Economics: an approximation

Economics is good at pursuing a way to explain phenomenon in the real world and captures some basic "economic" rules in our life; however, economics can never precisely describe the entire picture of the world. For example, economics is about how individuals make decisions based on profits (utility) and costs, when economics come to individual cases, it is hard for any economist to find a general and direct method to calculate the marginal cost, which is an extremely concept in economic theories studying firms' strategies. Moreover, when economists are talking about utility, utility is significantly dependent of individual tastes, different individuals can have different utility, economists tend to use a mean individual to represent the entire population, but it is just not possible to be sure if a right mean individual is found.

Secondly, economics describes the current situation based on economists' expectations of the future and does not deliver the prophecy. Economists tend to think individuals and the economic system behave or function in a typical cycle or following certain rules. No one knows the future, so based on several assumptions that create a stable and reasonable system, economists form some expectations of the future and create models based on these expectations. Furthermore, when economists tend to make predictions, they also bring the idea of stability from the models to the reality, by projecting a trend, they make their predictions along this trend which comes from their models.

Thirdly, economics is not natural science, though it tends to be mathematical and data-intensive. Because economics studies social issues that largely involves numbers, economists tend to bring in the concepts of experimental science, statistics and mathematics. The findings do not come from the nature, they come from the interaction between individuals and such interaction can change over time.

The idea of Asian Union

The US president Trump tweeted about his dislike of the TPP on Tuesday, this added pressure on Japan. Japan is a large exporter in the world economy that trade in goods and services accounts for 16% of its entire GDP. Japan is not the only Asian ally that seeks for a trade deal with the US, South Korea is another such country that its trade in goods and services accounts for 42.2% of its entire GDP. Although China is definitely not an ally of America and is not likely to join the TPP anyway, China shares many mutual economic interests with Japan and South Korea and many other countries nearby. These three countries export goods and services, but they do not produce similar goods and products, each of them has their unique comparative as well as absolute advantages in terms of trading. When they form a trade deal, they all could potentially boost their trading volumes even further.

In terms of cultures, we cannot say China, South Korea and Japan share the same culture, but we can see there is a lot of interaction across these three countries' cultures. Countries that are closer to each other are more likely to better understand each other. Because modern wars are catastrophic, these countries want peace in their district, though they could have some conflicts of interests.

The three countries are influential in East Asia, if they can unit together, it is almost guaranteed that there would be no serious conflict in this district. In addition, because of the political stability in the area, it would encourage further economic development in this district. They would become more powerful and influential when they unit together than they are currently.

Option trading

 Today I want to discuss if it is a good idea to trade options alone. Option is a type of derivates, and gives investors the right to buy or sell a specific stock at a specific price. There are some differences between American options and European options, but the existence of the option market narrows the difference between these two types of options. Buying an option is a bit like adding leverages to investors' portfolio, but there is some difference.

The prices of option are definitely more volatile than the stock prices; however, the prices of option will eventually collapse to the difference between the strike prices and the actual stock prices by the exercise dates or zero. Because option prices include the prices for timing, the longer time period involves higher uncertainty, since one of the option functions is to seek certainty, the prices of options with longer time periods to exercise dates are higher. Therefore, the values of options based on seeking for uncertainties are declining overtime, so it is very risky to hold options as assets for a very long period.

When investors do not hold options for long, they behave just like opportunists. When behaving like opportunists, investors turn to be more like noise traders rather than sophisticated investors who study the fundamentals. This increases individual risk. Therefore, it is not a good idea to trade options alone.

Why do we care more about copyright?

In China, people are caring more and more about copyright. This could be seen as a good situation that it could encourage more innovation and invention. Moreover, it protects companies (including foreign companies)’ rights as well. However, there are basic economic incentives to force people to care more about copyright.

Firstly, when more people want to make money from innovation and invention, they have to care more about copyright. Secondly, when people face more competitions in terms of their skills, they want to increase the scarcity of their skills. Copyright increases the cost of skills and knowledge, and creates a bar for people to earn new skills and knowledge. This will reduce the competitions for the people who initially control the skills and knowledge as well as those who have the ability to buy the skills and knowledge, so they will eliminate the competitions from those who cannot afford the costs of receiving new skills and knowledge. Thirdly, for companies, copyright lifts the costs of entry, creates some degree of market power for the large companies. In the court, those judges do not know about technology, they make their judgments based on which firm has the longest copyright list.

