Cyber Liability Insurance

As absolute dependence on computers and computer stored information grows there are new ways companies can be sued by third parties for damages.  When private information such as dates of birth, social security numbers, credit card numbers, etc are stolen off of your business' computer systems, it is called a data breach, and they are very costly to manage.  The insurance industry has calculated this cost to be about $200 per individual whose information was taken.  Also, if a malicious virus is distributed from your computer to a customer’s computer system and causes damage, you could be held responsible for cost to repair their system.  Your basic general liability policies are not designed to pay for such claims so many times when businesses look to their business policies the coverage is not there to help with these expenses.  Because of that, insurance companies have developed a new product called cyber liability.  It is designed to step up and pay for the third party damages caused by your data breaches and damage by viruses to other’s computer system.

So what kinds of business should be looking into this new cyber liability products?  Any business with a computer, especially one that stores or interacts with any private information or distribute emails to others should look into this product.  Restaurants and retail stores that take credit cards, professional business that store dates of birth, driver’s license numbers and social security numbers, even doctors’ offices are at risk for the types of claims mentioned above.  Unfortunately, even if a business has the best firewalls and antivirus software, they still are at risk of data breaches and malicious viruses.  Cyber liability is something designed to help protect your business assets if an unpreventable claim strikes.

Something Big happened in the early 70s

Dissertation successfully defended (it won't be official until I complete the byzantine formatting requirements, but that will happen in a couple days), so back to blogging slash getting ready to teach finance to MBAs...

Reading Paul Krugman this week, I found that a question that has often nagged me is nagging me more than usual. Take a look at these two graphs that Krugman put up:

Yes, I know that trends in squiggly lines can be illusions. They might not represent anything structural. "The trend is your friend until the bend at the end," as they say. But WOW, doesn't it look like there was some sort of trend break in the early 1970s? Also, that Krugman graph shows labor productivity, but if we look at Total Factor Productivity, here is what we see:

Now, this is not exactly couched in the careful, formal language of macroeconometricians, but it seems like Something Big happened in the early 1970s.

What was it??

First, there are a few candidate "trend break events" that seem dubious to me. The first is a general technological slowdown, a la Tyler Cowen. It does not seem very likely that the "low hanging fruit" of science would suddenly run out within a two-year period. Also, the "neoliberal"/Reagan policy revolution seems an unlikely candidate, since that happened after 1980. Finally, the entry of women into the workforce was slow and steady.

The decline of unions has been postulated as a cause. And there does look to be an especially steep dropoff in membership in the late 70s:

But this is a bit problematic too, because A) the trend break seems to come a few years later than the earlier ones, and B) it's not clear that union-bashing policies were in place in the early 70s. I guess I wouldn't rule this one out, but my intuition is that it was a result, not a cause, of the Something Big.

This leaves me with two candidate explanations for the possible early-70s trend break. These are the end of Bretton Woods in 1971, and the Oil Crisis in 1973.

The end of Bretton Woods seems like a big deal. It ushered in the era of floating exchange rates and ended the de facto gold standard that had prevailed since WW2. Why would this have held down wages in the U.S.? Well, it might have allowed the start of globalization, which began to add labor-rich, capital-poor countries to the rich-country trading system, thus holding down wages via factor price equalization. The catch-up of Europe and Japan in the 70s and 80s, and then of China et al. in the 2000s, might have held down U.S. wages as these countries' catch-up productivity gains outpaced their wages. Alternatively, exchange rate risk must have spiked after the end of Bretton Woods; this could have reduced investment as a percent of GDP, raising the return on capital relative to labor, while simultaneously decreasing nondurables TFP via endogenous growth effects. I'm not quite sure if either of these mechanisms holds up under close scrutiny, however.

