The use and abuse of technical analysis

The economist has a quite good review article about the development and performance of technical analysis.

As promising as technical analysis sounds (with regards to asset allocation risk is generally bad news, so what is wrong with predictability?) it is important to remember the various biases that migth cause the apparant abnormal performance by technical analysis: Survivorship bias, confirmation bias, disconfirmation bias, procedural bias etc.

PRACTICAL traders, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct mathematician. That is what Keynes might have said had he considered the faith placed by some investors in the work of Leonardo of Pisa, a 12th and 13th century number-cruncher.

Better known as Fibonacci, Leonardo produced the sequence formed by adding consecutive components of a series—1, 1, 2, 3, 5, 8 and so on. Numbers in this series crop up frequently in nature and the relationship between components tends towards 1.618, a figure known as the golden ratio in architecture and design.

If it works for plants (and appears in “The Da Vinci Code”), why shouldn't it work for financial markets? Some traders believe that markets will change trend when they reach, say, 61.8% of the previous high, or are 61.8% above their low.

Believers in Fibonacci numbers are part of a school known as technical analysis, or chartism, which believes the future movement of asset prices can be divined from past data. Some chartists follow patterns such as “head and shoulders” and “double tops”; others focus on moving averages; a third group believes markets move in pre-determined waves. The Fibonacci fans fall into this last set.

Buttonwood, who is daringly defying the tide of history by moving from Economist.com into the newspaper, has bad news for the numerologists. A new study* by Professor Roy Batchelor and Richard Ramyar of the Cass Business School, finds no evidence that Fibonacci numbers work in American stockmarkets. The academics looked at the Dow Jones Industrial Average over the period 1914-2002 and found no indication that trends reverse at the 61.8% level, or indeed at any predictable milestone.

This research may well fall on stony ground. Experience has taught Buttonwood that chartists defend their territory with an almost religious zeal. But their arguments are often anecdotal: “If technical analysis doesn't work, how come so-and-so is a multi-millionaire?”. This “survivorship bias” ignores the many traders whose losses from using charts drive them out of the market.

Furthermore, the recommendations of technical analysts can be so hedged about with qualifications that they can validate almost any market outcome. As Professor Batchelor writes: “The root of the problem is the failure of technical analysts to specify their trading rules and report trading results in a scientifically acceptable way. Too often, rules are so vague and complex as to make replication impossible.”

Fibonacci numbers at least have the virtue of creating a testable proposition; one that they appear to fail. But chartists will not be completely discouraged. A review of the academic literature** finds that, of 92 modern studies of technical analysis, 58 produced positive results (although the researchers say some of these studies may be flawed and that the best results occurred before the early 1990s).

If the efficient market theory is correct, technical analysis should not work at all; the prevailing market price should reflect all information, including past price movements. However, academic fashion has moved in favour of behavioural finance, which suggests that investors may not be completely rational and that their psychological biases could cause prices to deviate from their “correct” level.

Chartism probably holds most sway in the foreign-exchange market. Although currency markets are liquid and transparent, many participants (such as central banks) are not “profit-maximising”. So it is possible that currency prices are not completely efficient. Furthermore, some technical predictions may be self-fulfilling; if everyone believes that the dollar will rebound at ¥100, they will buy as it approaches that level.

Technical analysts also make the perfectly fair argument that those who analyse markets on the basis of fundamentals (such as economic statistics or corporate profits) are no more successful. Nevertheless, Buttonwood urges extreme caution in relying on their claims.

All that talk of long waves is distinctly mystical and seems to take the deterministic view of history that human activity is subject to some pre-ordained pattern. Chartists fall prey to their own behavioural flaw, finding “confirmation” of patterns everywhere, as if they were reading clouds in their coffee futures.

Besides, technical analysis tends to increase trading activity, creating extra costs. Hedge funds may be able to rise above these costs; small investors will not. As illusionists often proclaim, don't try this at home.

Mortgage hedging

The introduction of a new instrument that links the size of the mortgage with the development in house-prices. From the economist

FOR most homeowners, their house is their biggest single financial asset and their mortgage is their biggest single liability. House-price inflation has normally made this a good bet. But it makes little sense in financial theory for investors to borrow a lot to speculate on a single asset class. This is particularly true when high house prices in many nations have forced many buyers to take on debts that are a substantial multiple of their incomes.

The answer, according to Zurich Cantonal Bank, is to link the value of the loan to that of the property. On September 18th it launched a new product that offers two ways of doing so. One version includes a put option (a kind of insurance) linked to Zurich's house-price index. At a cost of around 0.5% a year, this option ensures that, if regional house prices fall, the size of the loan will decline in tandem. The second version links the level of the mortgage rate to the house-price index.

