemes for top executives but that rewards were weakly linked to corporate performance on the stock market. The authors concluded that the results called into question the current system of determining rewards and that the incentive schemes did not successfully align managerial interests with those of the shareholders. (This aspect is further discussed as a principal agent problem in Chapter 20.) To achieve the desired alignment between owners and managers there have been many changes in the UK to corporate governance rules to prevent the...

The Relative Significance Of Aggregate And Firmspecific Uncertainty

Understanding macroeconomics is not simply a useful aspect of the public relations role of the business person nor is it solely related to better understanding government policy. The health of a company or of an individual's job prospects and portfolio depends on the macroeconomy. Macroeconomic events like changes in interest rates, fluctuations in exchange rates, and shifts in the overall level of stock market prices affect individuals and companies. More local events like a rise in the wages of the company's workforce or the bankruptcy of a competitor are also important. Both types of fac-tors the localized and the general are uncertain. Economists distinguish between two types of uncertainty aggregate and idiosyncratic. Aggregate uncertainty affects all firms and sectors in the economy idiosyncratic uncertainty affects only a few individuals, firms, or industries. Macroeconomics is essentially about the aggregate sources of uncertainty that affect firms, workers, and consumers.

Debt Versus Equity Financing

A company must consider its position with respect to leverage. Does the company have a large proportion of its debt in bonds or preferred stock If so, the common stock is said to be highly leveraged. If earnings decline by say 10 , this could wipe out dividends to the common stockholders. The company might also not be able to cover interest on bonds without using accumulated retained earnings. There is a great danger when companies have a high debt equity ratio illustrating a weakness of companies with an unusually high ratio. Many capital-intensive industries like chemicals, petroleum, steel, etc. have ratios of 2 or 3 to 1. The danger is that they may be confronted with liquidating some of their assets to survive. On the other hand, if the ratio is of the order of 1 to 1, this strategy increases the chance of a takeover and does affect the stock price.

Populations And Samples

It is commonplace to come across the assertion that in today's world we are assaulted on all sides by a veritable barrage of numbers. It is impossible to read a newspaper or listen to a news report without having to digest the impact of such statements as the Dow-Jones average fell 6 points today, the Consumer Price Index rose by .8 last month, or the latest survey indicates that the president's approval rating now stands at 40 . Now, issues such as the state of the stock market, the rate of price inflation, and the electorate's opinion of the performance of the president are likely to be of concern to many of us. It is becoming the case that in order to obtain an intelligent appreciation of current developments in such fields, one must absorb and interpret substantial amounts of numerical information. Certainly, the amount of such information that is collected has grown at a phenomenal rate over the past few years. Government has contributed to this development, both through its own...

Why Study Financial Markets

Part II of this book focuses on financial markets, markets in which funds are transferred from people who have an excess of available funds to people who have a shortage. Financial markets such as bond and stock markets are crucial to promoting greater economic efficiency by channeling funds from people who do not have a productive use for them to those who do. Indeed, well-functioning financial markets are a key factor in producing high economic growth, and poorly performing financial markets are one reason that many countries in the world remain desperately poor. Activities in financial markets also have direct effects on personal wealth, the behavior of businesses and consumers, and the cyclical performance of the economy. The Stock Market A common stock (typically just called a stock) represents a share of ownership in a corporation. It is a security that is a claim on the earnings and assets of the corporation. Issuing stock and selling it to the public is a way for corporations...

Leaving Everything to the Market

The importance of the last criterion is fundamental. If we propose to establish a new corporation and sell stock on the stock market, we may require the concurrence of a very large number of people (buyers, sellers of other stock, regulators). But the number of people we require is a small part of all potential investors, and hence the people who will become stockholders are not prespecified. If we are proposing to improve police protection in Tucson or London, however, the number of people who are directly concerned is determined at the outset. If we permit individuals to decide whether they will pay for the police department, and given the technological conditions under which additional police protection is delivered, we would anticipate that very little police protection would be purchased. The only way out of this dilemma, assuming we have complete private property, would be to arrange a unanimous agreement under which each of us put up a certain amount of money in return for the...

Life the great risk shift

The benefits of incentivization were taken very happily during the boom years of the late 1990s, when almost all stock prices were going up, regardless of the quality of their management. But, once the bubble burst, enthusiasm for stock options declined. Large numbers of companies repriced the options they had already issued, setting the price low enough that their executives were once again in the money. This is

Types of Interpersonal Action Voluntary Exchange and the Contractual Society

The possibility of exchange with others means that an actor will now consider not only the direct use-value of a good but also its exchange-value. The marginal utility of a given unit of a good is the higher of these two (i.e., a person will continue to trade away units of a good so long as the exchange-value of the marginal unit is higher than the use-value). Because of diminishing marginal utility, owners of large stocks of goods (such as people producing for a market) usually consider the exchange-value more relevant.

