What does speed give and give away?

At most time, speed represents efficiency and productive as many employees want their employers and their business models to have fast response and reaction and complete missions fast. Many people use computers to boost up their productivity in terms of calculation speed and other types of efficiency, companies use computers to speed up their execution speed to allow them to make more business activities and decisions in the constrained period of time. However, does speed only provide competitiveness and strength? What is the cost of increasing the speed?

The benefits of having faster speed are relatively more obvious. Firstly ,when a company is able to execute more business decisions and activities than its competitors, it is more likely to generate more revenues and profits, and gain more market shares, as its productive capacity is greater than its competitors. Secondly, when a company is able to receive information faster, it can have more time for analysis or make responses ahead of its competitors. In some markets, especially the financial market, the access to information is crucial and in some cases it can determine the difference between success and failure. Thirdly, when a company is able to make faster analysis, the benefit of it is similar as when it can faster receive information, it can get upper hand advantage. Of course there are many other benefits. Since the benefits are obvious, I do not want to discuss too much on its benefit.

Increasing speed has its down side and costs. Firstly, the cost of increasing speed is geometrically growing. It is much easier to increase the speed from 5km/h to 10km/h than to increase the speed from 7200km/h to 7205km/h. As the difficulty increases enormously, the cost as well increases enormously. Sometimes, it is merely impossible to further increase the speed upon certain limits; for example, based on our current technology, it is impossible for us to reach the light speed, though we have been trying to get closer to the light speed. Secondly, once a speed technology is available, it forces all companies to increase their expenditures to reach the fastest possible speed in order to compete with each other. However, the efficiency of such investment is questionable, as the cost of speeding up its business may be much greater than the revenue improvement. When speed is used fro marketing, the function of increasing speed is no longer about productivity, instead its function becomes a signalling effect to present companies’ abilities of having certain achievement. For example, customers like screens with higher and higher resolutions; however, upon certain point, our human eyes cannot really tell the differences. Thirdly, speed is a magnifier it can enlarge the revenues and profits, but it can enlarge the costs and risks as well. Our human beings have our limits of reaction and response speed. When the speed is too fast, we are no longer able to cope with the issues and mistakes occurred in our superspeedy business model. Fourthly, speed is not always desirable in every single sector. Nowadays, we are dealing with machine more and more often that not only employees use their computers as their primary working tools, customer services are starting to use AI rather than human beings. It is almost certain that in the future, direct communication between human beings could become rarer and rarer; maybe patient listeners could become a very popular luxury service.

To conclude, the cost of further increasing speed is incredibly high, as it could potentially be used by large companies to win over their small competitors; however, when speeding up becomes the mainstream of our life, slowing down could potentially become a new popular luxury service.  

Bubble or not bubble?

This week, the stock market values of Amazon and Facebook rose over $500bn for the first time, Alphabet and Apple maintain their market values over $500bn. Billions of bonuses have been handed over to these tech tycoons’ employees. Some investors start to worry if the dotcom bubble will come again soon, especially when they see the tech companies are this profligate and their share prices are sky rocketing. Therefore, I want to discuss how bubbles would burst and if it is likely for the current dotcom bubble to burst in the near future.

I believe there are several phenomena which can predict the coming of bubble burst. Firstly, when too many new companies are established, it could indicate whether there is a fast expansion in the sector or there would be a bubble burst in this sector. If it is only a newly established sector, it is normal for many new companies to enter this sector when they see the opportunities in this sector; however, if it is not a new sector, the market is already compacted with too many companies, the investors have to choose the most competitive ones and get rid of the uncompetitive ones from the market, and this leads to bubble burst. The companies which can survive the bubble burst crisis in their sectors are the most competitive ones in their sectors. Once they are able to survive one crisis, they are very likely to survive even more crisis.

Secondly, when the sector is only growing in width instead of depth, bubble in the sector is more likely to burst. The meaning of my phrase, “growing in width”, is growing to cover more of the world population. When companies in one filed are only competing to gain more customers, there must be winners and losers, when the competition finishes, the losers will lose everything and leave the market. When there are more losers than winners in the sector, it can lead to a general crisis in the sector, which could cause a similar market move as the bubble burst.

Thirdly, when there suddenly appears a strong competitor, the bubble can burst immediately and the sector will lose everything to its new and strong competitor in a very short time period. One commonly know example is the story of DVD, CD, videotapes that they replaced their previous version in an incredibly fast speed. There is another historical example, which is the Anglo-Germany Naval arm race. The battleship, dreadnoughts, was the symbol of this race; once the first dreadnought was built by the British and believed to dominate any other battleships at the time, almost all countries had to abandon their previous battleship building plans and to build dreadnoughts instead in order to compete with each other. Investors and customers are like the countries at the time, and the battleships are the opportunities, once they find the existence of dreadnoughts, they will rush to the new field and abandon their previous favours.

To conclude, I think that there could be some short term volatility in these tech tycoons’ share prices; however, in the long term, as long as they can grow in depth and do not face challenges from completely new fields which are irrelevant from the concepts of AI or the Internet, their market values will continue to increase in real terms.  

Is it possible for state-owned companies to operate efficiently and productively?

There is one complaint about state-controlled companies that they are inefficient and unproductive as they lack incentives to make profits. Many of these state-controlled companies have monopolistic power in their fields, as they have the monopolistic power, they will have their business activities anyway so they do not need to work very hard to gain more market shares or get revenues.

However, this is not entirely true as the management and the ownership still separate in state-controlled companies. The ownership of these state-controlled companies belongs to the state government; however, the management is still in the hands of individuals. Individuals are working for the best of their interests, if their earnings and incomes are related to their performances, they will have the incentives to boost their companies’ revenues and profits when their performances are tied to the companies’ revenues and profits. Under such circumstance, it is not fair to say that state-controlled companies do not have incentives to grow. From the company’s side of view, it may not have the need to further expand the business; however, from the individuals’ points of view, they have the incentives to boost their earnings via expanding their business. This is a type of conflict of interest, but it is a healthy type of conflict of interest.