The efficient markets hypothesis can land you in jail

The use and abuse of the effecient markets hypothesis in the legal system is illustrated in the following example from the economist.

It seems that the legal system in this case is subject to the same limitations as journalists:

• Keep it simple and
  
• ignore any criticque of the assumptions behind the methods.

JAMIE OLIS knows better than most people that the ideas conjured up by economists in their ivory towers can have a big effect on the real world. The tax accountant, found guilty of committing fraud while working for Dynegy, an energy-trading firm, has been doing time since March 2004, in large part thanks to a controversial economic theory, the efficient markets hypothesis. Last October an appeals court threw out Mr Olis's 24-year jail term, because Judge Sim Lake, who sentenced him, got his economics wrong. But Mr Olis stayed in prison pending resentencing, again by Judge Lake. That will follow a hearing, due on September 12th, that is likely to be dominated by a debate over market efficiency.

In essence the efficient markets hypothesis, which was developed in the 1950s and 1960s, says that subject to certain conditions, the market price of a security—a share, say—fully and accurately reflects all the available information relevant to its value. In an efficient market the only reason why a price changes is that new information comes to light.

This hypothesis has been hugely influential in the world of finance, becoming a building block for other theories on subjects from portfolio selection to option pricing. Of more relevance to Mr Olis, it also has the rare distinction, for an economic theory, of the approval of America's Supreme Court. In 1988, in Basic Inc v Levinson, the court endorsed a theory known as “fraud on the market”, which relies on the efficient markets hypothesis. Because market prices reflect all available information, argued the court, misleading statements by a company will affect its share price. Investors rely on the integrity of the price as a guide to fundamental value. Thus, misleading statements defraud purchasers of the firm's shares even if they do not rely directly on those statements, or are not even aware of them.

That ruling has proved a goldmine for America's trial lawyers, who have won fortunes by suing firms for damages when news (often, in practice, a restatement of their accounts) is followed by a sharp fall in their share prices. The fall is treated as proof of overvaluation due to the initial, wrong statement.

Increasingly, a similar logic has been used in criminal cases, as Mr Olis discovered. His 24-year sentence stemmed from a calculation of the financial loss caused to investors in Dynegy by Project Alpha, an accounting fraud in which he took part. That financial loss was estimated using the fall in Dynegy's share price on the news that Project Alpha was fraudulent. According to Judge Lake, it was so big that, under sentencing guidelines then in place, Mr Olis had to go to jail for a long time.

In rejecting that sentence, the appeals court ruled that Judge Lake had attributed far too much of the fall in Dynegy's share price to Project Alpha and too little to other news. Next week the prosecution and defence will each use economists as expert witnesses to debate exactly how much of the loss was due to Project Alpha. This will highlight several tricky technical issues that arise when applying the efficient markets hypothesis to fraud.

Exhibit Alpha

According to the prosecution's expert, Frank Graves, of the Brattle Group, a consultancy, Project Alpha was responsible for $4.45 of the $11.13 decline in Dynegy's share price on April 25th and 26th 2002, after the firm announced that it had reduced its reported profits because of the fraud. According to the prosecution, that justifies a sentence of up to 15 years for Mr Olis.

But in a paper filed on behalf of Mr Olis, Joseph Grundfest, a Stanford law professor and a former commissioner at the Securities and Exchange Commission (SEC), claims that Mr Graves has made numerous technical errors. Correct these, writes Mr Grundfest, who is working pro bono, and a quite different conclusion follows: Mr Graves, he says, “fails to establish that Project Alpha inflated Dynegy's stock on any date by any amount” or that “any portion of Dynegy's stock price decline” on the dates in question can be attributed to Project Alpha.

Among other things, Mr Grundfest notes that the markets were also digesting far more serious news: of a pending SEC investigation into aspects of Dynegy's business that were unrelated to Project Alpha; and of threats by California's governor, Gray Davis, to try to reclaim profits made by energy traders, including Dynegy and its rival, Enron, by exploiting flaws in California's energy regulations.

More fundamentally, Project Alpha was designed to bring forward the date at which some profits were recognised in Dynegy's accounts; but its overall effect on the firm's cashflow over time was neutral. Surely in an efficient market investors would look past the accounts to the underlying economic reality, argues Mr Grundfest, so that the effect on the share price would be negligible. Indeed, he notes, Dynegy's share price did not fall on April 3rd, when the press first commented on problems with Project Alpha, a fact dismissed out of hand by Mr Graves.