Evaluating the Tech Stock Interest Rate Nonsense

Day after day, some equity strategist goes on TV to declare that higher interest rates don't matter when it comes to technology stocks. Starting with the old model, a company's stock price is determined by earnings expectations plus a risk-free interest rate, which is used to discount future earnings streams, plus an adjusted risk premium. There is one more channel, probably the most important one, through which interest rates affect a company's stock price the presumed sensitivity of demand for a company's product, McManus says. No matter how good the management of a company, they have no control over demand as affected by interest rates.

Harvard Business School Press

Of wealth, we can also answer the question How can we create more of it Beinhocker describes how new research is turning conventional wisdom on its head in areas ranging from business strategy and the design of organizations to the workings of stock markets and the world of politics and policy.

Mortgage Backed Securities

Although the size of the corporate bond market is substantially smaller than that of the stock market, with the amount of corporate bonds outstanding less than one-fourth that of stocks, the volume of new corporate bonds issued each year is substantially greater than the volume of new stock issues. Thus the behavior of the corporate bond market is probably far more important to a firm's financing decisions than the behavior of the stock market. The principal buyers of corporate bonds are life insurance companies pension funds and households are other large holders.

Venture Capitalists and the Financing Challenge

Even if the manager is motivated to maximize shareholder value, informational asymmetries may make raising external capital more expensive or even preclude it entirely. Myers and Majluf (1984) and Greenwald, Stiglitz, and Weiss (1984) demonstrate that equity offerings of firms may be associated with a lemons problem (Akerlof 1970). If the manager is better informed about the investment opportunities of their firms than the investors and acts in the interest of current shareholders, then the manager issues new shares only when the company's stock is overvalued. Indeed, numerous studies have documented that stock prices decline upon the announcement of equity issues, largely because of the negative signal sent to the market. nity. The decision to invest is frequently made conditional on the identification of a syndication partner who agrees that this is an attractive investment (Lerner 1994). In exchange for their capital, the venture capital investors demand preferred stock with...

Economic Cycles From 1926 To 2001

Figure 1-2 shows inflation and the level of the stock market, both before and after adjusting for inflation. This time, rather than showing the rate of inflation, we are showing the actual increase in the general level of prices. Then we show the level of the stock market, both before and after inflation. What we are showing is the value of 1 invested in the S& P 500 on January 1, 1926. The change in value reflects the impact of dividends, and the reinvestment of those dividends. The stock values are shown on what is called a logarithmic scale, where equal vertical distances represent equal percentage changes. The period from the mid-1960s through the 1970s is especially noteworthy since high inflation meant that the real return of stocks, after inflation, was close to zero. From the mid-1960s through the early 1980s, inflation turned upward again. This was due partly to massive government spending earmarked for the war in Vietnam and for a broad variety of government-sponsored...

Empirical Application

I consider daily closing prices for the MTMS (Moscow Times) share index obtained from Yahoo Finance. The time period under investigation is 01 01 97 to 23 01 04. There were altogether 1,575 observations in row data sets. Examining the data graphically reveals that the stock prices exhibit a prominent upward, but non-linear trend, with pronounced and persistent fluctuations about it, which increase in variability as the level of the series increases. Asset prices look persistent and close to unit root or nonstationarity. Descriptive statistics confirm that the unit-root hypothesis cannot be rejected at any significance. The data also exhibits large and persistent price volatility, showing significant autocovarience even at high order lags.

The Great Bull Market

During the first period, from 1981 through the early part of 1989, the driving theme was the end of inflation. The Federal Reserve moved decisively in the late 1970s to attack inflation, and when the new strategies showed signs of success in the early 1980s, financial markets rejoiced. The inflation rate came down, interest rates fell, and stock prices rose. Though there was a market crash in October 1987, the general investment environment was refreshingly benign. Source Standard & Poor's and Nasdaq Stock Market, Inc. Source Standard & Poor's and Nasdaq Stock Market, Inc. And then the environment got even better in the mid-1990s as the bull market entered a final manic phase driven by technology stocks. Investors embarked on a torrid affair with personal computers, the Internet, and other technological marvels that would boost productivity and generate outrageous profits for tech companies that were in the right place at the right time. Companies that were unlikely to show a...

The Public May Get More Than It Bargained

This is supposedly what the public is demanding to restore its faith in Corporate America and the stock market. Our elected and appointed officials are happy to oblige, competing with one another to see who can do more, rushing new legislation through Congress at a breakneck pace, with little regard for the long-term impact on the economy. During bad times the major stock indexes are posting double-digit declines this month alone, some 2 years into the bear market the public wants the government to do something. On some level, Americans would like the government to guarantee our investments, deliver double-digit returns on our stock portfolios, even ensure that our 401(k) nest eggs are intact when we retire. We want the upside to be unlimited, and we want to be protected from losses. (In other words, the government should write a put on the Standard & Poor's 500 Index.) Maybe what we really want is for the government to intervene to boost the stock market, in the same way that the...

