Home bias in sovereign ratings

 [Rather irritatingly, I wrote the below post at the end of last week and had been meaning to publish it on Monday. Unfortunately, I got snowed in with work and now see that Tyler Cowen and a bunch of other people have already covered the paper in question. Still, in a bid to get some blogging activity going around these parts again, here's my two cents.]

"The Home Bias In Sovereign Ratings" 

Fuchs and Gehring conduct empirical analyses of variation in nine different credit ratings agencies around the world that offer ratings of at least 25 sovereigns[...] The paper is motivated by two good questions: (1) Do ratings agencies assign better ratings to their home countries? (2) Do they assign better ratings to countries that have close cultural, economic, or geopolitical ties to their home country? 

[...] 

Fuchs and Gehring find clear evidence of “home bias”. Specifically, their analysis finds that agencies do indeed assign higher ratings to their home country governments compared to other countries with the same characteristics. This result was especially strong during the global financial crisis (GFC) years–nearly a 2 point “bump” in ratings.

As someone who has been both a consumer and producer of sovereign rating reports prior to starting a PhD, I find this sort of thing very interesting. The role of inherent biases in the industry is scope for bemusement and alarm. This paper by Fuchs and Gehring would at least seem to go some of the way in explaining why, say, Fitch places the United States in its highest credit ratings category... while (Chinese-based agency) Dagong only places the US in its third highest category.

That being said, Daniel McDowell (author of the above blog post) points out that it is not especially clear how such findings actually stand to affect future ratings. For one thing, changes in sovereign ratings sometimes have zero, or even paradoxical effects, such as when the demand for US treasuries actually rose following the country's downgrade by Standard & Poors in 2011.[*]

On the other hand, it should also be noted that if one of the other major agencies -- i.e. Fitch or Moody's -- had followed S&P's lead in downgrading the US credit score in 2011, then that probably would have had fairly major financial implications. Most obviously, a large number of investment funds have specific mandates regarding the type of securities they must hold... as determined by the average score among the big three credit ratings agencies. For example, a fund might be legally required to hold a minimum proportion of "triple-A-rated" bonds. Given how ubiquitous US treasuries are, some major portfolio rebalancing would almost certainly be required if the US lost its "average" credit rating. You may recall that this is something that a lot of people were worried about at the time. It is also one reason that the ratings agencies continue to have a practical (and potentially deleterious) relevance to financial markets.

Anyway, apologies for getting sidetracked. Interesting paper and blog post. Check them out.
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[*] A popular explanation at the time was that the downgrade provided the shake-up that Congress needed in order to overcome the political impasse over the debt ceiling...

Top posts on Stickman's Corral for 2013

As if you care!

I'll limit it to three because: a) Parsimony, b) Blogger is being recalcitrant b*tch at the moment and is not letting me see any more than that.

1) Econ blogosphere comment form. Way out in front -- with nearly 7,000 views thanks to links from FT Alpha, Barry Ritholtz and a bunch of people on Twitter -- was this spoof of the various personalities, trolls and anti-trolls that populate today's economic blogs. Some of the additional suggestions provided by commentators were golden.

2) Thinking of doing a PhD? My post advocating for postgraduate studies in Norway accumulated around a 1,000 views over the course of the year. It would appear that the idea of drawing a healthy salary whilst having access to great data and clean air could prove a viable alternative to crushing student debt (or miserly graduate stipends) and 80-hour work weeks. As an aside: A fairly large number of hits on this one where referrals from a single comment that I left under one of Noah Smith's blog posts. Thus is the way of the blogosphere layer cake.

3) Review - Extreme Environment (Ivo Vegter). It may not have reached the top spot, but my review of Ivo Vegter's anti-environmentalism screed was certainly the longest post of the year. Five thousand words for around 750 1,000 views may sound like a poor return to some, but it does occupy second place in the Google search rankings for Vegter's book behind only Amazon. Speaking of which: Rather irritatingly, my abridged review on Amazon has garnered more "unhelpful" votes than the other way around. I emphasise the "helpful" bit. This isn't about whether you agree with an author -- or reviewer for that matter -- but rather a question of whether a review enables you to obtain a better understanding of a book and it's relative merits. I guess in-depth, considered criticism is less helpful than gushing, one-line endorsements. (Or lazy dismissals for that matter.) Haters gonna hate. Derpers gonna derp.