To conclude, though copyright encourages innovation and invention, it can reduce the competitions in the market.  

Lobbyists and politicians

Lobbyists do not exist in China but widely exist in the western political system. The job of lobbyists is to persuade policymakers to make or withdraw certain policies. Lobbyists are very influential in the western politics. It is clear that there are unlikely any regulations on Facebook after Mark Zuckerburg’s hearing because even if the government decided to do so, Facebook could spend billions of dollars on lobbying and eventually block the regulations on it, said by one of the congressmen during the hearing.

The money spent on lobbying is a waste to the society because it does not actually produce any outputs other than shifting the policy directions. It is possible for lobbying to be socially beneficial that when lobbyists are more informed than politicians, they are possible to direct politicians to make more socially desirable policies. However, under such circumstance, because lobbyists have more information, they are easier to manipulate the politicians and make them misestimate the outcomes of their policies.

Moreover, lobbying could be seen as a legal bribery that theoretically speaking, lobbying and bribery give the same levels of private benefits to the politicians. Therefore, overall lobbying is not socially desirable.

A brief introduction of bubbles

Bubble is a phenomenon that the market price drifts away from its fundamental price. Large bubbles are rare but little bubbles happen all the time. We have experienced large bubbles several times, such as the Tulip Mania in the 17th century, the South Sea Company in the 18th century, the most recent 2007-8 Subprime Crisis. The bubbles could be put into four categories: rational/near rational bubbles, informational bubbles, intrinsic bubbles, fads.

For rational bubbles, the bubbles increase at the same rate as the interest rates when the assets have infinite maturities. In addition, there is a possibility of bubble bursts at each period. When the possibility of bubble burst increases, there is a need for high asset prices (high capital returns) compensate the high risk. This will lead to a great fool market that investors believe they can exit the market at the right time. For near rational bubbles, when investors are unrealistically overconfident, overoptimistic and myopic risk aversion, it will also contribute to create bubbles.

For intrinsic bubbles, investors overreact to the news about fundamentals. Stock prices are more volatile than dividend changes, so prices overreact to dividend changes easily.

For informational bubbles, if the market price is informationally efficient, there is no economic incentive to collect private information. Investors need to choose whether they collect their own private signals and respond to their private signals or just copy what the other investors (their trusted friends, colleagues) are doing.

For fads, investors sometimes believe there is a new fashion that we enter a new era. For example, the Dotcom bubble was created based on people's belief that we were entering the "Internet Era".

There are three theories that explain how bubbles arise: belief-based theories, preference-based theories and a speculative model (Shiller 2002). The belief-based theory suggests there is an extreme bullish view and there is an extreme bearish view, because of the short-sale constraint, the market reflects more about the bullish view rather than the bearish view, so the market price is overvalued. The preference-based theory suggests investors may have a strong preference for lottery-like payoffs, this would overvalue these stocks. Shiller suggests the essence of a speculative bubble is a sort of feedback, from price increases, to increased investor enthusiasm, to increased demand and hence further price increases. Behavior bias contribute to the feedback system: the representativeness heuristic, overconfidence, attention anomalies, self-esteem, conformity pressures and salience.

It is very difficult to spot a bubble, but bubbles commonly burst after a sharp price increase.

Why is it necessary to allow investors to place short positions

In the Chinese stock market, investors cannot place short positions on particular stocks. I think that the regulators would open the door for investors to place short positions in the future, because this is beneficial for the stock market overall.

When investors are only able to place long positions, the prices in the stock market are biased towards the investors who focus on the long side. All activities are done by the long side investors, and the investors are only able to show their short-side opinions about the stocks. However, buying and selling stocks are normal market activities and only extreme occasions would draw the market attention.

Placing a short position is a different trading move that directly shows the short-side's opinion. When placing a short position, the investors need to borrow stocks to sell, and the ones who are able to lend them stocks are usually institutions who are large long-side players. When the institutions are able to receive such orders from other investors including some institutions, they would realize the market opinion is contestable and there is a possibility of mispricing (bubble) in the market.

Therefore, if placing short positions is allowed, the market could be faster to realize the mispricing in the market.