The Evolution of the Capital Asset Pricing Model: How an Economic Model Evolves and Improves

by Calvin Price

In 1964, William Sharpe and John Lintner developed a formula called the Capital Asset Pricing Model (CAPM) for predicting the pricing of stocks. It was mathematically simplistic and intuitive; it asked the right questions; it was an immediate success in the economic community. It was taught in virtually all business schools as the stand-alone method for pricing stocks. There was just one problem with the model: it didn't work. 

Models attempt to simplify the real world, find a rule, and then apply that rule in reality. Through this stringent means of testing and retesting, hypothesizing and theorizing – applying the scientific method - researchers can find rules that govern economics. To reduce the complex system of variables that apply in any situation into a linear formula is no easy task – but it is especially difficult, and probably impossible to do so for the stock market. The stock market is subject to a complex scheme of crowd psychology, moods, global affairs, and seemingly unrelated topics all have the potential to shift prices. It is highly doubtful that any theory would be able to accurately measure these effects and create a theory from that.

In 1994, a famous investment company called Long-Term Capital Management (LTCM) was founded and was praised as being the largest gathering of academic and practical knowledge on the stock market in existence. It had several Nobel Prize winners, professors from prestigious academic institutions, and weathered pit traders and quantitative analysts from Wall Street. They enjoyed risk-free borrowing from banks and had access to the latest technology. Within three years they were hailed as possibly being the greatest investment company ever founded having made unheard of returns on investments. In 1998, the company flamed out of existence in a period of less than a month in a relatively non-volatile market. They are one of the most well known examples of trading errors, are frequently examined in case studies, have been the subject of a book and numerous academic articles, and relied heavily on the CAPM.

The Shifts and the Shocks: Lessons of the Global Financial Crisis

By Viva Avasthi

"In economic terms, the only other disaster that matches this is a world war. [...] This wasn't some minor event. We will be living with the consequences of this possibly forever."

The quote above is from Martin Wolf, the associate editor and chief economics commentator at the Financial Times, specifically from the highly passionate and immensely thought-provoking lecture he delivered at the University of Birmingham on Wednesday (5th October). Mr Wolf is, as his Wikipedia page puts it, 'widely considered to be one of the world's most influential writers on economics' and so it was with great excitement that I came to listen to him speak on what he is most passionate about: the financial crisis of 2008. I was not disappointed.

In outlining the key arguments which shaped his lecture, I will follow the same structure which he did by looking first at where we are post-crash, then how we got here, and finally what we should learn. Along the way I will insert my own comments and also some references to books, videos and ideas which I feel have already contributed well to the existing debate and which you readers may want to look into. In an effort to keep this article of a moderate rather than excessively long length, I have taken the liberty to condense Mr Wolf's arguments as much as possible, so please do forgive any ambiguity present. Comments are, as always, very welcome and I will be delighted if you make the effort to share your thoughts with me.

Quantitative easing? What's that?

by Viva Avasthi

This diagram shows the first part of the quantitative easing process.
Credit to awadvisors.com

You've probably heard of 'quantitative easing' when listening to the news, or read a bit about it and its implications while perusing various newspapers. It may have sparked your interest, but you might have found that in trying to do a little research on the topic you ended up having masses of technicalities to understand and opinions to wade through. If that's the case, you'll hopefully find this series useful.

The most recent reportage on quantitative easing (also known as QE) involved the US Federal Reserve's announcement in June of this year that it would scale back on its QE, and then its unexpected decision last month to postpone the scaling back. Both announcements (in June and in September) drastically affected markets and the economies of countries outside of the US, most notably India and China. The impact of the use of QE in the US will be explored in more detail in another article; this article will look at how QE works, when and where it was developed, why it's used and what the perceived risks of its usage are.

Although the theory, which I shall explain shortly, is quite straightforward, QE is fairly complex when applied to and analysed in the real world. The reason for this is that it depends upon what Keynes referred to as 'animal spirits', whether other countries are also using QE and how clear the channels which QE works through are, among other factors which can be difficult to predict and influence. That's one of the reasons why predicting the success of QE has been difficult in the past and why many people believe that QE has not been an effective policy tool at all.

Osborne to Re-set Banking System

by Karina Shooter

Photo courtesy of www.guardian.co.uk and Andy Rain/EPA

Today at JP Morgan, George Osborne announced that 2013 would be “the year we re-set our banking system”. He is forcing big banks to ring-fence their riskier investment banking operations from their retail operations, threatening that those banks which fail to comply will be separated completely.

But what does ‘ring-fencing’ mean? At the moment the investment banking division of big banks uses money from their high street operations (i.e. the money that we put into our current accounts)  to fund their riskier investments. This is what happened during the financial crisis of 2007, which meant that the government was forced to bail out banks with tens of billions of the tax payers’ money, otherwise the money which people had saved in high street banks would have been lost. In the new system, investment divisions will have to have enough money in their own accounts to fund riskier investment strategies, therefore they will put the taxpayer and the economy in a much less dangerous position.