If memory serves me correctly, I have a couple posts with 500-odd views here at Stickman's... while my most widely read articles of the year were almost certainly the series I did for the Energy Collective on natural gas. So, it's been a respectable year blogging-wise for yours truly. I might get around to listing my personal favourite posts of the year later during the week.

More good music for your listening pleasure

It occurs to me that I haven't mentioned my Noondaytune contributions in ages. Without further ado and including some snippets from my rather lyrical write-ups:

• Pretty Saro - Bob Dylan. ("Dylan fans are going to be rejoicing in their master’s munificence… and his bountiful back catalogue.")
• Been There Before - Ghost Beach. ("... a nice reminder that sometimes music doesn’t need to be anything other than fun and instantly accessible.")
• But We Did - Thomas Dybdahl. ("You’ll find shades of Bon Iver here (with a less annoying falsetto) and maybe even a distant hint of Jeff Buckley.")
• Indie Cindy - Pixies. ("Comparisons with their early work and sound is probably inevitable at this point. However... if there are any of those famous hard-soft dynamics at play in this song, then the order has been switched. The verses are now abrasive, while the choruses, instead of being explosive, are soothingly melodic.")
• Working For You - Patrick Sweany. ("... it feels like the world could do with a more generous helping of blues-infused rock. I’m doing what I can to remedy matters with this track.")
• Girl From The North Country - Secret Machines. ("This cover version manages to do that rare thing: Preserving the essence of a great song whilst reinventing its dynamics. Listening to it feels like being washed over by a storm and then left in the tranquil aftermath of its passing.")
• Always - Panama. ("... this Sydney-based quartet is helping to erase any lingering Antipodean antipathy I bear as a result of various cricket World Cups. More importantly, if this is where pop music is going, count me in.")
• I Got Love If You Want It - Slim Harpo. ("Taking his stage name from the harmonica (or “harp”) that he played with such laconic precision, his songs were gratefully adapted by a veritable who’s who of 1960s rock ‘n roll.")
• California - Mazzy Star. ("It has been 20 years since “Fade Into You” first drifted through the speakers of my night-time radio like a somnambulist’s love song. With this reunion album, Mazzy Star have embarked upon a continuation that is eerily reminiscent... Perhaps a small testament to L.P. Hartley’s famous observation about the past being a different country: they do things differently there.")
• Nothing To Lose But Your Head - Augustines. ("This latest single comes ahead of their eponymous sophomore album and exudes all the grit, verve and elation that made their last record such a tour de force.")

If I had to pick three favourites from the above list, it would probably have to be Secret Machines, Panama and Augustines. Ask me tomorrow though and that might change. Regardless, the bottom line is that we[*] here at Stickman's Corral are constantly scouring the internet for good music so that you don't have to!

[*] The royal "we".

Publication/dissertation update

After spending nearly a year in Land Economics' publication queue, I'm pleased to say that my joint paper on "Electricity Prices, River Temperatures and Cooling Water Scarcity" is now available online.

I've obviously discussed the paper on this blog and elsewhere before, but there's something ever-so-satisfying about seeing it typeset in official journal format. 

(For those that missed it and can't get passed the subscription paywall, a link to a working paper version and summary for the layman can be found here.)

To recap: We're expected to produce three papers for our PhD dissertation and this paper will obviously form the first of these for me. As for my next paper(s), I've been working on something more climate-related recently. I don't want to give too much away as my ideas are still evolving, but it's very much centered within the Bayesian paradigm and the way in which prior beliefs can affect society's best response to the climate problem. More updates to follow once I get closer finishing up a draft version!

Quote of the Day - Madiba

I was seven years old, and on the day before I was to begin, my father took me aside and told me that I must be dressed properly for school. Until that time, I, like all the other boys in Qunu, had worn only a blanket, which was wrapped round one shoulder and pinned at the waist. My father took a pair of his trousers and cut them at the knee. He told me to put them on, which I did, and they were roughly the correct length, although the waist was far too large. My father then took a piece of string and drew the trousers in at the waist. I must have been a comical sight, but I have never owned a suit I was prouder to wear than my father's cut-off trousers.

