Quantcast

Posts tagged with welfare economics

If you buy a loaf of bread from the supermarket both you and the supermarket (its shareholders, its employees, its bread suppliers) are made to some degree better off. How do I know? Because the supermarket offered the bread voluntarily and you accepted the offer voluntarily. Both of you must have been made better off, a little or a lot—or else you two wouldn’t have done the deal.

Economists have long been in love with this simple argument. They have since the eighteenth century taken the argument a crucial and dramatic step further: that is, they have deduced something from it, namely, Free trade is neat.

If each deal between you & the supermarket, and the supermarket & Smith, and Smith & Jones, and so forth is betterment-producing (a little or a lot: we’re not talking quantities here), then (note the “then”: we’re talking deduction here) free trade between the entire body of French people and the entire body of English people is betterment-producing. Therefore (note the “therefore”) free trade between any two groups is neat.

The economist notes that if all trades are voluntary they all have some gain. So free trade in all its forms is neat. For example, a law restricting who can get into the pharmacy business is a bad idea, not neat at all, because free trade is good, so non-free trade is bad. Protection of French workers is bad, because free trade is good. And so forth, to literally thousands of policy conclusions.

Deirdre McCloskey, Secret Sins of Economics

A wonderful essay. I’ll just add what I think are some common answers to common objections:




A One-Line Viewpoint on Trading

Given a time-series of one security’s price-train P[t], a low-frequency trader’s job (forgetting trading costs) is to find a step function S[t] to convolve against price changes P′[t]

image

with the proviso that the other side to the trade exists.

S[t] represents the bet size long or short the security in question. The trader’s profit at any point in time τ is then given by the above definite integral.

 
  • I haven’t seen anyone talk this way about the problem, perhaps because I don’t read enough or because it’s not a useful idea. But … it was a cool thought, representing a >0 amount of cogitation.
  • This came to mind while reading a discussion of “Monkey Style Trading” on NuclearPhynance. My guess is that monkey style is a Brownian ratchet and as such should do no useful work.
  • If I were doing a paper investigating the public-welfare consequences of trading, this is how I’d think about the problem.

    Each hedge fund / central bank / significant player is reduced to a conditional response strategy, chosen from the set of all step functions uniformly less than a liquidity constraint. This endogenously coughs up the trading volume which really should be fed back into the conditional strategies.
  • Does this viewpoint lead to new risk metrics?
  • Should be mechanical to expand to multiple securities. Would anything interesting come from that?

I wouldn’t usually think that multiplication of functions has anything to do with trading. Maybe some theorems can do a bit of heavy lifting here; maybe not.

It at least feels like an antidote to two wrongful axiomatic habits. For economists who look for real value, logic, and Information Transmission, it says The market does whatever it wants, and the best response is a response to whatever that is. For financial engineering graduates who spent too long chanting the mantra “μ dt + σ dBt” this is just another way of emphasising: you can’t control anything except your bet size.

UPDATE: Thanks to an anonymous commenter for a correction.