Archive for March 12, 2008

Big Corn

March 12, 2008 by Tom Armstrong.

Walter Williams on Big Corn and Ethanol.

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TIPS estimated inflation expectations

March 12, 2008 by Tom Armstrong.

Using TIPS to predict inflation.

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CDS indexes

March 12, 2008 by Tom Armstrong.

The purpose of this paper is to study iTraxx CDS indexes and their relationship with the stock price movements of the underlying entities making up the indexes. Conclusion:

One interesting finding in this paper is the significant positive autocorrelation present in all the studied iTraxx indexes. This is possibly an indication of an inefficient iTraxx CDS index market where index changes are predictable. The economical significance of profitsfrom trading strategies exploiting such regularities, however, is an interesting issue left for future research.

Moreover, significant correlations between iTraxx CDS index spreads and spread changes on the one hand and stock prices and stock returns on the other hand reveal a close link between the two markets. CDS spreads have a strong tendency to widen when stock prices fall and vice versa. Furthermore, in OLS regressions, both current and lagged stock returnsare found to explain much of the variability in CDS spreads. This suggests that firmspecific information is embedded into stock prices before it is embedded into CDS spreads. Hence, the stock market seems to lead the CDS market in transmitting firm-specific information and this is important information for arbitrageurs and others. Again, it is a possible indication of an inefficient European CDS market.

Stock index return volatility is also found to be significantly correlated with iTraxx CDS index spreads; the spreads are found to increase (decrease) with increasing (decreasing) stock volatilities. The link is particularly strong for 3-month historical volatilities. These results are in line with the theoretical literature on credit risk that emphasizes the importance of stock volatility for default probability predictions and it is further evidence of the importance of volatility forecasting in credit risk modelling.

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Obama’s proposed tax hike on high-income earners

March 12, 2008 by Tom Armstrong.

Mr.Obama has proposed lifting the SS cap on high-earners, now at around $100,000 per year. Notable:

The U.S. already collects far more Social Security taxes from high earners than other countries do. Social Security taxes here are currently capped at about three times the national average wage — far above other developed countries. In Canada and France payroll taxes are levied only up to the average wage. In the United Kingdom, taxes stop at 1.15 times the average wage; in Germany and Japan at 1.5 times. Social Security is already more progressive than these countries’ pension programs, and Mr. Obama’s plan would make it more so.

Here’s what Bill Clinton said about it as president:

President Bill Clinton considered lifting the wage ceiling modestly, but was skeptical of eliminating it outright. Doing so would “tremendously change the whole Social Security system . . . We should be very careful before we get out of the idea that this is something that we do together as a nation and there is at least some correlation between what we put in and what we get out,” Mr. Clinton said in 1998. “You can say, well, they owe it to society. But these people also pay higher income taxes and the rates are still pretty progressive for people in very high rates.”

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Expectations matter

March 12, 2008 by Tom Armstrong.

The Fed can’t fix home prices. It begins:

Is a housing bailout the solution for clogged-up credit markets and a faltering economy? What the Fed has been doing and did again yesterday hasn’t really worked, notwithstanding the pops it produces in the stock market every time it shovels liquidity into the system. The Fed’s latest move provides financial institutions another $200 billion in direct short-term lending against their unsaleable housing collateral. The Dow Jones jumped 416 points. But it won’t restart markets for the underlying collateral.

Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed’s liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.

To get to a real solution, speculators and investors need to believe that home prices are hitting bottom, that any mortgage debt they might buy today for 80 cents on the dollar today won’t be worth 30 cents tomorrow. Then the vultures will pile in: The transfer of wealth from the overleveraged banks and hedge funds to those who kept cash handy will be shocking, ugly and cathartic — but it will also be relatively quick. Credit markets will begin to function again. The economy will grow.

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