 -- Nelson Mandela, "A Long Walk To Freedom"

It has been a raw, emotional morning. Reading through the outpouring of tributes and obituaries has underscored what an extraordinary life this was. While Madiba's years as a revolutionary and statesman may have provided a legion of poignant quotes to choose from, the above passage, taken from his autobiography, is one that always gets me. It cuts to the heart of the humanity that made him such a beloved figure. The ability to affect those closest to us is, in many ways, more meaningful than the power conferred to even the most global of icons.

Asimbonanga (Mandela)

Asimbonanga (We have not seen him)

Asimbonang' uMandela thina (We have not seen Mandela)

Laph'ekhona (In the place where he is)

Laph'ehleli khona (In the place where he is kept)

Oh the sea is cold and the sky is grey

Look across the island into the bay

We are all islands 'til comes the day

We cross the burning water

Asimbonanga (We have not seen him)

Asimbonang' uMandela thina (We have not seen Mandela)

Laph'ekhona (In the place where he is)

Laph'ehleli khona (In the place where he is kept)

A seagull wings across the sea

Broken silence is what I dream

Who has the words to close the distance

Between you and me

Asimbonanga (We have not seen him)

Asimbonang' uMandela thina (We have not seen Mandela)

Laph'ekhona (In the place where he is)

Laph'ehleli khona (In the place where he is kept)

Steven Biko. Victoria Mxenge. Neil Aggett.

Asimbonanga Asimbonang 'umfowethu thina (We have not seen our brother)

Laph'ekhona (In the place where he is)

Laph'wafela khona (In the place where he died)

Hey wena (Hey you!)

Hey wena nawe (Hey you and you as well)

Siyofika nini la' siyakhona? (When will we arrive at our destination)

McDermott and Shleifer double-team Taleb and Kahneman

Not really. But I still enjoyed reading the following passage from Andrei Shleifer's review of Daniel Kahneman's (superb) Thinking, Fast and Slow:

The fourth assumption of Prospect Theory is quite important. [i.e. In assessing lotteries, individuals convert objective probabilities into decision weights that overweight low probability events and underweight high probability ones.] The evidence used to justify this assumption is the excessive weights people attach to highly unlikely but extreme events: they pay too much for lottery tickets, overpay for flight insurance at  the airport, or fret about accidents at nuclear power plants. Kahneman and Tversky use probability weighting heavily in their paper, adding several functional form assumptions (subcertainty, subadditivity) to explain various forms of the Allais paradox. In the book, Kahneman does not talk about these extra, assumptions, but without them Prospect Theory explains less.  

To me, the stable probability weighting function is problematic. Take low probability events. Some of the time, as in the cases of plane crashes or jackpot winnings, people put excessive weight on them, a phenomenon incorporated into Prospect Theory that Kahneman connects to the availability heuristic. Other times, as when investors buy AAA-rated mortgage-backed securities, they neglect low probability events, a phenomenon sometimes described as black swans (Taleb 2007). Whether we are in the probability weighting or the black swan world depends on the context: whether or not people recall and are focused on the low probability outcome. [Emphasis mine.]

This exactly the issue I was trying to point out here. Sometimes people greatly overweight the risks of low probability events (as suggested by Kaheman and Prospect Theory)... other times they completely underestimate them (as suggested by Taleb's black swan metaphor). As a result, we should be cautious in trying to make generalisable statements about human behaviour from either one of these theories alone.

You may also recall that -- for my temerity in pointing out this apparent tension between Kahneman and Taleb's theories -- I was labelled an "idiot" by none other than Taleb himself. As I coyly suggested in that second post, Taleb's affinity for labelling others as idiotic meant that I was at least likely to be in good company. I am sure of that now having read Shleifer's article.

Why economists love auctions

Some background first: South Africa's power market is utterly dominated by (a) coal and (b) Eskom, the parasitical parastatal monopoly. In a bid to encourage both fuel diversification and competition, the government has determined that 3,725 MW of new capacity up until 2030 should consist of renewable sources operated by independent power producers (IPPs). This translates to roughly 10,000 GWh of actual future electricity generation.

