From a recent Post artice: Looking at data from every trade made by all investors in Taiwan from 1995 to 1999, Odean discovered that the "aggregate portfolio of individual investors suffers an annual performance penalty of 3.8 percentage points," which includes trading costs. If investors had simply bought the index and not traded at all, they would have done about 3.5 percent better. The amount of money lost was equivalent to 2.2 percent of Taiwan’s gross domestic product.
This is mostly re-allocation of wealth. Question is whether it results in overall efficiency. My guess is no, because the 2% is more likely to end up with those who have lower marginal utility of wealth; they will slow the velocity of money and increase luxury consumption. So it's probably not a good deal overall.One possibly positive side (someone hited at this) is that more trading might make markets more efficient (improving prices by themselves is just a Ponzi scheme) and hence provide better incentives; I doubt that this is worthwhile.
Agree with Talisman; trading is zero-sum, so 2% loss to individuals is 2% gain to institutions. Seems like a stupid-tax, not an economy-wide tax.
Of course, noting the popularity of lotteries, despite horrible odds, the individuals may be gaining some utility from their trading activity, so that the 2% transfer to institutions includes a net entertainment gain and may be efficient.
Again, if trading is entertaining enough for individuals that they substitute trading for consumption, it would be doubly efficient, since consumption funds to into investment, part of the returns of which are transferred to institutions, but economy-wide investment nonetheless may rise.
talisman, good point. Just to be clear, there is a variety of indexes from which to choose--so there exists an opportunity for selection bias to creep in from the outset. For instance, in the U.S. the perfomance one achieves through an S&P 500 fund is going to vary somewhat from that of a Wilshire 5000 fund. Over the past several years, some foreign stock indexes have significantly outperformed the U.S. indexes.
I should add that in many cases the sophisticated players are in a different country, in which case the transfer amount would hurt one GDP and help another.
I think the mistake here is thinking that the "trading costs" just go up in smoke rather than into the pockets of more sophisticated market participants. There is deadweight loss in the work of the investors in planning their bad trades, in the work of the sophisticated players doing what they do, in the technology and clearing costs, etc., but this has little correlation to the size of the investor->sophisticated transfer.
I assume from the title that you mean to suggest that if brokers didn't make these trades then GDP would be 2% higher.
This seems incorrect to me. Surely the services associated with the trades do themselves count toward GDP. So all other things equal we are looking at having a bunch of traders and brokers who are currently doing stuff that is being counted toward GDP instead sitting on their hands and doing nothing. And so GDP it seems must go down by the value of those services which are no longer being performed aka 2%. Of course I'm ignoring the knock on effects of them all being unemployed which would increase that figure.
Now I guess you could argue that they'd be off doing more worthwhile stuff instead, so instead of the 2% of fat associated with all those trades we'd have 2% of something more inherently valuable. In that case the GDP figure would be unchanged as it doesn't try to determine the value of the product it simply counts all product as being worth whatever people will pay for it.
Byrne, yes active investment has a positive externality of improving prices and this increasing the average return on those investments. But whether this benefit is worth the cost on the margin is far less clear.
This is mostly re-allocation of wealth. Question is whether it results in overall efficiency. My guess is no, because the 2% is more likely to end up with those who have lower marginal utility of wealth; they will slow the velocity of money and increase luxury consumption. So it's probably not a good deal overall.One possibly positive side (someone hited at this) is that more trading might make markets more efficient (improving prices by themselves is just a Ponzi scheme) and hence provide better incentives; I doubt that this is worthwhile.
The favored policy and easiest way to make GDP go up is to understate inflation. Then blame pension funds for seeking non-paper-money assets.
I don't see how this tells us anything other than that the incompetent investors outweigh the competent investors.
I also think GDP would suffer greatly - on the order of the difference between West and East Germany in the 1980s - if there were no trading.
Agree with Talisman; trading is zero-sum, so 2% loss to individuals is 2% gain to institutions. Seems like a stupid-tax, not an economy-wide tax.
Of course, noting the popularity of lotteries, despite horrible odds, the individuals may be gaining some utility from their trading activity, so that the 2% transfer to institutions includes a net entertainment gain and may be efficient.
Again, if trading is entertaining enough for individuals that they substitute trading for consumption, it would be doubly efficient, since consumption funds to into investment, part of the returns of which are transferred to institutions, but economy-wide investment nonetheless may rise.
I've always wondered what makes the people who choose what stocks go in an index so good at picking stocks... ;)
talisman, good point. Just to be clear, there is a variety of indexes from which to choose--so there exists an opportunity for selection bias to creep in from the outset. For instance, in the U.S. the perfomance one achieves through an S&P 500 fund is going to vary somewhat from that of a Wilshire 5000 fund. Over the past several years, some foreign stock indexes have significantly outperformed the U.S. indexes.
I should add that in many cases the sophisticated players are in a different country, in which case the transfer amount would hurt one GDP and help another.
I think the mistake here is thinking that the "trading costs" just go up in smoke rather than into the pockets of more sophisticated market participants. There is deadweight loss in the work of the investors in planning their bad trades, in the work of the sophisticated players doing what they do, in the technology and clearing costs, etc., but this has little correlation to the size of the investor->sophisticated transfer.
Gordon, yes national welfare badly measured might not change.
I assume from the title that you mean to suggest that if brokers didn't make these trades then GDP would be 2% higher.
This seems incorrect to me. Surely the services associated with the trades do themselves count toward GDP. So all other things equal we are looking at having a bunch of traders and brokers who are currently doing stuff that is being counted toward GDP instead sitting on their hands and doing nothing. And so GDP it seems must go down by the value of those services which are no longer being performed aka 2%. Of course I'm ignoring the knock on effects of them all being unemployed which would increase that figure.
Now I guess you could argue that they'd be off doing more worthwhile stuff instead, so instead of the 2% of fat associated with all those trades we'd have 2% of something more inherently valuable. In that case the GDP figure would be unchanged as it doesn't try to determine the value of the product it simply counts all product as being worth whatever people will pay for it.
Byrne, yes active investment has a positive externality of improving prices and this increasing the average return on those investments. But whether this benefit is worth the cost on the margin is far less clear.
In case you weren't making fun of the study:
http://www.interfluidity.co...
I think a study like this is like noting that 90% of hypotheses are disproven, therefore we would be better off if we never hypothesized.