In addition, as the companies are in the control of the state government, and the state government is making decisions based on the target of maximising the total social benefits, the companies are also working to maximise the social benefits. Therefore, if the government sets the goal of increasing social benefits and ties the goal to the managers’ wages, the managers will also work to increase the social benefits. Therefore, state-controlled companies may be able to effectively increase social benefits and reduce social costs, as unlike private companies, they do not only consider maximising their own private benefits, they also respond to the state government decisions and increase social benefits.

I think that the major problem of state-controlled companies is that they try to represent governments. Once they try to represent the government, it causes lots of problems, as they no long just have the monopolistic power, but also have legislation and ruling power, at least create such impression for other players in their fields or even companies and individuals out of their fields. Under such circumstance, any attempts of trying to be more advanced could be blocked by these state-controlled companies when they represent the state government. When such phenomenon occurs, there is hardly any further development in the sectors, as state-controlled governments try to boost their performances by blocking development that could lead to competition rather than developing their own businesses and technologies.

To conclude, I think state-controlled companies can operate effectively and productively as their management and working groups have incentives to work hard and improve their efficiency and productivity if their wages are directly relevant to their performance, and they can also work for the social benefits which is a big advantage compared with private companies; however, when they try to represent their owner, the state government, it causes big problems and could lead to blocking development from their competitors. Therefore, I think when state-controlled companies only follow the directions planned the state government but do not represent the state government, state-controlled companies are beneficial to our society.

Is it ever possible to compete with large companies?

There are a number of multinational companies which are considered to be wealthier than several small or medium sized countries. This raises one question that if it is ever possible for newly established companies to compete with large players in their fields. My answer to this question is pessimistic that there is little chance for small companies to overtake large companies in the same fields. I think that there is one classic example. The developer of AlphaGo, DeepMind was bought by Alphabet (Google). Before the acquisition, DeepMind has advanced knowledge and development in the field of AI, especially machine learning; however, since Alphabet has enormous resources, it is able to acquire DeepMind before DeepMind is capable of using its technologies for commercial uses and generating profits. From this case, we can see that when small companies are not able to transform its advanced technology for commercial uses and effectively generate profits, large companies can very easily acquire this type of small companies and gain the advanced technological and developers.

In addition, small companies have another major disadvantages, many of them need initial investment to start up their businesses. Once they have good business models or advanced products and seek for investment, they are very likely to gain investment successfully; however, some of their initial investment may come from their large competitors in their fields. When their business models have been proved to be successful, the large competitors will still not be affected as they are shareholders of these small companies and have great chances to acquire these companies; if these small businesses fail, the large competitors maintain their dominations in their fields and the losses from the investment in these small businesses are only an insignificant amount compared to the revenues generated from monopolistic power.

Small businesses do have their unique advantages compared with large companies that they are far more flexible and easy to change their strategies. Moreover, the networking and communication are clearer and simpler than those in large companies, which makes their business activities more effective. However, such management difficulties in large companies are due to the complicated networking between human labours, especially when more people are hired, more conflicts of interests take place within their companies. If a large proportion of human labours can be replaced by machinery, as machinery does not have an issue of conflicts of interests, the machines would only serve the interests of the companies, so large companies can improve their productivities and efficiency to a significant degree.

I think that there is only one chance for small companies to compete with large companies in the same sectors that they can only compete with large companies before they use machinery for the majority of their productions. After full transformation, small companies lose almost all their advantages to large companies and become impossible to compete with large companies in the same fields.

What causes irrationality

Today I want to talk about what might cause some behaviours that seem irrational and I always believe individuals have their own measurement and reasons to take actions unless they are experiencing mental instability.

Firstly, I think that individuals’ risk preferences changing along with their wealth changing is one factor that causes behaviours that seem irrational. Based on the Arrow-Pratt measure of risk aversion tells that the tolerance for risk of an individual with positive (negative) absolute risk aversion will fall (increase) as his or her wealth increases (decreases). This means for individuals with negative risk aversion are very likely to increase the risk they are taking in order to seek for higher returns to boost their wealth when they are experiencing decreases in their wealth. So they are taking more and more risk, the expected returns could become negative when the risk is more likely to be unmatched with the potential returns, they are more and more likely to lose more and more over time. Under such circumstance, it is unfair to say that their behaviours are irrational though their behaviours are very different from others because this kind of individuals has unusual risk preferences.

Secondly, shortage of time for careful measurement is another important factor that could lead to behaviours that seem irrational. It is usually certain that once an individual has more time, he or she can think into more details and make relatively better decisions, as he or she can use more time for calculations, collecting information and other things to improve their knowledges and abilities to analyse their issues. Such “irrationality” are actually caused by limitations of resources.

Thirdly, loss aversion can be another source of making irrational decisions. Sometimes individuals may have time; however, their wealth or opportunities may be affected by time as they can be changing over time. When people are afraid of losing too much because they do not make quick decisions, under the pressure of loss aversion, they tend to limit their time voluntarily and force themselves to make very rush decisions, which are more likely to seem irrational.

Fourthly, education can be another important factor. I think well educated people are more likely to make better decisions than poorly educated people. This is because people have higher chances to access to more theories or methodologies which can improve their modelling skills to build better expectations. In addition, during their education, they may practice the theories and methodologies very often. However, people with rich experience are also very important to behave more “rational” decisions as their experiences can help them to build up their thinking process faster, as they can use their experiences to compare the problems they are facing with similar issues that they have experienced, such comparisons can help them find the possibly best method to build up their strategies.

To conclude, it is extremely difficult to identify which sort of behaviours is irrational unless they are caused by mental instability that every behaviour has its reason behind. In general, people usually believe people who make good decisions more often are more rational than those who make bad decisions more often; such identification does not make sense as such phenonomon may merely caused by their different risk preferences and constraints to time, knowledge (education), experience and other things.

What is the difference between investment and gambling?

Investment, especially stock trading, Forex trading, has been compared with gambling by some people, as investment and gambling have indeed some commons. Both actions have risk and it is important for participants in either field to understand the risk they are facing. In general, people have to be over 18 in order to participate in either activity. Of course, gambling has negative externalities and investment has positive externalities, this is why governments put more restrictions on gambling than on investment. I only want to focus on the nature of actions of investment and gambling, and their private costs and benefits. I will discuss the similarities between the two activities then move to their differences, and point out my beliefs about how to conduct rational investment strategies.