The Oil Crisis of '73 seems like a big deal. It represented the start of an era of highly variable energy prices. Since energy is an input for basically everything, lots of people have speculated that higher (and more variable) energy costs have caused a general productivity stagnation. Peter Thiel puts the argument thus:

[W]e've had basically no progress on energy.  And if you think about where oil prices were in 1973, it was $2 or so a barrel, it is now at north of $100 a barrel, and so you've had sort of a catastrophic failure of energy innovation.  And it's basically been offset by computer innovation.  I think that's sort of the simplified account of what's happened in the last 40 years.

This more limited version of the "Great Stagnation" hypothesis seems much more likely to me than the more general "end of science" version.

So there are two possible culprits for the Something Big that happened in the early 70s. Of course, even if one of these is the villain, it's possible that it's only a proximate cause for something more fundamental. The end of Bretton Woods may have been an inevitable, necessary response to increasing globalization that was made possible by falling transport costs, maybe due to the invention of containerized shipping (and, later, the internet). The rise in oil costs may have been due to increasing extraction costs and decreasing discoveries, and floating exchange rates might themselves have played some sort of role. The question of which "shocks" are truly fundamental, or truly "structural", is a bit like the question of whether guns kill people or people kill people.

But the important point is, something happened in the early 70s that seems to have been a trend break in how our macroeconomy works. We should be examining economic theory and econometric evidence, in ways far more careful and thorough than this blog post (or any blog post), for clues as to the processes that caused the trend break. If necessary, we may have to modify our theories...but isn't that always the case?

Update: It looks like Daniel Kuehn did a very similar blog post about a month ago, and came to some of the same conclusions...

Microfoundations would be nice if we had them

Matt writes:

But while reduction is something scientists inquire into, it's never been the case that reduction is the sine qua non of useful scientific inquiry. To the best of my understanding, Newton's account of gravity didn't have any microfoundations at all. It was a mathematical formalization of observations about how the world functions... 

And crucially the key test a purported effort to provide microfoundations for gravity must pass is that it has to explain gravity well. The trend in economics since the Lucas Critique seems to be the reverse. If a theory lacks adequate microfoundations, it's rejected out of hand while you get a lot of wriggle room in terms of accounting for the data properly... 

People who seem very bothered by the fact that the observed reality of nominal wage stickiness is not well-microfounded don't appear to have the same difficulty relying on the observed reality of gravity. This is particularly strange since microeconomics itself is not particularly microfounded in psychology or neurology... 

The right answer is that productive inquiry can happen at many different levels of understanding and the appropriate test of a theory is whether it gives some kind of useful account of the thing it's supposed to explain.

I have a few responses to this, which don't fit into a coherent whole, so I'll just make a list:

1. Gravity is different from macroeconomics in several ways. One way is that we don't actually know if there is any phenomenon "underlying" gravity. Gravity might not be explainable in terms of any broader, more general phenomenon. But we know for a fact that macroeconomics is the result of a whole bunch of little economic decisions by individuals and companies. This, not the Lucas Critique, is the real reason we look for microfoundations for macroeconomics. Now, maybe some macroeconomic phenomena don't have microfoundations; maybe they are emergent. But we don't know that yet.

2. Another way in which gravity is different than macroeconomics is that you can test gravity in a lab. With macro, our empirical data come from economic time series, which are basically a very poor window into the phenomena we're trying to understand. Time-series econometrics, currently our only tool for matching macro theories to data, is pretty inadequate. Microeconomics, however, often can be tested in a lab, or with reasonably abundant "natural experiments" that don't exist in macro. So finding microfoundations for macroeconomics would allow us to be more scientific about the whole thing.

3. Matt says "the appropriate test of a theory is whether it gives some kind of useful account of the thing it's supposed to explain". This is a paraphrase of Milton Friedman's quote that "theory is to be judged by its predictive power for the class of phenomena which it is intended to 'explain.'" But "useful account" and "predictive power" are not precisely defined terms. For example, people once believed that psychological stress caused ulcers. This explanation had good predictive power - people who were under a lot of stress started having ulcer pain. And it was a useful account, since you could reduce pain by reducing stress. But eventually we found out that bacteria play a big role in ulcer formation, almost certainly bigger than the role played by stress. In this case, a decent non-microfounded theory was vastly improved by a successful search for microfoundations.

