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Posted at 09:42 PM in Current Affairs | Permalink
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Since the mid-1970's the Supreme Court has been fashioning a series of doctrines that have been characterized as conservative, though I would call them liberal with a small l, the liberalism of classic individualism. These decisions - about race, free speech and campaign finance, property rights, constitutional criminal procedure, religion and federalism - have not, as their opponents have caricatured them, been extreme or lacking in nuance. ...BS. Yale law prof and blawgger Jack Balkin correctly points out the rather simple error in Fried's analysis:
What decisions like Casey v. Planned Parenthood, United States v. Lopez, and Hibbs v. Department of Social Services have in common is not they are are all classical liberal decisions. What they have in common is that Justice O'Connor joined in them or wrote them. So perhaps Charles is really saying that he wishes that O'Connor was more of a classical liberal, and that she has disappointed him in Grutter (the affirmative action case) and McConnell (the campaign finance case). Fair enough. But one shouldn't expect a swing Justice like O'Connor to match a particular coherent political ideology. That's simply not what such Justices do. And don't expect a Court whose decisions depend on what swing Justices do to produce a coherent political ideology. That's not what multimember bodies do, either.Exactly right. My professional life is devoted to studying a multimember decisionmaking body called the board of directors. Multimember decisionmaking bodies have a very hard time hewing to a coherent policy with respect to widely disparate decision opportunities. For one thing, group members often vote strategically. Vote trading is common on boards (and presumably on multimember courts of judicial biographies are to be believed). As I pointed out in my article, Why a Board? Group Decisionmaking in Corporate Governance, although we might assume that group decision making has a moderating influence, social dilemma experiments demonstrate that groups actually make more extreme decisions than individuals. Finally, basic collective action problems, such as Arrow's Impossibility Theorem, suggest that group decisionmaking can often cycle between competing preferences. In sum, Supreme Court decisions reflect the personal policy preferences of a temporary and often-shifting alliance of 5 or more justices, but cannot be expected to consistently reflect a dominant ideology in the absence of a much more cohesive grouping than exists on the Court today.
Posted at 08:31 PM in SCOTUS and Con Law | Permalink | Comments (0)
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Posted at 07:54 PM in Wine | Permalink
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Posted at 07:46 PM in Wine | Permalink
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The Wall Street Journal (sub. req'd) recently published a fascinating article on the debate between efficient capital markets theorists (exemplified by Eugene Fama) and behavioral economists (exemplified by Richard Thaler). As the Journal explained:
For forty years, economist Eugene Fama argued that financial markets were highly efficient in reflecting the underlying value of stocks. His long-time intellectual nemesis, Richard Thaler, a member of the "behaviorist" school of economic thought, contended that markets can veer off course when individuals make stupid decisions.
In May, 116 eminent economists and business executives gathered at the University of Chicago Graduate School of Business for a conference in Mr. Fama's honor. There, Mr. Fama surprised some in the audience. A paper he presented, co-authored with a colleague, made the case that poorly informed investors could theoretically lead the market astray. Stock prices, the paper said, could become "somewhat irrational."
Coming from the 65-year-old Mr. Fama, the intellectual father of the theory known as the "efficient-market hypothesis," it struck some as an unexpected concession. For years, efficient market theories were dominant, but here was a suggestion that the behaviorists' ideas had become mainstream.
"I guess we're all behaviorists now," Mr. Thaler, 59, recalls saying after he heard Mr. Fama's presentation."
The debate between Thaler and Fama matters a lot -- a whole lot.
The efficient capital markets hypothesis (ECMH) is one of the most basic -- and influential -- principles of modern corporate finance theory. During the 1980s, for example, the Securities and Exchange Commission (SEC) relied on the ECMH to justify many deregulatory initiatives. In the capital markets, acceptance of the ECMH by investors drove the burgeoning popularity of indexing as an investment strategy. The ECMH's validity thus has enormous implications both for the way in which we invest and how the government will regulate the capital markets. As the Wall Street Journal put it, the debate affects a host of "real-life problems, ranging from the privatization of Social Security to the regulation of financial markets to the way corporate boards are run."