Ignoring the fact that this is small potatoes in the scheme of things -- less than 5% of the country's current 240 TWh annual electricity consumption -- the point that I want to make here is mostly about how those IPPs are chosen.

Having played with various schemes, authorities eventually settled on something called the Renewable Energy Independent Power Producer Procurement Programme (REIPPPP). This is effectively a competitive bidding process, whereby applicants submit a guaranteed price that they are willing to accept for electricity that they generate in the future. In other words, it looks a lot like the idealised auction market advocated in economic textbooks.

So how have things turned out? Well, the results from the third round of bidding have just come in. (The previous bidding rounds were held in 2011 and 2012, respectively.) It would appear that things are progressing rather well:

The six successful solar PV bidders, which shared an allocation of 435 MW, were particularly aggressive with their pricing. Fully indexed prices using April 2011 as the base year showed that the average solar PV price fell from R2.75/kWh in bid-window one to 88c/kWh in the third round.

[...]Similarly, the price of onshore wind fell from R1.14/kWh in round one to 89c/kWh in round two and to only 66c/kWh in the latest round. A total of 787 MW was allocated across the seven wind projects

[...]Prices for the two 100-MW-apiece CSP [concentrated solar power] projects declined from R2.68/kWh in the first window to R1.46/kWh. 

We must of course be careful not to draw too many conclusions from the above figures. For one thing, the average price that South Africans currently pay for electricity remains lower than any of the above bids. Although, it is scheduled to approach (and even exceed, in the case of wind) them in coming years:

Even then, just because a small portion of wind or solar energy is expected to "reach grid parity" within the next five years, doesn't mean that the game is up for fossil fuels. There are major problems with peak balancing, intermittency and load-following constraints that renewables need to overcome, which I and many others have discussed at length before.

However, a 68% drop in the bid price of solar PV since 2011 -- say nothing of wind and CSP bids falling by nearly 45% -- is clearly impressive. Many people will see this as a evidence of how quickly renewable technologies are progressing. I wouldn't dispute that, but I also see it as a vindication of the auction system that was used for determining the winning bids.

It is something that South Africa's electricity sector could use a lot more of.

Bad science: Paleo diet edition

A while ago, I wrote a post praising the scientific approach that advocates of the paleo diet appeared to be adopting in arguing their case. In particular, the language used by people like Gary Taubes in discussing dietary health seemed to show a keen appreciation for the key principles underpinning the scientific method. This includes separating causation from correlation, controlling for placebo effects and selection bias, etc, etc.

However, apparently not all paleo advocates are such sticklers for good scientific practice. For example, see this blog post by Jacques Rousseau, which skewers a new "occasional study" by Tim Noakes.[*] There is a lengthy follow-up post that also well worth reading when you have time.

The short version is that Noakes is a very prominent sports scientist in South Africa. He also happens to be an extremely vocal proponent of the low-carbohydrate-high-fat (LCHF) paleo diet, having undergone a Damascene conversion in recent years. The occasional study in question was published in the South African Medical Journal and details 127 unsolicited responses that Noakes received from people who have followed his advice in switching over to LCHF. These correspondences tell of all manner of dietary miracles and health wonders that have followed as a result, from substantial weight loss to curing "incurable" diseases like type II diabetes.

The problem with this study should be all-to-obvious to anyone who understands anything about scientific practice -- more on that in a minute.  Furthermore, a lot of people are (rightly) up in arms about how it managed to get through the peer-review process and into the country's flagship medical journal. Cynical observers have not been shy in suggesting that this is almost entirely down to Noakes' status within the local research community and very little to do with the scientific merit of the study itself. (To be fair, I'm not sure that a double blind submission would have been possible in this case.)