4. Having said all this, I agree with Matt that there is too little respect for data in macro today (probably because if there were more respect for data, macroeconomists would have to say "We don't really know whats going on" much of the time). And I agree that productive theoretical analysis can in principle be conducted at any level of complexity. If this idea is used to argue that we shouldn't require macro theories to be microfounded, then I agree. If this idea is used to argue that looking for microfoundations in macro is a waste of time and effort, then I disagree. Having microfoundations is better than not having them. 

5. Once again, let me reiterate that the big problem with "microfounded" macro, as I see it, is that the "microfoundations" are bad: not credible, and generally not consistent with anything microeconomists have actually found. Bad microfoundations are worse than none at all.


Update: Here's Peter Dorman with some specifics about bad microfoundations. Actually, having read a bazillion experimental papers, I am of the opinion that some neoclassical micro matches reality pretty well and some doesn't. See here for a partial survey.


Update 2: Here's Tyler Cowen with some thoughts on microfoundations and wage flexibility. He also makes the excellent point that "microfoundations" is not synonymous with a certain policy attitude; in other words, we shouldn't make the mistake of thinking "microfoundations = hard money" and then conclude "Let's ditch microfoundations"...

Steve Williamson explains modern macro

...Well, not actually all of modern macro. Just the way that modern macroeconomists define the "business cycle". But since the "business cycle" is the phenomenon that macroeconomists want to explain, this is really key, and it's something that doesn't get talked about a lot. So go read Steve Williamson; the post is really quite excellent, you will learn more about modern macro from reading it than from days of reading a graduate textbook. After you are done reading, then come back and continue this post.

What is a "business cycle"? It's not immediately obvious what it is. We have this idea that sometimes the economy does well, and sometimes it doesn't do well. Sometimes jobs are hard to find and don't seem to pay very well, sometimes jobs are easy to find and just throw perks at you. Sometimes lots of new buildings are going up, sometimes not many are. Etc.

Unlike seasons, these business "cycles" seem not to all last the same amount of time, or come at regular intervals. So maybe the "cycle" is really just randomness. Sometimes something happens to make the economy go well, sometimes something happens to make the economy not go well.

BUT, here's the thing...the economy seems to do steadily better and better over time. Only rarely do things get so bad that we actually produce less stuff than the year before. So people often think of the economy as containing a "trend" - some underlying force making us do better and better - and a "cycle" - some random thing that makes the economy do even better than the trend, or even worse, for a short while before going away.

The Hodrick-Prescott "Filter" (or H-P Filter) does not clean your water supply. It is a method for turning a time-series - say, GDP - into a "cycle", by subtracting out the "trend". If you are a "business cycle theorist", what you do for a living is basically this:

Step 1: Subtract out a "trend"; what remains is the "cycle".

Step 2: Make a theory to explain the "cycle" that you obtained in Step 1.

The H-P Filter is just a method for doing Step 1. You take a jagged time-series and you smooth it out, and you call the smoothed-out series the "trend". That's it. Whatever is left you call the "cycle", and you make theories to try to explain that "cycle".

But how much do you smooth? That's a really key question! If you smooth a lot, the "trend" becomes log-linear, meaning that any departure of GDP from a smooth exponential growth path - the kind of growth path of the population of bacteria in a fresh new petri dish - is called a "cycle". But if you don't smooth very much, then almost every bend and dip in GDP is a change in the "trend", and there's almost no "cycle" at all. In other words, YOU, the macroeconomist, get to choose how big of a "cycle" you are trying to explain. The size of the "cycle" is a free parameter.

