Because I just started writing, I feel the need to do some explaining. In this case, as I mentioned, I’m doing a PhD. Let me explain where and why. If you are considering doing a PhD this and other related posts might be useful. It’s a fun enterprise but it can definitely be a bit franctinc
I’m doing my PhD in London. The reason for this is that I was living and working in London when I started it so it made sense to do so. Going back a step more, I enjoy living in London because there’s always something to do, whether intellectually or just for fun. There’s always some conference, some exhibition, a concert or a restaurant that you haven’t experienced. There are people from all places, cultures and walks of life. It’s difficult to be bored and easy to find people who politely disagree with you. I had also concluded my education here so it made sense to stay in the system. I’ve chosen Birkbeck for the same reasons I chose it for a masters and was more affordable than the LSE, where I had studied previously. It is appealing to me because it targets working students so it made sense for me to go there in order to continue working at the same time as I am doing research.
The main topic of my research at the moment is preferred habitat theory, which is at the intersection of macroeconomics and finance, at least the way I’m going about it. I was prompted by my experience while working as a fixed income analyst for sovereign markets. This is just the title of someone whose job it is to look at public debt and how national/state/municipal governments, agencies and international organisations finance themselves in bond markets. Every day the company I worked for received a lot of reports about what was happening in “the market” and in order to do my job I had to read at least a fraction of these. I generally focused on BNP Paribas and Unicredit, but also included the odd long term report from Deutsche Bank and Barclays. Stuff from across the pond was less usual, so I did not get much exposure to what American investment banks thought. This is mostly due to the fact that they tend to charge for their reports.
Anyway, I found that on the same days different investment banks gave you different explanations for on the same events from. Also, every-so-often I got the impression that the same analysts or at least the same investment bank would give you different explantions for similar events taking place in different days. Basically, I kind of thought everyone was riding either the prevalent narrative in the market or that people were trying to push the story their bank was coming up with. Kind of like when Goldman came up with the BRICS and for about 3 years all you heard about was the BRICS (it’s still something people through around a lot, although for the life of me I don’t know why you’d put all those countries together, other than that they are geographical leaders of their region… Always seemed more of a geo-political thing than anything else, but I digress…)
I realised that I could tell myself a story and tell other people the same story convincingly. However, seldomly did I come to different conclusions than the rest of the market. There were some marked exceptions, such as my prediction that the Euro-Zone would not collapse, that France’s funding costs were not about to explode through the roof and that Abenomics was going to work for Japan and at the very least it was not going to generate hyperinflation. Whether Brazil and China are going to have enormous recessions is still in the waiting stages, but put so bluntly I cannot but be right, given the nature of the business cycle. Of course the trick is to see whether the real estate market is a bubble waiting to burst in China and what effect this will have on the country’s internationalisation of its currency. Similarly, the trick will have been in predicting that bankruptcies come crashing onto the head of the Brazilian state development banks who will run to the federal government whose off-balance sheet accounting efforts will suddenly come crashing down on them in a multi-billion house of cards collapse. But we’ll see.
Either way, regardless of long-term structural discussions, on a daily basis, my interpretations of the volatilities of the market were pretty much along the market consensus. The publication of US jobless benefits claims from the Bureau of Labour Statistics, PMIs from Markit, Consumer Confidence, Producer Confidence, central bank meeting and speeches by governors and other board members, auctions, redemptions, holidays and cyclical effects tended to account for everything. Every-so-often EU Council meetings, Russian military movements and the Iranian election would creep in, but mostly it was stuff like this. However, two other things crept up:
First, technical analysis seemed to permeate most investment advice. People tended to focus on Moving Averages (MA) and talked of “Convergence” and “Divergence” and of the MACD. They talked about candlestick charts and discussed what market participants were going to do, based on fibonacci retracements, support and resistance, which as a dear colleague of mine at the time said was the economics/financial equivalent of trying to see where the wind was blowing. There was no real theoretical explanation for why it should work, other than that everybody experienced the same wind and measured it the same way. Basically everyone believes in it so it has been factored into the pricing algorithms.
A second type of reports would discuss the term structure of the yield curve, which is market talk for why certain maturities do something or other. Again flow was important, but this is where preferred habitat coincided with my job. Every-so-often someone would say that the price moved up or down because pension funds came into the market or because they had gone somewhere else. Other times it was insurance companies, or banks seeking to satisfy Basel III requirements or Dodd Frank. Other times it was quantitative easing or in the case of the USA and Germany, flight to safety. Anyway, the point was that according to some people’s narrative investors mattered, and different investors reacted differently or at different paces. But really, I never came across any good explanation for why certain investors behave in a certain way. So that got me wondering…
At the same time, when I started working the Euro-Zone was still going strong. We had just reached the point where it became fashionable to talk about flight-to-safety and about yield hunt. So some days, Italy was attractive because it offered some yield, but Germany was also attractive because of flight-to-safety. This is all about framing effects. Italy’s yield was supposed high because Italy was a poorer credit than Germany. The risk of default was higher so people wanted to pay a lower price for the asset, which led to higher yields. At the same time, the safety of Germany mean people were willing to pay a lot for it, which pushed yields down. Across the Adriatic and/or the Aegean sea meanwhile, the Greeks were a terrible credit and no one wanted to lend to them. Clearly there was a threshold that Greece had crossed, but no one really bothered to explain why Italy’s boon was Greece’s plague and why contradictory drivers brought investors to Italy and Germany. It made no sense, but no one seemed to mind.
Well eventually it started to bother me and I couldn’t find an answer in my spare time. Also I started getting pretty bored with my job, which I’d like to think is a sign I had gotten good at it. So as a result I enrolled on the PhD programme and here I am.
Eventually I did quit my finance job and since then a lot of other work has come my way, but I’m still looking for the answer to those questions and I would like to eventually return to the financial sector. In the aftermath of the financial crisis, plenty of research is being conducted into finance and its connections to macroeconomics, so it’s an exciting field. There’s plenty of research on financial multipliers, market imperfections, market responses to data and central bank news, and as I came to find out, some models of financial intermediation, investment and investor behaviour and others.
So what have I been doing? Mostly collecting data, learning how to model the term structure of the yield curve, learning about DSGE, Impulse response functions, Bayesian estimation, Kalman Filters, Markov Chain, Montecarlo similation and probabilities. Which is to say that for the last year I’ve conducted very little research and instead have taught myself plenty of quantitative techniques. Anyway, as I’m approaching the end of that learning process, I’ve decided to consolidate some of those files, and post them and comments on them here, just because otherwise I’ll lose them when the inevitable computer crash will happen.
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