The ECMH's fundamental thesis is that, in an efficient market, current prices always and fully reflect all relevant information about the commodities being traded. As applied to stock markets, the ECMH thus has two principal implications. First, stock prices follow a random walk. Put another way, the ECMH predicts that price changes in securities are random. Randomness does not mean that the stock market is like throwing darts at a dart board. Stock prices do go up on good news and down on bad news. Randomness simply means that stock price movements are serially independent: future changes in price are independent of past changes. In other words, investors can not profit by using past prices to predict future prices.
Second, the ECMH posits that current prices incorporate not only all historical information but also all current public information. This form predicts that investors can not expect to profit from studying publicly available information about particular firms because the market almost instantaneously incorporates information into the price of the firm's stock.
The ECMH assumes investors are rational actors whose behavior is consistent with that predicted by the rational choice model. Over the last decade or so, behavioral economists (such as Thaler) have drawn on experimental economics and cognitive psychology to identify systematic departures from rational decisionmaking, even in market settings. Put another way, behavioral economics claims that humans tend to make decisions in ways that systematically depart from the predictions of rational choice.
The ECMH has been one of the behavioralists' favorite targets. Thaler and others have argued that markets are made of human actors, who bring to bear their own individual foibles. Idiosyncratic valuations generate noise that may skew the market's valuation of stock prices. (Just as it is hard to carry on an accurate conversation in a noisy room, it is hard to accurately value stocks in a noisy market.) Research in cognitive psychology suggests that investor idiosyncrasies do not always cancel one another out. Instead, investors sometimes act like a herd all running in the same direction, which can produce pricing errors. Large speculative bubbles that appear out of nowhere and crash without apparent reason are the most visible form of this phenomenon.
The behavioralists have also identified a host of lesser anomalies that are hard to explain in ECMH terms. Stocks tend to suffer abnormally large losses in December and on Mondays. Stocks with low price/earnings ratios tend to outperform the market, as do stocks of the smallest public corporations. Big round numbers (like 10,000) tend to act as psychological barriers. And so on.
So is Thaler right? Are we all behavioralists now? Well, perhaps not quite.
There is considerable evidence that markets adapt to investor irrationality over time. If investor irrationality produces pricing errors, it becomes possible to profit by taking advantage of them. At one time, for example, the capital markets showed a systematic bias against small cap firms. As a result, it was possible to earn abnormal returns by investing in a portfolio weighted towards small caps. Over time, many investors did so, including a substantial number of mutual funds that specialized in small cap investing. As a result, the small cap anomaly gradually faded to the point at which it was no longer possible to systematically beat the market by investing in them. We have observed much the same with respect to other anomalies. Hence, there is considerable evidence that experienced traders can learn their way out of the irrational behavior patterns that lie at the bottom of so many market anomalies.
Accordingly, while the ECMH may not be perfect, it still probably does a better job of predicting market behavior over time than any of the behavioral theories. Indeed, Richard Thaler apparently admitted as much to the WSJ:
Mr. Thaler ... concedes that most of his retirement assets are held in index funds, the very industry that Mr. Fama's research helped to launch. And despite his research on market inefficiencies, he also concedes that "it is not easy to beat the market, and most people don't."
So where are we? It is clear that behavioral economics can identify instances in which the capital markets are inefficient, some of which persist for very long periods and /or across many market sectors. Yet, on balance, the capital markets still appear to be pretty efficient, if not perfectly so.