Now, let's think about those explanations. One such explanation is the original RBC ("real business cycle") model, invented by the same Prescott who invented the Hodrick-Prescott Filter. This model won Prescott a Nobel Prize in 2004. I've criticized the RBC model, but let's forget about that criticism for now. How did Prescott show that his model explained the business cycle? What he did was this: First, he chose some values for the parameters in the RBC model that seemed reasonable to him ("calibration"). Then, he simulated an economy with the RBC model, and measured the size of the simulated fluctuations that it produced. Finally, he compared the size of those fluctuations with the size of the "cycle" that he got out of an H-P Filter, and decided that the two were pretty close in size. Thus, he concluded, the "cycles" of economic activity that we see in the real world could be generated by the RBC model, and hence the RBC model was a good one.

Now, I've criticized this method of validating models (which is called "moment matching"). But let's put aside that criticism for now, and think about the H-P Filter. Remember that we get to choose how much to smooth the time-series. The less we smooth, the smaller the "business cycle" becomes. So, up to a point, by choosing how much to smooth, we can choose to make the business cycle as big or as small as we like!

So what Prescott did was:

A) Chose how big of a "business cycle" he wanted to model,

B) Built a model of business cycles that produced fluctuations of about the size he chose in step A, and

C) Claimed to have explained the business cycle.

Now this may sound like a big fat hoax, but it's not quite. The amount of smoothing in the H-P filter is a free parameter, but if you choose it too big or too small, people will be skeptical. After all, we have other measures of recessions, like the "NBER recessions". If you smooth so much or so little that your "cycles" don't coincide at least roughly with those recessions, people won't buy your theory. They will say "Aww come on, really?" And in fact, some people responded that way to the RBC theory when it came out. But a critical mass of people gave it credence, which is why it became the basis of most subsequent models of the business cycle, and won a Nobel Prize.

What I want to point out here is how many judgment calls there are in modern macro. There is the judgment call of how big you think the "business cycle" is compared to the "trend". There is the judgment call of the parameters you think are reasonable to stick into your model. And there is the judgment call of whether you think the simulated fluctuations produced by your model are "close enough" in size to the real fluctuations. Actually, there are more judgment calls I haven't even talked about, such as the judgment call of whether a "shock" (a random thing that causes "cycles") is "structural" or not (see here if you want to learn more about that).

Now, some modern macroeconomists will tell you that all these judgment calls are fine. A theorist's conclusions, they will tell you, follow from their assumptions. Judgment calls are just assumptions.The job of a theorist, they will tell you, is to make a theory that is internally consistent. The purpose of the mathematics is to show that the conclusions - the policy recommendations, the forecasts - flow logically from the assumptions, or judgment calls. As for which judgment calls are appropriate, well, that is what academics spend their time arguing about, using their common sense to guide them.

Doesn't it seem to you that this way of doing "science" is a little too vulnerable to cultural/political biases among the body of practicing macroeconomists? It seems that way to me. But maybe I am wrong.

"This time it's different": China edition

I confess: I take a guilty pleasure in reading articles that claim "This time it's different". Back in 2004-5, when I started reading financial and economics news, all of those yarns were about how U.S. housing prices had reached a permanently high plateau, or how the financial system had evolved to be able to spread risks to the people most willing to bear them, etc. etc. It was fun. Everyone seemed to know it was BS. We just sat there imagining who would possibly believe it.

Anyway, the fun is back. As China slips into a slowdown, a few people are piping up to claim that no, this time it's different, China has it all figured out, their culture is different, their government is better, and so forth. But so far, I haven't seen anyone do this routine as beautifully as James White, analyst at Colonial First State. In an article flagged by Izabella Kaminska of FT Alphaville, he writes:

China’s rise confounds economic history, but not necessarily economic theory...[its] foundations seem brittle to western investors used to judging the health of an economy through the returns on capital. But the Chinese are comfortable with low capital returns if the pay-off is a stronger economy. This has been the case... 

The Chinese don’t play chess. They play wei qi [also known as Go]...The Chinese government views the economy as though it’s wei qi. Each piece has its own role in the economy, but each is no more important than another. 

