Do Men Marry Their Mothers?

March 24, 2009 in Uncategorized | Tags: , | by | 7 comments

Its a tempting hypothesis.  And its entertaining to look at the wives of your relatives/close friends and theorize which attribute of their mothers they replicate (likewise for husbands/fathers.)  But this seems like a difficult hypothesis to carefully test.  Here is one attempt.  Assemble a dataset of bi-racial families.  We want the race of the father and mother, the sex of the child, and the race of the child’s spouse.  To control for the racial proportions in the population, we compare the probability that a bi-racial male with a white mother marries a white wife to the probabiltity that a bi-racial male with a black mother marries a white wife.  The hypothesis is that the first is larger than the second.

Now, marriage is a two-sided matching market.  This means that we cannot jump to conclusions about the husband’s tastes on the basis of the characteristics of the  wife.  It could be that this husband would prefer a black wife (other attributes equal) but the best match he could find was with a white wife.

For example, an alternative story which would explain the above statistic is that black spouses are generally preferred but having a white father makes you a more attractive match and so bi-racial children with white fathers are more likely to match with their preferred race.  (Any theory would have to explain why there was a difference in the ultimate match between those with white fathers and those with black fathers.)  But the data would enable us to potentially rule this out.  If this alternative story were true then bi-racial daughters with white fathers would also be more likely to marry black husbands than those with black fathers.  That is, girls marrying their mothers rather than their fathers, the opposite of what the original hypothesis would predict.

So if the data showed that boys marry their mothers and girls marry their fathers, we could rule out this particular alternative story.  Of course there will always be some identification problem somewhere, and here the following story would be observationally equivalent:  having a white father makes you a more attractive mate, women like white men, men like black women.  (Allowing men and women to have different racial preferences adds the extra degree of freedom to explain the [hypothetical] data.)

Eliminating Terror and Political Institutions

March 24, 2009 in Uncategorized | Tags: , | by | 7 comments

What is the incentive of the Pakistani government to catch terrorists and hoe does it depend on how democratic the government is?

A democratic leader’s incentives are driven by the desire to get re-elected.  Suppose voters vote retrospectively – that is they are backward looking and punish the leader for bad performance.  (This can be made forward-looking by adding some story about political competence revealed  by performance.)

If terrorism adversely affects the “voters” but voting is not occurring as the country is a dictatorship, it’s optimal for the U.S. to promote democratization.  A leader motivated by re-election has better incentives  to reduce terrorism.  But if terrorists are supported by the median voter, there is no incentive to promote democratization.  In fact, if the dictator is threatened by terrorists, it is better to have a dictator in place.

So, a realist perspective suggests only partial support for spreading democracy.  The “model” above is very simple  but would already suggest checking the preferences of the average voter before pursuing democratization.  Hamas anyone?

This is only a sketch but there are alkso sorts of more subtle incentive issues that come out of it.  Future posts.  Maybe Jeff can get in on the game?

I am a Vampire

March 23, 2009 in Uncategorized | Tags: , | by | 5 comments

I have disturbing condition that needs a bill of rights and a support group, at the very least it needs medical terminology.  You know those “motion activated” faucets and towel dispensers that are now ubiquitous in public facilities?   They don’t work for me.  Well, at least 30% of the time they act as if I do not exist.  I wave my hands in front of the fixture and nothing happens.  I show it my palms, my wrists, my fingernails.  I clap, jump up and down, step out of and then jump back into its line of sight and nothing happens.

Sometimes  showing the right body part does the trick, other times a shoe or my phone has to be pressed into service.  It gets really embarrassing when I am standing there dripping and I have to ask a total stranger to repeatedly trigger the air-drying device on my behalf.  This is not an option at the hand-washing stage when all of the faucets are activated by infrared sensor.

The engineers who designed these devices must be aware from pre-market testing that there is a small segment of the population that is deficient in motion-activating-aura.  You would think that they would equip the devices with some fallback analog instrumentation, but no, we the unreflective, the hypo-present, the less-than-solid,  we are subjected to the tyranny of digital sanitation and the mockery of little infrared panels that stare back at us like HAL9000 saying “I wouldn’t do that if I were you Dave” as we sneak back into the stall to dry our hands with toilet paper.

The worst part of being a member of the infra-undead is that its a condition that seems to ebb and flow.  And that is a disaster when you are sitting on a toilet that is flushed by motion-activation.  If you think about it for a moment you will understand what I mean.

Too Big to Fail (Part 2): Credible Incentive Compatible Bailouts

March 23, 2009 in economics | Tags: , , | by | 4 comments

Suppose a bank is “too big to fail”. It’s got some bad assets that the government wants to buy so the bank becomes liquid again and people are willing to lend to it. But the assets come in different qualities and the government  would like to buy them at different prices to minimize the loss to the taxpayer.  It might want to pay a low price for the really bad stuff and a medium price for the medium bad stuff etc.  If it knew the quality of the assets , no problem – you can just pay different prices for different qualities.  But if the bank knows the quality it would try to palm off bad asset as a medium quality asset to get the better price.  The standard solution to this is to use inefficiency to “screen” different types of assets.  For example, the government says it is willing to buy a lot at the low price but less at the high price.

You have to set the quantity traded carefully so there is no incentive to sell the bad assets at the medium price as the amount the government would buy is too small to make it worth it.