Mean And Variance For Grouped Data

Suppose that an investigator has available only data grouped into classes, such as the information in Table 2.6 on inflation-adjusted returns of common stocks. Given only this information, we want to obtain estimates of the mean and variance. We will not. of course, be able to find the precise values of these summary measures if the raw data are unavailable. For example, from Table 2.6 we know that seven of the returns are between 20.05 and 40.05 . However, we do not know where in this range these seven returns lie. In order to make further progress, some approximation is needed. Since the exact location is a particular class of all its members is unknown, one obvious possibility is to proceed as if they were all located at the midpoint of the class interval. Thus, we would take each of the seven returns between 20.05 and 40.05 to have the value 30.05 . If this is done, we are in the position of having multiple-observation values and can proceed to calculate their mean and variance...

An Empirical Investigation Of The Samuelson Rational Warrant Pricing Theory

Have criticized the independent increments assumption, and Osborne 2 has examined the assumption of stationariness, Mandelbroit 2 and Pama 2 argue that stock and commodity -price changes follow a stable-Paretian distribution with infinite second-moments. The non-academic literature on the stock market is also filled with theories of stock price patterns and trading rules to beat the market, rules often called technical .analysis or charting, and that presupposes a departure from random price changes.

Hedge Funds And The Bull Market

Making money in the bull market was easy, so vast portions of the U.S. population got hooked on the stock market. Some of this new interest in stocks was part of a healthy and growing equity culture, in which more and more people invested in diversified stock portfolios through their individual retirement accounts (IRAs), 401(k) plans, and other investment accounts. But some of this interest was not healthy. Some people became obsessed with the stock market, even giving up their more conventional jobs to become day traders. The United States became a market-obsessed culture, in which people watched financial news on television and spent time at parties swapping stories about stocks, mutual funds, star portfolio managers, and so forth. Newspapers advertised mutual funds run by investment wizards who had compiled dazzling performance records. The financial pages became an extension of the sports pages as investors pored over the statistics, and the paychecks, of celebrated financial...

Three Ways Of Dealing With A Problem4

Consider the action of thinking (which is presumably most relevant among the activities of economists). The action can imply the ignoring of the tension. Hearing about time going backwards creates a tension which I subsequently try to forget. Ignoring tensions is what we do all the time in our scholarly activities. The problem can also cause subversion of, or liberation from, all we know. That tends to happen when we experience something out of the ordinary, such as the death of someone close, chaotic behaviour of a physical system, a plunging stock market, or maybe the reading of Geertz, MacIntyre, or others. Another way of dealing with a tension is to recognize it as a problem and seek its solution within what we know already. This is what the normal scientist does with selected problems.

Median And Interquartile Range For Grouped Data

In Section 2.2, we defined the median as the middle value when the observations are arranged in ascending order. Now, if we have available only data grouped into classes, so that the original observation values are unknown, we will not be able to arrange them in ascending order. Still, we can do part of that job. Referring to the returns on common stocks in Table 2.7, we know that the two smallest returns are in the class -39.95 to -19.95 , the eight next smallest are in the class - 19.95 to .05 , the eleven next smallest in the class .05 to 20.05 , and so on. We will illustrate this rather forbidding-looking formula by estimating the median and other quartiles of the inflation-adjusted returns on common stocks. As a first step, we retabulate the data in Table 2.11. Here we show the cumulative frequencies, that is, the total number of observations up to and including those of the corresponding class.

Greenspan Admits Bubble Ducks Responsibility

In the traditional kick-off speech at Fed Camp, otherwise known as the Kansas City Fed's annual Jackson Hole Conference, Federal Reserve Chairman Alan Greenspan admitted the late 1990s stock market boom was a bubble. Then he washed his hands of the whole thing. With one exception in 1996, for which he was widely booed, the Fed chief kept his suspicions to himself. In fact, he quickly became the head cheerleader for the New Economy, touting equity analysts' long-term forecasts as a justification for the lofty levels of stock prices. (Greenspan's faith in earnings forecasts is even more ludicrous in retrospect, with many analysts exposed as go-getters for investment-banking business.) What about the little-used Fed tool of changing margin requirements, which is the amount an investor is required to deposit in his brokerage account (The firm lends him the rest to buy stocks.) Margin requirements have been at 50 percent since 1974. No doubt anticipating he would be reminded of that...