None of these objections challenges the use of the efficient markets hypothesis. Yet for years the hypothesis has been under increasingly fierce attack in academia, unnoticed by the legal system. In a recent paper, Bradford Cornell, of California Institute of Technology, and James Rutten, of Munger, Tolles and Olson, a Los Angeles law firm, argue that even highly developed financial markets such as the New York Stock Exchange are not efficient enough to allow courts to use declines in share prices to calculate the financial damage caused by a fraud. In particular, markets often react disproportionately to news, especially bad news. They therefore conclude that estimates of damages based on the hypothesis and on share-price movements will be overstated. If Judge Lake has been spending the summer getting up to date on economics, perhaps Mr Olis will be out of prison much sooner than he must once have feared.

Government support and alcohol consumption

Denmark is usually known as a country with one of the highest levels of alcohol-consumption by teenagers and student. According to the following article from the ft, this might all be due to the high level of governmental allowances:

As a new crop of freshers departs for university, will they be spending more time in the library or the student union bar? History suggests the bar, but something has been changing in the world of lectures and mortar boards. For two decades the cost of a university education has grown ever less subsidised, and there are reasons to think that this trend will make the library look more attractive.

A recent study led by Nick Foskett, professor of education at the University of Southampton, looked at the experience of fee-paying students in Australia and New Zealand, as well as asking British students about their plans and expectations. Among a number of broader conclusions, they expect an outbreak of sobriety in the student body.

This is partly for social reasons. As students pay higher fees, they become more likely to have some kind of job and more likely to be living at home. Neither trend is conducive to heavy boozing.

But there is another, more direct, channel of causation. Booze costs money, even at the Leeds student union bar. Students with less disposable income may, rather than mugging old ladies or turning to prostitution, simply drink less.

Two economists have tried to be a bit more precise about this sort of thing. Sara Markowitz and John Tauras, both based in the US, recently released a paper titled “Even for teenagers, money does not grow on trees.” Examining the spending patterns of 9,000 US teenagers, they found evidence of both direct and indirect effects.

An example of the indirect effect comes from the price of petrol. When it is more expensive, teenagers drink less but smoke more. This suggests that drinking and driving go hand-in-hand - possibly because kids need to drive to a friendly bar - but that they can smoke anywhere and if immobilised by high transport costs, they probably will.

The direct effects are always mixed in with the indirect. Richer teenagers spend more money on everything, including booze, fags and weed. Yet this is not purely an effect of extra spending power. The source of the money counts too. A teenager who earns an extra $1,000 through a job is 1.1 per cent more likely to smoke and 1.6 per cent more likely to drink and 0.6 per cent more likely to use marijuana. But when the same sum comes from pocket money, the effects are more than five times greater: a teenager with an extra $1,000 annual allowance is 6.2 per cent more likely to smoke, 9.6 per cent more like to drink and 4.5 per cent more likely to use marijuana.

It is not clear whether this difference is because part-time workers have less time to indulge, whether they come from different backgrounds (some effort is made in the research to allow for this) or whether there is a difference in character between the workers and the pocket-money scroungers. Still, the conclusion is clear enough: cut off pocket money for teenagers and lower the minimum wage at once. It’s the only way to keep our teenagers living clean lives.

Perhaps things shouldn’t be allowed to rest there. After all, these results are not totally convincing. For example, Markowitz and Tauras cannot find any evidence that when the price of beer falls, teenagers drink more beer. That has to raise questions as to how much weight we can put on any of this.

It is too early to say, then, whether higher tuition fees really will empty out the student union bars. Is cheap beer really no more popular than expensive beer? Clearly some intensive field research is now required.

Walmart

The role of wal-mart in the US described in the WP:
Notice Wal-marts share in raising the productivity in the US(if the numbers are rigth). If they would be able to do the same in Europe, we could catch up in no time...

The median household income of Wal-Mart shoppers is under $40,000. Wal-Mart, the most prodigious job-creator in the history of the private sector in this galaxy, has almost as many employees (1.3 million) as the U.S. military has uniformed personnel. A McKinsey company study concluded that Wal-Mart accounted for 13 percent of the nation's productivity gains in the second half of the 1990s, which probably made Wal-Mart about as important as the Federal Reserve in holding down inflation. By lowering consumer prices, Wal-Mart costs about 50 retail jobs among competitors for every 100 jobs Wal-Mart creates . Wal-Mart and its effects save shoppers more than $200 billion a year, dwarfing such government programs as food stamps ($28.6 billion) and the earned-income tax credit ($34.6 billion).

