World Economic Forum Risks Landscape 2012

[World Economic Forum, Global Risks 2012]

The general theory of employment, interest and money

It is not too much of an exaggeration to argue that Keynes’ own 1937 review of The general theory of employment, interest and money is the actual masterpiece. In it, he explains quite lucidly the “comparatively simple fundamental ideas which underlie my theory” and in so doing, why, at least, the Book is titled the way it is. → Read More

Drug dollars


Source: Bernstein Research, The Long View: Pharma R&D productivity – When the cures fail it makes sense to check the diagnosis, September 30, 2010

Source: The Boston Consulting Group, Life Sciences R&D: Changing the innovation equation in India, 2011

Investing in risk

Ben Bernanke’s Op-ed in the Washington Post of November 4, 2010 outbluffed even the most subversive blogger. Quite unscrupulously the chairman of the Federal Reserve let it be known that the buying of hundreds of billions of dollars of freshly issued Treasuries was meant to prop up the stock markets. Volatility obeyingly fell to unhealthily low levels. Anyone smelt a free lunch? → Read More

Chapter 12

John Maynard Keynes’ The general theory of employment, interest and money (1936) is a controversial monument. But one chapter has become justly famous among friend and foe alike. Chapter 12, The state of long-term expectation, touches upon the heart and soul of  when to invest, what return to expect, why financial markets fluctuate and where the government’s role lies. → Read More

Keynes: reasoning with probability

What is probability?

Probability is the study of the grounds which lead us to entertain a rational preference for one belief over another. That part of our knowledge which we obtain directly supplies the premisses of that part which we obtain by argument. All propositions are true or they are false. Probability refers to a relationship with a corpus of personal knowledge, actual or hypothetical, and not to a characteristic of the propositions themselves. As our hypotheses change, our conclusions will have new probabilities, but relatively to these new premisses. It is the degree with which it is rational to entertain a belief that a particular proposition is true based on our – subjective – knowledge, our intuition: we know that proposition so-and-so bears a relation with a degree of probability such-and-such to the corpus. Such a probability is determined through the objective application of logical rules of inference, upon which arguments can be based and which can be perceived, between the propositions of our direct knowledge and our indirect knowledge. → Read More

Hume on mind and probability

Ideas and impressions

The outside world as we know it derives from our inner imagination. The impressions the senses convey form the basis of all our beliefs and our actions. To hate, to love, to think, to feel, to see; all this is nothing but to perceive. All of the sciences are thus related, to a greater or lesser extent, to human nature. → Read More

Is it worth the wait?

A company decides to invest in, say, an additional production line if the expected profit exceeds costs. In other words, the expected rate of return must exceed the company’s cost of capital. That is the theory, at least: fifty years ago.

In practice entrepreneurs have known for quite some time that the threshold to invest is markedly higher. According to a survey by former US Secretary of the Treasury Lawrence Summers CEOs discount project cash flows at rates amounting to three times the weighted average cost of capital!

Inversely, companies terminate loss-making projects only — and correctly — when revenue is far below (variable) costs. Textbook investment theory apparently deviates from entrepreneurial practice. Which crucial issue has been ignored? → Read More

The most telling risk profile indicator

If you were a banking supervisor, which public disclosure or internal bank report would be most valuable to you? The net duration of interest-bearing assets and liabilities? The average value-at-risk number for the reporting period? Or its Tier 1 capital ratio? If I were a banking supervisor, I would go for the employee compensation. → Read More

Entrepreneurial investment management

Introduction

The fruits of truly great minds never go out of season. They are cherished for the rarefied insights they continue to deliver when all of their contemporaries have long withered away.

Risk, uncertainty, and profit, Frank Hyneman Knight’s 1916 dissertation, undoubtedly ranks among these achievements in the field of economics. The essay makes a thorough investigation into the nature of profit and to whom it should accrue. Knight’s conclusions are well-known: it is the presence of intrinsic uncertainty in business decisions that allows for a difference between market price and production costs and which gives rise to a very particular class of economic agents — the entrepreneurs — who specialise in managing this uncertainty.

In this entry, we reread Risk, uncertainty, and profit with a particular business activity in mind, viz. investment management — the organisation of committing capital in order to gain a financial return. → Read More