This is an important observation. In the developed world...Falling or negative returns on capital are a sure sign of economic weakness reflecting the end of a period of over-investment...In China, capital is just one piece on the board where the aim is to raise living standards of all households...The government’s role is paramount. Despite claims of dramatic imbalances (investment spending has made up to 45% of GDP in recent years, compared to below 15% in some developed economies), investment is driving sustainably higher economic growth... 

At a macro-level, the higher allocation of capital in China has led to falling profit growth and lower returns for capital...Since 2004...China['s stock market] is up just 46%...2011 has been punctuated with stories of large capital losses across the economy... 

By not using capital returns as a scorecard for economic progress, China improves the allocation of capital in its economy and raises living standards. Effectively, China takes a broader perspective to the value of capital in an economy... 

First, and most obviously, the government has the ability to fund losses on individual capital projects through the accumulated financial reserves, totalling at least $3.2 trillion. Second, and most importantly, the Chinese government, as ultimate capital allocator, can recoup returns from projects by capturing the positive externalities from projects in the form of higher tax revenues created by higher levels of activity... 

China’s economic performance in the last 20 years has been remarkable; very strong growth and low inflation...The government, as the largest capital allocator, can both manage losses from individual projects and capture the benefits of loss-making projects through its taxcollecting authorities. 

I love this. It has all the classic hallmarks of a "This time it's different" piece. First - and this is my personal favorite - we have the cultural analogy. Chinese people don't play chess, they play Go! And by realizing this we can understand why low capital returns are irrelevant! It's all about the Eastern Mystique...this time it's different because these people are different.

(Of course, an astute reader might point out that Japanese people also play Go, and until the last couple of decades absolutely dominated international Go competitions. That didn't prevent the Japanese economy from tanking, and it didn't change the fact that wasteful investment was a central feature of said tanking.)

Next we have the faith in the government. China's government, we are told, is a benevolent sort of oligarchy, whose "aim is to raise living standards of all households". Never mind the massive corruption and state-corporate collusion. Never mind the negative real rates of return on Chinese household deposits. Never mind China's slow consumption growth and low share of household consumption in GDP. Never mind the Latin America-like levels of inequality. China's government, unlike our Western variety, is all for The People, despite the curious fact that The People there have less say in the government's operations. (Note how this also plays to Orientalist stereotypes: the Chinese as a Confucianist hive mind.)

But the Chinese government isn't just benevolent, it's omnipotent! The government can bail out loss-making capital projects with its massive stock of foreign asset reserves. Never mind the fact that the government acquired those reserves from private banks by swapping government liabilities for foreign assets. 

Finally we have the blatant trend extrapolation. China has grown strongly for the last 20 years; hence it will continue to grow strongly. It's growth is "sustainably higher" than that of other countries. If you bet against China in 2001, you were a sucker; hence, if you bet against China now, you are a sucker.

So because China's government cares more about the general populace than about the profits of capitalists, which somehow has to do with the fact that they play Go instead of chess, it will use its foreign asset reserves to bail out loss-making projects that produce positive externalities that raise GDP growth overall. Hence, "This time it's different", and we should view the 20-year trend of Chinese growth as something structural instead of the kind of transitory catch-up phase observed in every other country in history, including Japan, South Korea, and Taiwan. Therefore, the market's expectation that growth will slow - reflected in the only-46% rise in Chinese stocks since 2004 - is seriously wrong.

Got it.

Anyway, fun-poking aside, I have always been struck by the sheer volume of words expended on the question of whether newly industrializing economies will break the Solow Model or not. Really, it's very hard to see how you can break the Solow Model - keep accumulating capital, and your growth will be fast but steadily decreasing as you converge to the rich-world average. Sure, you can fall short of the Solow Model and get stuck in a "middle income trap". Sure, there are questions as to how fast technology can be transferred from richer countries, or whether investment has a maximum "speed" beyond which it becomes more wasteful, or what kind of institutions are optimal. But the idea that growth must slow - gently or otherwise - as a country gets richer should, in my opinion, be the jumping-off point for any predictions about development. 

It's very weird that after all these years, we're still trying to extrapolate countries' futures based on what kind of board games they play.