People who buy their groceries from Wal-Mart -- it has one-fifth of the nation's grocery business -- save at least 17 percent. But because unions are strong in many grocery stores trying to compete with Wal-Mart, unions are yanking on the Democratic Party's leash, demanding laws to force Wal-Mart to pay wages and benefits higher than those that already are high enough to attract 77 times as many applicants than there were jobs at this store.

Experience economy

There has been a lot of focus on the rise of the experience economy lately. However, remember that this entroduces a whole new perspective on the trade off between innovation and efficiency compared to what we saw in the late 90's. In the experience economy it is satisfying customers that counts as this article from fastcompany also illustrates:

In the course of this year's Customers First research, no company produced a more polarizing debate than Apple and its Apple Stores. Some people lauded Apple's in-store service desks, called Genius Bars, for spinning an experience out of customers' problems with their iWhatevers. An equal number argued that Genius Bars mask the fact that Apple products don't always get the job done.

The divide cut to the heart of a larger question: Do you have to master the basics before you create meaningful customer experiences? Or can experiences, in effect, ameliorate any underlying troubles in your business? To us, the answer is clear--which is why Apple Stores isn't among our winners. "Are you delivering on the promise of your business?" asks Phil Terry, CEO of experience consultancy Creative Good. "Once you get that right, then you can innovate and do exciting stuff."

Certainly, it can be tempting to ignore the nuts and bolts in the rush to create experiences. "The idea of getting basics in place is about efficiencies," says Lewis Carbone, CEO of Experience Engineering. "That's not indicative of growth. We need a huge shift from 'make and sell' to creating powerful experiences." Hell, let's make it even more tempting: A great experience can bake poor service right in. Think of every velvet-rope nightclub or snooty boutique hotel where the staff lords its cool over you. Why not heed the call? Creating experiences is fun. The hard stuff of satisfying customers isn't.

....

When Jeanne Bliss, a 25-year veteran of the customer-experience wars and the author of Chief Customer Officer, worked at Lands' End at the beginning of her career, she realized, "You've got to do reliability first: 24-hour delivery and answering the phone on the second ring 99.9% of the time. Then you've earned the right to do more." Get the package there on time, and you can add a holiday poem to the box--which is what Lands' End did. Then, because kids often have as much fun with the box as they do with their gift, the company included instructions for turning the cartons into cows, sheep, or horses.

Suddenly, getting a mail-order package is an experience, from the inside out. But Lands' End (and UPS) had to deliver first, and play games second. It knew it would take more than a genius to fix a Christmas present that showed up on December 28.

You want knowledge sharing... look at the markets.

A lot of posts have recently been about prediction markets, and I guess it is because of my background in finance However, the thing about markets is that if they are allowed to work freely they are one of the easiest ways to share knowledge. This is also obvious from the statement by Ed Faubert in this article from fastcompany

To the untrained eye, the coffee futures ring is a pretty unlikely arrangement: 250 people hopping up and down hysterically. Looking down on the tumult from the eighth-floor gallery at the New York Board of Trade (NYBOT) in Lower Manhattan, however, Ed Faubert sees only order. "It's the collective wisdom of the entire coffee world asserting itself," he says. "All the coffee knowledge on the planet at this moment is being channeled into one place. Co-op farmers in their fields in Guatemala are monitoring what's going on with pagers; there are people in Japan calling in contracts in the middle of the night. It's amazing how well it works."
...
As with other commodities, the process of "discovering" the daily price for coffee is built on hand signs and even lip-reading; each contract accounts for 37,500 pounds of the estimated 16 billion pounds of coffee grown annually worldwide. Faubert and the other 47 NYBOT-licensed cuppers determine which coffee gets sold at the open-market price and which at a punitive discount because of inferior quality. So when the traders in the pit that morning were buying arabica futures for March 2007, they were betting not only on the size of the October 2006 harvest in, say, Antigua, Guatemala, but on what Faubert and his fellow cuppers would think of it.

finally this comment about Vietnams entry into the coffee market:

The Vietnamese "strategy," Faubert explains, was to dump 16 million bags of low-quality robusta into a world market with only 1.2% annual growth, promptly crushing the world's robusta price: "They haven't entirely figured out capitalism yet"

The value of shareholders vs. employees

Morch et.al., 1989, "Alternative mechanisms for corporate control", The American Economic Review, vol 79 (4) pp. 842-852