Similarity

The biggest similarity is investment and gambling both deal with risk and uncertain future. Both activities are trying to betting based on investors’ or gamblers’ expected future. As investors and gamblers are dealing with risk, their actions are no longer only based on their utility preferences or expected returns, but also based on their individual risk preferences. This is why we can see some investors have many similar behaviours in the financial markets as gamblers behaving in casinos. Individuals have three types of risk preferences: risk-averse, risk-neutral and risk-loving; however, their risk preferences can change according to their wealth changes. If we believe, risk averse is the most common risk preferences among the whole population, the Arrow-Pratt measure of risk aversion tells that the tolerance for risk of an individual with positive (negative) absolute risk aversion will fall (increase) as his/her wealth increases (decreases). Therefore, individuals in casinos and financial markets have different risk preferences and act differently, but the general behaviour in financial markets has lots in common as the general behaviour in casinos, and this usually is an important factor that makes many people link investors and gamblers together. And frankly speaking, investors and gamblers are more risk-loving than the rest of the population.

Moreover, either gambling or investment is a money game that people inject money and hope for higher returns. Moreover, the market power can be controlled by individuals with significant amounts of resources. Although theoretically in either investment or gambling, all participants should receive the same information (public information), some have much stronger analysing abilities than the others and some inappropriate abilities (including controlling games or inside trading). Therefore, many people think that there are many frauds within financial markets as well as casinos that people with significant resources have control of information and pricing. Such frauds could make a significantly large number of small investors and gamblers more easily lose their money to larger investors and casinos and gambling companies. Although governments and regulators have imposed many regulations and laws on financial markets and the gambling industry, it is impossible to clear all frauds and such frauds make small participants feel they are bullied by the large participants in both sectors.

Difference:

However, there are many differences determining the two actions have different natures and participants have to have different strategies in the two sectors. Firstly, the outcomes delivered by financial markets are continuous outcomes, there are an infinite number of outcomes for financial markets; however, the outcomes delivered by gambling are discrete, usually there are only two or three possible outcomes (win, lose and draw). Therefore, it is much harder to predict financial market outcomes than gambling outcomes precisely.

Furthermore, the possibilities in financial markets are floating but the possibilities in gambling are mostly fixed. This does not mean there are more uncertainties in the financial markets, instead it means there are more market volatilities in financial markets. Although possibilities in gambling could be floating, for example, when a football matching is progressing, the possibility of winning can change; however, the gambling companies normally tend to fix the possibility by closing betting after the game starts, in addition, they hire actuarial professionals to calculate the possibilities. Here comes another difference between investment and gambling, investment assets are tradable when the events are progressing but gamblers cannot trade their bets with each other. The activities of investment are far more flexible than gambling.

Lastly and most importantly, the results delivered by investment and gambling are totally different. Gambling is for no doubt a zero-sum game that winners win everything, and losers lose everything; however, investment is something different, if the investment target or the economy is growing, there is no clear definition for winners and losers, some may win short term profits but gain no further profits in the future, and some may lose short term cash but gain profits in the future. Therefore, gamblers are directly competing with each other, as they literally take money out of other gamblers; however, investors are making trades with each other, just like other ordinary goods, it is certainly inappropriate to say a fruit seller is winning over a fruit buyer. Buyers may find the utilities of the financial products are higher or lower than their expectations but such mistakes are not caused by their sellers.
 

Conclusion

There was news that some institutional investors will soon be able to try sports betting fund by using algorithms to predict game results. Such fund may be seen as an asset class (as it is issued by financial institutions), but it is just purely gambling. Although there are many outcomes, but outcomes of such fund are still discrete, as the final outcome must be one in the set of all combinations of possible game results, and the possibilities are relatively stable though their calculations are very complicated.

My belief is that investment is no different from buying ordinary goods, like apples, investors should only consider buying assets which have higher utilities (expected returns in financial markets) than the costs, their decisions should be independent of the sellers’ activities or opinions; and investors should sell their assets when the market prices are higher than their expected returns, without considering the opinions from the buyers. This sounds extremely simple, but it is true that many investors have been trying to be smarter than other investors, but forget their preferences. For example, some investors look for fixed returns without too much risk, then government bonds with low returns are not a bad choice for them. Investors should balance their preferences towards return and risk, and only invest assets that fit their demands for future incomes. It is possible that there is some whispering in financial markets, if it cannot be proved to be accurate, then see it as an uncertainty rather than an opportunity.  

What could break a win-win cooperation?

In the real world, there are many situations when participants can benefit more from cooperation but end up competing with each other. Such phenomenon could be caused by several reasons. 

Firstly, conflict of interests can be one major reason of why many companies cannot cooperate for a stable long period. There always are conflicts of interests within companies that the interests of management can be different from the interest of ownership, and the interest of ordinary employees can be different from each other. When individuals are acting for the best of their own individual interests, as cooperation does not necessarily serve every single participant’s interest to the best, even there is cooperation, when some participants are not supporting the idea of cooperation, any accident between the cooperating parties of companies can damage and even destroy the cooperative relationship, and such accidents could even be made intentionally by some people within the two parties or companies. 

Secondly, imperfect information is another cause. Imperfect information or lack of transparency could be another cause to cooperation breakup. Due to regulations and laws, under many circumstances, the cooperating companies cannot make their information open to each other, in some cases, they cannot even tell each other they have intentions to cooperate. Therefore, under such circumstance, they could only try to understand each other by analysing the possible signals sent by their cooperative partners via the market (for example, they set new prices to send signals). However, the signals could be misunderstood. When a misunderstanding occurs, it is hard for the cooperating companies to continue their cooperation. 

Thirdly, individuals' expectation differences would be a major cause of cooperation breakup between either organisations or individuals. Individual person or organisation has its own expectations about itself, the environment and its potential partners and competitors. When they have different expectations about each other and themselves, they are more likely to have different strategies towards each other. If they do not have similar expectations about the future they are facing, it is difficult for them to have a base for stable and constant cooperation. They are possible to cooperate to fight against some challenges they share in the short term, but as they have different plans for their future based on their different expectations, there is less room for them to successfully cooperate with each other. 

Overall, in my opinion, a long-term stable cooperation between individuals or organisation or countries will never be possible. 

How much does time matter in financial markets?