Inflation for the People

For the past few weeks I've been getting acquainted with the popular wing of the "Austrian economics" movement. First I discovered the Bizarro Economics World of online forums, then I got re-acquainted with Zero Hedge, which seems to have taken a more and more inflationista/goldbuggy/Austrian tone in recent years.  Then a bunch of Texan friends started posting "End the Fed!" memes to my Facebook feed. So I went on Facebook and I asked: "Why do people want to end the Fed?" In response, a friend sent me this video:

In the video, a guy loses his house, and his American Dream is crushed. He is then taken back in time by a guy with a horribly fake African-American accent, to witness the source of his problems. As it turns out, everything is the fault of bankers, who steal people's money through fractional reserve banking. Eventually, banking power is concentrated in the hands of a shadowy cabal headed by the Rothschilds, to whom even J.P. Morgan must kowtow. Thomas Jefferson and Andrew Jackson temporarily hold off the evil bankers here in America, ushering in a huge boom "with real money, backed with real gold." But eventually the bankers get in, and end up forming the Fed, which proceeds to steal people's hard-earned money even more via inflation and collaboration with the IRS. 

Anyway, for now I'll ignore the oddity of anti-semitic video makers latching onto an economic philosophy (Austrianism) invented by a Jewish guy and a movement (the Ron Paul movement) inspired by another Jewish guy. Anti-semitism has always been a bit weird like that. I'll also put aside the thing about fractional reserve banking (a subject for another post). Instead, I'd like to talk about inflation.

The classic simple example of inflation is this: The Fed (or the banking system, giant Rothschild robots, whatever) doubles the money supply. So money becomes only half as valuable as before. Therefore, the price of everything doubles. So:

Price of a gallon of milk:  $4 --> $8

Price of a gallon of gasoline:  $4 --> $8

Price of a new house: $200k --> $400k

..and so on. BUT, inflation also doubles your salary, in exactly the same way:

Salary: $40k --> $80k

However, (unless you own a special kind of bond called TIPS), inflation does not change the size of your bank account:

Your savings: $80k --> $80k

So while prices and your salary double, the number of dollars in your savings account stays the same. This makes you poorer, because you can't buy as much stuff with your savings:

Your savings: 20,000 gallons of gasoline --> 10,000 gallons of gasoline

So inflation steals your money, right? Well, sure. BUT, wait a second. What if you have a mortgage? Suppose you already bought a house, but you haven't paid off your mortgage yet. You have debt! What happens to this debt when inflation happens? Does it go up? Nope! Just like your bank account, it stays the same:

Your mortgage debt: $160k --> $160k

Now remember, your salary went up when inflation happened. So now, it takes you much less work to pay off your mortgage:

Your mortgage debt: 4 years of your salary --> 2 years of your salary

Inflation stole money from you by shrinking your bank account, but it put money in your pocket by shrinking your mortgage debt!! Notice that the way I have the numbers here, your net worth went up, because your mortgage debt was bigger than your bank account. 

So if your net worth goes up and the purchasing power of your income stays the same, as in this simple example, inflation makes you richer. Inflation hurts people who have more savings than debt, and helps people who have more debt than savings.

Who has more savings than debt? Old people and rich people. Who has more debt than savings? Young workers who are paying off mortgages. In other words, the video has it exactly backwards - inflation will not take your house away from you, inflation will prevent your house from being taken away from you. It will save your American Dream. If you don't believe me, go back and look at my example again. It works.

And that hyperinflation that people on Zero Hedge are always screaming about? Well, first of all, it's not coming. But if it did happen, it would mean that your mortgage would be paid up instantly. Really. If our money turned into Monopoly money, you could just pay off your mortgage with a wheelbarrow full of Monopoly money. Perfectly legal!

(Now, you may say "Inflation is still bad, because it punishes saving and rewards reckless borrowing." Well, you're right. That's a danger that the Fed thinks about when they are trying to decide whether to print money in an attempt to boost GDP growth.)