On the other hand, when the whole industry is suffering, the board is reluctant to make changes that raise market value. In particual, even when board members know how to raise value, they may refuse to do so because the required changes in a declining industry (layoffs, investment cutbacks, and divestitures) harm employees, who are considered more important to the organization than shareholders who are only " out for speculative profit"

Prediction markets in the US

As a financial guy I like the concept of markets, but as we all know: markets only work if people actually have to put their money where their mouth is.
The legal stand in the US is therefore saddening as the following excerpt from the new yorker also illustrates:

Lotteries and most casino games are games of pure chance; the house has an ineradicable advantage and, over time, the inevitable outcome is that gamblers lose. Mathematically speaking, as the saying goes, no one wins the lottery. Sports betting, by contrast, involves skill, and it is possible, although very difficult, to consistently win money on it. Sports bettors are closer to stock or commodities buyers than to people who buy lottery tickets. How much difference is there, after all, between betting on the future price of wheat (an activity banned in some states in the nineteenth century) and betting on the performance of a baseball team?
...
In the past few years, a host of prediction markets, as they’re usually called, have appeared online, offering people the chance to speculate on subjects ranging from the box-office performance of Hollywood films to the outcome of Presidential elections and the spread of bird flu. These markets’ forecasts have proved remarkably accurate—just as bettors collectively do an exceptionally good job of predicting sports results. (In 2004, for instance, Tradesports, a Dublin-based prediction market, called thirty-three out of thirty-four races in the Senate correctly, and called all fifty states correctly in the results for the electoral college.) But in the U.S. these markets have to use play money, because using real money would constitute gambling. The online gambling ban prevents these markets from getting bigger and more accurate.

That might seem an acceptable cost if the war on Internet betting looked set to accomplish its goals. Instead, it’s likely to make the problems it was designed to solve worse. Online bookmakers have been portrayed as shady operators, but the biggest of them are far more transparent and easy to regulate than illegal bookies, many of whom have ties to organized crime. David Carruthers, before he was arrested, had been actively calling for the regulation of his industry. Congress may think that driving bettors back underground can curb underage gambling and money laundering, but don’t bet on it.

Small is beautiful

Seth godin has a nice little blog covering the benefits of being small

This is the giant advantage of the small. Small organizations have the privilege of looking their customers in the eye. Small doesn't necessarily mean small in numbers. It's an attitude. Does your organization require a form to get something done, or does one human choose to interact with another? Does bad news come in the form of memos that obfuscate the truth, or is it delivered face to face?

Conference Calls Unlimited has gone so far as to practically ban email in communication with clients. They call you after each call to see how it went. When I went to Stanford, the director of admissions called every single person they admitted to share the news. Compare that to the anonymous ALL CAPITAL LETTERS notes you get from your car insurance company.

The efficiency of loyalty programs

from knowledge@wharton

When making a purchase, a consumer has a choice between using frequent-flier miles, cash, or some combination thereof. Which will he or she choose? Another consumer has an opportunity to participate in a special program to get a free car wash after paying for a certain number of washes. What's the best way for the car-wash owner to motivate the customer to participate?
...
For example, a consumer may be indifferent as to whether he spends $500 or 25,000 miles on an airline ticket, but prefers paying $400 plus 5,000 miles rather than paying either of the single-currency alternatives. "At $0.02 per mile, the combined-currency price brings in the equivalent revenue to the airline, yet inflicts a smaller psychological cost to the consumer," the researchers write.

It is important to note, they add, that this consumer's preference for the combined-currency price indicates that each mile or dollar spent is not valued equally. The perceived cost of paying more dollars and/or miles increases as the payment in that currency increases. As a result, it will be best for a company to charge a combined-currency price for, say, an airline ticket when two conditions exist: The consumer does not value each unit within a currency equally and the perceived cost function for one of the currencies is said to be "convex." Convexity means, for example, that 25,000 miles appears to be worth more to the consumer than twice as much as 12,500. Why? "Twenty-five thousand miles will get you a free round-trip ticket within the United States, while 12,500 miles might only get you an upgrade," says Drèze.
...
"You would think that if people were offered money and miles, they would always take the money, but a lot of people want the miles instead," Dreze says. "Their feeling is, 'Money is only money and if I take money instead of miles, I'll just use the money to pay a bill.' There's nothing special about paying a bill. But when they take frequent-filer miles as a reward instead of cash, they will use them to take trips and that gives them memories. That makes the miles special. The airlines consider their programs 'aspirational' as fliers earmark their miles for special trips. There's a lot going on psychologically when it comes to taking miles or some other kind of rewards points. People don't consider miles or points to be the same thing as money."