In financial markets, the decisions made by investors largely depend on their expectations about the future. Expectations are largely made based on the historical performances of themselves as well as their investing targets. They compare the historical performances of their models with the actual targets' historical performances in order to improve the effectiveness of their models, then they use their amended models to make their expectations. Every investor in financial markets is doing the same, the only difference is the differences between their models. Some people argue that people do not only look back to the history, they also try to foresee changes in the future, for example, the coming central bank monetary policies and governments' fiscal policies. However, do people really make forecasts without looking back from the history? The answer is definitely no. Many peoples' forecasts are made by their individual experience, and their experience is made of the history they have experienced.

We have to admit that without considering black swan events, when the future is further ahead, it is harder to predict, this is because more changes will be made when the future is further ahead of us. Usually in order to compensate higher risk, we expect higher returns, this is why the rates for long term investment are generally higher than the rates for short term. However, if we consider the discount rate, it means the value in the future is lower than the value at the moment. If the discount rate is much greater than the risk-free return rate, it is almost meaningless to expect returns from a long term project, as for a company, the decisions are usually made based on at most a 5 year period, even for the majority of governments, this is true as well; therefore, the returns from a project which lasts over 5 years are more dependent of the exogenous factors rather than the endogenous factors. There are much more uncertainties about exogenous factors than uncertainties around endogenous factors, as countless factors are able to influence the environment and different participants can have different degrees of influence on the environment, which makes it impossible to estimate an appropriate outcome of the environment (the market or the economy) in a long time.

Therefore, I think being “short-sighted” is probably a good choice when participating in the financial market, as almost all of our possible expectations and decisions are made on our historical experience and observations, when the future is further ahead, our expectations and decisions become more likely to be wrong. Give an example, the housing crisis in US in 2007 was a result of Clinton’s housing plan which aimed to provide housing for more people in America. Even if you could see a crisis would come in 2007, you could not short the housing market immediately, the most profitable way would be shorting in early 2007, and such profiting method is not about making good expectations about some events in the future, it is about having critical observation of the market and making the right move ahead of others.

Is trading in financial markets a zero-sum game?

Many people see trading in financial markets as a zero-sum game, as when one individual sells and another buys a product, the cash transfer is only one direction which is from the buyer to the seller. From the cash holding side, at that particular time point when the trade is just made, it is a zero-sum game, as the amount of cash that the seller gains and the seller loses is the same and the total amount of cash holding for the two individuals does not change before and after the trading takes place. However, if we believe asset values change over time, this is commonly believed by most of us, the total asset value of the two individuals can change over time. As the total value of the assets held by the two individuals can change before and after the trading takes place, it is then not a zero-sum game. However, to change the value of the product, (let’s say the product is a share), both individuals do not have influences on the actual value of the product, although they can place different prices in the market as they are the only players in the market.; the actual value of the share depends on the returns from the company that if the company gives greater dividends, then the value increases, and vice versa. Then what is the dividend yield dependent of? It depends on the revenue and profit it can get from the economy. Then back to the cash holding for the two individuals, especially the buyer, as the company gives out dividends to its shareholders, its shareholders, it means the total cash holding for the two individuals increases when the company gives out dividends. Of course, some companies do not give out dividends, they have other methods to inject more cash into the financial markets. For example, they have buy back schemes that they purchase their companies’ own shares from their shareholders, this is one method to directly supply cash for the financial markets from the real economies. Moreover, expectation is another source of cash supply in financial markets, investors have expectations about their target companies, the expectations are about how much cash their target companies will give out to their shareholders. Investors change their expectations over time when their expectations become more optimistic, they supply more cash in the financial markets and vice versa. Let us assume there is a financial market that no company gives out dividends or has other types of cash giving out schemes, then the total amount of cash is dependent solely on investors’ expectations. When the expectations stay the same over time, it means no more cash will be injected into the market, then trading becomes a zero-sum game, as the total amount of cash held by the investors is the same over time and before and after trading happens. However, when the investors’ expectations become more optimistic, more cash will be injected into the financial market, then it is no longer a zero-sum game and the total amount of cash will increase; if the expectations become more pessimistic, more cash will be pulled out of the market, it is not a zero-sum game either and the total amount of cash will decrease. Of course, if the total amount of cash is fixed in the economy, the trading is more like a zero-sum game, as the amount of cash cannot increase forever. However, in an economy with a fixed amount of cash, it is more likely to have a deflation, which means the real value of a fixed nominal value increases over time, then it is not a zero-sum game either in terms of real value of the cash in the financial market as well as the economy.

Overall, the return from the financial market depends on the values created by the real economy and people’s expectations and discount rates. If a financial market is experiencing a trend is very different from its economic growth trend, then there must be something wrong in the financial market. In addition, the decision of trading should be made based on a comparison between its current price and expectations of overall discounted cash return, investors are not actually competing with each other.

Further on moral hazard

Yesterday, I talked about some possible ways to mitigate the issue of moral hazard in financial markets; however, either the way of giving more powers to participants on average or the way of improving the effectiveness of market monitoring cannot solve the problem completely.

Yesterdays’ solutions are more to do with organized illegal market activities. If we think that the market activities are all done by powerful organizations to merely serve their interests, then when all participants are powerful enough, they certainly do not have the incentive to conduct illegal market activities. Moreover, the number of powerful participants is relatively small, so it makes the market regulators easier to monitor their activities. However, in reality, it is fair to say that no market decision is solely made based on the organization’s individual interests. Any organization takes actions in the financial markets by hiring employees to represent them in the markets. Therefore, the conflict of interests between employees and their employers is a highly likely cause of moral hazard in the markets.

It is almost impossible for anyone to have perfectly matched interests with his/her employer; therefore, it is very possible for employees to have conflicting interests. When having conflicted interests, employees tend to choose to satisfy their own individual interests ahead of their employers’, when this happens, it is possible to lead to insider trading or other types of illegal market activities.

Using economics to understand the problem of inside trading, there is an equation to show the expected returns of insider trading:

Expected return = probability of not getting caught * benefits gained from successful insider trading – (1 – probability of not getting caught) * costs of getting caught

When the expected return is equal to zero, the two options for risk neutral people are indifferent, to look good, they may choose not to involve in insider trading, risk averse people will reject the idea of insider trading but risk lovers will choose to involve in insider trading.

