Tag: financial markets

Redundancy in movies

I’m writing this while watching this Hindi movie called Cocktail, which is being shown on the pay-per-view Showcase channel on Tata Sky. Ten minutes after the movie started, I remembered this review of the movie that I’d read back when I was released, and thanks to that lost most interest in the movie. However, I continue watching, giving company to the wife, and reading papers and writing, as I watch.

The last Hindi movie I watched with any degree of seriousness was Gangs of Wasseypur (1 and 2), which is an absolutely mindblowing movie. While watching that movie, I remember that time moved insanely slowly. After what I thought was an hour of the movie, I looked at my watch only to realize that only half an hour had passed. Each part of the movie (which actually lasts about two and half hours each) felt like it individually lasted five hours! There was so much action that was packed into the movie.

So coming to the point of the post – the problem with most Hindi movies (not of the GoW variety) is that there is heavy redundancy packed into the movie. Each concept that ties into the main plot of the movie is explained so many times, most times not even through different means, that it is quite easy to miss a part of the movie and still be clued in to the overall plot. Not so with the GoW type, where there is absolutely no redundancy built in, because of which you can’t afford to miss even a couple of minutes of the movie, without losing part of the overall plot.

If you were to read Benoit Mandelbrot’s excellent book on the financial markets (The (mis)behaviour of markets), you would be introduced to this awesome concept of “trading time”. In the book, Mandelbrot explains that markets are not uniform – there are times when there is much more action packed into the markets (like the first and last fifteen minutes of trading every day) than in slower times (mostly around mid-day). Thus, to get a better analysis of the market, Mandelbrot explains, you need to look at it not from the point of view of “clock time” but from the point of view of “trading time”, which “measures time” by way of volume of trade.

Drawing an analogy, a movie like Gangs of Wasseypur is like a snapshot of the financial market during the opening 15 minutes of trading. At every moment in the movie, there is so much happening. Scenes are short, and cut abruptly, and say only what absolutely needs to be said. So you get much more “action” for each minute you spend watching the movie.

(Ok I realize that by repeating the funda in the previous paragraph, this post tends more towards Cocktail than GoW.) Maybe that’s why I don’t particularly enjoy most movies that I watch – there is so much redundancy I get bored. Problem with most mango people is that it takes too much mindspace to be focused through the duration of the movie, so they end up losing parts of the plot in movies such as GoW, and so movies such as these are not as commercially successful as slower paced movies.

Upendra’s Super is a funny movie, in terms of the pace at which it moves. The first two hours are full of theatrics, and unnecessary redundancy that makes you ask why you are watching the movie at all. The last half an hour, both in terms of content and the concept it gets across (property rights, concept of ownership, etc.) packs in so much that you leave the hall feeling satisfied. Maybe the two parts of the movie are aimed at different segments and Uppi seems to have cracked the formula!

The problem with real estate taxation

I spent a year working in an India-focused high frequency trading hedge fund. I used to trade stocks and equity derivatives there. We were primarily an arbitrage hedge fund, and our aim was to make money by trading on assets that were mispriced, in order to make riskless profits. For example, if the price of a certain stock at a certain instant was Rs 100 on the BSE and Rs. 99 on the NSE, we would buy the stock at the NSE and sell it at the BSE, simultaneously, thus making riskless profits. Contrary to what some of the “99%ers” say, we saw social value in what we did. We were making prices fairer for the rest of the market, and removing anomalies.

There was one big problem though, this beast called “securities transaction tax”. Every transaction in securities in India attracts this tax. While it seems to be a fairly small number, when you are trading large volumes and looking to arbitrage out wafer-thin margins, it ends up being significant. This tax, we figured, was a big hindrance in true arbitrage-free pricing of securities in India. The tax meant that assets could be mis-priced up to a certain limit, because wiping out that mispricing through a trade was unprofitable thanks to this tax. This “flow tax”, thus, makes financial markets inefficient.

The problem is bigger when it comes to real estate. Historically, property taxes have been really low, but property transaction taxes have been high. There is a good reason for this. Back in the old days where record-keeping was inefficient and incomplete, it was impossible for the government to map out who owned which piece of land. Instead, they figured that they would have a record on all property transactions, and thus put a tax on that. This is a worldwide phenomenon.

It has led to two big problems in India. First is the market inefficiency that I spoke about with my equities example. High transaction taxes means that property markets are illiquid, and this prevents more people from entering and investing in the market. This also means that any price changes in the broad market are not reflected easily enough across a vast majority of property. Secondly, the high transaction taxes means there is massive under-reporting of the actual prices at which transactions take place. Both the buyer and the seller have an incentive to do so, and deprive the government of tax money. This leads to creation of massive amounts of black money in real estate. The problem is similar to the creation of all those Swiss bank accounts back in the days of 99% marginal tax rates.

There is a side-effect also, one that our socialist-minded government and the National Advisory Council (NAC) might be sympathetic to. Low reported prices of land transactions also implies lower realization for farmers and other villagers when land is forcibly acquired by the government. Though compensation might be declared as multiples of the “market value”, the true market value in most cases is so depressed that farmers usually get paid a pittance.