All well and good it seems but remember this bank is “too big to fail”.  So, here’s what can happen: The bank sells bad assets to the government pretending they are medium assets.  It keeps the bad assets the government does not buy.  If they tank, guess what, as it’s too big to fail, the bank can dump the assets on the government anyway.  So, in the end, this scheme does not work, the government ends up buying medium and bad assets at the medium asset price.

I haven’t worked this out, but it seems to be what when banks are too big to fail this is what’s going to happen whatever you try to do: you end up paying high prices for bad stuff and there’s nothing you can do about it.  (Morally speaking, I’m replicating an old argument of Dewatripont and Maskin’s on the “soft budget constraint.”) The banks are happy as they get lots of surplus and the taxpayers pay a high price for liquidity.  The fact that the government has a social motive, saving the financial system, makes it impossible to eliminate adverse selection.

One solution might be just to find out the quality of the stuff you’re buying directly by auditing the asset value carefully.  Of course, you might have to rely on the bank for information and then they manipulate it and we’re back where we started.

What then is fair to taxpayers and saves the financial system?  Some equity ownership in the banks for the taxpayer.  Otherwise, all the surplus goes to the banks.

The Geithner CDS

March 23, 2009 in Uncategorized | Tags: , , , | by | 3 comments

This post from Mark Thoma is useful in spelling out some of the accounting behind the Geithner plan and its old incarnation due to Paulson and co.  But we cannot asssess the policy unless we come to grips with the Treasury’s motives for intervening in the first place.  When we do the picture changes a lot and it becomes clear that this amounts to a blanket insurance policy for the banks.

Suppose that a bank has a stockpile of toxic assets, and suppose that this bank is solvent only if those assets value at least $X.  When TALF comes to negotiate the purchase of these assets, we know that the bank will not accept anything less than $X for them.  Accepting less than $X turns a concern which is potentially solvent (under rosy assumptions about a recovery in the market for the assets) into one which is certainly insolvent.  The balance sheet woud now be transparent and the bank will be shut down.

So TALF either results in no sale, or a sale above $X. A sale at $X or higher ensures that the bank is solvent and therefore amounts to guarantee of the bank’s liabilities.

I am not expert enough to know whether guaranteeing the bank’s liabilities is a good idea (I suspect it is not the best), but I can say this.  If free insurance is what the Treasury wants out of TALF, then TALF is a bad way to do it.  A simpler and far better way is to simply declare that the bank’s liabilities are backed by the government.  It amounts to the same thing if TALF were to work properly.  But there are many ways TALF could go wrong.

For example, there is no assurance that under TALF the bank will actually use the $X cash from the sale to stay in business.  No doubt Geithner will make sure that an AIG-style transfer to executives and shareholders will not happen but there are too many other possibilities to guard against in law.  By contrast, a real insurance guarantee means that the money does not change hands until the creditors come calling and then it goes directly to the creditors without the bank ever touching it.

A second problem with TALF is that the government typically does not know the exact value of $X.  To be sure that it actually covers $X, it would have to accept the high probability that it overpays.  With a real insurance policy there is no need to guess at X because it will be revealed when the bank defaults.

BTW, I made a related, but somewhat different point about TALF’s predecessor here (pretty technical.)

Saturday Night Wine(s): Hospice de Beaune, Volnay, Cuvée Général Muteau (2002) and Goldeneye (2004)

March 23, 2009 in food and wine | Tags: | by | 1 comment

The Premier  Cru Volnay came from a trip 4-5 years ago.  Volnay is a village in Burgundy.  I remember old men playing pétanque on a communal, gravel court.  We were on the lookout for a nice cafe but we saw nothing.  That is a big difference between Italy and France.  Every small village in Italy has a cafe with some wizened old men who seem to spend all day there.  Even the most prestigious vineyards/towns in Burgundy had nowhere to socialize or snack.

To the wines:   I decanted them an hour or so before drinking.  The Volnay was closed, bitter and disappointing.  We shipped it from Burgundy and got slapped with huge customs duties.  (We had been told that there was chance we might escape taxes as their application was random.  It was  not to be. )  So, with that memory of additional expense, I was doubly disappointed.  The Goldeneye was smooth and delicious.  Slutty and available. Lots of fruit but not overwhelming like a California Cab. We enjoyed a glass before dinner and it lasted into the first course.  I returned to the Burgundy for my next glass.  What a revelation!  It opened up completely.  Vegetal rather than fruity.  Three dimensional.  Celery and definitely barnyard on the palette.  Great with food.  We had a white bean, bacon and arugula salad from the Patrica Wells Paris cookbook.  The Volnay stood up to it really well.  The Goldeneye had faded a little bit.  Apparently, it went well with the chicken. I am baconatarian (“vegetarian except for bacon”) so I skipped the chicken.

In the end, both were great and I would have them again, though they are on the expensive end.  The US vs France wine clichés were reinforced.

Link: Pricing Toxic Assets

March 21, 2009 in Uncategorized | by | Leave a comment

Jeff and I blogged about externalities.  But there is another aspect to the bailout.  How should toxic assets be priced and why are they toxic in the first place?  My old friend and co-author Sandro Brusco blogs about this issue at noiseFromAmerika, a fun blog site managed  by a number of well-known Italian economists.  Sandro’s blog is an excellent exposition of the theory of mechanism design and it’s application to pricing.  Mechanism Design is the field in which Hurwicz,  Maskin and Myerson made fundamental contributions and got the Econ Nobel in 2007.  I work in this area, as does Jeff and my buddy Tomas Sjostrom who is now on the Nobel Committee (no, it’s not a secret!).  You can find a link to his discussion of the 08 prize on my research webpage (as well as all our papers!).   A general audience description of the area is here and a technical one is here.