As the benefits gained from successful insider trading is incredibly enormous, no matter how we increase the probability of getting caught or the costs of getting caught, there always are some risk lovers that are willing to take the risk and involve in insider trading. When our financial markets become more and more complicated, the probability of getting caught could be decreasing over time. The most effective way is to reduce the gap between the benefits from cheating and not cheating, in order to reduce the extra benefits gained from insider trading. However, it is impossible to erase insider trading completely.

How to prevent moral hazard, especially insider trader, in financial markets

The existence of moral hazard is a serious problem in the financial markets in any country; in the developed countries, the governments have created very harsh laws and regulations to prevent moral hazard and punish the insider traders and any other market participant who breaks the laws and involve in the moral hazard activities. In the developing countries, the regulations and laws tackling the moral hazard are lacked, this is a reason that why in the developing countries the problem of moral hazard in their financial markets is much more significant. To reduce the existence of moral hazard I think is to reduce the benefits of making insider trading or other moral hazard activities as well as to increase the costs.

Firstly, to reduce the benefits of making insider trading, it is important to balance the powers of all market participants. There are two methods to balance the powers of all market participants: to lower all market participants’ powers or to lift up all market participants’ powers. The power in the financial markets involves several components: the efficiency of analyzing public information, the speed of accessing to public information, the access to people or parties who have private information, the power of manipulating market prices. However, it is impossible to make participants with different amounts of resources to have equal powers on these sectors. Large participants have more resources in all kinds: firstly, they have more elite employees with professional knowledge, so they are more likely to make better analysis on the markets; secondly, they have more funds, when more funds are injected into the market, they can influence the market prices; thirdly, they are large clients of other financial institutions, so they are more likely to know more people and have good relationships with people and parties who have private information; fourthly, they have more resources to spend on equipment to have early access to the public information as soon as the information is made public. It is impossible to divide large participants and make them smaller. Therefore, it is better to merge smaller participants and create several large groups and let them gain more power in the financial markets to narrow their power differences compared with those large traditional participants. As when all participants have the abilities to participate in the insider trading activities, the competition of benefiting from illegal trading activities is likely to be similar as the competition of benefiting from the legal activities, then the benefits from taking these activities will decrease due to the increased competitions, so considering the legal risk of taking illegal trading activities, it is better for every participant to follow the regulations and laws.

Secondly, to increase the costs of making insider trading, the most common and efficient way is to create more complete regulation system involving the legislative and judicial departments. When facing much more harsh penalties, the market participants will be less likely to involve in the insider trading activities.  Moreover, these departments need more professionals who know how to track these illegal market activities. Maybe these departments should seek more help from the IT industry to develop software to monitor the market activities and look for possible illegal activities. In addition, it is also important to reduce the number of people and parties who are outside the financial sector but have private information or the abilities to have critical influences on the financial activities. When the number decreases, fewer are expected to participate in insider trading activities.

To conclude, I think that to reduce the existence of insider trading or other ill incentive market activities, it is important to have one independent department that monitors the market, makes critical market decisions; this can make the non-participants who have private information concentrated in one department and it is easier for the central judicial department to monitor the activities of this department. Moreover, small market participants should be encouraged to merge to form large groups to balance their power with other participants’ power in the market in order to reduce the expected benefits from insider trading. 

My expectation of the Chinese government’s future regulations on its financial market

The Chinese National Financial Work Conference this year took place on the 14^th and 15^th July and was led by the President, Xi Jinping. President Xi stated during the conference that the priority function of the financial sector was" to serve the real economy while guarding against systemic risks" (quoted from People's Daily).  From the President's statement, the reforms involve two parts: to serve the real economy, and to reduce systemic risks in the financial market. More reform policies and regulations will be made based on the statemen and some reforms have been announced. For example, it has been announced that China will accelerate developing laws and regulations governing the financial sector and set up a committee to oversee financial stability and development, and the central bank will play a stronger role in the macro-economic management. I want to first discuss the announced reform plan of a larger role of the central bank, as the other plans are less specific and we still and then discuss how the Chinese financial market may be influenced and reformed in the coming years.

A more powerful central bank:

The function of a central bank in any country is undoubtedly important in terms of determining the economic performance as well as the financial market stability. However, the tool for any central bank to influence the economy as well as the financial market is its monetary policy. Nowadays, the most common monetary policies are changing base rates and asset purchasing programmes. If the central bank is limited to only using these two tools, it is almost impossible for the central bank to become more powerful. Therefore, to enlarge the influence of the central bank, it is necessary for the Chinese central bank to have more tools to make impacts on the economy and the financial markets. However, when a central bank uses too many tools to control over the supply of the money, other unwanted effects could be caused. For example, the use of the RMB in foreign countries could be affected when the Chinese central bank and the government seem to have too much control over the RMB. There is a theory called “impossible trinity” in the monetary policy that a monetary system cannot have all the three policy positions at the same time and the three positions are free capital flow, fixed exchange and sovereign monetary policy. This suggests that given the Chinese government and the central bank must maintain the current sovereign monetary policy, they have to find a balance between free capital flow and fixed exchange rate. When they weight more on fixed exchange rate, the capital flow could be affected and vice versa. Therefore, in the short term, it does not seem very easy for the Chinese central bank to further expand its influence over the economy and the financial market.

How the Chinese financial market may be reformed in the future:

Firstly, I expect more regulations and restrictions on the Chinese equity market. The equity market is a market that is considered to be more risky, especially given the Chinese equity market was unusually volatile last summer in 2016. To the very extreme, I think a restriction on the qualification of entering the equity market could be made. There are still many small share traders in China. The average return for these share traders are negative, and some of them are not fully aware the risk they are taking and more importantly they have not been educated about how the financial market is functioning. Therefore, the existence of these small traders could add more systemic risk, their reactions to the market are more easily manipulated by some ill-motivated large traders. Though the total number of small active trading accounts has been decreasing over time, it is still possible for the government to limit the access of some poorly educated traders to the financial market in order to reduce the systemic risk as well as eliminating the risk for those who do not understand the risk. On the other hand, I expect some regulations will aim to eliminate the profitability of purchasing newly listed companies or going for public listing. The profitability in the financial market should be independent of the act of purchasing or going for public listing and become dependent of the individual competitiveness of the company. This could encourage the companies to increase their individual competitiveness rather than seeking some shortcuts by getting their companies publicly listed. This could be beneficial for the real economy as companies are possible to become more competitive; meanwhile, it can lower the systemic risk, as the possibility of mispricing which is a source of risk could be lower when the profits gained from the financial market become more dependent of companies’ individual performances. In addition, the financial instruments will be limited, as when he various financial instruments could increase the complexity of the financial market, when people do not fully understand the instruments, the systemic risk is enormous, the 2007-08 financial market could be seen a crisis that was caused by people creating financial products they did not understand.