What then should investors and regulators do? As for investors, they should still treat Burton Malkiel's Random Walk Down Wall Street as the investment bible. In the last section of Random Walk, Malkiel distills ECMH and the related concept of portfolio theory into an eminently practical life-cycle guide to investing based on two propositions. First, diversification. Second, no one systematically earns positive abnormal returns from trading in securities; in other words, over time nobody outperforms the market. Mutual funds may outperform the market in 1 year, but they may falter in another. Once adjustment is made for risks, every reputable empirical study finds that mutual funds generally don't outperform the market over time. Malkiel's recommendation therefore is that you should put your money into no-load passively managed index mutual funds, which by the way appears to be precisely where behavioralist Thaler puts part of his money even though he also operates a investment advisor that uses behavioral principles.
As for regulators, because the ECMH is often brought to bear as a justification for deregulation in politically charged policy disputes, such as mandatory corporate disclosure and insider trading, those who support regulation of such areas find comfort in the behavioral critique. One problem with such arguments, of course, is that it takes a theory to beat a theory, and no behavioralist theory yet advanced does a better job of explaining the vast bulk of stock market phenomena than the ECMH.
Assume, however, that markets frequently behave irrationally due to behavioral biases. The mere existence of such a market failure does not -- standing alone -- justify legal intervention. In addition to the standard prudential arguments in favor of limited government, which counsel caution in concluding that a purported market failure requires government correction, behavioral economics itself argues against presuming the desirability of intervention. As NYU law professor Jennifer Arlen observed in a Vanderbilt Law Review article:
"Proposals designed to address biases generally entail the intervention of judges, legislators, or bureaucrats who are [themselves] subject to various biases. The very power of the behavioralist critique -- that even educated people exhibit certain biases -- thus undercuts efforts to redress such biases. In addition, the decisions of government actors also may be adversely influenced by political concerns -- specifically interest group politics. Thus interventions to "cure" bias-induced inefficiency may ultimately produce outcomes that are worse than the problem itself. "
In other words, the claim that law can correct market failures caused by decisionmaking biases or cognitive errors treats regulators as exogenous to the system. Once the state is indigenized, however, regulators must be treated as actors with their own systematic decisionmaking biases. It thus becomes evident that behavioral economics loops back on itself as a justification for legal intervention.
My bottom line? Put your money in passively managed index funds and vote for free markets.
Posted at 10:53 AM in Economic Analysis Of Law, The Stock Market | Permalink | Comments (0)
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The Jost article claims that conservatives are angry and fearful and it builds on a literature that claims that conservatives are unhappy. I find this strange, given the decades of superb data showing the opposite. In the NORC General Social Survey (a standard social science database, second only to the U.S. Census in use by U.S. sociologists), the GSS asks the standard survey question about happiness in general. In the 1998-2002 GSS, extreme conservatives are much more likely to report being "very happy" than extreme liberals--47.1% to 31.6%. Earlier years show a similar pattern.
This conservative happiness carries over into most other aspects of life as well. Conservatives usually report being happier in their jobs than liberals. In the 2002 GSS, for example 65.2% of extreme conservatives report being "very satisfied" with their jobs in general, while only 50% of extreme liberals report being very satisfied. When the question is broadened to satisfaction with job or housework, a similar pattern obtains. In the 1998-2002 GSS, 61.0% of extreme conservatives reported being very satisfied, compared to 53.6% of extreme liberals.
As to finances, in the 1998-2002 GSS 34% of extreme conservatives report being satisfied with their finances compared to 26.4% of extreme liberals. More extreme liberals (34.5%) than extreme conservatives (25.8%) report being "not at all satisfied" with their finances.
Conservatives usually tend to report less marital unhappiness than liberals. In the 1998-2002 GSS, 5.1% of those who report being "slightly liberal" say that they are "not too happy" in their marriages, compared to 0.9% of those who are "slightly conservative." Ordinary liberals (3.7%) and extreme liberals (8.9%) also differ from ordinary conservatives (2.4%) and extreme conservatives (4.1%) in the levels of reported marital unhappiness. Indeed, in the 1998 GSS, 18.2% of extreme liberals reported that their marriages were "not too happy," while only 1.6% of extreme conservatives reported marital unhappiness.
