The increasing interdependence between financial media and market participants

The picture above is of Jim Cramer, a financial news anchor, host of Mad Money. The one beaten up by  John Stewart  there and there. The whole clash is a must-see and is about the transmission of information. On one side, the financial news industry in the US and probably to a lesser extent in Europe is simplifying the complicated intricacies of modern financial sectors. Because educating wouldn't be good for ratings. This is about the diffusion of financial news to the wider public with the mask of entertainment. But the relationship between media and finance at the beginning of the transmission belt is problematic too. Oberlechner and Hocking studied empirically the linkages between financial journalists and analysts: 

More than two thirds of journalists agree strongly or agree that market participants can influence news providers (87%), that news media and market participants have become more dependent on each other (75%), and that the immediate reporting of events has significantly gained in importance vis-a-vis background analyses (67%). Sixty three percent of financial journalists agree that they depend on market participants to interpret news. More than half of the journalists agree that new technology has brought along an increased risk to report unverified news (59%), and that speed has become more decisive than contents in financial news reporting (55%). [...] Foreign exchange traders and financial wire journalists mutually rate each other as the most important information source. The most important informa- tion sources of wire journalists, their personal contacts at commercial banks, are also the main customers of the financial wire services. Consequently, information of the news services often consists of trading participants' perceptions and interpretations of the market, which are fed back to the traders in the market. As a result, a highly circular cycle of collective information processing in the market emerges. The finding that for non-wire financial journalists, the wire services are the most important sources of information further enhances this circularity of information gathering and disseminating in the foreign exchange market

 More photos of Jim after the jump.

Central banks and the media

A new study by the Swiss National Bank compares the two ways central banks have to reduce financial markets overreaction to their statements: "disclosing information to a fraction of market participants only (partial publicity) or by disclosing information to all participants but with ambiguity (partial transparency)". 

I would love to be able the comment on the mathematical formulas in it or, even better, refine it...but...

How to finance the missing middle

Debt or stocks ? Banks or equity markets ? As France fears for its petite et moyennes enterprises, whose access to bank loans is going to be more expensive, the chief executive of the London Stock Exchange Group insists that even small entreprises could be financed through equity. The biggest problem of financing SMEs is informational asymmetries, as the reason why they are financed by debt where the interest rate of the loan function as a risk management mechanisms. So Mr. Rollet seems to think simple disclosure would be enough:

The cost of satisfying disclosure requirements must be reduced, as well as the time required to bring an issue to market. A shelf registration system would allow companies greater flexibility, accessing the public funding markets while satisfying all applicable disclosure requirements. The recent US JOBS Act – Jump Start our Business Start-ups – is designed to reinvigorate access to equity funding for entrepreneurs. The UK needs its own JOBS Act.

He misses two points, to my opinion: 

1. He seems to equates information with knowledge. SMEs businesses are blurry and banks are reluctant to finance them if they do, the costs of capital - the interest rate - reflect the uncertainty inherent in any young business. But disclosing more accounting data or being more transparent will not reduce this uncertainty. The right equity investors for SMEs are the one capable of manufacturing knowledge with information. 

2. And that is why SMEs need finance accompanied with management and experience. So I don't think that the "hands off" approach to equity finance of SMEs through stock market that Mr. Rollet advocates is the right one. The "hands in" approach to private equity though, might be much more appropriate. New studies (NBER, University of Chicago) show that private equity contributes greatly to employment through SMEs growth. 

The costs of complexity II

The Economist underlines what I think is going to be a growing debate about financial regulation:  The push for simple rules:

But it did not do what a regulator charged with supervising exceedingly complicated institutions should: focus on the simplest rules possible where there is the least room for interpretation. Banks need to obey high capital standards, backed by robust leverage ratios that are not easily gamed.

"Boring banking vs fancy finance"

Krugman's aphorism describes more than a sense of nostalgia for the good old bankers of our parents. Boring banking had regulatory and "moral" implication advantages that fancy finance, for all the (alleged) efficiency it brings to financial markets, seems to lack. Matthew Yeglesias takes the latest LIBOR scandal to illustrate the point and concludes: 

The lesson of Libor is that regulators need to recognize that bankers have cast aside the clubby values of yore, and they need to respond in kind. Banks will try to abide by the letter of the law, but where loopholes exist, they’ll be ruthlessly exploited—through dishonest means if necessary—and the financial cops need to have a fundamentally suspicious attitude toward the regulated entities. Time and again, when tighter regulation of trading is proposed, the concern is raised that stringency will push activity to foreign centers. In the short run, that’s almost certainly true. Banks will want to move to wherever they’re most likely to be able to get away with more shady dealings. But an economic development strategy based on turning your country into an appealing location for dishonest banking is just going to get you a financial system that’s rotten with dishonesty. It’s time to stop being surprised and start realizing that these are the inevitable fruits of a regulatory system that’s weak by design.

High Frequency Trading and Market Quality

 A new report by Credit Suisse looks at the data and finds that HFT has not made markets worse off. Their chosen measures of market quality is volatility, spread, the messaging traffic and the risks of flash crash events. While one must applaud the effort of looking at a set of objective data, the report says nothing about allocational efficiency. Yes ! HFT certainly helps to bring down volatility, but it then means that HFT, like most financial innovation these past decades, helps allocating risk - and not capital.

Does finance has a natural size limit ?

The murky world of hedge fund suggests that there is some truth in it. From Bloomberg's interview with Richard Maraviglia, a small hedge fund manager who outperformed better-known rivals managing billion: 

“If you want strong outperformance, a smaller fund has a better chance of producing that,” said Maraviglia, who plans to close his hedge fund to new money after receiving commitments from investors for the $250 million. “How big an allocation can a big fund make to a great trading idea for it to make much of a difference in their total portfolio?”

 This points to a dilemma between the size and efficient captital allocation. Would the same reasoning be valid at the whole financial sector level ?