Thursday 22 December 2011

Insider trading

Of the cohort of fellow students going through grad school at George Mason, one of the ones who went on to reasonable financial success left the programme after finishing his coursework but before the comps. He started working in a Senator's office, then went over to CBO before flipping to "the dark side". When we last chatted a couple years ago, he told me his main job was working out what was going on in one reasonably important policy area so as to advise hedge funds how to plan investments in that industry.

And so I was mildly amused to see The Wall Street Journal's minor outrage at that there's an industry that works to figure out what Congress is planning so they can trade based on the information. Here's the (gated) article, with the video embedded below.


I mostly don't see what the big problem is. Rent extraction is a problem: legislation designed never to be passed but rather to extract campaign contributions for abatement. That doesn't seem here to be the problem.

Everything that Congress does is going to have effects on the stock market. And so there'll be a big industry in trying to figure out what's likely to emerge from the Congressional sausage factory. If the information gets out sooner rather than later, that just helps prices more quickly towards equilibrium; there's some transfer from the dispersed folks who'd be well placed to move quickly after a public announcement to those who are politically connected. But if Congressmen get some value out of the exchanges in helping to craft better legislation, as the article does suggest, then perhaps the whole deal is efficient.

If I pull my Don Wittman hat on even tighter, it's efficient even in the case where the hedge funds are able to convince legislators to shift policy to avoid imposing capital losses on their portfolios. Legislation is presumably most likely to change where it would otherwise be imposing really large costs relative to expected benefits, so many such changes will be efficient rather than inefficient "logic of collective action" deals. Instead, it's more likely to push us to Peltzman-style regulations that balance the interests of the regulated with the interests of the public at large; the social welfare function also has to put some weight on the utility of the lobbyists' clients. </Wittman>

If you want to be outraged about anything, be outraged that Congress can quickly create or destroy billions of dollars of wealth through legislative acts. As long as that's the business Congress is in, there'll be a corresponding industry in trying to hedge folks' political risk. And, while I do wish that we were in a world in which Congress couldn't do that, how can we begrudge the Congressional Intelligence industry for doing exactly what it should be doing given the world we are in? Would you kill the birds for singing? Poison the fish for swimming? Shoot the children for laughing?


  1. Only slightly related, but I was interested to read recently that some of the hedge funds (Derwent Capital was specifically mentioned) are starting to use analysis of trends on social media for making trades.

  2. I'd seen a paper a couple months ago on how use of Twitter mentions as predictor of company performance could yield portfolios that beat the average; not surprised that hedge funds are well on top of it.

  3. Not sure about the idea of moving prices toward equilibrium however.
    The concept of reflexivity that George Soros writes about seems to describe what is happening with this sort of market interaction.

  4. Hi Eric, hope you and family are OK. Those were nasty - Way to ruin Festivus wretched EQNZ.

  5. @Anon: Thanks, we're fine. House is a bit more cracked than before, but still perfectly liveable. Our small pre-Christmas dinner went ahead as scheduled, albeit with a couple cancellations. Didn't lose water or power.