ECON 252: Financial Markets (Yale Spring 2008)

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Financial institutions are a pillar of civilized society, supporting people in their productive ventures and managing the economic risks they take on. The workings of these institutions are important to comprehend if we are to predict their actions today and their evolution in the coming information age. The course strives to offer understanding of the theory of finance and its relation to the history, strengths and imperfections of such institutions as banking, insurance, securities, futures, and other derivatives markets, and the future of these institutions over the next century.

Robert J. Shiller is Arthur M. Okun Professor of Economics at Yale University and a Fellow at the International Center for Finance at the Yale School of Management. Specializing in behavioral finance and real estate, Professor Shiller has published in Journal of Financial Economics, American Economic Review, Journal of Finance, Wall Street Journal, and Financial Times. His books include Market Volatility, Macro Markets (for which he won the TIAA-CREF's Paul A. Samuelson Award), Irrational Exuberance, and The New Financial Order: Risk in the Twenty-First Century.

 

Audio, video, and course materials for all lectures can be found HERE

 

1. Finance and Insurance as Powerful Forces in Our Economy and Society

2. The Universal Principle of Risk Management: Pooling and the Hedging of Risks

3. Technology and Invention in Finance

4. Portfolio Diversification and Supporting Financial Institutions (CAPM Model)

5. Insurance: The Archetypal Risk Management Institution

6. Efficient Markets vs. Excess Volatility

7. Behavioral Finance: The Role of Psychology

8. Human Foibles, Fraud, Manipulation, and Regulation

9. Guest Lecture by David Swensen

10. Debt Markets: Term Structure

11. Stocks

12. Real Estate Finance and Its Vulnerability to Crisis

13. Banking: Successes and Failures

14. Guest Lecture by Andrew Redleaf

15. Guest Lecture by Carl Icahn

16. The Evolution and Perfection of Monetary Policy

17. Investment Banking and Secondary Markets

18. Professional Money Managers and Their Influence

19. Brokerage, ECNs, etc.

20. Guest Lecture by Stephen Schwarzman

21. Forwards and Futures

22. Stock Index, Oil and Other Futures Markets

23. Options Markets

24. Making It Work for Real People: The Democratization of Finance

25. Learning from and Responding to Financial Crisis, Part I (Guest Lecture by Lawrence Summers)

26. Learning from and Responding to Financial Crisis, Part II (Guest Lecture by Lawrence Summers)

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Thanks. Good read with the transcript.

Session 6. Efficient Markets vs. Excess Volatility

Brad Barber and Terry O'Dean were professors at UC--at different campuses of California--teamed up with some economists from Taiwan and looked at data of--they got really good data from Taiwan about day traders and their actual returns. Day traders are people who trade everyday in the markets and they found that there was a really predictable pattern. The young people--they start in as a day trader and they quickly lose everything; they lose badly because they're trading too much and they really can't predict the market. There's like 1% of them, though, who seem like they can actually beat the market. This looks like really good for efficient markets. They found that there are some Taiwanese people who know how to beat the market--1% survives and stays in. Is that contrary to efficient markets? Well, it does seem contrary because they found that a small number of people did find some forecasting rule and succeeded. On the other hand, none of the--hardly any of them got really rich and so it's very rare--Warren Buffett is an extremely rare outcome. So it's--I guess, when I talk about efficient markets I want to help prevent you from suffering under any delusions about your forecasting ability. I don't mean that Warren Buffett can't do it or that you can't do it if you develop yourself into a Warren Buffett.

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At the beginning of lecture 21 he talks a little more about efficient market theory and makes some good points....

 

Professor Robert Shiller: I wanted first to just think back a little bit about the lecture we got from Steve Schwarzman on Friday. Before he came, I talked with him in my office and I had the audacity to ask him if he thought there was any chance that his fortune was just due to luck. I said, why we have this efficient markets theory in finance that says that nobody can beat the market. So, what do you think he said? Well, obviously he believes in himself, but I'm inclined to believe in him also. Efficient markets theory never sounded right; one thing about efficient markets theory that has always bothered me is this idea that the so-called "smart money" sets prices in the market. The thing that bothers me about it is, who is the "smart money," anyway? It's as if it's all or nothing thing; there's the smart money and then it's the dumb money and the smart money rules. Aren't there all different gradations of intelligence and insight? It's not like--why should there be just one level of smart money? So, I think he probably exemplifies a higher level of smart money than smart.

 

I think a lot of mistakes people make in judging financial markets is being easily impressed by someone's stockbroker or someone's analyst who seems very smart and is very smart, but may not be enough to outsmart the markets. That's the lesson of efficiency, especially when you're young. I think you may not realize how many smart people there are in the world, so when you're dealing in a--trying to win in financial markets--you have to take account of who is really out there and how much insight and effort and research are they putting into their trading. Do you really think you can beat that? That's the lesson of efficient markets. I don't think the lesson is that you can't--it's impossible for anyone no matter how smart to beat the market. Now of course, Albert Einstein never made any money in the stock market. In fact, TIAA-CREF, the pension fund, had an ad campaign in which they pointed that Albert Einstein left all of his pension investing to TIAA-CREF. He was a professor and they're a pension fund for professors.

 

Einstein didn't think he could beat the market and Mr. Schwarzman very candidly pointed out that he didn't have the greatest math scores. Isn't that how he put it? He said he was no math genius and you think finance requires a lot of math, but I think that it's something about practical intelligence. Psychologists have talked about different kinds of intelligence [power point discussion/trouble] But, remember Carl Icahn, when he talked to us, said something about he always just had some--he was always just good at making money. I think that there are separate talents. I mean, some people love markets and they like to think about them and figure out how they work. If they have the right kind of intelligence and the right kind of spirit to do the work, they ought to be able to beat the market.

 

I've talked to Icahn a number of times and I have the idea that he's a very down-to-earth, solid, inquisitive sort; he wants to know what's going on. When I've talked to him, sometimes he'll ask the same question of me; he's trying to get information from me. He asks the same question from me three different ways because apparently my answer isn't satisfactory and he must think I might know something because he keeps asking. But, I think that's the kind of persistence--certain personality traits--persistence at trying to figure out what really makes things work is important in these markets. I think it's just relish or inclination to keep thinking about them, so maybe that's why I went into economics as a professor. I don't know that I really was someone who wants to watch the markets all day; so, you have to judge your own interests. Anyway, it was very nice that we got--that Steve Schwarzman came and told us about his life's work.