Archive for January, 2021

Jiu-Jitsu Comes to the Stock Market

Jan Kregel | January 29, 2021

The core philosophy of this Japanese defensive art used by the weak against the stronger Samurai is to mobilize the opponent’s greater force to your own advantage. Many have criticized the run-up in the quotation of the GameStop shares as a violation of market principles or regulations. Far from it, it simply represents the fact that day traders may be dumb money, but they have understood how to apply jiu-jitsu.

If the intent was simply to profit from trading the stock, no retail trader could ever compete with the institutions. To attempt to directly manipulate the price of the stock through outright purchase or sale would be impossible. The strategy that was used was simply to recognize, as Softbank had done earlier in the year, the nature of market hedging.

There is a myth that hedging can eliminate risk. This almost never happens, unless there is a perfect match between risk of gain and risk of loss. In all other cases, hedging requires compensation to transfer the risk—to those more able to bear the risk, as Greenspan would say. After the 2008 financial crisis, we learned that ability had nothing to do with it; it was who was willing to bear the loss, and most were not able and required the government to bail them out.

So in the run-up in the market quotes of GameStop shares, this was not really a question of the dubious behavior of a bunch of day traders; it was an application of market knowledge of how financial contracts work in practice. continue reading…

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Why “Output Gap” Is Inadequate

Lekha Chakraborty | January 4, 2021

by Lekha Chakraborty and Amandeep Kaur[1]

The macroeconomic uncertainty during the Covid-19 pandemic is hard to measure. Economists and policymakers use the “output gap” variable to capture “slack.” It is a deviation between potential output and actual output, which is a standard representation of a “cycle.” The potential output is an unobserved variable. There is an increasing concern about the way we measure potential output—decomposing the output into trends and cycles. This is because the business cycle is not always a “cycle.” Sometimes, the “cycle is the trend.”[2]

When macroeconomic crises and recessions tend to “permanently” push down the level of a country’s GDP, it is inappropriate to assume that output will bounce back to previous levels. The notion of the output gap is ill-conceived and ill-measured. Scholars have highlighted the significance of “hysteresis” (the dependence of economic path on history) in analyzing the output dynamics in crisis.[3] Against the backdrop of the Covid-19 pandemic crisis, there is a renewed interest in hysteresis and business cycles. The state of the economy and the level of GDP are history dependent (hysteresis). The concept of hysteresis has urgent relevance for designing apt fiscal and monetary policies to tackle low demand during recessions. continue reading…

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