PS I’ll be blogging on my own perpective on pricing later on!

A Subtle Channel for Financial Contagion

March 21, 2009 in Uncategorized | Tags: , | by | 1 comment

Banks who bought CDS protection from AIG could, and did, hedge against failure of AIG by buying CDS protection against AIG default.  So where’s the problem?

The problem facing the banks had AIG failed has less to do with their $ exposure to AIG and more with their position exposure to AIG. For example, let’s say I buy $100mm of protection from AIG and then I buy protection on AIG to hedge against the case of AIG’s bankruptcy. Let’s say AIG does in fact go bust. In the ideal scenario the collateral plus the AIG hedges offset exactly my CDS MTM exposure against AIG, then the banks don’t actually lose money. However, the problem is that they are now long risk $100mm of protection (because their $100mm short risk position against AIG is now gone). What happens then is the market realizes that a dozen banks have massive long risk positions in much of the same trades that they will all now try to hedge at the same time. Spreads blow up and the banks lose.

There is much more in this interesting article.

Too Big to Fail: Externalities and Market Failure

March 21, 2009 in economics | Tags: | by | 5 comments

Why should we bail out big banks?  Capitalism and Darwinism are closely related – only the strong survive.  Bailing out the weak and unprofitable wastes resources and reduces efficiency, undermining the benefits of capitalism.

One response to this perspective is to get all lovey-dovey like David Brooks on one of his bohemian days.  Embrace social Darwinism rather than the selfish gene.  Bail out your fellow man as he is your fellow man.

But there is s a much simpler and standard explanation: externalities.  If a small firm goes under there’s no problem.  The depositors are insured and the main burden falls on the management and employees of the bank itself.  They should not be rewarded for bad decisions.  That would be bad for incentives and efficiency.   Capital and labour flows to better uses.

If a big bank goes under, there is a ripple effect thoughout the economy and we start hurting good businesses who are not to blame for bad decisions by the big bank. This reduces output more than justified on efficiency grounds. And this justifies intervention. It has nothing to do with hurting for your fellow man – it is hard-headed economic calculation.

Unfortunately, this creates an additional incentive problem.  If big banks know they are going to be bailed out, they have the incentive to take on risky projects that payoff big when they succeed as they get bailed out when they fail.  They do not fully internalize the impact of their decisions.  This is like the classic problem of the polluting factory that does not fully suffer the environmental impact of its pollution.

What is the solution?  Eric Maskin and Roger Myerson (Nobels 2007) either hint or are explicit about their answers.  Some kind of regulation is necessary.   Banks might be forced to have larger reserve requirements as they become big.  Or it might simply not to be allowed.

So, to summarise: we have to bail out big banks as their failure has large, external effects.  Because of this, to prevent moral hazard, we either have to regulate to keep banks small or impose higher capital requirements so they grow responsibly.

This ideas are simple but it’s great to see Sheila Bair, head of the FDIC, embracing them.  Maybe the ideas are in fact not that straightforward as they do not fall easily into the “markets are good” markets are bad” dichotomy.  Free markets are sometimes bad is a more complex message.  But I think it is the slightly right-of-centre philosophy that someone like David Brooks should embrace.

Friday Night Wine: Ridge Lytton Spring Dry Creek Valley 2005

March 21, 2009 in wine | Tags: | by | Leave a comment

Rated 88 – A zesty spice bomb of a Zinfandel, with boysenberry, ripe cherry, licorice and roasted herb notes and long, deep flavors that build toward firm, cedary tannins on the finish. Best from 2008 through 2012. – Wine Spectator

No tannins or licorice left by 2009.  Definitely spicy, lots of cherry.  Complexity added by blend of Petit Sirah and Carignane.  Long finish, lingers with a  bit of roughness at the back of the throat.  Sweet at the start, bitterness at the end too and a little acidity.  I love it and am going to try to track down some more.  Around $30 (on sale for $25 if you’re lucky).


Non-coincidences

March 20, 2009 in Uncategorized | Tags: , , | by | 2 comments

I remember once thinking what an amazing stroke of luck it was that on the Earth there happen to be so many wonderful gifts for people to enjoy.  For example, it seemed close to definitive proof of a benevolent God that tangerines were just hanging there from trees for us to pick and eat.  Somebody had to understand us very well and care about us a lot to give us this delicacy for free.

Of course this is a fallacy.  It was not the fruit that was designed for our taste buds but the other way around.

We need to be incentivized to consume whatever we need to survive. And there is no need to bring any Designer into the story because this can be taken care of by natural selection.

These points are nicely recounted in this TED lecture by Dan Dennett.  However, he stops short of considering the plot twist in which we develop conscious thought and learn how to manipulate nature’s incentive scheme.  It starts with nutra-sweet, vasectomies and pornography.  That’s when the real game begins.

Top Chef Season 5

March 20, 2009 in Uncategorized | Tags: , | by | Leave a comment

If you Google “Top Chef”, the first news link is this.  It seems I agree with the overwhelming majority of viewers that the wrong guy, Hosea, won the season.  Hosea did do the best cooking in the final and so there was nothing unfair in him winning.   The other two contestants had “fatal flaws”.  Stefan is overconfident and Carla is too laid-back.  Hosea is a solid and consistent performer.  As the other contestants gave in to their flaws in the final show, Hosea ran past them onto the winner’s podium.  Good luck to him.