Secondly, I expect the bond market will be expanding. As stated in the Chinese official newspaper that “developing direct financing will be prioritized”, it implies that companies may be more able to finance themselves directly from the financial market. Due to the volatile nature of the Chinese stock market, loosening regulations on the stock market seems undesirable; therefore, to make companies easier directly finance themselves, instead of allowing more activities in the stock market, companies may be encouraged to issue more bonds and commercial papers directly to the financial market. When more bonds and commercial papers are issued, the bond market will become more active and be expanding. Moreover, due to the natures of bonds, the bond market is unlikely to be more volatile than the stock market, and bonds are normally  ‘safer’ than stocks; therefore, expanding the bond market is less risky than expanding the stock market, and it can help companies to gain more direct finance as well.

Thirdly, the pace of the reforms and deleveraging could vary across different sectors. Leveraging and taking risk should not be seen as totally bad ideas in my opinion that leveraging and taking higher risk are the effect of individuals seeking for higher profits. People should be free to choose how much risk they want to take as long as the risk does not affect others. However, nowadays we are all connected with each other and we are all sharing our risk to different degrees; therefore, the regulations aim to balance the social benefit against the social risk, when the social benefit is high, it is reasonable to take some more risk and vice versa. The government has its views on which industries need more development and which industries should start to give some resources to other industries. Therefore, the pace of the reforms and deleveraging will dependent of how much the government supports the sector. In the industries which the government is willing to give more support, the companies are easier to get financed directly and indirectly from the financial market and the pace of deleveraging could be slower, even it is possible for some companies to be leveraging up their assets to gain more development. And in the industries which do not gain support from the government, companies may face more regulations when accessing to the financial market, the pace of deleveraging will be faster.

Conclusion:

I expect that in the future the Chinese bond market will have a faster growth rate than the stock market, as more regulations will be placed on the stock market as it has higher systemic risk to the economy. Moreover, the restrictions of regulations and laws will depend on the support from the central government. Finally, the financial sector is not seen as an individual industry by the Chinese government, it is seen as a tool for generating economic growth in the real economy; therefore, the profits of the financial sector could be sacrificed for the real economy. 

How much do you like cheap goods or services?

The easiest and most common type of competition is price competition and the economic golden rule tells that when the price of a good decreases, people’s demands for the good increase. However, do people always look for goods and services with the lowest prices? I previously suggested that when the prices of some goods and services are very affordable and the qualities matter the utility of uses, people will balance their requirements for qualities and prices; and I maintain my point of view.

Under different circumstances, people weight their preferences towards quality and price differently. Usually people weight the importance of qualities of products when the products require complicated producing processes. This is because products with complicated producing processes have more differentiations between similar types of products, as companies may have different processes to produce their products and different qualities can be made. Moreover, such products are not one-time consumer goods or services, they are usually consumer goods that consumers demand for their long term purposes. When a product is consumed from satisfying long term demand, consumers will judge the costs of consuming such products over the products’ using time periods. When a good can be used for a longer time period, the average cost of consuming the good over the using time period is relatively low. On the other hand, if a good can be only used for a short time period, the average cost of consuming the good over its using period is relatively high. If we believe a good with a better quality can have a longer using period, our expected average time period cost is lower. From this point of view, the quality determines the average time consumption cost, and people choosing products with better qualities is still a price choice.

In addition, different qualities represent different functions of these products. Sometimes when a product has better quality, it has more functions than its competitors. Because of the extra utilities gained from consuming this product, people will decide whether the additional functions match their preferences and demands or not. If these additional functions meet consumers’ urgent demands, the consumers are more willing to pay extra money for the additional functions.

Overall, choosing between quality and price is still depend on the price judgment; however, such price judgment is more than short term price judgment, it also involves price judgment over long time periods and price judgment across different functions.

What kind of companies will set dressing codes for their workers?

First of all, everyone is rational or at least they make independent decisions to maximize individuals’ profits. Some companies and organizations have set dressing codes for their employees to follow, some do not have more flexible dressing codes. In addition, people can use different work dressing to identify their work. Some people just feel that dressing codes do not have any actual benefits, this opinion is wrong.

We should not question the benefits of any policy taken by companies, because any policy that is made by companies must match the interests of the companies. Dressing codes have several benefits for companies. Firstly, dressing codes can help to attract more clients. Having formal dressing code can provide companies’ clients with a sense of professional, for example, the majority of the employees of banks wear suits for their work, this could make their employees. Sometimes dressing codes help clients to know the services provided by different employees with different dressing, for example, cooks and waiters have different dressing and customers can know their jobs from their dressing. In addition, employees can use their dressing to establish close relationship with their clients. For example, in a company, the department which has the most casual dressing code is its tech division or tech related divisions. There has been a culture in the tech sector that few people wear formal suits for work. Therefore, it will be awkward for people to wear formal suits to meet their clients from the tech sector and wearing casual clothes can bring the relationship closer. Recently the Goldman Sachs also relaxes its dressing code for its tech division. Secondly imposing a dressing code is a strategy to keep a sense of unity and hierarchy in the company. When employees wear similar clothes, they are more likely to feel they all belong to one organisation or company. Moreover, they may feel proud of their working places and wearing uniform with their company badges can make they feel more proud. This could increase incentives to work harder for their companies. In addition, the differences in uniform could tell employees’ ranks in their companies, it could notify employees that they need to work harder to get promoted in order to receive the same rank as someone around him/her. It increases the competition within the companies and is likely to improve productivity.