Anyway, what's interesting is that inflation was not always seen as the enemy of the common people. When Thomas Jefferson railed against banks, he worried about deflation as much as inflation. And in the 1800s, the Populist Movement - basically, a bunch of small farmers in the South and West - fought for inflation! At that time, farmers owed a bunch of money to big banks on the East Coast (including J.P. Morgan, who was presumably busy kowtowing to his secret immortal Rothschild masters). Without inflation, they would have to sell their farms to the banks and go be factory workers. So they fought for the United States to go off the gold standard and go on the silver standard - debasing the currency in order to reduce their debts! 

Actually, the big banks defeated the Populist farmers. The gold standard was maintained, inflation was prevented, and a lot of people lost their farms. So maybe the robotic Rothschild octopi had the last laugh after all. But they didn't do it through inflation! Quite the opposite. Time was, inflation and currency debasement were seen as the savior of the common man.

Just remember: Inflation hurts people with savings and helps people with debt. An awful lot of Americans these days fall into that second category. Before you go embracing the hard-money, Austrian, gold-standard stuff, think about which category includes you!

(Then again, why should you believe me? After all, I am a Jew. I could be working for...THEM...dum dum dummmmmm...)

How Zero Hedge makes your money vanish

In 2001, Brad Barber and Terrance Odean published a very famous finance paper called "Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment". The upshot is this:

Theoretical models predict that overconfident investors trade excessively...Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households...We document that men trade 45 percent more than women. Trading reduces men’s net returns by 2.65 percentage points a year[.]

It has been known for quite some time that individual investors - this means you, sitting at your computer clicking away on e*Trade - almost all underperform the market. In other words, you suck at investing. In 1999, Odean found that a lot of this poor performance comes from the fact that individual investors trade too much. In other words, one reason you suck at investing is because you have an itchy trigger finger. And this 2001 Barber and Odean paper found that men have itchier trigger fingers than women.

Which brings me to the website Zero Hedge.

Zero Hedge is a financial news website. The writers all write under the pseudonym of "Tyler Durden", Brad Pitt's character from Fight Club. Each post comes with a little black and white icon of Brad Pitt's head. On Zero Hedge you can read news, rumors, facts, figures, off-the-cuff analysis, and political screeds (usually anti-Obama, anti-government, and pro-hard money). On the sidebars, you can click on ads for online brokerages, gold collectibles, and The Economist. 

The site is a big fat hoax. And if you read it for anything other than amusement, you're almost certainly a big fat sucker.

That's a bold claim! Why do I make this claim? Well, in one sense, all financial news is a hoax. Financial news, by definition, is public information - if you've read it, you can bet that thousands of other people have too. That means that if the market is anywhere close to being efficient, any information in any article you read will already have been incorporated into the price of financial assets. Reading or watching public information should not, in theory, give you any "alpha".

But OK fine, suppose the market is not efficient. Suppose there are some smart people who can interpret the public news really well, and some suckers who take home the wrong message. And also suppose that the suckers stupidly believe that they are the ones taking home the right message, and that the other folks are suckers. In that case, the smart people can make money by reading Zero Hedge, interpreting it correctly, and taking money from the suckers who either didn't read Zero Hedge or who took home the wrong message...right?

Wrong. Because there's another problem here. If the writers of Zero Hedge really knew some information that could allow them to beat the market, why in God's name would they tell it to you? If they had half a brain, they'd just keep the info to themselves, trade on it, and make a profit! Maybe then, after they had made their profit, they'd release the news to the public (and collect ad revenue), but by then the news would be worthless. Financial news sites, you should realize, are not in the business of giving you insider tips out of the goodness of their hearts.

So the only way you can make money by reading Zero Hedge is if you're not only smarter than a bunch of suckers who look and act a lot like you, but if you're smarter than Zero Hedge's writers too. Not gonna happen. The fact that financial news is big business fits perfectly with the mass suckering of America's individual investors documented by Barber & Odean (2001). Financial "news" is noise.