The fault lay in the initial choice of contestants.  Despite this show being in New York, there just wasn’t a great selection of good, young chefs.  It’s the producers who lost.

Snakes and Mushrooms

March 20, 2009 in Uncategorized | Tags: , | by | 9 comments

Most of us are “irrationally” afraid of snakes…but few of us are afraid of mushrooms. Since both can be potentially fatal and both can be good eating, this is puzzling.

That’s from “Information, Evolution and Utility,” a paper by Jeroen Swinkels and Larry Samuelson about why natural selection shaped our preferences the way it did.  In their story, Nature accepts that there are things that we can learn that she hasn’t had time to program into us (like which mushrooms are safe to eat.)  So instead of giving us a complete set of instructions for how to behave in every situation, she gave us beliefs and the instinct to experiment and learn.  Then she lets us choose.

But there are somethings she knows better than us .  For example that snakes will likely kill us.  So, forseeing that these beliefs she has given us can, and often do, go astray, she builds in backup measures to stop us from acting on them in contexts where she is confident that she knows best. Hence irrational fears.

I think there is wide open arbitrage opportunity in behavioral economics to import ideas from principal-agent theory to explain why Nature (the principal) has given us (the agent) certain preferences (incentives.)

The Quantity Theory of Money

March 20, 2009 in Uncategorized | by | 2 comments

Undergraduates majoring in economics all have to take some sort of introductory macroeconomics course.  And they all come across the Quantity Theory of Money.  When I was taught it, I associated with Milton Friedman as it is the theoretical foundation of monetarism, the theory Friedman proposed.  What is the quantity theory?  It boils down to the manipulation of one equation:

MV  = PT

where M= money supply, V= velocity of money P= price level and T = transactions.  Basically, the total value of transactions has to equal the product of the money supply and the number of times money changes hands.  It is an accounting identity, a tautology and so far it’s not a theory of anything.

Monetarism or Chicago style economics is one theory.  Money exists simply to facilitate transactions and reduce transactions costs.  T is driven by fundamentals such as preferences, endowments of real goods and technology.  V is stable in the short-run.  So, if you increase M you increase P with no real effects.  This idea is very old and goes back maybe to the 19th century.

The other idea is Keynesian.  In this world, T can fall below full employment levels because of a failure of “aggregate demand”.  When this happens the government can stimulate demand by printing money and buying stuff with it.  Or it could give tax cuts etc.  Bernanke is doing something along these lines by buying securities with money.  This  increases demand for the securities, driving up their prices and driving down the interest or return they have to pay.  As it’s cheaper to borrow money, businesses can start to borrow more etc…at least in theory.

For an academic economist, the question is: what happened to Chicago style macro?  To get an answer, check this out.

It’s a video of eminent economists, including Kevin Murphy and Robert Lucas (Nobel Prize winner).  It’s hard to follow Murphy as he keeps referring to an equation which is never shown.  Lucas is very interesting.  He uses the quantity theory of money to argue for an increases in the money supply, at least this is how I interpret it.  In doing this, he honestly seems to disown some of his own famous research where he showed that in a world with rational expectations, increasing the money supply should have no effect.  The basic idea is that decision-makers realize that increases in the money supply have no real effects and are not fooled by monetary expansion.  He seems to say that this does not hold in a depression/recession.  He gives no real explanation for why.

I take two things from this.  First, Robert Lucas is a confident intellectual.  Confident enough to acknowledge when he does not fully understand what is going on.  Second, there is huge amount of work to be done in macro.  I wish I’d carried on studying it.

Derivatives

March 19, 2009 in Uncategorized | Tags: , | by | Leave a comment

In my inbox this morning:

REF/PAYMENTS CODE:06654

This is to inform you that we have verified your payment,Nigerian 419 scam practiotioners where Arested,your name has been shortlisted and approved for this payment as one of the 419 scam victims,get back to me immedately

Yours faithfully,

Dr.John Odey

– MINISTRY OF INFORMATION

Does the Web Decentralize?

March 19, 2009 in Uncategorized | Tags: , , , , | by | 7 comments

I have been enjoying reading the blog of Seth Godin.  In a recent post he wrote the following.

It’s quite possible that the era of the professional reviewer is over. No longer can a single individual (except maybe Oprah) make a movie, a restaurant or a book into a hit or a dud.

Not only can an influential blogger sell thousands of books, she can spread an idea that reaches others, influencing not just the reader, but the people who read that person’s blog or tweets. And so it spreads.

The post goes in another direction after that, but I started thinking about this conventional view that the web reduces concentration in the market for professional opinions.  No doubt blogs, discussion boards, web 2.0 make it easier for people with opinions to express them and people looking for opinions to find those that suit their taste.

But does this necessarily decrease concentration?  If everybody had similar tastes in movies, say, the effect of lowering barriers to entry would be to allow the market to coordinate on the one guy in the world who can best judge movies according to that standard and articulate his opinion.  Of course people have different tastes and the conventional view is based on the idea that the web allows segmentation according to taste.  But what if talent in evaluating movies means the ability to judge how people with different tastes would react to different movies?  A review would be a contingent recommendation like “if you like this kind of movie, this is for you.  if you like that kind of movie, then stay away from this one but you might like that one instead.”

