This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?
I’m the author. Thank you for saying it is an excellent read — that was no small amount of work.
You ask “Where is the productive output of all these arbitrage shell games?”, which is a very fair question. The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them. E.g., you are not the optimal person to hold the risk that, through no fault of your own, your house burns down. That risk exists, and you are not the optimal holder of it. Hence insurance. A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk.
Of course, with markets come some ‘unproductive’ stuff. Likewise, democracy is good, but that is not necessarily praising the optimality of all parts of campaign finance legislation.
Let me also mention that I am the author of the definitive reference book on old Vintage Port: Port Vintages (and seemingly the board disallows a link).
> The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them.
That is just one of the purposes; others are:
- time-shifting of consumption: borrow when you study or build a house, then invest and save during work years, then live of retirement portfolio
- maturity transformation enabling investment: extra cash goes in the bank (and can be redeemed on demand), is bundled and lent (long-term) to fund construction or businesses [1]
- allocative function: send capital to its most productive use. For that, you need accurate prices, supported by equity research and markets.
So, in real financial markets, all the arbitrage games etc. [2] at least support actual productive purposes.
In crypto, it's just a pure cargo cult copy of financial markets without any underlying productive purpose.
[1] that whole banking business is somewhat precarious, but reasonably well understood (since Bagehot) and regulated/insured, though in recent times obviously hasn't worked great. Alternative models (narrow banks + private credit) are conceivable.
[2] and to be clear: the amount finance skims of the economy is way too large. Similarly, building a somewhat straighter fibre (and then microwave towers) from Chicago to NY has no societal benefit I can discern. (But the solution to that is fintech and regulation, not crypto.)
Note also that in some cases you might be the optimal person to hold the risk that your house burns down, if, for example, your liquid net worth is 100x the replacement cost of your home. And that's illustrative of the value of markets: you can choose to transact in them, depending on your personal circumstances. The insurance market exists because for the vast majority of people, rebuilding their home is not feasible with their current net worth. But for a small number of people it might be, and for a small number of firms it's probably worth it to insure many thousands of people, and then you can even slice up the shares of those insurance firms and sell them on the stock market so that the risk of your house burning down gets socialized across all the other shareholders but at the same time you have a stake in the profits.
It definitely shows, thank you for publishing it freely
>The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them.
This makes a sense to me, thanks for explaining. I can definitely understand how insurance collectivizes and smooths individual risks, and from this and other examples I can see why a lending institution might seek something similar to enable them to keep cash moving. It does seem a little epicyclic to me that a farmer faces a glut as a result of organizing food production through a market economy, and then we resort to like a second-order market trick to resolve that problem. Presumably it would be simpler to just dump all the food in the middle of the table and then hand it out evenly, but I've heard this runs into its own set of difficulties.
>Let me also mention that I am the author of the definitive reference book on old Vintage Port: Port Vintages
Very welcomed, I may not buy the book but I will definitely go buy some port. TGIF!
> A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk.
Are you familiar with the arguments of (more popularly) Aaron Brown and (transitively) Jeffrey Williams?
Essentially, the idea that a farmer would be an active participant in a futures market is quaint, but the vast majority of activity is speculation. This is not a contradiction of your point, but an elaboration of a counter-intuitive part of it.
One might look at a futures market and see that well over 98 % of the activity is buying and selling by people who never have any reason to care about wheat other than for the possibility of its price going up or down. But this large-scale speculation is precisely the thing that makes it possible for a farmer to hedge (by providing liquidity and a motive for the counterpart of the hedge) or, as Williams' points out, perhaps more commonly "take out loans in commodities" for their convenience yield.
Essentially, the Lincolnshire farmer can lock in a price with a plain forward contract. However, that does take a double coincidence of demands (or whatever the phrase is) and the standardised nature of futures contracts help avoid that problem.
But! The most common use of futures contracts (aside from speculation) is not (or at least was not, when Williams wrote his book) hedging, but effectively borrowing and lending in commodities.
It is an interesting reframe to think of insurance as a, roughly, ATM put.
Having some experience with both trading derivatives and gambling though, I’m fairly confident saying that it’s a distinction without a difference. In both cases a little guy with an understanding of risk and bankroll management and some aptitude for the game, which for trading is a Keynesian beauty pageant, can scrape up a few bucks. But most people are going to be fish for the house. The derivative markets are providing exactly the same service as casinos, albeit with considerably higher limits and opportunities for crafting complex bets.
I would love to hear your opinion on Silicon Valley Bank and First Republic Bank. Did they deserve their fate on equal terms and also in retrospect who should have been the optimal holder of their risks?
Except that is not exactly "productive", isn't it? After all, risk was not eliminated, only redistributed. Productive output, e.g., would be something that reduces the chance of your house catching fire.
Why have them privately controlled at all? The fed prints the money. The fed could be the bank and insurer as well, and obviate the middle men skimming the pot.
I think you did a great job of explaining why someone might want each of these products, starting from first principles of "a company borrows some money from its bank". To still ask GP's question is either to not have understood the book, or to not understand any scenario where one might want to lend or borrow money.
Prices and financial markets in general exist solely for information transmission. The central problem of economics is "How do you produce the things that your population needs, in the quantity and at the time they need them, as efficiently as possible?" This is why every centrally-planned economy eventually fails, and why we were stuck in the feudal middle ages for a millennia. Information (and incentives) about what to produce and how to produce it efficiently weren't getting to the population at large, which caught us in a local subsistence minima. Financial markets give all the players an incentive (in the form of profit) to transmit information (in the form of prices) from people who want goods to people who can supply them.
This is also behind the theory of why certain forms of financial transactions are legal and others are illegal. Arbitrage = legal, because it converges prices in two separate markets in a way that gives producers in both those markets better information about true demand. Futures markets = legal, because they smooth out temporal fluctuations in demand so that producers only have to worry about producing, while also incentivizing the construction of just enough storage & buffering to hold that product. Pump & dump schemes = illegal, because they distort price information in the market in an unsustainable way and then leave later participants to bear the cost of this. Same with Ponzi schemes. Equities markets = legal, because they transmit information about the overall cost of capital within the economy to firms, which can then use it to decide the profitability or unprofitability of various investments.
Certainly one function of financial markets and prices is to convey information, but that's not "solely" their purpose. They also provide a mechanism for resource allocation, risk management, wealth generation and collective action, among other things.
Your point about centrally planned economies, while historically corroborated in cases like the Soviet Union, might be an overgeneralization. The effectiveness of an economic system depends on numerous factors, including its degree of flexibility, the effectiveness of its institutions, and its ability to adapt to changing circumstances.
Not all centrally planned economies are doomed to failure; some have been quite successful, notably in East Asia where countries like China and Vietnam have managed a mixed economy with elements of central planning and market mechanisms.
Many capitalist corporations are centrally planned economies larger than many nation states. While everything fails eventually, these centrally planned organizations can last multiple human generations, and can be more durable than many markets and market-oriented economies.
The assertion about the feudal Middle Ages also needs some nuance. The Middle Ages, and the feudal system in particular, had complexities beyond simple information and incentive problems. Numerous sociopolitical factors were at play, including a rigid class structure, the influence of the Church, and the lack of certain technological innovations. Ascribing the issues of a historical period mainly to its economic structure oversimplifies the multitude of factors that influenced societal development.