After having discussed the benefits that could be brought by corporate dressing code, it is not hard to see that large companies are more interested in imposing  corporate dressing codes to provide a sense of unity and hierarchy within the companies. However, the function of dressing code to attract clients implies without the dressing code imposed by the company, employees are still likely to self-adopt a similar dressing code to boost their performances if their incomes are dependent on their performances. For example, even in the financial sector, the relationship managers who is dealing with clients from the tech sector wears very different clothes than those who are dealing with the clients with sovereign background.

Our development could be misguided and misled by our current technology limitation

We are all enjoying the benefits brought by our technology development and the speed of new innovations and inventions; more importantly, many innovations and inventions are no longer coming from the demand for military purposes, like previously, some are directly invented to serve consumers’ demand, for example, the driverless cars. However, as we know our technology is not perfect, it could happen that our development is misguided by our technology limitation due to several reasons.

Firstly, due to technology limitation, when we are developing some products, we face some technological difficulties. In order to develop the products as soon as possible, companies usually do not directly solve the technical difficulties which need more investment and longer time, instead, they may find an easier way to get around the problem and provide products with acceptable imperfection. The classical example for this is our keyboard layout. The QWERTY keyboard layout is the most common layout for most of our computers. It was first developed in the early 1870s. Many people have suggested that this type of layout was initially designed to separate often-used keys farther apart to prevent jams due to the technical issue at the time. The layout is definitely not perfect for typists, as when using the English language, it is true that typing strokes are more often done by the left hand than the right hand, this is helpful for left-handed people but unfriendly to right-handed people. However, as we have been using this layout for over a century, people are used to this layout. Even nowadays jams are unlikely to occur with the modern keyboards, people are still using the imperfect keyboard layout, which was designed to get around a mechanical problem in the past.

Moreover, when we are developing a system, it involves many different small parts, each of the parts have different development speeds. However, since developing a system takes a very long time period, it is not strange to see in such a large system, it has the most advanced technology with some very outdated technologies. This always happens to the national defense industry. When developing a defense system, such as fighters or ICBM, the hardware is more likely to be very advanced while the software could be very outdated. This is because the update and development speed of software is much faster than the development speed of hardware. Since these defense developers have to combine the hardware and the software together, they need to choose the most advanced technology at the time. As developing a new aircraft usually takes around 20 years, when the development finishes, the majority of the technologies used is very likely to be 20 years old. To some fields, 20 years old technology could still be very advanced, for example, engines, materials, which involves long time periods of experiments and mature theoretical development and research; to some field, 20 years old technology could be extremely outdated, the update period in the IT sector is usually believed to be 18 months, the 20 years old technology in this sector is too old. However, since the system is a complete system, when one part is changed, all other parts have to be changed accordingly; therefore, if we want to update the software or other outdated technologies, the whole design has to be changed, and this is very costly and even when the changes are done, we could find some technologies become outdated at that time.

Overall, technical difficulties may force our developers to seek cheaper solutions to get around these issues and such imperfect solutions could increase the long lasting issue of imperfection. If we develop more technologies based on the imperfection, it could expand the scale of the imperfection (the imperfect keyboard layout does not affect typists, but since the increased use of computers, almost everyone who has access to computers is affected by the imperfect keyboard layout).

How important is the population size in terms of economics?

A country’s population size has been an important factor in terms of economic and political matters. Governments have different measures and opinions about their countries’ population sizes. Usually, there is one golden rule: when the resources are scant, a reduction in the population size is more likely to be favoured, and vice versa. In the past, land and human were the two major factors of production, governments had to balance the two factors; nowadays, capital and entrepreneur are another two factors, these two factors are unlike land and are not limited by humans, as when the population size is increasing, capital per capita will not be limited. To judge the importance of the population size in an economy should be considered with two sides: one is the demand side, the other is the supply side.

Firstly, when the size of the population is increasing, it is very likely for the potential production frontier to shift outwards. Moreover, the quality of labour forces is another important factor in determining the potential output of one economy. This is why almost all countries want to increase spending on increasing the scale of education provision and improving the quality of education. In addition, many governments are urgent dealing with the age population issue in their countries, as the ageing population is not good for training young new labours and could influence the productivity of the economy over the long turn. Of course, the payment of pensions is another issue that governments have to face. When the importance of capital and technology becomes more and more significant, some production processes become much easier and do not require highly skilful labours; however, in the research and development fields, extremely well-educated and skilful labours are highly demanded. Therefore, on the supply side, the quality overwhelms the quantity of labour forces, and the skill requirement in the labour market could have a widening gap.

On the other hand, the demand is highly dependent on the size of the population. Unlike the supply side, I think that the quantity will overwhelm the quality of consumers, as I expect that the costs of production in the future will continuously decrease and the prices for the majority of products will become more and more affordable. When the prices are low in general, the quantity becomes extremely important. Therefore, a large population could provide a huge market that generates very high revenues for companies.

Overall, I think that the quality of the population (for example, education, training and other characteristics) becomes more important in terms of determining the potential overall production of the economy than the size of the population, but the size of the population determines the potential consumption of the economy.

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Foeign direct investment (FDI) and its implication

Vietnam attracted $36.7 billion of announced greenfield foreign direct investment (FDI); according to the Financial Times data service, Vietnam was the third place of attracting FDI across the world, only after the US and the UK. FDI is an important index to measure the world expectation about the economy’s future growth. Usually when an economy is believed to have a high economic growth rate, foreign investors will see the opportunity and invest in this economy to seek returns from the possible high economic growth in the economy. However, sometimes it is not necessary to be a perfect measurement of the market confidence and the expected growth of one economy.

FDI is determined by several factors. Firstly, the world expectation of future performance of an economy is one and probably the most important factor determine the FDI level. Investment is more likely to have higher return rates in an economy with high economic growth than it in an economy with low economic growth. Secondly, uncertainty is another important determinant. When an economy has a very risky future, this implies that investors in this economy need to face many uncertainties and if their expected returns are not high enough to compensate the high risks, they will drop their investment plans. Uncertainties come from economics as well as politics. Economic uncertainties could be caused by complicated structural changes and sharp increase in the numbers of players in the economy; political uncertainties could be caused by highly frequent political shifts, corruption, radical political ideologies and etc. This is why the US and the UK have higher FDI than other countries, the US and the UK are considered to be the economies with the least uncertainties and their 10 year government bond yields are considered as the risk-free market return rate. Thirdly, FDI could be influenced by the local governments and central government’s attitudes towards foreign investors and regulations. This could influence the costs of investment. When the regulators and governments welcome foreign investment, foreign investors could have very low costs and even sometimes they can have immediate returns. However, when governments are afraid that foreign investment could let foreign influence too powerful domestically, they are likely to limit the activities of foreign investors. Fourthly, the domestic investors can influence FDI as well. The financial market has its constraint of opportunities, this means the demand for investment is not infinite. When domestic investors have powerful influence domestically, they have more competitiveness than foreign investors. When domestic investors are growing stronger,  foreign investors do not enough competitiveness, they may not invest as much as previously.