In fact, a third effect of the web is to make it easy for experts to find out what different tastes there are out there and how they react to movies.  This tends to increase centralization because it creates a natural monopoly in cataloging tastes and matching tastes to recommendations.  Indeed, Netflix’s marketing strategy is based on this idea and I am lead to hold out Netflix as a counterexample to the conventional view.

Larry Lessig on Political Corruption

March 19, 2009 in economics | Tags: | by | 4 comments

I had the privilege to introduce Larry Lessig at a Kellogg Distinguished Leader talk.  He is famous as an exponent of “open source” software and websites, like Mozilla Firefox, UNIX, Wikipedia etc.  These institutions work a bit like academia.  Many things we do as academics, and even academic economists(!), involve free labor.  Refereeing comes to mind first of course but editorial work is hugely onerous and often unpaid.  People who do all this work for free seem to contradict the basic rational selfish actor model of economics.  The rational actor is flexible enough that it can be “jazzed up” to make these facts consistent with selfishness.  Maybe your papers get better refereeing if you referee well, publishing your papers in good journals leads to outside offers which leads to higher pay etc. etc.

But why employ a convoluted explanation when the obvious one is available?  People do all this stuff for free because of the prestige, the power and the fulfillment from affecting the direction of research of entire fields of research. In our case, Jeff and I are doing this because we’re vain enough to think our random musing are interesting and useful.  I’d be at the New York Times website as usual right now if I weren’t doing this so why not?

Similar motives underlie the development of open source software and websites.   It’s got to be pretty cool to have been behind UNIX, LATEX etc.  And the stuff that has huge positive impact on welfare in much the same way as academic science has had huge impact on knowledge.  Both systems use a confusing mix of monetary and non-monetary incentives.

Larry Lessig made his mark initially by advocating looser copyright laws to facilitate this kind of free exchange of ideas.  He helped to set up the Creative Commons project at Stanford.  He worked on various cases to reduce extension of copyright laws.  But he hit a roadblock.  Special interests with an interest in protecting their monopoly power lobbied Congress, funded political campaigns and prevented his ideas being put into action.  Even commonsensical ideas (e.g. promoting reduced sugar intake) were killed off.  Larry realized the fault lay with our political system and has set out to reform it.   He and Joe Trippi have joined up to advocate for campaigns being citizen-funded rather than funded by corporations – see Change Congress.

This was the content of his talk.  I do not know if this scheme will work.  First, it’s going to depend on how much money politicians raise from regular people versus special interests.  Obama was very successful at energizing donations but other politicians are not.  If they do rely on individual donations, then there is some leverage.  But why do people may donations?  There is a huge free-rider problem in voluntary donations so the be must be some non-economic factors at work.  In my case, the one and only time I contributed, I felt as if I was paying to support my favorite sports’ team.  Just like I might buy Bulls’ T-shirts, stickers and memorabilia, I bought Obama stuff even though I knew my contribution was minor and I could buy wine with it instead!   I don’t think people like that are going to be dissuaded by Change Congress.  But perhaps some people are driven by political philosophy when thye donate.  If this is correlated with wanting to change congress this might Lessig-Trippi proposal might work.  I hope so.  Because Lessig’s main point is basic but fundamentally true.

Finally, I must turn to style.  Larry’s talk is by far the best talk I have ever attended.  I was blown away by Gore’s Inconvenient Truth presentation.  As a B school prof I’m always impressed by Powerpoint slides!  I never saw Gore’s talk live.  Lessig I saw live and this is the best talk I have ever witnessed in person.  To get a flavor, see here.  I must sign off and work on my slides for next 1/4.

Short Z

March 18, 2009 in Uncategorized | Tags: , | by | 10 comments

Scrabble point revaluation in the works?

“Za,” “qi” and “zzz” were added recently to the game’s official word list for its original English-language edition. Because Z’s and Q’s each have the game’s highest point value of 10, those monosyllabic words can rack up big scores for relatively little effort. So now that those high-scoring letters are more versatile, some Scrabble aficionados would like to see the rules changed — which would be the only change since Alfred Butts popularized the game in 1948.

Let’s kill two birds with one stone.  Eliminate the role of chance in scrabble by having players buy their letters rather than draw them at random.  Whenever a player needs to replenish his tiles, a tile is turned over and put up for auction.  Players bid for the tile with points.  A player who already has seven tiles who wins the auction selects one of his tiles to replace and puts that tile up for auction. This continues until all players have seven tiles.

This removes chance from the game and also eliminates the need to revalue the tiles because that will be taken care of endogenously by competitive bidding.

Update:  Free Exchange at http://www.economist.com makes fun of me.

Casa de Isaac

March 18, 2009 in food and wine | Tags: | by | Leave a comment

Highland Park is very chi-chi and let’s face it, white.  Then, you go a little further north and you enter an ethnic enclave which is less Cartier and Prada.  It’s nice.  There’s a fair there in the summer, lots of nice little restaurants with near-Highland Park prices.  My favorite so far is Casa de Isaac. (I still have to try the Curry Hut.)  It’s the only Jewish Mexican restaurant I have ever heard of.  They open sundown on Saturday and are closed Friday night.  Apart from that, there is so discernible Jewish influence.  In fact, one of my Israeli friends thinks the whole thing is a big marketing ploy to differentiate it from other closeby establishments!  We had chilaquiles – one red and spicy, the other green and tangy.  Both were delicious.  And we got to watch Aston Villa vs Tottenham Hotspur on the T.V.  It was great.