Moreover, while financial markets do help in transmitting information from consumers to producers, they are not infallible. They can, and often do, suffer from issues like information asymmetry, where one party in a transaction has more or better information than the other. This can lead to problems like adverse selection and moral hazard. Financial markets can also be subject to speculation, which can distort the "signal" provided by prices.
The focus on profit as the sole incentive in the market might be somewhat limited. People's decisions to buy, sell, and produce are influenced by a host of factors beyond profit, including societal and environmental concerns, personal values, and ethical considerations. Financial systems, to be truly effective, need to take into account this wide range of motivations.
Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples?
What percentage of futures trading is on farmers crops?
What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death?
How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
There is a societal benefit that comes with individuals internalizing their own costs of risk. Treating society like it's in an economic womb while Mother Finance shields it from the world of worries rewards ignorance and in my opinion accelerates us toward the world depicted in Idiocracy.
It is nice as a purchaser of such securities that you can build things more quickly than usual and transfer worry to someone who is willing to be worried for you. However I don't believe the SEC financial highway patrol has enough cruisers or sophistication to pull over enough abusers to deter the disproportionate fraud that increasingly arcane financial instruments create.
The costs of a few bad actors building piles of money illegitimately do not show themselves immediately. They pop up slowly, in dark money investments in destabilizing elections, funding of war criminals, market manipulation, etc. The societal cost of a charlatan having several lifetimes worth of an honest person's influence are grave and not to be laughed off.
I get why farmers do it but what's the societal benefit of letting a rando like me buy and sell (i.e. make bets on) such contracts? Do farmers really prefer that random people do this?
Whilst arbitrage is certainly something which exists in the financial markets, the vast majority of what's done isn't arbitrage. Arbitrage assumes differing views on valuation of an asset today. So I can buy something from person A, which they believe to be worth value x, and sell it to person B, who believes it to be worth y, where y > x. That's arbitrage in its simplest form - the market has priced something incorrectly, and I can buy it from willing sellers, and sell it to willing buyers at different values at the same time.
The vast majority of financial transactions aren't this - they're speculative. They bank on the idea that money now is worth more than money in the future, and the future value of an asset (using the definition of an asset that it's a sequence of cashflows) is both variable and uncertain. So therefore the promise of future money is inherently tied to the concept of risk. The majority of financial markets trading is based around this concept of risk, and the management of it.
There's vastly more complexity under the hood, but that's roughly speaking, accurate.
Commodities, homes, lands, water, minerals, etc (let’s call them real assets) can not inflated as freely as possible, the way money can be expanded/inflated. That’s the large source of speculation. This is why people borrow in order to acquire real assets.
Third world countries want to issue debt in American dollars, because no one wants to buy their bonds in their home currencies.
Gotcha gotcha, that makes sense, thanks for the clear explanation! So I can see how the arbitrage (thusly defined) has the risk mitigation benefits other people talk about, can the same be said about speculation?
> Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?
If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital. So companies that bring value to society should be able to expand their business.
At the same time, regular people can invest in such companies at somewhat fair prices without doing much analysis. Basically, because the profits above the market average have been taken by smarter investors already. But it’s still good to always be able to put money somewhere and receive avg. market returns.
Yeah, exactly. There is absolutely no way you could have ETFs if the "quick games" were forbidden. Not only because it's the HFTs that essentially run the fund on a day to day basis (see Authorized Participant for details).
One famous example with a completely extinguished price discovery is the Soviet Union. I think this is what killed it more than any internal or international political problems.
> If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital.
This only true of companies that were underpriced. Overpriced companies, either because of hype (Pets.com), fraud (Enron) or other reasons (maybe Jim Cramer issued a buy) do not benefit from a fairer price.
McDonald’s is known to have almost invented and streamlined cooking to industrial level. But McNuggets were made possible only through financial engineering:
Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets. Markets exist as a global network of interactions and persistent imbalances anywhere in the system can have massive consequences. Generally, these consequences rhyme with "two counterparties which don't interact with one another directly all that often suddenly discover grave disagreements in the desired price and quantity of something they'd like to trade". Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase.
So, markets work pretty hard to make sure that information from one area of the global economy can flow to all of the rest of the system with relative efficiency. This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time. Much like telephone, each pair of neighbors wants to do a good job sharing information without loss and, also, over long distances minor errors add up.
Arbitrage is the glue which prevents this from happening. Arbitrage says that any time anyone discovers some level of disconnection occurring, they can make money at very low risk by voting to shift markets to better align with one another.
Arbitrageurs are getting paid to provide a service to the market and subsequently the entire world. Their actions ensure that information flows throughout the global financial system quickly and without relying on centralized planning. Without them, markets could become disconnected and wander out of agreement.
>Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets.
>This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time.
Hell yeah I'm not sure where I fall on accepting this way of thinking about things, but the line of poetics/skeuomorphics/analogy is very cool to me.
>Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase.
This is kind of my sticking point because on direction of that risk is like an actual hazard to my biology and the other is the consequence of allocating food by market. Not saying it's 'wrong' per se, but it does stand out that we're resolving market problems with like market^2
The arbitrage game keeps the prices consistent with each other. It serves to create liquidity so that participants can get their business done without either waiting too long or paying too much.
The thing that I’ve always found wild is that the money people make on markets seems to be so much higher than the money people who actually make goods/services.
Why has the global economy put such a high benefit from investment bankers compared to, for example, family doctors?
they can only scale at most linearly, with the number of hours they work.
A financier can scale multiplicatively, because the amount of the monies they deal with can increase without "extra work". The multiplicative nature means the more capital you have access to, the more money you get to make, which approaches exponential at some point.
And in the end, the financier speculating on the markets can affect many more people than the doctor ever can in their life.
For one, finance is a macro force multiplier; it can make or break entire other industries. There’s also a bit of selection (global top) and survivorship (plenty of less visible non-success stories) in the wild money stories you can see out there.
This isn't false but it feels reductive. A financial instrument that allows one to bet on the corn harvest is obviously valuable to the corn farmer, as it allows them to use profits from good seasons to hedge against bad seasons. They're also valuable to people whose business is affected by the corn harvest - cereal manufacturers, say. The problem is that they can also be used by people with no exposure at all who simply want to bet on the corn harvest, and from the scale of the finance sector it seems like we are pouring a lot more of our resources and brainpower in to designing exotic new ways to bet on the corn harvest than we are on growing corn.
The output (generally speaking, not specific to money markets) is better prices. There are large scale examples of economies in which prices were mismanaged either due to lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union). While providing market information signals via prices is certainly an abstract concept that most people will never appreciate, it is important regardless.
For complex instruments in money markets, the main effects are bridging mis-priced treasuries on different time frames and hedging against various outcomes for pensions, banks, and dealers in physical commodities.
Most of the complex stuff either serves one of those purposes or becomes a zero sum game that doesn't affect non-participants. It's important to judge each instrument by its purpose and mechanism rather than bunch everything as a way to make bankers richer (e.g. a future vs. a CDO).
> lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union)
Venezuela has never had Soviet-style central planning. It's a market economy with a public sector only slightly larger than the OECD average. Their current situation is largely the result of excess social spending: first at the expense of investment and diversification away from oil prices were high, then at the expense of currency stability when oil prices crashed.
Futures and options were born from commercial needs.
Suppose you produce oranges. It'll take a few months for the harvest, and while costs are generally well understood and stable, at what price will you sell those oranges? What if by then the price of oranges tanks and you find out you're not turning a profit? This is where futures come in. The producer can sell a number of futures contract to lock in a future selling price, making cash flows much clearer and predictable.
Conversely, there's the case of a factory that needs to buy oranges for its products. They have the opposite problem and would like to make costs more predictable. Then they'd buy futures to lock in a future buying price.
> How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?
Interesting observation given that your own wealth is managed this way.
Whether its the simple bank deposit in a checking account, if you've ever chased an interest rate for a savings account, or had your earnings managed in a retirement account from your employer, or if you attempted to make money faster because a debt was coming due.
Its all tied together and a product of this system.
The goal is to keep money moving within the economy, as people also race to hoard it.
Generally speaking you can group large financial institutions into two groups: sell side and buy side. I’m no expert, but afaik, these firms either SELL liquidity (e.g. investment banks, market makers etc.) or BUY liquidity (for example pension funds, certain hedge funds). Liquidity is the key here - that is (if any) the benefit they bring to society. I can buy/sell pretty much any financial product/risk with reasonable spreads because there’s always someone on the other side of the trade ready to be my counterparty.
Not that I want to defend some of these institutions, though some are better than others, but it’s important to keep in mind that they do take on risk in order to provide us liquidity, and most of them specialize in managing the risk, some of them are even good at it. Their infrastructure and connectivity and the price they charge you to provide liquidity allows them to make profits, but they do lose money sometimes. Also, compared to 20 years ago, there’s fierce competition now in pretty much every aaset class - if you work in one of the buy/sell side firms, you’ll very often hear terms such as spread compression etc (except the Covid years of course - people just wanted to trade, nobody cared about the price of liquidity (e.g. spreads or sales credit etc.) they had to pay)
Not sure if you meant “money market” as it’s understood to be the market lending/borrowing for terms of less than a year, or if you were referring to fixed income markets in general.
Either way it’s hardly a waste of time or money, and banks make money not from “arbitrage shell games” but by matching buyers with sellers. Some people have money to lend and sone people have enterprises they need to fund.
While there are casinos, think: A farmer wants to get a fixed price for next years crop and insure against a bad harvest. Thats why you need these things.
Ok the farmer example is a trope apparently. Any business where you need to hedge financial risk. Lending too many mortgages to self employed people? Sell that risk / revenue stream on to someone else and buy something different to diversify.
Others have provided excellent answers. There's one thing I'd like to add. In order for the financial markets to provide more utility, a financial transaction tax needs to be introduced. It will indirectly kill unproductive or counterproductive financial activity such as high frequency trading.
Sibling comments have provided good explanations of why modern economies need finance: risk management, capital allocation, enabling ventures, and so forth.
At the same time, it’s worth asking the question of why the financial sector just keeps growing and whether that’s desirable. Shouldn’t improved efficiency with digital systems make this intermediation layer thinner, less labor-intensive, more competitive? Instead it seems to be capturing an ever larger share of the economy’s output to itself.
In my opinion regulators should try deploying some blunt tools like transaction taxes and hard salary caps, and see if we’d be any worse off with a smaller and poorer financial sector.
One example which is applicable to majority of the working population: in the UK at least the fixed-rate mortgages are priced off the Swap rates as that is how banks hedge them.
The value add is offering financial products that consumers want.
Businesses and people need to loan or borrow money, offering a wide variety of products that suit different needs supports economic growth.
A good example of this are all the foreign companies that decide to go public on the NASDAQ. They aren't doing it in their home country because of a weak (or non-existant) equities market, or burdensome regulation.
When it results in a concentration of wealth in the hands of people who can abuse it for political ends, or results in market crashes that cause knock-on impact to real humans - then yes, worrying about it is reasonable and justified.
I'm with you, but I apply the same logic to all rent-seekers and shareholders. We'd be a lot better off if we didn't have parasites and bottomless pits embedded in the economy by design.
Same with the majority of tech companies. All you do is endless meetings, plannings, reviews and extremely little actual human brain is used for productive output.
Quite. The general response I get from questions like this to financial folks is that these markets and vehicles and products are important "for liquidity", but they can never quite tell me who liquidity benefits other than the system itself.
All these Financial guides are very interesting. But beware of falling into the illusion of being a good-enough active investor. It's like entering the Pro league as an overconfident amateur. The other players are the best in the universe. And they have cybernetic extensions: algorithmic trading with virtually limitless amounts of resources and information. And sometimes they have "alpha" you'll never, ever get your hands on. They prey on "dumb money" like naive/retail investors and pension/mutual funds.
And at these times of high rates and inflation, the only safe move seems to be money market accounts and take the delta inflation hit. Try to focus your time in more valuable things like your friends and family. And keeping your sources of income.
Agreed, strongly. Which is why the online edition has some “Cautionary words”:
> Pricing Money is a beginner’s guide: it says so in big letters on the front cover. I believe it to be an excellent beginner’s guide — presumably many authors believe their own books to be excellent — but, being a beginner’s guide, it will not immediately make you a world-renowned expert.
> It was written around the turn of the pedant’s millennium. In some parts it shows its age. It has been slightly freshened by the addition of green-boxed updates, but these have been written very concisely, more to point to developments than to explain them fully.
> Please do learn from and be informed by Pricing Money. But also be cautious: it is not enough to make you a world-renowned expert; it does not list the many details that are both dull and necessary; some things have changed since it was written; it cannot be your risk manager.
I’m not going to argue that asset managers and trading desks have plenty of resources and that they can transact very quickly and cheaply. But having been on the inside of small and large asset managers for almost ten years, I can say there’s a lot of groupthink and rather brain dead behaviour to be seen on a trading floor.
Call me jaded but I’ve worked with both systematic and discretionary traders. The algos I’ve seen tend to be heavily overfit, and stop working as soon as they hit production. The discretionary traders usually have a tonne of gambler’s tics and have a bad habit of assigning narratives to market noise.
Most institutional traders aren’t the best in the universe. They just do dumb things faster and at bigger scale than day traders.
Indeed, institutional traders and asset managers are still the "buy side" and as such are not crazily more informed than retail.
The real sharks are on the sell side, using low-latency arbitrage and massive leverage, and have the ability to unwind risky positions over months. Fleecing buy side and retail is highly profitable for them.
In their defense of course they'll say they're "providing liquidity", and given how much buy side tends to pile up on one side of the trade, you can see their point: somebody's going to take the other side of these big moves.
Agree that people should not do active investing, although the solution would be passive investing (index funds), which allow you to focus on friends & family without missing out of the economy's long term gains.
i feel that this assumes the large investors on wall.street are playing the same game as retail investors. Given the size and scale of their accounts, I'd imagine it's an entirely different playbook.
My (limited, retail only) experience tells my gut that most retail investors do it to get rich, and not to learn the markets, learn the risks, and build a business. They are different goals, granted both do seek to make long term gains.