As you might expect, it's not hard to look back at Zero Hedge's predictions and see that a large number of them are junk. For example, here's a bunch of posts from 2009 predicting imminent hyperinflation. Hope you didn't make any trades based on that bit of wisdom! (Note for the sake of fairness: Yes, in terms of giving "hot tips", there are a lot worse sites than Zero Hedge...see Update 3 below.)

So how does Zero Hedge get away with this hoax? Barber & Odean (2001) give a big hint. Tyler Durden, whose name and image grace every Zero Hedge Post, is a symbol of masculinity. More specifically, he is a nerd's imagined vision of what a really masculine nerd would be like. In Fight Club, Durden says: "All the ways you wish you could be, that's me. I look like you wanna look, I f*** like you wanna f***, I am smart, capable, and most importantly, I am free in all the ways that you are not."

In other words, you are a young smart (i.e. nerdy) guy sitting at your computer with rivers of testosterone coursing through your veins. And now here comes Tyler Durden, your generation's Platonic ideal of pure masculinity, telling you that Real Men Take Risks. At the top of the site, there is a Tyler Durden quote: "On a long enough timeline the survival rate for everyone drops to zero." In other words, gamble. Bet that you're the smart guy and not the sucker. Because hey, you're going to die anyway, so there's no use hedging your bets. Zero hedge, right? (Or you can read a sister site called "Testosterone Pit".  Not kidding!)

In other words, "Tyler Durden" knows what Barber & Odean (2001) knew. Men take risks that, on average lose them money. Zero Hedge is a brilliant behavioral-finance technology that uses the predictable regularities of human psychology to extract money from testosterone-addled dupes. The people who run the site are far from idiots; they are geniuses. In fact, I wouldn't be surprised if "Tyler Durden" were actually a bunch of behavioral finance grad students, snickering behind their hands at everyone who takes their site seriously.

Now, dear reader, maybe you are a fan of Zero Hedge. Maybe you have been getting angrier and angrier as you read this post, and maybe even now you have a comment box open and are typing the first words of an angry diatribe: "You're an idiot and you teach at a shit school which does not acknowledge fact or logic which is keystone in finance and econ!!!" (an actual Tweet I received the other day from a self-described drunk undergrad.)

And maybe you're right. Maybe I am an idiot who is blinded to the obvious wisdom dispensed by Zero Hedge, wisdom that would make me rich if I was just smart enough to read the site and man enough to make some big bets. Maybe. But before you hit the "send" button on that comment, take a glance in the mirror. You're young, right? You're a man, right? You trade pretty frequently, right? And you're not a rich, successful hedge fund manager or investment bank trader, are you?

Here's a radical thought: Maybe you're the sucker.


Update: I showed this post to a few friends in the finance industry, and while all of them agreed, one came up with by far the best one-line response: "Retail investor is retail."

Update 2: John Aziz has a rebuttal over at Zero Hedge, in which he says: 1. The rise in the price of gold shows that hedging against hyperinflation has been a good bet, 2. The name "Zero Hedge" actually doesn't mean you shouldn't hedge, it means you should hedge against a total crash of the financial system, and 3. Zero Hedge has done a good job of exposing corruption in the financial system. I don't think I need to respond to point (1). Point (2) is interesting, I hadn't thought of that, but I'm not particularly convinced it's true. And Point (3) is true; good news is a good thing good to read, and journalism that exposes corruption is valuable. But reading news is different than trading on it, which is what I'm talking about in this post.

Update 3: Some people have pointed out that in terms of offering trading tips, there are a lot worse offenders than Zero Hedge. That's certainly true - The Motley Fool and StockTwits come to mind, not to mention Jim Cramer or any show on CNBC. Compared to those sites, Zero Hedge has a lot more news and less tips. I just picked on Zero Hedge because the testosterone thing gave me a perfect opportunity to whip out Barber & Odean. And also because it's become a haven for goldbug/"Austrian"/"hyperinflation-is-coming"/"the Fed is a UN conspiracy to destroy the white race" kind of BS.