"Artificial Advancement"

In another paper, "The Endowed Progress Effect: How Artificial Advancement Increases Effort," Nunes and Drèze outline how companies can structure certain rewards programs to make them more attractive to customers and hence more profitable. Endowed progress means that people who are provided with artificial advancement toward a goal show greater persistence towards reaching the goal than they otherwise would. By artificial advancement, a company advances a customer toward a goal while simultaneously moving the goal further away, so that the task requirements and the reward remain unchanged.

and a caveat... the always returning causality:

But Nunes points out that the long-term impact of loyalty programs is not yet completely understood. For instance, an online study by Maritz, a market research and consumer loyalty program consulting and implementation company, found that members of programs spend more. But it was unknown whether the program drives spending or whether big spenders are just more prone to join programs and get rewards for their spending.

and finally the never-ending quest for status:

Drèze and Nunes are continuing their research into loyalty programs. Among other issues, they are currently exploring the use and effectiveness of "status" -- gold cards, platinum cards and the like -- in loyalty programs. "A lot of loyalty programs endow customers with status, which they earn through purchases or other actions," Nunes explains. "Our research is looking into how stratifying customers and endowing some with status makes them feel different and thus behave differently."

The researchers have just begun investigating the topic. But from what they have discovered so far, it appears that assigning a customer to a category -- such as gold status -- may put them in the top 5% of all customers but it does not necessarily make the customer feel special. It turns out that gold customers feel much more distinctive and apt to spend more if they know that there is another class of people -- those endowed with 'silver' status, for instance -- below them. This paper is tentatively titled, "A Cut Above: Exclusivity and Status in Consumer Loyalty Programs."

"If you go back 10 or 15 years, a gold card was really special," Drèze says. "Today, if you don't have a platinum card, which confers greater status than gold, you're nobody. The interesting thing is that what has evolved over time is that more and more customers need status. Marketers need to find ways to separate one class of customer from another."

Product diffusion and sales modelling

As an econometrician developments like these are always amusing. Data mining always reveals
interesting things, and if companies want to figure out the costs and benefits of their marketing effort they need to do the number crunching.

from knowledge@wharton

Two Wharton researchers have developed a mathematical model that they say will allow companies, for the first time, to predict at what pace new products will gain acceptance in markets where purchasing decisions by knowledgeable, influential customers sway the buying habits of others.

Wharton marketing professor Christophe Van den Bulte and doctoral student Yogesh V. Joshi say their model can be put to use in industries as diverse as movies, music, pharmaceuticals and high-technology. It is possible the model may also be a way to identify directors and actors who are ready to make the leap from small films to the Hollywood mainstream, they add....

Marketers have long tried to deepen their understanding of how new products gain acceptance among customers, a process known as product diffusion. Companies are especially interested in diffusion in markets that consist of two segments: "influentials" (knowledgeable people who keep abreast of product innovations and readily accept them) and "imitators" (people whose purchasing decisions are swayed by their savvier counterparts). Targeting influential prospects who are more in touch with new developments than most people and converting them into customers, the thinking goes, allows companies to benefit from a "social multiplier" or "social contagion" effect in marketing campaigns.
...

Van den Bulte and Joshi confirm Moore's findings that there can indeed be a drop in sales of a new product between the time it is introduced and bought by influentials to its diffusion among imitators. But in contrast to what Moore claims, the Wharton paper says that "it need not always be necessary for firms to change their product to gain traction among later adopters and [for] the adoption curve to swing up again."

Another important insight is that the proportion of adoptions stemming from influentials need not decrease at a steady pace but may first decrease and then increase. The management implication is that, while it may make sense for a company to shift the focus of its marketing efforts from independent-minded influentials to imitators shortly after launch, it may want to revert its focus back to independents later in the process. "Frankly, we were surprised by this mathematical result. It seems counterintuitive at first and flies in the face of the current consensus taught in most business schools," says Van den Bulte. However, the paper not only explains why this can happen, but also backs up the claim with actual data on adoptions of a new drug from a study originally sponsored by Pfizer.

That insight has important implications for targeting and resource allocation. "Managers who confuse the distinction between influentials and imitators with that between early and late adopters -- and ignore our results and others' empirical evidence that the bulk of the late adoptions may stem from people not subject to social contagion -- may end up wasting money by poor targeting," the Wharton researchers write.

ROI on celebrity endorsements?

