Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Mon, 27 Dec 2010

Einstein Nobel futures contract

Last week FiveBooks carried an interview with well-known Einstein biographer, Walter Isaacson, reviewing his favourite five books on Einstein. Isaacson discusses a very interesting futures contract related to Einstein’s Nobel Prize:

This is a great piece of writing and of research about Einstein’s relationship with his first wife who served as his sounding-board in the miracle year of 1905 when he discovers special relativity and lays the groundwork for quantum theory. Mileva Maric was a physics student at Zurich Polytechnic, and when she and Einstein met they fell madly in love.


When the passionate relationship exploded and Einstein wanted a divorce he couldn’t afford the money Maric wanted to raise their two boys. So Einstein says to her that one day he’ll win the Nobel Prize for his 1905 work and if she gives him a divorce he’ll give her the prize money when he wins. She takes a week to calculate the odds and consult other scientists, but she is a good scientist herself and she takes the bet. He didn’t win until 1921 but he did give her the money and she bought three apartment buildings in Zurich.

I was aware that Einstein gave the prize money to his first wife, but did not know that there was actually a futures contract (or more precisely a forward contract). Wikipedia has more details about the transaction. As I think carefully about it, this futures contract is actually quite hard to value:

Despite all these difficulties, the fact is that Mileva Maric was able to arrive at a reasonable valuation and conclude the negotiations. It is interesting to read that the information asymmetry was resolved not only by her own competence as a physicist, but also by consulting other scientists. This is similar to the use of rating agencies in debt markets.

In the real world, instruments do end up getting valued despite the theoretical difficulties involved. One of Einstein’s famous quotes is probably relevant here with suitable modifications: “God does not care about mathematical difficulties, he integrates empirically.”

Posted at 18:02 on Mon, 27 Dec 2010     View/Post Comments (8)     permanent link

Sat, 25 Dec 2010

Self promotion

My blog has been listed among 50 Best Business Professor Blogs by The list includes 15 blogs on finance and accounting. If one excludes the accounting and personal finance blogs, the list is even shorter. Perhaps too few finance professors are blogging.

Posted at 05:10 on Sat, 25 Dec 2010     View/Post Comments (12)     permanent link

Fri, 24 Dec 2010

Hard to act against systemic risk

Richard Bookstaber says in an interview yesterday that it is not difficult to detect systemic risk – the hard part is to take useful action against it:

But I don’t think systemic risk is hard; at least monitoring systemic risk is not difficult. Nobody can hide risk of that magnitude. It’s there to be seen. As I already mentioned, it is taking action that is difficult.

I entirely agree with this assessment. For example, in Indian banking (and many other parts of the financial sector), it is not at all difficult to see that infrastructure finance is a big systemic risk:

In short, it is the classic tail risk mitigated by the high likelihood of a sovereign bailout. It is simply not in the interest of anybody (lender, borrower, regulator or government) to do anything about it.

Posted at 15:59 on Fri, 24 Dec 2010     View/Post Comments (4)     permanent link

Fri, 10 Dec 2010

Financial history books

In my blog post more than a month ago on books related to the global financial crisis, I promised to post a list of books related to financial history. One of the lessons from the crisis was that practitioners, regulators and academics in the field of finance need to have a good understanding of financial history.

If you wish to read only one book on financial history, I would recommend A History of Interest Rates by Sidney Homer and Richard Sylla. This book covers the evolution of credit markets over 5,000 years and is packed with charts and tables about interest rates across space and time. It was from this book that I learned for example that credit predates money and probably predates barter.

Another important book is The Early History of Financial Economics, 1478-1776: From Commercial Arithmetic to Life Annuities and Joint Stocks by Geoffrey Poitras. I found it surprising that so much of financial economics including net present value and expected utility had been developed prior to Adam Smith and the Wealth of Nations. Poitras also covers the early development of the stock market in Amsterdam and has extensive extracts from Joseph de la Vega’s pioneering book Confusion de Confusiones of 1688.

I was fascinated by The Origins of Value: The Financial Innovations that Created Modern Capital Markets edited by William N. Goetzmann. This wonderfully illustrated book covers financial innovations from ancient Mesopotamia and China to the modern world. For example, it describes how Benjamin Franklin printed United States government bonds at home introducing technical innovations designed to make counterfeiting difficult.

Manias, Panics and Crashes: a History of Financial Crises by Charles Kindleberger would probably be the favourite financial history book for many academics. It is also one of my favourite books – I have been fond of saying that one must approach the study of finance with Ito’s lemma in one hand and Kindleberger in the other. In this list, I have ranked it lower for two reasons. First, it is more a theory of financial crises than a history. Second, it covers only the period since modern financial markets developed in Holland in the late 16th and early 17th centuries.

For an institutional perspective of financial history, I enjoyed The Origins and Development of Financial Markets and Institutions: From the Seventeenth Century to the Present edited by Jeremy Atack and Larry Neal. I also learned a lot from Meir Kohn’s forthcoming books on commerce and finance in preindustrial Europe (draft chapters are available on his website)

In my post on crisis related books, I mentioned This Time is Different: Eight Centuries of Financial Folly by Carmen Reinhart and Kenneth Rogoff but I must mention it again here. This book is more of a macroeconomist’s view of financial crises than a financial economist’s view but the wealth of data and analysis in this book make it indispensable.

Among the books that I read but did not enjoy as much as the above books are:

Turning to the financial history of the 19th and 20th centuries, there is a wealth of material that is available on each country and each period. Among the books that provide an interesting multicountry perspective, I would like to mention:

I believe that the plural of biography is not history and have therefore not included the numerous books that have been written about individual banks and bankers. For example, Niall Ferguson is absolutely outstanding in his two-volume book on The House of Rothschild. There are also many good books on the House of Morgan and on the Medici, but I have not seen any on the Hopes of Rotterdam/Amsterdam.

Posted at 11:14 on Fri, 10 Dec 2010     View/Post Comments (7)     permanent link

Thu, 02 Dec 2010

Where is the rupee-dollar market?

In two blog posts three months ago, I put together data from the BIS and the RBI to suggest that half of the rupee-dollar market is outside India. Now we have the data from the BIS. Table D.6 gives the location wise break up of the rupee-dollar market: 50% is in India, 16% is in Singapore, 12% in UK, 11% in Hong Kong, and 9% in the US with the balance scattered across four countries (Switzerland, Australia, Japan and Canada) each with less than 0.5%. The offshore market exceeds $20 billion a day.

One of the reasons most people underestimated the size of this market is that they were looking only at Singapore, while the market is spread across several locations.

Posted at 15:39 on Thu, 02 Dec 2010     View/Post Comments (3)     permanent link