Just Google It...

by Karina Shooter

How Google searches can predict economic indicators and give us an accurate picture of today’s economy

Up until recently, Central banks have only used official data when calculating and predicting economic indicators such as unemployment, housing starts and consumer confidence.  However official data is published a significant time after it has been collected (usually at least a month) which means that bankers found it difficult to calculate up-to-date predictions. How could bankers determine the present and future state of the economy, using figures that were only a reflection of the past? As Brynjolfsson, a professor at MIT, said “When central bankers were looking at traditional data, they were essentially looking out the rear-view mirror.”

However research has emerged which suggests that by analysing Google searches, we can obtain a clear picture of today’s economy as well as being able to accurately predict future cycles. For example, when trying to estimate unemployment figures, researchers found that by calculating the proportion of Google searches which contained key words such as “JSA” (short for jobseeker’s allowance), “jobs” and even “solitaire”, they could accurately calculate figures that almost exactly matched the official data when it was published weeks later.

How Will The Rise of the BRICS Affect Us?

by Viva Avasthi

On Saturday 27th October I attended a lecture on the rise of the BRICS (Brazil, Russia, India, China, South Africa) as part of the University of Cambridge's Festival of Ideas. 

The speakers were:

Jaideep Prabhu
University of Cambridge
Judge Business School

Isabel Hilton

Journalist

Martin Jacques
Author
'When China Rules The World'

Michael Keith
University of Oxford

 In this series of six articles...

I will be presenting the economic development of each country from the BRICS in detail by addressing the three questions posed below. In order to do this, I will use my research as well as the opinions of the aforementioned speakers.

1. Why have the BRICS experienced such rapid economic growth?
2. How has this affected us?
3. How will this affect us?

The first article in the series is on Brazil, since it is the 'B' in 'BRICS'.

The final article will be an overview of how the BRICS have affected us and will affect us as a group of countries.

The graph below highlights the fact that there has most definitely been a rise of the BRICS. 



This graph measures the GDP based on the PPP (Purchasing Power Parity, which accounts for differences in spending power available through different currencies) of each country rather (than the more common) GDP based on current prices. 

I have included the data on the US, UK and Germany so that the BRICS can be compared to other non-BRICS countries. Please move your cursor over the graph to see the various statistics.

The Legend of Apple

by Shireen Avasthi

Why is Apple so popular? There are so many companies out there that sell products many people consider to be better than Apple's, not to mention much more affordable. What is it that attracts people so much that they end up buying such ridiculously priced merchandise? In this article I will be exploring what makes Apple popular and what makes them currently the most valued company in the world.

Made In Britain: Book Review (Part 2)

by Viva Avasthi

Last time, we left 'Made in Britain' halfway through, with a detailed analysis of the first and second parts of the book. In this article, Part 3: Intellectual Property will be explored. Part 4: Services will be reviewed in the final of this series of  three articles.

To allow this review to make better sense, I think it is best to mention what intellectual property is. Intellectual property is a term categorising the ideas that are created by our minds and have some commercial value. Examples of intellectual property include films and music as well novels, architectural designs and scientific inventions. Developed countries tend to have a 'Harry Potter economy' which means that the creativity and originality of the comparatively well-educated public is used to create intellectual property, which helps the nation generate its income (as opposed to manufacturing which can be done by fairly basic economies).  That's not to say that manufacturing ceases to remain important, of course. In this section, Davis mentions that some forms of intellectual property effectively combine with manufacturing in the UK.

Clever Scheme or Immoral Scam?

by Karina Shooter

 Ironic? Jimmy Carr has already been in the media spotlight for his UK tax avoidance schemes, now Starbucks is following in his footsteps… Photo courtesy of London 24

Amazon, Facebook, Google, Starbucks, Ikea and eBay – just some of the major corporations who have been in the news recently because of their UK tax avoidance schemes. Although their clever tricks and cover-ups are absolutely legal, we are left wondering whether their actions are morally questionable. 

The Facts and Figures

• Over the past three years Amazon has generated more than £7.6bn of sales in the UK but has paid no corporation tax on the profits of these sales.
• Facebook paid only £238,000 in tax last year in the UK despite making an estimated £175m in sales. 
• It has been revealed that, despite earnings of £3bn in sales since 1998, Starbucks has only paid £8.6m in UK tax in the last 12 years. Last year it generated £398m in UK sales but paid no corporation tax.
• EBay’s UK division has paid just over £1 million of corporation tax, despite generating sales of almost £800 million in the UK.

Made In Britain: Book Review (Part 1)

by Viva Avasthi

Before I read this book I wasn't sure how the British economy plans to sustain itself, considering the fact that we are only just coming out of a double-dip recession and there are always complaints about how little we manufacture compared to China and Germany. Although it is quite clear that Britain had the clear economic advantage over other countries during the times of the British Empire, what Britain has exported after that had been fairly unclear to me, especially since the media portray the image that Britain does not export very much at all.