I like to believe that retail investors can make it if they put in the effort and learn to manage risk appropriately. At least I need to tell myself that as I work towards making money in the markets myself.
I am definitely dumb money right now, and I could also be delusional, but saying there is no hope so give up and just do something else completely is just defeatist.
Surely it must be possible to learn how to do whatever these so called "smart money" types are doing. Or at the very least learn how they operate so we can identify and avoid their attempts at predation.
I read a couple of pages and it looks good. I’m not a complete beginner but it’s still filling in some gaps in my knowledge. I appreciate the author’s work and giving it away for free.
That said I feel like it’s skipping some explanation for what’s supposed to be a beginner’s guide. One thing that sticks out to me is that it jumps straight into talking about interest rates without explaining the time value of money and why interest exists.
I wanted a book I could recommend and to others who knew even less than me, but I don’t think this could be it.
(And maybe interest is covered later on, but the ordering is important)
This is really interesting. Very early in my career I worked on a team that supported the interest rate swaps desk at a large investment bank. Not one person told me to read this book. I still don't know what they are. Wish I read this back then!
I am always amazed by Finance. But the engineer in me somehow always failed to grapple after few trenches deep into the realm of terminologies. I am strongly considering the MITx Finance specialization, but this resource is a great stop gap.
Growth doesn't require more resources. If your barber finds a way to cut your hair 10% faster, that shows up in GDP growth. Increasing efficiency leads to increased GDP.
You must think in terms of ratios, or not think at all. Debt-to-GDP ratio is a good measure that takes into an account most other variables like changes in population, productivity etc.
Question about the "Yields of Australian Commonwealth government bonds as of 21 January 2000" graph in Chapter 2 (page 13 of the A4 version):
The y-axis (Yield in percent) values don't seem to match the data points. For example, the point for Feb '01 is labelled '7%' but the point is just above the 6% mark and well below the 6.5%. What am I not understanding?
Coupon is the bond’s interest rate, per 100 nominal. Yield is the effective return on the money per 100 cash paid, so allowing for price. Coupon ≢ Yield.
One bit of feedback is that it seems quite difficult to read on a phone with small font requiring zooming and then horizontal scrolling. Both the website and the PDFs.
Being so text heavy I imagine it should be fairly easy to add some CSS to make it more readable.
I am interested in this, but already confused on page 1. The book describes a bank needing to borrow swiss francs, but that doesn't make sense to me. Why not just borrow the money in their native currency? Does the book ever go into this?
If you borrow in a different currency than your assets then you introduce currency risk. For example, if I make a loan of 100 CAD by borrowing 100 USD, then when the loan finishes I might only be able to convert 100 CAD to 50 USD.
If you download the html of the page, you can put it into Calibre and use Calibre's convert feature to generate an epub. I have not tried putting the generated file on my e-reader but it looks fine on desktop.
Caution: the PDF is a bit behind the HTML. My fault. In particular, the (excellent) chart on the recent crash in fixed0-income price is not in the PDF.
This looks like an amazing resource. The problem I have is digesting all the information and financial/mathematical data. I tend to get overwhelmed by densely rich books and sort of tune out as I read.
On a related note: does anyone have good recommendations for printing services that can print and bind an online PDF, etc? I've looked into lulu.com and printme1.com but haven't used either for this purpose.
I've wanted to do something similar for some of Beej's guides that are not in regular print, and would definitely consider for this too.
I looked at lulu for printing Scott Alexander's Unsong. Their terms of service declaim [0] anyone looking to print content that they do not have copyright or a license for. That's the entire point of copyright.
Most local printing places (places that do business cards, flyers, and the like) will gladly supply a quote for a single printed and bound PDF. Last time I did this only had to send the PDF for a complex flight sim. Shop local!
I had a college course use Lulu to print the notes into a textbook. The quality was good for a paperback. I think you're limited to black and white though. The formatting of the TeX notes could have been better, but that's probably on the professor to have fixed.
While stocks last, hard copies of Pricing Money can still be purchased from Wiley, Waterstones, Amazon.co.uk, Amazon.com, Amazon.fr, Amazon.de, Amazon.co.jp, Abe books, as well as other bookshops: cite ISBN 0‑471‑48700‑7
I commented it elsewhere with the correct link (but it's good enough to deserve its own post so here it is but I posted the link on my phone so something got borked)
This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?
I’m the author. Thank you for saying it is an excellent read — that was no small amount of work.
You ask “Where is the productive output of all these arbitrage shell games?”, which is a very fair question. The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them. E.g., you are not the optimal person to hold the risk that, through no fault of your own, your house burns down. That risk exists, and you are not the optimal holder of it. Hence insurance. A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk.
Of course, with markets come some ‘unproductive’ stuff. Likewise, democracy is good, but that is not necessarily praising the optimality of all parts of campaign finance legislation.
Let me also mention that I am the author of the definitive reference book on old Vintage Port: Port Vintages (and seemingly the board disallows a link).
> The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them.
That is just one of the purposes; others are:
- time-shifting of consumption: borrow when you study or build a house, then invest and save during work years, then live of retirement portfolio
- maturity transformation enabling investment: extra cash goes in the bank (and can be redeemed on demand), is bundled and lent (long-term) to fund construction or businesses [1]
- allocative function: send capital to its most productive use. For that, you need accurate prices, supported by equity research and markets.
So, in real financial markets, all the arbitrage games etc. [2] at least support actual productive purposes.
In crypto, it's just a pure cargo cult copy of financial markets without any underlying productive purpose.
[1] that whole banking business is somewhat precarious, but reasonably well understood (since Bagehot) and regulated/insured, though in recent times obviously hasn't worked great. Alternative models (narrow banks + private credit) are conceivable.
[2] and to be clear: the amount finance skims of the economy is way too large. Similarly, building a somewhat straighter fibre (and then microwave towers) from Chicago to NY has no societal benefit I can discern. (But the solution to that is fintech and regulation, not crypto.)
35 replies →
Note also that in some cases you might be the optimal person to hold the risk that your house burns down, if, for example, your liquid net worth is 100x the replacement cost of your home. And that's illustrative of the value of markets: you can choose to transact in them, depending on your personal circumstances. The insurance market exists because for the vast majority of people, rebuilding their home is not feasible with their current net worth. But for a small number of people it might be, and for a small number of firms it's probably worth it to insure many thousands of people, and then you can even slice up the shares of those insurance firms and sell them on the stock market so that the risk of your house burning down gets socialized across all the other shareholders but at the same time you have a stake in the profits.
10 replies →
>that was no small amount of work.
It definitely shows, thank you for publishing it freely
>The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them.
This makes a sense to me, thanks for explaining. I can definitely understand how insurance collectivizes and smooths individual risks, and from this and other examples I can see why a lending institution might seek something similar to enable them to keep cash moving. It does seem a little epicyclic to me that a farmer faces a glut as a result of organizing food production through a market economy, and then we resort to like a second-order market trick to resolve that problem. Presumably it would be simpler to just dump all the food in the middle of the table and then hand it out evenly, but I've heard this runs into its own set of difficulties.
>Let me also mention that I am the author of the definitive reference book on old Vintage Port: Port Vintages
Very welcomed, I may not buy the book but I will definitely go buy some port. TGIF!