Earlier General Social Surveys found that conservatives were more satisfied with their health, their friendships, their family life, and the city or place they live--all in all, a remarkably consistent picture.
Another claim in the Jost paper is that conservativism is driven by anger and fear. Again, their claims conflict with some of the highest quality data available. In the 1996 GSS, questions were asked about anger and fearfulness. Extreme conservatives were much less likely to report being mad at someone every day in the last week--7.3% to 24.2% for extreme liberals. Extreme conservatives were also less likely to report being fearful in the last week--32.5% to 56.3% for extreme liberals. In other words, a staggering one-quarter of extreme liberals report being mad at someone EVERY DAY and most extreme liberals report being fearful at least once a week.
I am surprised that the Jost group was not aware of the very strong and remarkably consistent data that conservatives report being happier than liberals about their lives in general, their jobs, their finances, their health, their friendships, their family life, and where they live. Nor does the Jost group deal with the less extensive data suggesting that conservatives are less fearful and less angry than liberals. I will have to look into more of the studies that Jost cites to see why these fairly obvious patterns are missed. I wonder whether Jost relied too much on studies that either used unrepresentative samples (such as undergraduates) or used biased questions or indices -- asking about issues on which conservatives tend to be unhappy but not about issues on which liberals tend to be unhappy. In either event, the Jost group seems to have missed decades of very high quality survey data that undercut their thesis.More by Lindgren on this topic here. See also non-Lindgren commentary here.
Posted at 08:30 PM in Law School | Permalink | Comments (0)
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The Jost article claims that conservatives are angry and fearful and it builds on a literature that claims that conservatives are unhappy. I find this strange, given the decades of superb data showing the opposite. In the NORC General Social Survey (a standard social science database, second only to the U.S. Census in use by U.S. sociologists), the GSS asks the standard survey question about happiness in general. In the 1998-2002 GSS, extreme conservatives are much more likely to report being "very happy" than extreme liberals-- 47.1% to 31.6%. Earlier years show a similar pattern.
This conservative happiness carries over into most other aspects of life as well. Conservatives usually report being happier in their jobs than liberals. In the 2002 GSS, for example 65.2% of extreme conservatives report being "very satisfied" with their jobs in general, while only 50% of extreme liberals report being very satisfied. When the question is broadened to satisfaction with job or housework, a similar pattern obtains. In the 1998-2002 GSS, 61.0% of extreme conservatives reported being very satisfied, compared to 53.6% of extreme liberals.
As to finances, in the 1998-2002 GSS 34% of extreme conservatives report being satisfied with their finances compared to 26.4% of extreme liberals. More extreme liberals (34.5%) than extreme conservatives (25.8%) report being "not at all satisfied" with their finances.
Conservatives usually tend to report less marital unhappiness than liberals. In the 1998-2002 GSS, 5.1% of those who report being "slightly liberal" say that they are "not too happy" in their marriages, compared to 0.9% of those who are "slightly conservative." Ordinary liberals (3.7%) and extreme liberals (8.9%) also differ from ordinary conservatives (2.4%) and extreme conservatives (4.1%) in the levels of reported marital unhappiness. Indeed, in the 1998 GSS, 18.2% of extreme liberals reported that their marriages were "not too happy," while only 1.6% of extreme conservatives reported marital unhappiness.
Earlier General Social Surveys found that conservatives were more satisfied with their health, their friendships, their family life, and the city or place they live--all in all, a remarkably consistent picture.
Another claim in the Jost paper is that conservativism is driven by anger and fear. Again, their claims conflict with some of the highest quality data available. In the 1996 GSS, questions were asked about anger and fearfulness. Extreme conservatives were much less likely to report being mad at someone every day in the last week--7.3% to 24.2% for extreme liberals. Extreme conservatives were also less likely to report being fearful in the last week--32.5% to 56.3% for extreme liberals. In other words, a staggering one-quarter of extreme liberals report being mad at someone EVERY DAY and most extreme liberals report being fearful at least once a week.