Evaluation and Calibration

One strand of the literature on point forecasts comprises descriptive accounts of forecasts and forecast errors in specific episodes of particular interest, often business cycle turning points. For example, Wallis (1989) reviews several accounts of macroeconomic forecast performance during the recessions of the 1970s. It is striking that many studies of the performance of options-based densities adopt the same approach, describing the behavior of the implied probability distributions before and after such events as the U.S. stock market crash of October 1987 (Jackwerth and Rubinstein, 1996), the Persian Gulf crisis of 1990-91 (Melick and Thomas, 1997), the crisis in the European exchange rate mechanism around 16 September 1992 - black Wednesday - (Malz, 1996) together with the following month's announcement of a new monetary policy framework in the United Kingdom (Soderlind, 2000) and, at a more mundane level, announcements of economic news and shifts in official interest rates...

Brief History Of Hedge Funds

Jones's fund was what we will later classify as an opportunistic equity hedge fund. Jones's strategy was to invest in individual stocks, taking either a long position (a bet on rising prices) or a short position (a bet on falling prices), depending on the results of his analysis. The total portfolio could be net long (the value of the longs Although it is traditional to consider Jones as the founder of the hedge fund business, this view has to be taken with at least two grains of salt. First, it is likely that there were investment partnerships prior to Jones's that engaged in one or more hedge fund strategies but did not attract the attention that Jones's fund attracted. We know, for example, that Benjamin Graham (who became famous partly because of Warren Buffett's early admiration for Graham's approach to value investing) formed an investment pool in 1926. Although this pool was oriented mainly toward long-term investments in severely undervalued stocks, Graham may also have done...

Bubble Babble Is Even Sillier Three Years Later

Using the same metric and logic, semiconductor stocks, which had risen 50 percent since the start of 2000, were actually cheaper than drug stocks, according to the story. A portfolio manager said technology stocks were the place to be for the short and long term. Projected growth turned out to be a poor predictor of both earnings growth and the stock price. Looking out a year from the peak, net income for semiconductor stocks in the Dow Jones Semiconductor Index fell 42 percent in the first quarter of 2001 compared with a year earlier, according to Thomson First Call. Pharmaceutical stocks in the comparable Dow Jones index saw profits rise 17 percent. Analysts explained the divergence between old-line industrial stocks and new-era technology stocks as reflective of investor fears that higher interest rates would hurt the former. The Federal Reserve had raised the overnight interbank rate by 100 basis points between June 1999 and the Nasdaq peak on March 10, 2000. The Fed was to...

Macroeconomic history

During the past 11,000 years, humanity's achievements there have been rather like the performance of financial stocks declines in some regions have been matched by growth in others. By the 16th century, the technological gap between the seafaring nations of Western Europe and the Americas was so large that a combination of guns, steel, and European germs enabled tiny groups of invaders to conquer the New World. Becky's very successful part of the world is in effect the outgrowth of a societal transplant that took place less than 500 years ago.

Do Asset Prices Belong in the Central Banker Toolkit

Consider that the last two recessions in the U.S. and the series of recessions in Japan in the 1990s were arguably the result of popped asset bubbles. In the U.S., the bubble was in real estate in the late 1980s early 1990s and in the stock market in the late 1990s. Japan had a double whammy overvalued real estate and equities in the bubble economy of the 1980s. Residential real estate is booming in the U.S., and some analysts think stock prices have outrun the fundamentals yet again. Carson advocates using a broad price index, which includes a weighted average of real estate and stock prices in addition to consumer and producer prices, to assess the stance of monetary policy. Currently, the gap between the growth rate in his proprietary broad price index and the federal funds rate is the widest in 20 years. What about the squishy concept of the output gap, the difference between potential and actual GDP The gap is notoriously difficult to measure in real time, yet it remains an...

Empirical Evidence on State versus Private Ownership

So which group of theorists worships the True Faith those who favor state ownership of commercial enterprises or those who oppose public ownership 6 Ultimately, this question can be resolved only by using the tools of empirical research. Given the importance of this issue, it is not surprising that economists have long attempted to examine whether state ownership is inherently more or less efficient than private ownership. What is surprising is that, until quite recently, empirical research was unable to provide an unambiguous answer to this deceptively simple question. Early empirical studies tended to produce ambiguous or finely balanced results. Whereas several early papers found that private ownership was superior, a roughly equal number found that state ownership was not inherently less value-maximizing than private ownership, and a few even documented that state ownership was superior. In support of private ownership, Davies (1971) compared the performance of Australia's two...

Riskier projects at least those which are implemented in an equilibrium will yield higher expected pecuniary returns

Some recent articles in the finance literature have questioned whether systematic risk and expected returns are correlated as the capital asset pricing model suggests (e.g., Fama and French 1992 Roll and Ross 1994). The arguments of this book do not require that the capital asset pricing model has predictive power for the cross-sectional returns of different stocks. I focus on a far blunter comparison between risk and return. If entrepreneurs are to invest in risky and ambitious ventures, rather than holding T-Bills or spending more on consumption, they must expect relatively high returns from their real productive investments.

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