> A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk.
Are you familiar with the arguments of (more popularly) Aaron Brown and (transitively) Jeffrey Williams?
Essentially, the idea that a farmer would be an active participant in a futures market is quaint, but the vast majority of activity is speculation. This is not a contradiction of your point, but an elaboration of a counter-intuitive part of it.
One might look at a futures market and see that well over 98 % of the activity is buying and selling by people who never have any reason to care about wheat other than for the possibility of its price going up or down. But this large-scale speculation is precisely the thing that makes it possible for a farmer to hedge (by providing liquidity and a motive for the counterpart of the hedge) or, as Williams' points out, perhaps more commonly "take out loans in commodities" for their convenience yield.
Essentially, the Lincolnshire farmer can lock in a price with a plain forward contract. However, that does take a double coincidence of demands (or whatever the phrase is) and the standardised nature of futures contracts help avoid that problem.
But! The most common use of futures contracts (aside from speculation) is not (or at least was not, when Williams wrote his book) hedging, but effectively borrowing and lending in commodities.
3 replies →
It is an interesting reframe to think of insurance as a, roughly, ATM put.
Having some experience with both trading derivatives and gambling though, I’m fairly confident saying that it’s a distinction without a difference. In both cases a little guy with an understanding of risk and bankroll management and some aptitude for the game, which for trading is a Keynesian beauty pageant, can scrape up a few bucks. But most people are going to be fish for the house. The derivative markets are providing exactly the same service as casinos, albeit with considerably higher limits and opportunities for crafting complex bets.
7 replies →
Do you mean this[0] when you wanted to link to `the definitive reference book on old Vintage Port: Port Vintages`?
Also, welcome!
- [0]: https://www.portvintages.com/
I would love to hear your opinion on Silicon Valley Bank and First Republic Bank. Did they deserve their fate on equal terms and also in retrospect who should have been the optimal holder of their risks?
6 replies →
Except that is not exactly "productive", isn't it? After all, risk was not eliminated, only redistributed. Productive output, e.g., would be something that reduces the chance of your house catching fire.
15 replies →
Why have them privately controlled at all? The fed prints the money. The fed could be the bank and insurer as well, and obviate the middle men skimming the pot.
13 replies →
I think you did a great job of explaining why someone might want each of these products, starting from first principles of "a company borrows some money from its bank". To still ask GP's question is either to not have understood the book, or to not understand any scenario where one might want to lend or borrow money.
> you are not the optimal person to hold the risk that
The view presented here assumes that the market prices risk (premium) arbitrarily correctly, and then argues the benefits of that.
What is optimal depends on the premium and a subjective assessment of the risk. There is no guarantee that what market offers is optimal.
Thanks for the book.
I started with blockchain development, but noticed a huge gap in knowledge when it came to economics.
Hopefully, this book can give me some insights on tokens that resemble "money".
Is https://www.portvintages.com/ the book?
The book is from 2001; are there any substantial changes in the landscape a motivated finance student should be aware of?
4 replies →
I like how this guy has written two books on completely different subjects - Money and Wine
3 replies →
Prices and financial markets in general exist solely for information transmission. The central problem of economics is "How do you produce the things that your population needs, in the quantity and at the time they need them, as efficiently as possible?" This is why every centrally-planned economy eventually fails, and why we were stuck in the feudal middle ages for a millennia. Information (and incentives) about what to produce and how to produce it efficiently weren't getting to the population at large, which caught us in a local subsistence minima. Financial markets give all the players an incentive (in the form of profit) to transmit information (in the form of prices) from people who want goods to people who can supply them.
This is also behind the theory of why certain forms of financial transactions are legal and others are illegal. Arbitrage = legal, because it converges prices in two separate markets in a way that gives producers in both those markets better information about true demand. Futures markets = legal, because they smooth out temporal fluctuations in demand so that producers only have to worry about producing, while also incentivizing the construction of just enough storage & buffering to hold that product. Pump & dump schemes = illegal, because they distort price information in the market in an unsustainable way and then leave later participants to bear the cost of this. Same with Ponzi schemes. Equities markets = legal, because they transmit information about the overall cost of capital within the economy to firms, which can then use it to decide the profitability or unprofitability of various investments.
> solely for information transmission
Certainly one function of financial markets and prices is to convey information, but that's not "solely" their purpose. They also provide a mechanism for resource allocation, risk management, wealth generation and collective action, among other things.
Your point about centrally planned economies, while historically corroborated in cases like the Soviet Union, might be an overgeneralization. The effectiveness of an economic system depends on numerous factors, including its degree of flexibility, the effectiveness of its institutions, and its ability to adapt to changing circumstances.
Not all centrally planned economies are doomed to failure; some have been quite successful, notably in East Asia where countries like China and Vietnam have managed a mixed economy with elements of central planning and market mechanisms.
Many capitalist corporations are centrally planned economies larger than many nation states. While everything fails eventually, these centrally planned organizations can last multiple human generations, and can be more durable than many markets and market-oriented economies.
The assertion about the feudal Middle Ages also needs some nuance. The Middle Ages, and the feudal system in particular, had complexities beyond simple information and incentive problems. Numerous sociopolitical factors were at play, including a rigid class structure, the influence of the Church, and the lack of certain technological innovations. Ascribing the issues of a historical period mainly to its economic structure oversimplifies the multitude of factors that influenced societal development.
Moreover, while financial markets do help in transmitting information from consumers to producers, they are not infallible. They can, and often do, suffer from issues like information asymmetry, where one party in a transaction has more or better information than the other. This can lead to problems like adverse selection and moral hazard. Financial markets can also be subject to speculation, which can distort the "signal" provided by prices.
The focus on profit as the sole incentive in the market might be somewhat limited. People's decisions to buy, sell, and produce are influenced by a host of factors beyond profit, including societal and environmental concerns, personal values, and ethical considerations. Financial systems, to be truly effective, need to take into account this wide range of motivations.
1 reply →
Farmers use futures contracts to protect against price risks [0]. As do energy suppliers [1].
[0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219....
[1] https://emp.lbl.gov/publications/primer-electricity-futures-...
Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples?
What percentage of futures trading is on farmers crops?
What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death?
How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
22 replies →
There is a societal benefit that comes with individuals internalizing their own costs of risk. Treating society like it's in an economic womb while Mother Finance shields it from the world of worries rewards ignorance and in my opinion accelerates us toward the world depicted in Idiocracy.
It is nice as a purchaser of such securities that you can build things more quickly than usual and transfer worry to someone who is willing to be worried for you. However I don't believe the SEC financial highway patrol has enough cruisers or sophistication to pull over enough abusers to deter the disproportionate fraud that increasingly arcane financial instruments create.
The costs of a few bad actors building piles of money illegitimately do not show themselves immediately. They pop up slowly, in dark money investments in destabilizing elections, funding of war criminals, market manipulation, etc. The societal cost of a charlatan having several lifetimes worth of an honest person's influence are grave and not to be laughed off.
1 reply →
I get why farmers do it but what's the societal benefit of letting a rando like me buy and sell (i.e. make bets on) such contracts? Do farmers really prefer that random people do this?
