My Virtual Display
 Random thoughts and notes to self

The Returns to Entrepreneurial Investment:
A Private Equity Premium Puzzle?

Tobias J. Moskowitz; Annette Vissing-Jorgensen
The American Economic Review, Vol. 92, No. 4. (Sep., 2002), pp. 745-778.

Abstract
We document the return to investing in U.S. nonpublicly traded equity. Entrepreneurial investment is extremely concentrated, yet despite its poor diversification, we find that the returns to private equity are no higher than the returns to public equity. Given the large public equity premium, it is puzzling why households willingly invest substantial amounts in a single privately held firm with a seemingly far worse risk-return trade-off. We briefly discuss how large nonpecuniary benefits, a preference for skewness, or overestimates of the probability of survival could potentially explain investment in private equity despite these findings.

Hamilton (2000)… documents that individuals in the 1984 Survey of Income Program Participation (SIPP) choose self-employment despite facing a median (but not mean) stream of future earnings significantly less than that available as a paid employee. In addition, the cross-sectional standard deviation of self-employed earnings is substantially larger than that of wages from paid employment.

Why am I uncomfortable with this?

1. At least some self-employed individuals (most notably, older immigrants who own small retail and service establishments) are downright unemployable; try finding a job if you are a 50-year-old with a limited command of spoken English…
2. Self-employed individuals have the ability to pay at least some personal expenses out of pre-tax money and have it deducted from taxable income. So, given equal pre-tax income, a self-employed individual probably enjoys higher standard of living compared to a paid employee.

In addition, if entrepreneurial income is skewed and has substantial implied volatility, should we value self-employment as an option, rather than a stream of cash flows?

Informational Efficiency of Loans versus Bonds:
Evidence from Secondary Market Prices

EDWARD I. ALTMAN, AMAR GANDE, ANTHONY SAUNDERS

December 2004

Abstract
This paper examines the informational efficiency of loans relative to bonds using a unique dataset of daily secondary market prices of loans. We find that the loan market is informationally more efficient than the bond market prior to and surrounding information intensive events, such as corporate (loan and bond) defaults, and bankruptcies. Specifically, we find that loan prices fall more than bond prices prior to an event, and less than bond prices of the same borrower during a short time period surrounding an event. This evidence is consistent with a monitoring advantage of loans over bonds. Our results are robust to a different empirical methodology (Vector Auto Regression based Granger causality), and to alternative explanations which control for security-specific characteristics, such as seniority, collateral, recovery rates, liquidity, covenants, and for multiple measures of cumulative abnormal returns.

Full text: http://ssrn.com/abstract=639081

Committees Versus Individuals:
An Experimental Analysis of Monetary Policy Decision Making

Clare Lombardelli, James Proudman and James Talbot
International Journal of Central Banking, May 2005

Abstract
We report the results of an experimental analysis of monetary policy decision making under uncertainty. A large sample of economics students played a simple monetary policy game, both as individuals and in committees of five players. Our findings — that groups make better decisions than individuals — accord with previous work by Blinder and Morgan. We also attempt to establish why this is so. Some of the improvement is related to the ability of committees to strip out the effect of bad play, but there is a significant additional improvement, which we associate with players learning from each other’s interest rate decisions.

Full text: http://www.ijcb.org/journal/ijcb05q2a5.pdf

Just dug this out from The Economist Online (originally published in print on September 9, 2004)… Can’t help but wonder what kind of yields these index values correpond to; in other words, if someone bought a house today and rented it out tomorrow, what kind of current income would they be receiving?

Since the question seems difficult to answer directly, can there be a clue in the world of publicly traded companies?

A quick look at AIMCO, a large apartment building operator, reveals book assets of $10 billion and operating income of $329 million; operating yield, therefore, appears to be just above 3%. This doesn’t look like a lot…

Of course, the approximation is crude, but is there a better one?

Based on his “Fed model,” Ed Yardeni seems to think so:

(More related charts can be found in Ed Yardeni’s Valuation Chartbook)

The basic idea behind the “Fed model” is that over the long run, the earnings yield E/P (the inverse of the P/E ratio) of the broad stock market should be in line with the 10-year Treasury bond yield. When the stocks’ earnings yield exceeds the 10-year Treasury yield, the stock market is considered undervalued; conversely, if the stocks’ earnings yield is below the 10-year Treasury yield, the stock market is considered overvalued.

According to Yardeni’s computations, the U.S. stock market has not been this undervalued since 1979… The important thing to remember, however, is that this perceived undervaluation can be corrected in three ways:

• Stock prices may rise, pushing the E/P down, or
• Earnings may fall, again, pushing the E/P down, or
• The Treasury bond yields may rise (possibly, along with inflation)

While the first two can be anyone’s guess, the third, in my opinion, is a matter of when, not if…

The Economist published an interesting chart a couple of weeks ago. Just dug it out of the online edition:

It appears that Eastern Europe’s native banks (with the exception of Hungary’s OTP) have been dwarfed by larger institutions from the West. At least some of the time, this happened via acquisitions (e.g., acquisition of 53.2% of Poland’s second-largest Bank Pekao by UniCredito in 1999).

I wonder what (if any) the impact was on the wages in the financial services sector…

Another one to ponder: how do you even begin to think of a market where nearly all major players are small segments of much larger organizations?