Overall, when the two economies have similar economic and political characteristics, the levels of FDI can be a signal to show which one is expected to have a higher economic growth rate in the future. However, when the economies are at different phases of economic growth and development, the levels of FDI may not be a good index to measure the world confidence of the economy’s future performance. Therefore, Vietnam overtakes China, I still think that the potential of the Chinese economy is much greater than Vietnam, as I think that the differences in the levels of FDI are caused by the regulators’ attitudes, and more importantly two economies having different development phases and two countries’ domestic investors’ strengthen.

My personal experience of being opportunist and the lesson I have learnt

Making right investment and trading decisions is about making right predictions, this is definitely right; however, I think some people define predictions too narrowly that they only think predictions are all about pointing out the correct state that will occur in the future among all the possible states. I view such investment or trading strategy not difference from gambling, especially when making some short-term decisions. Before an event exactly takes place, there is not any certainty that it is only right to say this event has a significantly high likelihood to take place than all the other events do. I think that there are other predictions that are also important and could bring us high returns from the financial markets. I am not good at disagreeing with others and being right at the same time, so I predict the returns of each possible state and borrow concepts from hedging to build up my portfolio. I have some successful examples and some failed cases. Today I want to compare one relatively successful case with one failed case to show the strength and the weakness of this investment strategy. Some people believe learning from successful stories is more useful and some argue learning from failure is more useful; albeit my opinion is only by comparing successful stories with failed stories in the same sector is more reliable to provide reasonable answers about what determines success and failure.

The two examples are my strategy for the Brexit referendum and my strategy for the US presidential election. These two cases share one important character that they only have two states: the Brexit referendum only had “leaving the EU” and “staying in the EU”, and the US presidential election only had “Trump” and “Hillary”. In addition, both cases happened in 2016, this was also important that as they took place in the same year, many market structures and characteristics were not very different in the two cases. In both cases, I used the same strategy. Firstly, I agreed with the “common public opinions”, which were represented by polls conducted by newspaper and other “reliable sources” at the time. I thought in the Brexit referendum people would choose to stay in the EU and in the US election, I thought Americans would choose Hillary. Secondly, I put a large weight on those assets which were in favour of my predicted state that I bought a pool of US listed multinational companies’ shares before the Brexit referendum and I bought solar shares before the US presidential election that multinational companies were the large supporters of the “staying in the EU” campaign and Hillary was supporting the renewable energy sector. Thirdly, I invested some, which was lower than my estimated return from my investment in my predicted state, to counter the situation when the other state happened. The instrument I chose for hedging was options, as options could limit my losses and lower the costs, and it could have some leverage functions as well. In both cases, I chose bank put options, the reason for the Brexit referendum was simple, it was because banks dislike the idea of Brexit and they would face increasing costs when Britain leaves the EU and the free trade deal. The reason for the US presidential election was because Hillary was marked as the candidate supported by the Wall Street and Trump had some very radical comments on the Wall Street bankers which made we believe he might place aggressive regulations on banks when he became the president.

It is very obvious that my strategy for the US presidential election was a disaster but my strategy for the Brexit referendum was a huge success. I would like to discuss my success first. My returns in the Brexit referendum came from two sides. The first part is the US dollar appreciation against GBP. The majority of my portfolio is American assets.  As I live in Britain and spend GBP, I use GBP as my calculate unit for my account, if I use USD as the unit, the return rate could be lower. In addition, I chose to buy American multinational companies, large portions of their assets were in USD when GBP depreciated against USD, their asset values increase in GBP value. This prevented some losses as well. The second part came from the gains from the call options I bought. Their values were tripled and even quadrupled. This successful case is built on several good predictions: my prediction about Forex change, my prediction about the changes in the market if Brexit is chosen. These predictions were not correct (I underestimated the GBP depreciation), but they were very close to the reality and helped to gain profits. In addition, my success was also based on conservative strategies that I chose American multinational companies rather than British banks, as American multinational companies would face fewer losses than British banks from Brexit (they would still benefit from the free trade deal between Britain and the rest of the EU, since they are multinational businesses). However, one of my predictions might be a weakness in my strategy. I might overestimate the returns from the state of staying in the EU, if this was the case and the state actually happened, my portfolio could face a loss. But this loss is relatively limited and small, and given there is no arbitrary opportunity in the complete market, my strategy should still be considered as a success.

The US presidential election was a different story. The losses came from the sharp drop in the solar sector and the Trumpflation since Trump was elected. The sharp drop in the solar sector matched my prediction almost perfectly; however, the gains in the banking sector were not something I expected. Of course, cutting taxes was something banks like; however, his comments on the banking sector were not very friendly and his political ideology has some paradox and may create more confusion and uncertainties in the market, this is not good for the US economy and the banking sector. Based on such belief, I predicted the banking sector would lose if Trump is elected. I think my bad prediction is because of the complexity of politics; compared with the presidential election, the economic impacts behind the Brexit referendum are more immediate, simpler and clearer.

To conclude, from the two cases, firstly we can see politics seems the determinant of whether my prediction is good or bad. Politics is extremely complicated and changes individual behaviours that there are two totally different behaviours in the market to react the Trump presidency before and after the election. Therefore, such strategy and prediction might be only good in the cases of relatively pure economic events. Secondly, the instrument chosen to hedge against the unlikely event should be options of companies which are most directed to the core of the issue, as the price changes for such companies are the most volatile and options could provide a safety net and prevented extreme losses. Other instruments that have similar characteristics could be tried. Thirdly, it is worth mentioning in either case, it is impossible to judge the accuracy of the predicted returns from the unhappened state. Therefore, such strategy does not necessarily provide arbitrary opportunities.