19 replies →
Whilst arbitrage is certainly something which exists in the financial markets, the vast majority of what's done isn't arbitrage. Arbitrage assumes differing views on valuation of an asset today. So I can buy something from person A, which they believe to be worth value x, and sell it to person B, who believes it to be worth y, where y > x. That's arbitrage in its simplest form - the market has priced something incorrectly, and I can buy it from willing sellers, and sell it to willing buyers at different values at the same time.
The vast majority of financial transactions aren't this - they're speculative. They bank on the idea that money now is worth more than money in the future, and the future value of an asset (using the definition of an asset that it's a sequence of cashflows) is both variable and uncertain. So therefore the promise of future money is inherently tied to the concept of risk. The majority of financial markets trading is based around this concept of risk, and the management of it.
There's vastly more complexity under the hood, but that's roughly speaking, accurate.
Commodities, homes, lands, water, minerals, etc (let’s call them real assets) can not inflated as freely as possible, the way money can be expanded/inflated. That’s the large source of speculation. This is why people borrow in order to acquire real assets.
Third world countries want to issue debt in American dollars, because no one wants to buy their bonds in their home currencies.
Gotcha gotcha, that makes sense, thanks for the clear explanation! So I can see how the arbitrage (thusly defined) has the risk mitigation benefits other people talk about, can the same be said about speculation?
6 replies →
> Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?
If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital. So companies that bring value to society should be able to expand their business.
At the same time, regular people can invest in such companies at somewhat fair prices without doing much analysis. Basically, because the profits above the market average have been taken by smarter investors already. But it’s still good to always be able to put money somewhere and receive avg. market returns.
Yeah, exactly. There is absolutely no way you could have ETFs if the "quick games" were forbidden. Not only because it's the HFTs that essentially run the fund on a day to day basis (see Authorized Participant for details).
One famous example with a completely extinguished price discovery is the Soviet Union. I think this is what killed it more than any internal or international political problems.
> If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital.
This only true of companies that were underpriced. Overpriced companies, either because of hype (Pets.com), fraud (Enron) or other reasons (maybe Jim Cramer issued a buy) do not benefit from a fairer price.
3 replies →
Without them we wouldn’t have McNuggets.
McDonald’s is known to have almost invented and streamlined cooking to industrial level. But McNuggets were made possible only through financial engineering:
https://tackletrading.com/tackle-today-the-rise-of-chicken-m...
I just finished some McNuggets so it’s even more funny to me right now.
> Without them we wouldn’t have McNuggets.
youtube.com/watch?v=uG3uea-Hvy4
Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets. Markets exist as a global network of interactions and persistent imbalances anywhere in the system can have massive consequences. Generally, these consequences rhyme with "two counterparties which don't interact with one another directly all that often suddenly discover grave disagreements in the desired price and quantity of something they'd like to trade". Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase.
So, markets work pretty hard to make sure that information from one area of the global economy can flow to all of the rest of the system with relative efficiency. This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time. Much like telephone, each pair of neighbors wants to do a good job sharing information without loss and, also, over long distances minor errors add up.
Arbitrage is the glue which prevents this from happening. Arbitrage says that any time anyone discovers some level of disconnection occurring, they can make money at very low risk by voting to shift markets to better align with one another.
Arbitrageurs are getting paid to provide a service to the market and subsequently the entire world. Their actions ensure that information flows throughout the global financial system quickly and without relying on centralized planning. Without them, markets could become disconnected and wander out of agreement.
>Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets.
>This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time.
Hell yeah I'm not sure where I fall on accepting this way of thinking about things, but the line of poetics/skeuomorphics/analogy is very cool to me.
>Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase.
This is kind of my sticking point because on direction of that risk is like an actual hazard to my biology and the other is the consequence of allocating food by market. Not saying it's 'wrong' per se, but it does stand out that we're resolving market problems with like market^2
The arbitrage game keeps the prices consistent with each other. It serves to create liquidity so that participants can get their business done without either waiting too long or paying too much.
Maybe this is a dumb question, but who are the participants? What is the business they need to get done? What are they waiting on?
4 replies →
The thing that I’ve always found wild is that the money people make on markets seems to be so much higher than the money people who actually make goods/services.
Why has the global economy put such a high benefit from investment bankers compared to, for example, family doctors?
> family doctors
they can only scale at most linearly, with the number of hours they work.
A financier can scale multiplicatively, because the amount of the monies they deal with can increase without "extra work". The multiplicative nature means the more capital you have access to, the more money you get to make, which approaches exponential at some point.
And in the end, the financier speculating on the markets can affect many more people than the doctor ever can in their life.
For one, finance is a macro force multiplier; it can make or break entire other industries. There’s also a bit of selection (global top) and survivorship (plenty of less visible non-success stories) in the wild money stories you can see out there.
Risk management is the product. Surely you agree that a product that reduces risk is worth something, right?
Sure I’m pro-risk management. So by arbing lending-rates which risks are mitigated?
2 replies →
This isn't false but it feels reductive. A financial instrument that allows one to bet on the corn harvest is obviously valuable to the corn farmer, as it allows them to use profits from good seasons to hedge against bad seasons. They're also valuable to people whose business is affected by the corn harvest - cereal manufacturers, say. The problem is that they can also be used by people with no exposure at all who simply want to bet on the corn harvest, and from the scale of the finance sector it seems like we are pouring a lot more of our resources and brainpower in to designing exotic new ways to bet on the corn harvest than we are on growing corn.
6 replies →
The output (generally speaking, not specific to money markets) is better prices. There are large scale examples of economies in which prices were mismanaged either due to lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union). While providing market information signals via prices is certainly an abstract concept that most people will never appreciate, it is important regardless.
For complex instruments in money markets, the main effects are bridging mis-priced treasuries on different time frames and hedging against various outcomes for pensions, banks, and dealers in physical commodities.
Most of the complex stuff either serves one of those purposes or becomes a zero sum game that doesn't affect non-participants. It's important to judge each instrument by its purpose and mechanism rather than bunch everything as a way to make bankers richer (e.g. a future vs. a CDO).
> lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union)
Venezuela has never had Soviet-style central planning. It's a market economy with a public sector only slightly larger than the OECD average. Their current situation is largely the result of excess social spending: first at the expense of investment and diversification away from oil prices were high, then at the expense of currency stability when oil prices crashed.
6 replies →
CDOs aren't particularly crazy until you start pricing them using completely fictitious numbers and reasoning (IMO at least).
Futures and options were born from commercial needs.
Suppose you produce oranges. It'll take a few months for the harvest, and while costs are generally well understood and stable, at what price will you sell those oranges? What if by then the price of oranges tanks and you find out you're not turning a profit? This is where futures come in. The producer can sell a number of futures contract to lock in a future selling price, making cash flows much clearer and predictable.
Conversely, there's the case of a factory that needs to buy oranges for its products. They have the opposite problem and would like to make costs more predictable. Then they'd buy futures to lock in a future buying price.
> How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?
Interesting observation given that your own wealth is managed this way.
Whether its the simple bank deposit in a checking account, if you've ever chased an interest rate for a savings account, or had your earnings managed in a retirement account from your employer, or if you attempted to make money faster because a debt was coming due.