Taliban, Jeff, Sandeep and Melinda Gates

March 18, 2009 in Uncategorized | Tags: | by | Leave a comment

What does Melinda Gates want that the rest of the four of us have?

When to Snuff It

March 18, 2009 in Uncategorized | Tags: , , | by | 5 comments

This post suggests that data on suicide seasonality debunks the myth of “winter blues.”  Most studies show that suicide rates peak in the Spring suggesting that Spring is a more depressing season than Winter.  But to make this inference we need a model of the optimal timing of suicide.

Suppose that your emotional well-being is a stochastic process which is mixed with a seasonal trend.  If Winter makes everyone unhappy, then this transient shock confounds the movements in the underlying stochastic process. You are not able to uncover the realization of your emotional random walk until after Winter is over and the seasonal component has washed away.

So you are really depressed in the winter but you are willing to wait it out to find out how you feel in the Spring. If Spring arrives and you are still depressed, you know you are riding a permanent shock.  Thus, the spike in suicides in the Spring actually proves that Winter is indeed the most depressing season.

Obama’s Tax Problems

March 18, 2009 in Uncategorized | Tags: | by | 1 comment

Tom Dashle apparently really, really wanted to go back into public life and stop making lots of money.  So, when he was making lots of money, he was careful not to cross the line that legally defines “lobbying” – though he was doing it in all but name.  If you’re so super-careful about this and do want to go back into a career where you’re highly likely to be vetted, you’d think you should be equally careful about your taxes.  Right?  So, let’s say he (or presumably his deductible  accountant) was plain confused.  On the same day Dashle withdrew, so did another Obama nominee, Nancy Killifer, for not paying around $1000 taxes for household help, etc.., etc…..

So, I think these people were more careful than the average person in trying to pay their taxes properly as they stood a greater chance of a public audit.  And, if that is the case, how much “accidentally” unpaid tax is there out there in the economy from all the people who don’t think they’ll ever be scrutinized ?  Anyone who has anything beyond the basic mortgage deductions Turbotax handles so well I think are very likely to be in trouble.  Any household help, nanny type stuff is confusing probably.  What expenses can you deduct if you travel?  I’m not sure I even know.

It just calls for simplifying the tax code.

The Boss has Lost it : Business Strategy and the Strategy of Conflict

March 17, 2009 in Uncategorized | Tags: , , | by | 7 comments

The New York Times describes the Israeli strategy in the recent war in Gaza as follows:

The Israeli theory of what it tried to do here is summed up in a Hebrew phrase heard across Israel and throughout the military in the past weeks: “baal habayit hishtageya,” or “the boss has lost it.” It evokes the image of a madman who cannot be controlled.

“This phrase means that if our civilians are attacked by you, we are not going to respond in proportion but will use all means we have to cause you such damage that you will think twice in the future,” said Giora Eiland, a former national security adviser.

It is a calculated rage. The phrase comes from business and refers to a decision by a shop owner to cut prices so drastically that he appears crazy to the consumer even though he knows he has actually made a shrewd business decision.

I think the word “consumer” should be replaced by the word “entrant” for this passage to make complete sense – consumers like lower prices, entrants do not.  Then, the Israeli strategy becomes the classic story about predation:  When an entrant dares to enter a market, the incumbent may want to prove he is “tough”, cut his price drastically and drive the entrant out of the market.  This will also help the entrant “to think twice in the future” as they say above and deter future entry.  This assumes the entrant has nothing to prove.  But Hamas also want to prove its tough.  If it backs off now, then Israel will learn that Hamas is soft and will surely push the advantage in a future war.  So, Hamas has the same incentives as Israel and will not back down.  That is, the possibility of future war and the reputation each player wants in that war makes both players tougher.  So the war can be very very terrible.  For a preliminary model along these lines see my paper “Reputation and Conflict” with Tomas Sjöström.  For the Prime Minister this is a ” ‘el harb el majnouna,’ the mad or crazy war”.  And it’s all unfortunately quite rational:

Shlomo Brom, a researcher at the Institute for National Security Studies at Tel Aviv University and a retired brigadier general, said it was wrong to consider Hamas a group of irrational fanatics.

“I have always said that Hamas is a very rational political movement,” he said. “When they use suicide bombings, for example, it is done very consciously, based on calculations of the effectiveness of these means. You see, both sides understand the value of calculated madness. That is one reason I don’t see an early end to this ongoing war.”

I say unfortunately because I hope (irrationally?!) that rational behavior can be taught and irrationality eliminated.  But if crazy behavior is rational, what are we to do?

Wynne Godley – the British Roubini

March 17, 2009 in economics | Tags: | by | 1 comment

My first job after grad school was as a Research Fellow at King’s College, Cambridge.  It was then that I first came across Wynne Godley.  I was an undergraduate at St. John’s almost a decade earlier but I do not have any memory of him from that time.  Wynne is a little like my imagined Lord Emsworth from the P G Wodehouse Blandings novels.  Wynne was famous or infamous, depending on your point of view.  Many rumours circulated about him and I will repeat some of them here.

My favorite is that the character of Tigger in Winnie the Pooh is based on Wynne Godley.  It is claimed that Wynne went to school with Christopher Robin Milne.  A A Milne is meant to have encountered him there and seen a little Tigger in his soul. Unfortunately, I don’t think this one is true because Wynne went to Rugby and Milne went to Stowe.  Also, the Wynne I met was more like Eeyore than Tigger.  I could be remembering the original story incorrectly and perhaps it is Eeyore that Milne saw in Godley.  Anyway, I dearly, dearly hope this story is true.  If not, let’s repeat it anyway so future generations believe it.