Seems like a good research project if you're interested in marketing.

from knowledge@wharton

Like much in marketing, athlete and celebrity endorsements are as much art as science. Research makes clear, for example, that stars can create halos around brands, giving consumers good feelings about a company, says Wharton marketing professor Americus Reed. What's less clear is whether, on average, endorsements lead to greater sales -- or at least big enough jumps to justify the hefty sums that companies cough up, Reed adds. Among stock-car racing fans, for example, they clearly do. "I have videotape of a focus group where Nascar fans are saying, 'If my driver endorses such-and-such oil, then I'm going to buy that product, too, because doing that supports my driver and helps him win.'"

But in other fields, consumers won't buy something just because of an athlete's or celebrity's halo. "When you sit down and do the math and you're trying to come up with a return-on-investment number, sponsorships can be a real crap shoot," says Jennifer Miller, director of marketing for Seven Cycles, a high-end bicycle maker in Watertown, Mass.

...

Some appear to be moving away from endorsements, at least in traditional American sports like football, basketball and baseball. "They were tired of giving away 'X' percent off the top when they knew something like what happened to Kobe could happen again," says Dan Levy, a sports agent at Octagon.

"There is a select group of athletes who can break through the clutter -- a dozen to 25 can do that," he says. Instead of lavishing money and gear on less recognizable athletes in the traditional sports, companies have begun to spend more on nontraditional ones like soccer -- women's soccer star Mia Hamm is a Levy client -- and on online and grassroots campaigns.

Despite the recent scandals, Levy adds, companies' approaches to negotiating individual endorsement deals haven't changed. "People always had morality clauses in agreements." If an endorser violates the provision, a company has a legal right to end the contract. The prohibitions "can include everything from felony charges to just disparaging the brand," he notes.

Companies can avoid having to exercise such clauses by thoroughly researching any potential endorser, he points out. Levy's division at Octagon, for example, does that before it agrees to represent someone. "We make sure that their reputation is in line with the culture," he says. Once an athlete becomes a client, "we stress that every decision you make can impact your ability to work with people off the field and on the field."

If a client does land in trouble, the basic principles of crisis communication apply, he says. "It's important to get out in front of it and not to be reacting. People make mistakes and are forgiven all the time. If they continue to do the right thing in the future and take care of their business on the court, the other stuff will eventually come back. You're never going to please everybody anyway."

Retirement saving in the US

from the Journal of Political economy:

We solve each household's optimal saving decisions using a life cycle model that incorporates uncertain lifetimes, uninsurable earning and medical expenses, progressive taxation, government transfers, and pension and social security benefits. With optimal decision rules, we compare, household by household, wealth predictions from the life cycle model using a nationally representative sample. We find, making use of household-specific earnings histories, that the model accounts for more than 80 percent of the 1992 cross-sectional variation in wealth. Fewer than 20 percent of households have less wealth than their optimal targets, and the wealth deficit of those who are undersaving is generally small.

a comment from MR:

In other words, most Americans are saving enough for their retirements.

Rainfall vs. conflict

First seen at MR

Abstract

Estimating the impact of economic conditions on the likelihood of
civil conflict is difficult because of endogeneity and omitted variable
bias.We use rainfall variation as an instrumental variable for economic
growth in 41 African countries during 1981–99. Growth is strongly
negatively related to civil conflict: a negative growth shock of five
percentage points increases the likelihood of conflict by one-half the
following year. We attempt to rule out other channels through which
rainfall may affect conflict. Surprisingly, the impact of growth shocks
on conflict is not significantly different in richer, more democratic, or
more ethnically diverse countries.

Wikipedia' legal role disappears

User generated content come in many forms - stock markets, prediction markets, wikipedia , etc. - and is basically just a result of a "market".

However, one must always remember that markets may be a good thing in general, but even if they function relatively efficient markets may encounter deviations from their equilibrium or true levels. These deviations means that markets only shows the "truth" on average.

It should therefore not come as a surprise that the legal role of wikipedia has disappeared as it is illustrated in the Freakonomics blog

For the record, I like Wikipedia just fine, as long as people understand what it is and what it isn’t. What it is: a useful and engaging enterprise in user-generated content about a mind-blowingly diverse range of subjects. What it isn’t: a dependable substitute for a reference work, at least not in many cases. We have touched on this dichotomy here and here and here and here.

The argument in defense of Wikipedia that I find most troubling is that it is self-correcting and self-policing, which is to say that, Hey, in the end all the mistakes and vendettas get fixed by caring and level-headed people. The problem, of course, is that if someone happens to read or cite a Wikipedia entry at a moment when all those things haven’t been fixed, which is obviously a vast, vast, vast majority of the time, then the mistakes get promulgated as fact.