Now, Jacques does a very good job in explaining the manifold problems of the study. He also points out that Noakes' position on the necessity of such anecdotal evidence is very inconsistent. (If we had proper, scientifically validated evidence about the benefits of LCHF then we wouldn't require anecdotal evidence on top of that. To argue otherwise is to suggest that the scientific evidence in favour of LFHC is not actually particularly strong.) However, I think some of the commentators actually do a better job of pinpointing exactly why this study does not belong anywhere near a reputable scientific journal. For instance, "Chris" writes:

[...]You could prescribe or promote absolutely anything, and you would see some people benefit. The key point is that the sample you have is self selected from those who benefited enough that they felt the need to contact you. That is likely to be a small number of the total number of people who did indeed benefit. And we have no idea what proportion of the total number of people to have tried LCHF those people are. The fact that there are 127 people who've shown a benefit is evidence of one thing, and one thing only: those people's ability to write you an email. Can you tell me exactly what their dietary regimes were, down to the last macronutrient? Can you assure me that the change in their diet was not simply a catalyst for them to become more active, thus they expended more energy? Can you tell me that there were no other outside influences that could potentially act as a confounding variable? You can't, and you say so yourself in the article. Which begs the question of why did it get published? If we can't say anything other than these people got amazing results and said they were on LCHF then what exactly can we say?[...]

Emphasis mine. A follow-up contribution by another commentator (who was actually involved in one of the cases that Noakes cites) is equally worth reading here.

To underscore something that Jacques and many of his commentators try to make abundantly clear; criticism of this particular study does not amount to criticisms of LCHF in of itself. The outcry is entirely about sloppy scientific reasoning and misuse (absence?) of the scientific method. Proponents of LCHF and other paleo-style diets may well be correct in identifying the causes of our modern dietary ills. I personally know more than a few people who credit it with helping them to shed weight and improve their overall sense of well-being. On the other hand, I can say exactly the same thing about friends who have converted to veganism. (You see the problem with anecdotal evidence!)

To conclude, if paleo advocates want to maintain scientific credibility, they need to distance themselves from this type of research. At the very least, they should not try to defend it.
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[*] You may recall that I actually mentioned Prof. Noakes at the beginning of my previous post. Rousseau is a senior lecturer at the University of Cape Town, whom it should be said took me for an introductory philosophy and business ethics course during my undergrad.

TEDxBergen

I mentioned the other day that I acted as moderator for the recent TEDxBergen conference. Videos of the various talks have now been posted online, but here are two that I particularly enjoyed as a sample.

1) Mads Nordmo gave a talk on moral psychology, which challenges the traditional "transactional" view of behaviour -- as is favoured by a lot of economic theory.

Mads is actually doing a PhD with me -- albeit in the strategy department -- and also has a degree in clinical psychology. His opening remark about showing that "it wasn't just beginner's luck" was in reference to a quip that I made about him winning a 'Best lecturer' award from NHH bachelor students. (Link in Norwegian.)

He used various examples to underscore his points, including the growing popularity of CrossFit and the paleo diet.[*] For instance, a purely transactional view provides us with very little insight into why people pay such exorbitant sums of money to join CrossFit gyms. The exercises mostly require far less equipment than ordinary gyms and we could all do as many sit-ups and push-ups as we want at home (for free!). However, Mads argued that these "movements" actually constitute a quasi-religious experience -- much like we would encounter at a rock concert or sports match -- where the sense of communal spirit and exaltation actually enable participants to achieve some kind of transcendence.

In the Q&A afterwards (not shown), I suggested that economics would normally explain the high membership fees paid to crossfit gyms as a commitment device. Mads agreed that this too is an important psychological driver. However, there is at the least no reason to regard such phenomena as mutually exclusive. (Interestingly, he also said that psychology is moving closer to economics... not simply the other war around, as is often asserted in some heterodox circles.) Anyway, he is a smart and funny guy, and I think that both traits are evident in his talk. Check it out:




2) The Grammy-nominated violinist, Peter Sheppard Skærved talked about reinvention and finding new purposes for old tools. Peter is a fascinating person -- the Library of Congress has described him as a polymath -- and I thoroughly enjoyed chatting to him about a range of topics, from anthropology to haptic technology, over the course of the day. In this video, he not only makes a compelling case for preserving "museum pieces" by actively using them as much as possible, but also treats the audience to a range of music pieces from across the ages.

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[*] As someone who has a number of friends into (at least one of) CrossFit and the paleo diet, I freely admit that I am predisposed towards finding this discussion both amusing and enlightening.