Its all tied together and a product of this system.
The goal is to keep money moving within the economy, as people also race to hoard it.
Generally speaking you can group large financial institutions into two groups: sell side and buy side. I’m no expert, but afaik, these firms either SELL liquidity (e.g. investment banks, market makers etc.) or BUY liquidity (for example pension funds, certain hedge funds). Liquidity is the key here - that is (if any) the benefit they bring to society. I can buy/sell pretty much any financial product/risk with reasonable spreads because there’s always someone on the other side of the trade ready to be my counterparty.
Not that I want to defend some of these institutions, though some are better than others, but it’s important to keep in mind that they do take on risk in order to provide us liquidity, and most of them specialize in managing the risk, some of them are even good at it. Their infrastructure and connectivity and the price they charge you to provide liquidity allows them to make profits, but they do lose money sometimes. Also, compared to 20 years ago, there’s fierce competition now in pretty much every aaset class - if you work in one of the buy/sell side firms, you’ll very often hear terms such as spread compression etc (except the Covid years of course - people just wanted to trade, nobody cared about the price of liquidity (e.g. spreads or sales credit etc.) they had to pay)
Not sure if you meant “money market” as it’s understood to be the market lending/borrowing for terms of less than a year, or if you were referring to fixed income markets in general.
Either way it’s hardly a waste of time or money, and banks make money not from “arbitrage shell games” but by matching buyers with sellers. Some people have money to lend and sone people have enterprises they need to fund.
While there are casinos, think: A farmer wants to get a fixed price for next years crop and insure against a bad harvest. Thats why you need these things.
Ok the farmer example is a trope apparently. Any business where you need to hedge financial risk. Lending too many mortgages to self employed people? Sell that risk / revenue stream on to someone else and buy something different to diversify.
Others have provided excellent answers. There's one thing I'd like to add. In order for the financial markets to provide more utility, a financial transaction tax needs to be introduced. It will indirectly kill unproductive or counterproductive financial activity such as high frequency trading.
These days - figure that it is 1% "honest & productive uses", and 99% society-undermining casino.
Sibling comments have provided good explanations of why modern economies need finance: risk management, capital allocation, enabling ventures, and so forth.
At the same time, it’s worth asking the question of why the financial sector just keeps growing and whether that’s desirable. Shouldn’t improved efficiency with digital systems make this intermediation layer thinner, less labor-intensive, more competitive? Instead it seems to be capturing an ever larger share of the economy’s output to itself.
In my opinion regulators should try deploying some blunt tools like transaction taxes and hard salary caps, and see if we’d be any worse off with a smaller and poorer financial sector.
One example which is applicable to majority of the working population: in the UK at least the fixed-rate mortgages are priced off the Swap rates as that is how banks hedge them.
The value add is offering financial products that consumers want.
Businesses and people need to loan or borrow money, offering a wide variety of products that suit different needs supports economic growth.
A good example of this are all the foreign companies that decide to go public on the NASDAQ. They aren't doing it in their home country because of a weak (or non-existant) equities market, or burdensome regulation.
Sounds like you worry too much about what other people do with their own time and money.
When it results in a concentration of wealth in the hands of people who can abuse it for political ends, or results in market crashes that cause knock-on impact to real humans - then yes, worrying about it is reasonable and justified.
4 replies →
I'm with you, but I apply the same logic to all rent-seekers and shareholders. We'd be a lot better off if we didn't have parasites and bottomless pits embedded in the economy by design.
Same with the majority of tech companies. All you do is endless meetings, plannings, reviews and extremely little actual human brain is used for productive output.
Meaningful prices for the rest of us
[dead]
Great questions, but no reply will be coming at you.
Except an apologetic nonsense-logic-it-is-obvious-it-works trope.
Only product is the profit.
Quite. The general response I get from questions like this to financial folks is that these markets and vehicles and products are important "for liquidity", but they can never quite tell me who liquidity benefits other than the system itself.
4 replies →
All these Financial guides are very interesting. But beware of falling into the illusion of being a good-enough active investor. It's like entering the Pro league as an overconfident amateur. The other players are the best in the universe. And they have cybernetic extensions: algorithmic trading with virtually limitless amounts of resources and information. And sometimes they have "alpha" you'll never, ever get your hands on. They prey on "dumb money" like naive/retail investors and pension/mutual funds.
And at these times of high rates and inflation, the only safe move seems to be money market accounts and take the delta inflation hit. Try to focus your time in more valuable things like your friends and family. And keeping your sources of income.
Agreed, strongly. Which is why the online edition has some “Cautionary words”:
> Pricing Money is a beginner’s guide: it says so in big letters on the front cover. I believe it to be an excellent beginner’s guide — presumably many authors believe their own books to be excellent — but, being a beginner’s guide, it will not immediately make you a world-renowned expert.
> It was written around the turn of the pedant’s millennium. In some parts it shows its age. It has been slightly freshened by the addition of green-boxed updates, but these have been written very concisely, more to point to developments than to explain them fully.
> Please do learn from and be informed by Pricing Money. But also be cautious: it is not enough to make you a world-renowned expert; it does not list the many details that are both dull and necessary; some things have changed since it was written; it cannot be your risk manager.
I’m not going to argue that asset managers and trading desks have plenty of resources and that they can transact very quickly and cheaply. But having been on the inside of small and large asset managers for almost ten years, I can say there’s a lot of groupthink and rather brain dead behaviour to be seen on a trading floor.
Call me jaded but I’ve worked with both systematic and discretionary traders. The algos I’ve seen tend to be heavily overfit, and stop working as soon as they hit production. The discretionary traders usually have a tonne of gambler’s tics and have a bad habit of assigning narratives to market noise.
Most institutional traders aren’t the best in the universe. They just do dumb things faster and at bigger scale than day traders.
Indeed, institutional traders and asset managers are still the "buy side" and as such are not crazily more informed than retail.
The real sharks are on the sell side, using low-latency arbitrage and massive leverage, and have the ability to unwind risky positions over months. Fleecing buy side and retail is highly profitable for them.
In their defense of course they'll say they're "providing liquidity", and given how much buy side tends to pile up on one side of the trade, you can see their point: somebody's going to take the other side of these big moves.
Agree that people should not do active investing, although the solution would be passive investing (index funds), which allow you to focus on friends & family without missing out of the economy's long term gains.
This is a terrible moment for index funds.
9 replies →
i feel that this assumes the large investors on wall.street are playing the same game as retail investors. Given the size and scale of their accounts, I'd imagine it's an entirely different playbook.
My (limited, retail only) experience tells my gut that most retail investors do it to get rich, and not to learn the markets, learn the risks, and build a business. They are different goals, granted both do seek to make long term gains.
I like to believe that retail investors can make it if they put in the effort and learn to manage risk appropriately. At least I need to tell myself that as I work towards making money in the markets myself.
I am definitely dumb money right now, and I could also be delusional, but saying there is no hope so give up and just do something else completely is just defeatist.
Surely it must be possible to learn how to do whatever these so called "smart money" types are doing. Or at the very least learn how they operate so we can identify and avoid their attempts at predation.
I read a couple of pages and it looks good. I’m not a complete beginner but it’s still filling in some gaps in my knowledge. I appreciate the author’s work and giving it away for free.