I am surprised that the Jost group was not aware of the very strong and remarkably consistent data that conservatives report being happier than liberals about their lives in general, their jobs, their finances, their health, their friendships, their family life, and where they live. Nor does the Jost group deal with the less extensive data suggesting that conservatives are less fearful and less angry than liberals. I will have to look into more of the studies that Jost cites to see why these fairly obvious patterns are missed. I wonder whether Jost relied too much on studies that either used unrepresentative samples (such as undergraduates) or used biased questions or indices -- asking about issues on which conservatives tend to be unhappy but not about issues on which liberals tend to be unhappy. In either event, the Jost group seems to have missed decades of very high quality survey data that undercut their thesis.More by Lindgren on this topic here. See also non- Lindgren commentary here. All of this does raise an interesting question: what makes someone a liberal or conservative? Nature or nuture? Environment, education, or economic success/failure? My guess is that conservatives and liberals tend to be born, not made. Doubtless factors like environmental and class play into it, but my guess is that we tend to be hardwired for one side or the other. (When I asked Lindgren this question, he suggested looking at twin studies, which apparently are the classic way of doing nature versus nurture studies. A post over at the 2Blowhards discusses a twin study that seems to confirm the nature hypothesis.) Sidenote: Lindgren notes that he can't study libertarian attitudes is because the number of people who self-report to the GSS as libertarians is so small that they don't even collect the data. Heh.
Posted at 04:57 PM in Law School | Permalink
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For forty years, economist Eugene Fama argued that financial markets were highly efficient in reflecting the underlying value of stocks. His long-time intellectual nemesis, Richard Thaler, a member of the "behaviorist" school of economic thought, contended that markets can veer off course when individuals make stupid decisions.
In May, 116 eminent economists and business executives gathered at the University of Chicago Graduate School of Business for a conference in Mr. Fama's honor. There, Mr. Fama surprised some in the audience. A paper he presented, co-authored with a colleague, made the case that poorly informed investors could theoretically lead the market astray. Stock prices, the paper said, could become "somewhat irrational."
Coming from the 65-year-old Mr. Fama, the intellectual father of the theory known as the "efficient-market hypothesis," it struck some as an unexpected concession. For years, efficient market theories were dominant, but here was a suggestion that the behaviorists' ideas had become mainstream.
"I guess we're all behaviorists now," Mr. Thaler, 59, recalls saying after he heard Mr. Fama's presentation.Well, perhaps not quite. The ECMH is central to both many SEC policy debates and investment techniques. Its validity is thus a critical question. I plan to address the continued validity of the hypothesis in a TCS column (assuming Nick takes it). In the meanwhile, check out these old blog posts:
Posted at 08:29 PM in Economic Analysis Of Law | Permalink | Comments (0)
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One of the most useful tools in analyzing legal rules and the policy problems to which they apply is game theory. The basic idea of game theory is simple. Many human interactions can be modeled as games. To use game theory, we build a simple model of a real world situations as a game. Thus, we might model civil litigation as a game played by plaintiffs against defendants. Or we might model the confirmation of federal judges by the Senate as a game played by Democrats and Republicans. This week's installment of the Legal Theory Lexicon discusses one important example of game theory, the prisoner's dilemma.I used the prisoner's dilemma to model the behavior of sovereign debtors vis-a-vis creditors in my article Comity and Sovereign Debt Litigation: A Bankruptcy Analogy:
Abstract: On repeated occasions in the post-war period, the cumulative effects of policy mistakes, recessions, inflation, and other economic problems have made it difficult for sovereign debtors to service their external debt. Unlike a domestic U.S. private debtor, who may resort to formal bankruptcy procedures in the event of insolvency, a defaulting sovereign debtor has no formal mechanism for triggering a restructuring of its debt.