A second story  is that the statue of St Michael outside Coventry Cathedral is based on Wynne Godley.  Wynne was quite good-looking in his younger days.  It is true that Godley married, Kitty,  one of the daughters of Jacob Epstein, the sculptor.  Epstein is responsible for the statue in question.  And you can find the odd informed person to support this story.

The third and final story links it all back to Roubini.  My Kevin Bacon number with respect to Roubini is two and I did meet him in person about ten years ago.  I can report that he used to be a little bit Tigger-like himself. His current Dr Doom incarnation is more Eeyore-like.  Jeff pointed out this  story which suggests he still has a little tiger in him.  The main connection between Godley and Roubini is macroeconomic forecasting.  Godley spent his career trying to develop a macroeconomic forecasting model in the style of Lawrence Klein but built on old Keynesian ideas.  Eventually, he had a column in some British weekly magazine (the New Statesman?).  All of his forecasts were gloomy and he was often wrong.  But there was a point where Godley’s model predicted slump, other models predicted boom and there was an actual slump!  His name was made.  When I met him, we was one of the “Six Wise Men” advising H.M. Treasury  on their forecast.  The Treasury was under attack because its forecasts were so often wrong.  So, in a brilliant move they appointed six critics who had their own crazy forecasts.  This allowed them to show how often these critics were wrong and the Treasury was right.  Obama should do something like this.  Get the guy from the Club for Growth, Mankiw, Roubini, Krugman, someone from Cato etc to join some official forecasting group. Have them nail their colors to the mast and screw up.

Let’s face it, this is not really a blog entry about forecasting but about a certain type f academic.  I am impressed by what Roubini has built for himself and all the other successful econo-bloggers too.  But they and I all lack the flair of a Wynne Godley.  No “top five” publications to his name but quite a life.  I think it”s possible to have both.  Creativity certainly helps in doing top-shelf research.  And I’m going to pretend to be Tigger for the rest of the day and try to get rid of my natural Eeyore.

Credit Rationing and Loan Sharking

March 17, 2009 in Uncategorized | Tags: , , | by | Leave a comment

NPR had a story this morning about the rise of loan sharking in Italy as a fallout from the credit crisis.  The question to ask is why is the credit crunch affecting banks but not loan sharks?  Credit is credit so why does the credit crisis make lending cheaper for loan sharks than for banks?  Put differently, if loan sharks have an advantage over banks why didn’t they have the same advantage before the crisis?

A simple story is based on a fundamental problem with the way credit markets operate.  The market for credit is like any other market with supply and demand and a price.  The price is the interest rate.  The problem with the credit market is that the price often cannot serve its usual market-clearing purpose.  When the supply of credit goes down, the interest rate should rise to clear the market.  Clearing the market means reducing demand to bring it back in line with the low supply.  The problem is that high interest rates reduce demand by disproportinately driving away borrowers who are good credit risks and leaving a pool of borrowers who are now more risky on average.  This makes lending even more costly, reducing supply, driving the price up again…

The effect is that there may be no way to clear the market by raising interest rates.  Instead credit must be rationed. This is part of the story of the credit crisis.  By itself it doesn’t explain the rise of loan sharks yet because loan sharks face the same problem.

One way to improve rationing is to increase collateral requirements. But borrowers who are already excessively leveraged (the other part of the credit crisis story) will not have additional collateral to compete for the rationed loans.  Here is where the loan shark comes in.  Loan sharks use a form of collateral that banks do not have access to:  kneecaps.  Highly leveraged borrowers who are rationed out of the credit market cannot post collateral to service their debt so they turn to loan sharks.

The Roubini Cycle

March 17, 2009 in Uncategorized | Tags: , , | by | 5 comments

Tyler Cowen asks why do people lose originality as they gain influence? There are two observationally equivalent ways to explain it.

  1. Since nobody really knows anything more than anybody else, opinion-rendering boils down to a game where everybody makes a random guess.  The outcome of this game is that one person says something unconventional that turns out to be right.  (by pure luck.)  He gets noticed for that.  Influence is the reward for being noticed.  (We don’t have to assume that the public is unaware that he is just as ignorant as everyone else.  The public is just trying to coordinate on whom to listen to.  Winning the random-guessing game makes him a focal point.)  Having influence is nice and in order not to jeopardize that he goes on saying the same thing as before which turned out to be right and is now conventional wisdom.
  2. Since nobody really knows anything more than anybody else, opinion-rendering boils down to a game where everybody makes a random guess.  And people go on making random guesses over and over.  People whose guesses are right get noticed and get influence, the more unconventional the guess the more you get noticed. Its very rare that something really unconventional is correct, so the people who repeatedly make unconventional guesses eventually lose influence.  It follows that those that survive this game for a long time are those whose random guesses were unconventional once and conventional the remainder of the time.  We forget about all of the others.

Tyler asked for case studies.  But given the nature of the question what he really wants is a theory that generates a forecast that we can test against future data.  So as you guessed from the title, my case study is Noriel Roubini.  In 10 years he will either continue to be a regular talking head who no longer says anything unconventional (theory 1) or he will continue to make unconventional guesses and will have lost influence and be forgotten (theory 2).