That said I feel like it’s skipping some explanation for what’s supposed to be a beginner’s guide. One thing that sticks out to me is that it jumps straight into talking about interest rates without explaining the time value of money and why interest exists.
I wanted a book I could recommend and to others who knew even less than me, but I don’t think this could be it.
(And maybe interest is covered later on, but the ordering is important)
It's not a book, but Advanced Investments from The Great Courses starts at the basics and gets into the weedy details of bond pricing, etc.
If you want something related in video form, the lectures[0] from MIT 15.401 Finance Theory I [1] by professor Andrew Lo are great.
[0] https://www.youtube.com/playlist?list=PLUl4u3cNGP63B2lDhyKOs...
[1] https://ocw.mit.edu/courses/15-401-finance-theory-i-fall-200...
This is really interesting. Very early in my career I worked on a team that supported the interest rate swaps desk at a large investment bank. Not one person told me to read this book. I still don't know what they are. Wish I read this back then!
Related ongoing thread:
Probability and Markets [pdf] - https://news.ycombinator.com/item?id=36354259 - June 2023 (60 comments)
I am always amazed by Finance. But the engineer in me somehow always failed to grapple after few trenches deep into the realm of terminologies. I am strongly considering the MITx Finance specialization, but this resource is a great stop gap.
World government debt went from 5T at the beginning of the XXI century to about 305T today. Is this sustainable?
Isn't this the same discussion of infinite growth versus the ceiling of finite resources.
It is logically not possible might take 20 years or 700 years but eventually a ceiling is reached.
Growth doesn't require more resources. If your barber finds a way to cut your hair 10% faster, that shows up in GDP growth. Increasing efficiency leads to increased GDP.
4 replies →
Thinking in nominal values is rookie mistake.
You must think in terms of ratios, or not think at all. Debt-to-GDP ratio is a good measure that takes into an account most other variables like changes in population, productivity etc.
Well, world debt went from 5T to 305T while world GDP went from 33T to 96T in the same period
As ratio we went from to 16.5% to 317%.
Same question. Is this sustainable?
This is absolutely fantastic, it reminds me of Bits About Money[0]
[0] https://www.bitsaboutmoney.com/
I love classic hypertext. I miss some of the old internet.
Question about the "Yields of Australian Commonwealth government bonds as of 21 January 2000" graph in Chapter 2 (page 13 of the A4 version):
The y-axis (Yield in percent) values don't seem to match the data points. For example, the point for Feb '01 is labelled '7%' but the point is just above the 6% mark and well below the 6.5%. What am I not understanding?
Coupon is the bond’s interest rate, per 100 nominal. Yield is the effective return on the money per 100 cash paid, so allowing for price. Coupon ≢ Yield.
That's the coupon, rather than the yield.
Ah, thank you!
> some things have changed since it was written; it cannot be your risk manager
this is a fair warning. the book does a better job than the usual pre-crisis interest rate literature discussing credit risk.
a lot of the more advanced treatments were too self-absorbed in their made-up mathematical universe.
This looks great.
One bit of feedback is that it seems quite difficult to read on a phone with small font requiring zooming and then horizontal scrolling. Both the website and the PDFs.
Being so text heavy I imagine it should be fairly easy to add some CSS to make it more readable.
I am interested in this, but already confused on page 1. The book describes a bank needing to borrow swiss francs, but that doesn't make sense to me. Why not just borrow the money in their native currency? Does the book ever go into this?
If you borrow in a different currency than your assets then you introduce currency risk. For example, if I make a loan of 100 CAD by borrowing 100 USD, then when the loan finishes I might only be able to convert 100 CAD to 50 USD.
I love it. That said, I’d love to see an updated version with QE as that has a gigantic effect in recent times.
For simplicity it can be thought of as a proxy to interest rate adjustments but how it works is complex and can lead to strange side effects.
Too bad it is not available in .epub format, I'd love to read it on my ereader.
If you download the html of the page, you can put it into Calibre and use Calibre's convert feature to generate an epub. I have not tried putting the generated file on my e-reader but it looks fine on desktop.
I just want to say thank you to the author for writing this. It's very easy to read, and it's something I've sent to many close friends after reading.
Interesting insights... it is going to take me a couple of reads to comprehend all the value here. Thx JDAW
P.S. Thx for the PDF version
Caution: the PDF is a bit behind the HTML. My fault. In particular, the (excellent) chart on the recent crash in fixed0-income price is not in the PDF.
An EPUB version would also be really cool :)
Would gladly buy a physical copy of this book for $20-$30. Why on earth is it so expensive? ($92 on Amazon)
The price of bad money is war.
I deeply appreciate the green box. Thank you very much, look forward to the read.
It’s hard to put a date on it, but surely it’s no more recent than (2021).
is there a version of this not presented in a timecube format?
all these monie things seems to me like so much more evolved form of (horse race) betting.. essentialy playing with risk
This looks like an amazing resource. The problem I have is digesting all the information and financial/mathematical data. I tend to get overwhelmed by densely rich books and sort of tune out as I read.
Then read slower
Would love to be able to buy a printed copy.
On a related note: does anyone have good recommendations for printing services that can print and bind an online PDF, etc? I've looked into lulu.com and printme1.com but haven't used either for this purpose.
I've wanted to do something similar for some of Beej's guides that are not in regular print, and would definitely consider for this too.
I looked at lulu for printing Scott Alexander's Unsong. Their terms of service declaim [0] anyone looking to print content that they do not have copyright or a license for. That's the entire point of copyright.
I recommend that you contact beej directly.
[0] https://www.lulu.com/terms-and-conditions section 3 paragraph 3
Most local printing places (places that do business cards, flyers, and the like) will gladly supply a quote for a single printed and bound PDF. Last time I did this only had to send the PDF for a complex flight sim. Shop local!
I had a college course use Lulu to print the notes into a textbook. The quality was good for a paperback. I think you're limited to black and white though. The formatting of the TeX notes could have been better, but that's probably on the professor to have fixed.
I would love to buy an eBook version of it. That isn't the $75 Kindle version on Amazon.
Um, the second paragraph has a link [0] to Wiley's page for it, which only offers a paperback edition.
[0] https://www.wiley.com/en-us/Pricing+Money:+A+Beginner's+Guid...
Para says (with links):
Is there an audiobook version of this?
(This comment is just a stub so I can bundle a bunch of obsolete subthreads about a former typo in the URL)
This link is right. Don't think I can edit the submission's URL (@dang ?) http://www.jdawiseman.com/books/pricing-money/Pricing_Money_...
Fixed now. Thanks!
404
The link had extra periods at the end. Edited, the page loads fine:
http://www.jdawiseman.com/books/pricing-money/Pricing_Money_...
Yes, my phone's clipboard has betrayed me. I've emailed dang
Fixed now. Thanks!
404.
9 upvotes for the post currently, though, which I have a hard time seeing with a bad URL. Maybe they removed it when traffic spiked?
I commented it elsewhere with the correct link (but it's good enough to deserve its own post so here it is but I posted the link on my phone so something got borked)
@mhh__ Link 404's.
pricing money is easy. they usually print the price on both sides of the bill.