In some cases, sovereign debtors have resorted to a moratorium on debt payments. This article argues that U.S. courts ought to give effect to such moratoria under the international law principle of comity. Using standard game theory methodology (the so-called "creditors dilemma" variant of the famous "prisoners dilemma"), the article argues that creditors of such debtors would agree in advance to give effect to such a moratorium provided it neither repudiated the sovereign's debts not gave preference to certain creditors. A legal test for granting comity to sovereign debt moratoria is therefore proposed.
Posted at 08:28 PM in Economic Analysis Of Law | Permalink | Comments (0)
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Posted at 08:54 PM in Wine | Permalink
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James Glassman nails SEC Chairman William Donaldson:
When President Bush admitted in Friday's debate that he had "made some mistakes in appointing people," he certainly had in mind someone with the initials P.O'N. But perhaps he also was thinking of someone with the initials W.D.
William Donaldson, who last year became chairman of the SEC, the nation's top financial regulator, had all the right credentials: co-founder of a Wall Street investment firm, dean of the Yale School of Management, chairman of the New York Stock Exchange, CEO of Aetna, Under Secretary of State to Henry Kissinger.
Yet, to put it mildly, Donaldson, 73, has been a disappointment. It's hard to believe his is the Bush Securities and Exchange Commission. More and more, policies reflect the views of a hard-line Democrat, Harvey Goldschmid, a Columbia University law professor who was SEC general counsel during the Clinton Administration.
Glassman then goes on to rip one SEC policy after another.
Posted at 07:42 PM in Securities Regulation | Permalink
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Somewhere in the middle pages of ?1984,? Winston Smith is being inducted into the shadowy and, as it turns out, nonexistent ?Brotherhood? of resistance to Big Brother, and, to celebrate, the Inner Party member O?Brien pours him a glass of wine. Winston has never had wine before, but he has read about it, and he is desperately excited to try it, since he expects it to taste like blackberry jam and to be instantly intoxicating. Instead, of course, the wine tastes the way wine tastes the first time you taste it?a bit acidic and bitter?and a single sip, or glass, isn?t intoxicating at all. The intensity of this experience as a model of disappointment was significant enough for Orwell so that he inserted it in his dystopia right there among all the greater horrors?as though the future weren?t bad enough, that whole wine thing will go on, too.
Fifty years later, we live in a wine world where, for the first time, there are wines that do taste like blackberry jam and are instantly intoxicating, or nearly so, and how these wines came into being is the subject of a new book, ?Noble Rot? (Norton; $24.95), by William Echikson. The book tells the story of the wine life of the Bordeaux region of France over the past twenty years, and, though Echikson does not quite have the narrative skills to assemble it, he lays out all the pieces of a first- class Henry James comedy about the brutality of American innocence, the helplessness of French sophistication, and the need for intoxicants that are always called by some other name and claimed for some other purpose.Thanks to Vintage Bob for the tip. I'm about halfway through Noble Rot and I'm finding it quite fascinating. It does a very fine job of exploring the modern wine industry and, in particular, the highly controversial role of über-wine critic Robert Parker.
Posted at 07:29 PM in Wine | Permalink
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My vocational interests focus on ec onomic analysis of the law of public corporations. Although my training at UVa emphasized the tools of neoclassical economics, I have since concluded that institutional economics and, to a somewhat lesser extent, behavioral economics have considerably greater explanatory power. As a result, I'm always looking for good overviews of those fields. I recently came across Allan Schmid's relatively new book Conflict and Cooperation: Institutional and Behavioral Economics, which is unusual in combining these two important fields. Schmid has done a great job of explaining the insights these areas of economics can provide for understanding not only economic questions, but also legal and policy issues. I'm finding it highly useful and recommend it to anyone with an interest in law and economics.
Posted at 12:30 AM in Books | Permalink
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Posted at 11:18 PM in Wine | Permalink
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Posted at 11:04 PM in Wine | Permalink
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