I found very well-explained answers in Made In Britain, by Evan Davis, which has provided me with an excellent overview of how Britain's economy is structured as well as how it has developed into what it is and what the outlook for Britain's future is.

The book is made of four main sections, and I will be stating my opinions on what the most interesting and relevant ideas in each section were. Please note that I will only be giving summaries and so I highly recommend that you read the book for yourself for a more detailed explanation of the ideas I mention. This review has been split into three parts and the first part stops at the end of half of the book. The second part of the book review covers Part 3: Intellectual Property and the third part of the review covers Part 4: Services.

End of the Eurozone Crisis?

by Karina Shooter

An announcement has been made by Mario Draghi, the President of the European Central Bank, which could potentially mark a major turning point in the Eurozone crisis. Draghi announced that the European Central Bank (ECB) promises to provide unlimited support to troubled Eurozone countries such as Spain and Italy.

Mario Draghi  Photograph by Mario Vedder/dapd/AP Photo

Draghi's plan is to remove the limit on the number of bonds that the ECB can buy from governments in troubled countries, which would cut those countries' borrowing costs. However there is a catch - Nations would first have to request help from the ECB as well as accept new conditions including an austerity clause. This may cause problems for countries such as Spain, where riots continue at the prospect of a bailout.

Although markets soared when the announcement was made, critics from the German Central Bank say that Draghi's plan is not a long term solution and is just propping up governments.

The announcement has taken away some major question marks about who's responsibility it is to support the Euro when it is under pressure. Governments have failed at this task, and it is now the ECB's turn to see if they can offer the protection and insurance that the Euro badly needs.

Following this announcemnt, one thing is for certain, I definitely won't be making any bets that the PIIGS (Portugual, Ireland, Italy, Greece and Spain) will default on their debts or bail out of the Euro any time soon.

The LIBOR rate scandal - Is Barclays solely to blame?

by Karina Shooter

On Friday, Barclays announced that Anthony Jenkins would be Bob Diamond's successor as CEO. It seems that months after the LIBOR scandal broke out, Barclays is still the only bank whose public reputation is being destroyed - Barclays shares have plummeted by over half compared to its peak rates before the scandal. But is Barclays solely to blame for fixing the LIBOR rate? 

Barclays shame: Boss Bob Diamond has given up his bonus after the bank was hit by a £290m fine. Picture courtesy of thisismoney.co.uk

When the chips are down, the trades are up!

by Daniel Hearn

Poker – a game of luck where the player with the strongest hand always wins, right? Well, not always and in fact it can be very rare that the strongest hand actually does win! So surely, this doesn’t relate to modern day trading where other peoples’ money is invested. You’d be surprised! Poker (a bluffing game of luck) is seen by many as having direct links with trading…

Stephanomics Review: Whose fault is the economic crisis?

by Viva Avasthi

"Who deserves most blame for the financial mess we're all in? Is it the bankers? Or should we also save some time for the economists?"

Stephanie Flanders, the BBC's Economics Editor, asks these questions in an episode of Stephanomics, her programme on economics. The episode reviewed here focuses on the economics of the global financial crisis and the problems regarding the Eurozone. This article is, in sorts, a summary of the discussion Stephanie Flanders had with the billionaire investor George Soros, Sir Howard Davies (former chairman of the Financial Services Authority and former deputy governor of the Bank of England), and Dr DeAnne Julius (chairman of Chatham House and a former member of the Bank of England's monetary policy committee). Only the discussion about the global financial crisis has been summarised to prevent the article from becoming too long. To read an article explaining the problems in the Eurozone, click here.

Dr DeAnne Julius

George Soros

Sir Howard Davies

GoCompare: Major Hate or Clever Scheme?

by Shireen Avasthi


Many of the British readers of this blog will have noticed GoCompare's new billboard advertisements - they're everywhere! If you haven't seen them, they look like this:

A Simple Guide to the Libor Rate

by Viva Avasthi

The biggest issue being discussed on British news lately is the Barclays scandal which involves accusations that the Libor rate was fixed by Barclays to make the bank falsely appear to be doing well. The questions that arose in my mind were, "What is the Libor rate?" and, "Why should I care if it's been fixed by Barclays?"


No doubt many of you have also been wondering what this mysterious but supposedly highly important Libor rate is. Alongside informing myself on the subject, I thought it might be good to clear up the facts for you as a reader, too. Don't worry though, this article won't be too long and it'll be fairly easy to get to grips with.

Sweatshops: a Curse or a Boon?

by Viva Avasthi

Sweatshops have been branded as places where the poor in developing countries are forced to work under horrible conditions for massive multinational companies such as Nike, for example. But is this really the case? Are there benefits to so-called 'sweat shops'?

Contents of Investigation:

1. Introduction
2. The problems with sweatshops
3. An alternative approach to the issues surrounding sweatshops
4. Conclusion