That aside, so what prevents us from dismantling these distortionary transaction taxes on property? Firstly, they are a massive source of income to state governments and local bodies, and if they are to be dismantled they need to be replaced with another equivalent tax. Economists usually advocate property holding taxes as a less distortionary and more stable means of funding local governments. Till recently, however, bad record-keeping meant those weren’t enforceable. You already have nominal property taxes that are collected, but reports in newspapers suggests that implementation is lax, and there is significant tax evasion there.

Even if all property records are formalized and computerized, there is another major hurdle in dismantling property transaction taxes and increasing property holding taxes. Higher property holding taxes means that the value of property will see a sudden drop (lower “free cash flow” each year, and all that). Markets might become more efficient and liquid, but real estate companies who have sunk in millions assuming a certain valuation of their properties will see a sudden erosion in that value, and see value in lobbying against this change taking place. In the long run, they will benefit, in terms of greater investment, greater liquidity and faster disposal of the properties they have built. But the initial “shock” in terms of reduced valuations will mean they will lobby against this change.

Thus, unless something drastic happens in terms of reforms, it is likely that we will be stuck in this inefficient regime of high property transaction tax.

Cross posted at The INI Broad Mind

Travel agents and investment bankers

The more I think about it, the more I’m convinced that travel agents perform a very similar role to investment bankers. In the olden days, not everyone had access to financial markets. In order to buy or sell stocks, one had to go through a brokerage company, who would be paid a hefty commission for his services. The markets weren’t that liquid, and they were definitely not transparent, so the brokers would make a killing on the spread. With the passage of time, advent of electronic trading and transparency in the markets brokers aren’t able to make the same spreads that they used to. Customers know the exact market price for the instruments they are trading, and this results in brokers not able to make too much out of these trades.

It is a similar case with travel agents. Vacation markets (flights, hotels, etc.) are nowhere as liquid as financial markets, and will never be. Sometimes, when you are booking holidays to a strange place, you know little about it, and hence commission a travel agent to find you a place to stay there. Given that you know little about that place, the agent can charge you hefty commissions, and make a nice spread. Of course, nowadays such opportunities are diminishing for agents, as you have websites such as Agoda which allow you to book hotels directly. Now, at one place you can compare the prices of different hotels, and have better information compared to what the agents traditionally offer you. The spread is on the downswing, I must think.

Then, don’t you think package tours are very similar to structured products? Structured products are nothing but a package of several risks packaged together. By acting as a counterparty on a structured product, a bank (even now ) can afford to charge fairly hefty fees. Structured products are illiquid,  and there is no publicly available “market price”, so it is easy for banks to make themselves good spreads on such products. However, all it takes to defeat this is an intelligent customer. All the customer needs to do is to try and understand the risks himself, and start “unbundling” them. Once he unbundles the risks, he can now trade each of them independently, on more liquid markets, and get a much better price than what bankers will offer him. The catch here is that he’ll need to put in that effort in unbundling.

It’s the same with package tours. Given the bundles, it is easy for the agents to make higher spreads. However, if you as a customer simply unbundle the package (hotels, transport, food, etc.), you can find out the price of each (available on sites like agoda and elsewhere) and find out for yourself the spread that the agent is making. And then you compare the agent’s premium with the “cost” of making all the bookings yourself and make an informed choice.

Apart from communication, among the greatest boons of the internet has to do with dismantling middleman monopolies. It is incredible how much use a little information can be of!

Fractal life

Recently I finished reading Mandelbrot’s The (mis)Behaviour of Markets for the second time. Fantastic book. I think it is a must read for people who are interested in financial markets, and especially for those who work in capital markets. While it stays away from equations and “math”, and prefers to use pictures (or cartoons) to illustrate and show concepts (a method I definitely prefer to obscure math), it does raise a lot of very interesting fundaas.

So last week I was feeling stressed out. I realized that I had worked too hard on Wednesday and Thursday hence I got stressed out on Friday. A couple of months back, I took a couple of days of medical leave because I was stressed out. I reasoned that was because I’d pushed myself too hard the earlier two weeks. And thinking about all this today, I thought the incidence of stress has gone up over the last couple of months. This, I reasoned to pushing myself excessively for over a year now. And if I were to analyze my today’s work, I could probably say that I pushed myself too hard in the afternoon and hence got stressed out in the evening.

Same pattern, you see. At different scales.You get the drift, I guess. And stress is just an example I took. If I think about how my louvvu for my wife has evolved, again same pattern. There is a “global pattern”, and that same “global pattern” repeats itself over shorter intervals over the last two years. Irrespective of the quantum of time I look at, I see that same “global pattern” stretched or compressed to the appropriate time scale. In other words, love is also a fractal.

You can see fractals all around you. You can see self-similarity everywhere. And yet, even when you have small samples. you instinctively try to model it as a normal distribution. Without realizing that the “normal” distribution in life is the Power law.