Guiding Seminar II

Question 1

Hedge Funds: Past, Present, and Future (Stulz, Rene M. (2007)

Answer 1

Main Question: Economic functions of hedge funds and mutual funds are the same – provide returns for investors, so why do both exist?

• Difference in regulation between hedge and mutual (hedge funds are unregulated)
• Difference in managerial compensation (hedge funds have substantially higher compensation)
• Difference in entry (need to be sophisticated and rich investor to enter hedge funds)
• Hedge funds have different strategies (long and short positions, event driven, macro arbitrage, fixed income arbitrage)
• Top hedge funds tend to outperform mutual funds

Future expectations for hedge funds: more regulators attention as industry grows, will perform worse in the future due to more participants, will gain more institutional investors who will restrict them.

Question 2

The microeconomics of cryptocurrencies (Halaburda, Hanna, Guillaume Haeringer, Joshua Gans, and Neil Gandal (2021)

Answer 2

Main Question: What drives supply demand, price and competition of cryptocurrencies?

Supply: Hefty rewards incentivize competition between miners, bitcoin is susceptible to double spend attacks given that some entity has substantial hashing power. Authors discuss mkt. design choices (Proof of work and Proof of stake)

Demand: Lack of trust in banks does not seem to be the primary driver of crypto. Bitcoin has likely gone through 3 phases of use (early, illegal, business)

Price: Currently a speculative asset, does not serve well as a store of value. Price better predicted by innovation than chatter.

Competition: when bitcoins price moves the price of other cryptocurrencies moves to a greater extent, a lot of pump-and -dump schemes.

Question 3

Blockchain Analysis of the Bitcoin Market (Makarov, Igor, and Antoinette Schoar (2021))

Answer 3

Main Question: How should regulators deal with bitcoin? What it is used for?

• 90% of bitcoin volume is a byproduct of user’s preference for anonymity, (75% of remaining 10% linked to exchanges, 3% to illegal activities)
• Know-Your-Customer restrictions imposed on exchanges can be bypassed
• Mining capacity is highly concentrated (Top 10% of miners control 90% of hashing power, majority of power is in China)
• Wealth is concentrated (Top 10k investors hold 30% of all bitcoin)

Question 4

Towards a Political Theory of the Firm (Zingales, Luigi (2017))

Answer 4

Main Problem: Companies in the current day are larger than many countries. Political power becomes concentrated.

• Example of East India Company – a 15 year monopoly right that lasted 233 years
• Growth in political power results in Medici vicious cycle (mkt. power gives competitive advantage at gaining political power and vice versa)

Conclusion: Have to maintain a goldilocks balance where government is not strong enough to expropriate corporations but not weak enough to allow for corporations to define laws.

Question 5

A 30-Year Perspective on Property Derivatives: What Can Be Done to Tame Property Price Risk? (Fabozzi, Frank J., Robert J. Shiller, and Radu S. Tunaru (2020)

Answer 5

Main Problem: Movements in property prices possess severe risks to their holders, no well-established derivatives market for property prices.

• Derrivatives, can help to infer information about future prices
• Allow to hedge against housing price risk
• Can get exposure to real estate without owning it

Conclusions: There are large obstacles to derivative mkt. for real estate. Mainly: negligible liquidity, index construction mismatch, creating a pricing model is a challenge, regulatory issues.

Question 6

Prone to Fail: The Pre-crisis Financial System (Duffie, Darrell (2019)

Answer 6

Main Question: What made the financial system in 2007 so fragile, what are the remaining issues?

Causes: Weakly supervised balance sheets of largest banks, large dealers relied inadequately on short term funding, weak regulation, reliance on mkt. discipline (self-governing). Repo’s and CDO’s.

Response: shift to clearing houses (mitigating risk), largest banks are under supervision of Fed, reduction of unsafe practices.
Remaining: clearing houses are the new too big to fail, some unsafe practices will come back in time

Question 7

Moore’s Law versus Murphy’s Law: Algorithmic Trading and Its Discontents (Kirilenko, Andrei A. and Andrew W. Lo (2013)

Answer 7

Main Question: Review of the emergence of AT and associated risks

• Moore’s law – total Mcap of US stock mkt. has been doubling every decade
• Murphy’s law – whatever can go wrong will go wrong
• Quantitative finance, arbitrage activities and push for lower costs has given rise to AT
• 2007 Quant meltdown – successful hedge funds suffered record losses due to a feedback loop in automation
• 2010 Flash Crash - biggest one-day point decline due to the fact that, frequency traders began to unwind long positions quickly, when liquidity was sparse
• 2012 Facebook IPO – Due to high interest in shares, NASDAQ system was trying to recalculate price while offers/cancellations kept coming, resulting in a loop
• 2012 BATS – cancellation of an IPO due to a ticker symbol bug in the system, making the stock inaccessible on the BATS system
• 2012 Knight Capial – bugs in new software resulted in significant price swings for 150 stocks, company had to liquidate positions

Conclusions: Financial regulation cannot keep up with the technology, authors propose financial regulation 2.0 (complex systems, safegurads, transparency and platform-neutral)