Wiley-Blackwell Policy on NIH Open-Access Mandate

March 16, 2009 in Uncategorized | Tags: | by | 2 comments

The relevant part seems to be:

Wiley-Blackwell will support our authors by posting the accepted version of articles by NIH grant-holders to PubMed Central upon acceptance by the journal. The accepted version is the version that incorporates all amendments made during peer review, but prior to the publisher’s copy-editing and typesetting. This accepted version will be made publicly available 12 months after publication. The NIH mandate applies to all articles based on research that has been wholly or partially funded by the NIH and that are accepted for publication on or after April 7, 2008.

So it seems that NIH-funded articles will appear in an Open-Access outlet, but 12 months after publication.  I don’t know all of the details of the NIH rules, but this does seem a step in the right direction.

Big Shoes to Fill

March 14, 2009 in Uncategorized | Tags: , , | by | 1 comment

From CNN:

They’ve sung his praises on social networking pages, calling him a “hero,” “the greatest man of our time,” “a legend.” They’ve said he deserves to be knighted and should be decorated with medals. They’ve cried out for his amnesty and have even proposed serving time for him.

The article is about the man who threw his pair of shoes at the former President of the United States.  He was sentenced this week to three years in prison.  The quote raises the question of whether we should allow a third party to serve jail time on behalf of (and instead of) the convicted criminal.

In the economic theory of criminal justice, a punishment is designed to make potential “criminals” internalize the costs imposed on society by their crime.  The principle is that we can never know in advance whether any act should be allowed.  There are always circumstances in which the private benefit exceeds the social cost and so we design the punishment so that the act will be committed if and only if that is the case.

For example, driving too fast raises the chance of an accident and the driver internalizes only half of the consequences of an accident.  So traffic fines are set in order to cover the gap.  (The fine equals the cost of the damage times the increased probability of an accident due to speed.  This explains why the fine is small and why it is increasing in speed.)  We understand that sometimes it is socially optimal to allow the driver to speed.  For example, his wife may be about to give birth all over his nice upholstry.  So we allow him to speed for a price.  If the price is set correctly, he will choose to do so only when it is socially optimal.

As it turns out there are occasions in history when it is socially optimal to throw a shoe at the leader of the free world.  A pair of shoes in fact.  Since this is not always the case, there is a punishment for it which ensures that it will be done only when it is socially optimal.  But here’s the problem.  Let’s suppose that those who benefit from seeing a shoe nearly leave its heel print on the cheek of the departing Decider are prevented from ever getting within range.  Then it is socially optimal to enforce a contract which appoints a representative who will be in range to do the throwing and to have a third party enjoy the video and then pay the penalty.

In fact, when the benefit of seeing said video is shared by millions around the world, but the benefit to each is not enough to outweigh the cost of the penalty, then it is optimal to allow each of us to volunteer to serve a small jail sentence in return for watching the shoe fly.

All part of bringing Western democracy and justice to the Middle East.

A Record 10 Patient Kidney Donor Chain Cleared

March 13, 2009 in Uncategorized | Tags: , , | by | 5 comments

Al Roth, Utku Unver and Tayfun Sonmez are economists who study matching markets:  mechanisms for linking buyers and sellers.  They have for the last few years been involved in a remarkable project which utilizes the ideas from matching markets to improve the way kidney donors are matched with patients who need kidney transplants.  Traditionally there have been only a few ways in which these transplants were made possible:

  1. a patient’s family member with matching tissue characteristics donates a kidney.
  2. a patient receives a kidney from an altruistic donor with matching tissue characteristics.
  3. two patients who have family members willing to donate but whose tissue characteristics match only the other patient have four simultaneous operations to transplant the kidneys from patient A’s family member to patient B and from patient B’s family member to patient A.

1. is unlikely because there are a surprisingly high number of characteristics that have to match.  2. happens but there is a very long queue of kidney patients waiting for donors and many patients die before reaching the top of the queue and finding a matching donor.  (On top of that, waiting around on artifiicial kidney dialysis = suffering.)  The possibility of 3 improves the chances of a succesful transplant for many.

What these authors did was to point out the tremendous increase in the potential number of successful transplants that would arise if longer chains of transplantation were allowed and suggested mechanisms for matching patients along long chains where a donor gives to a patient who has a family member whose tissue matches with another patient who has a family member whose tissue matches… eventually returning to a family member of the original donor.  Even better, if the original donor is an altruist, one fewer constraint has to be satisfied.

Well, today it was announced that the longest donor chain in history was just succesfully carried out:  10 patients long. Here is a link to the announcement on Al Roth’s blog.

Paying for Grades

March 7, 2009 in Uncategorized | Tags: , , | by | 4 comments

The NY Times reports on some preliminary results from one of Roland Fryer’s field experiments in which students are rewarded with cash for high AP test scores.

Results from the first year of the A.P. program in New York showed that test scores were flat but that more students were taking the tests, said Edward Rodriguez, the program’s executive director.

Fabio Rojas at Orgtheory.net, interprets this as saying that the incentive didn’t work.

The question is simple: does paying kids improve performance? As I mentioned yesterday, the preliminary evidence is that children are more likely to participate in the test, but they are not more likely to get better grades.

I think he has jumped to his conclusion.  If more students take the test, then we are drawing in the marginal students whose baseline test scores would be lower than average and would bring therefore bring the average down.  Since the average did not go down that means that performance by infra-marginal students (and probably even the marginal students) improved.