So I was surprised to read in the 9/4/06 issue of Business Week that the U.S. Patent & Trademark office had been using Wikipedia as a source to help determine the validity of patent applications. According to the BW article, “Wikipedia has been cited in patent decisions on everything from car parts to chip designs.”

But as of August 15, the patent office pulled the plug on Wikipedia. “We’ve taken Wikipedia off our list of accepted sources of information,” said Patents Commissioner John Doll. The article also quotes Greg Aharonian, who publishes a patent newsletter and is a longtime critic of the patent office: “I’ve been complaining about this for years. From a legal point of view, a Wiki citation is toilet paper.”

Children's intelligence

Brain development impacted by temperature?
this is from bps:

Countless studies have found that children’s intelligence appears to be related to the time of year they were born in. Some investigators have argued this is because seasonally varying environmental factors like temperature and infections can affect brain development. But now Debbie Lawlor and colleagues have analysed data from 12,150 children born in Aberdeen between 1950 and 1956, and they’ve concluded that the effect of season of birth is almost entirely explained by the age children happen to be when they start school.

Reading ability at age 9 and arithmetic ability at age 11 were both related to season of birth (children born in late Winter or Spring performed better), but this association virtually disappeared once age at starting primary school and age relative to class peers were taken into account. That is, season of birth was only related to later intelligence because it affected the age children started school, with those who started school younger or older than the average tending to score less well on later intelligence tests.

It is not always necessary to make things too advanced. Sometimes there is a simple solution, such as the one found in my earlier post about equality in the quality of students:

Prediction markets (again)

Prediction markets are currently getting more and more attention, since they allow investors to hedge risks they couldn't do before.

This example is from mySA.com

HedgeStreet.com, an online futures exchange, has opened up a hurricane predictions market where people can wager on the financial damages caused by a specific hurricane — or by the whole hurricane season.

The California-based exchange, regulated by the Commodity Futures Trading Commission, launched the hurricane market two weeks ago. While it may seem like a morbid novelty aimed at gamblers or weather junkies, company officers tout the new market as much more.

They claim it offers hurricane-weary residents a way to hedge their risk, and could develop into a powerful tool for predicting storm damage.

...

The exchange sells small contracts in an effort to attract individual as well as institutional investors. Contracts cost something less than $100, depending on what the market bears. If you're right, they pay out $100. If you're wrong, you get nothing.

For example, if you think the damage from this year's hurricane season, as calculated by the Insurance Services Office, will top $10 billion, you can, as of close of business Friday, buy a contract on HedgeStreet for $32.80. If damage tops $10 billion, you get $100 back. If it doesn't, you get nothing.

but remember two things that are important in determining the efficiency of markets: they work best with lots of liquidity and neglible transaction costs:

Borghesi, however, isn't sold on the ability of the new market to allow people to hedge against hurricane risk.

"If you own a house and a hurricane is heading towards you, you would have to bet a lot of money to hedge your risk," he said.

...

Although futures markets can be good predictors, there are no guarantees, Strumpf said. A good way to judge such markets is by how close the asking price and the bidding price are. Within a dollar or two is best, Strumpf said.

By that measure, HedgeStreet has a ways to go with its hurricane market.

People haven't exactly flocked to it yet. Trades over the first couple weeks are measured in the dozens, and there's commonly a $5 or $10 difference, or even more, between a bidding price and an asking price.

finally mickslam has a good comment about prediction markets on marginal revolution

It is possible that this market doesn't have enough volatility on a daily basis to attract the ecosystem of traders required for a vibrant market. Or enough data points to attract traders. I think thats one of the problems with Robert Shillers take on things, that for many of the markets that might be good (ok very, very good) for the economy, it would be difficult, if not impossible to create the necessary critical mass for these markets that would make them viable tools for risk managers.

I am very encouraged that we are seeing these markets. I am skeptical that these markets can be fully used. For example, Jason Ruspini and I have talked about the problems inherent in GDP contracts for example, and his favorite idea, tax futures, has the problem that implementing them would very likely be prohibitied, for very good reasons.

It will be a long winding road. The confluence of quantitative risk management, widespread recognition that markets really do work and the ability to dream is creating opportunities that didn't exist just a few years ago.

Something else I am starting to think on again is the Nassim Taleb critique - "we don't know what the real risks are". The odds are pretty high that for some events and styles of markets, we will never know enough for people to feel informed enough to trade them. Trading these would not be trading, but gambling. Any cogent person looking at these markets will demand a wide spread to trade them - which will work against the the very point of having a market in the first place.