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Frameworks are important. Without them the world makes no sense. A framework (or mental model) is a small set of disciplined ideas that lets you organize facts and argue coherently about how the world works. A framework is more than a set of opinions or stories. They are tools for thinking— a way of imposing structure on a complicated world.
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The Merton model, introduced by Robert C. Merton in 1974, conceptualizes a company’s equity as a call option on its assets, with the debt’s face value serving as the strike price. This framework is instrumental in assessing a firm’s credit risk by estimating the probability of default.
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A recent discussion with a friend led me to think about path dependence in portfolios. This idea is captured by the statistical property of ergodicity. Deeper discussions can be found here, or here. The ergodic property compares the time average to the ensemble average. The time average, looks at the behaviour of a single individual over time. An ensemble average, looks at the behaviour of many individuals at a single point in time. A system is said to be “non-ergodic” when the time averages of individual realizations differs from the ensemble average of all possible outcomes. In other words, in a non-ergodic system, the outcomes experienced by a single individual over time are not representative of the average outcomes across all individuals at a single point in time.
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In this post I discuss how to think about inflation. This a topic which routinely captures a lot of media attention, especially given the roller coaster inflation has been on in the last 3 years. Along with this attention, comes a lot of misunderstanding of what inflation is, what causes it, and how it should be controlled. This post will hopefully clarify these concepts.
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In recent years, “gamma squeezes” have become a hot topic amongst practitioners and academics. This phenomenon, rooted in options trading mechanics, can have a significant impact on underlying stock prices, often leading to rapid and significant price movements. In this post I’ll discuss what a gamma squeeze is, how it occurs, and look at some recent examples. To understand a gamma squeeze, it’s important to know a bit about options and the concept of “gamma.” Options are financial derivatives that give investors the right, but not the obligation, to buy or sell a stock at a specific price (the “strike price”) by a certain date.
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In this post I discuss whether there is useful information contained in industry-specific credit spreads for predicting economic activity.
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In this post I discuss the pre-FOMC drift and whether there exists a pre-RBA drift.
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In this post I discuss monetary policy communication and macroeconomic forecasts.
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In this post I discuss persistence in the popularity of stock splits.
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In this post I ask a simple question, do expectations of future inflation change on Congressional Budget Office (CBO) announcement days? Specifically, I examine the announcement of the CBO’s budget deficit forecasts, which occur semi-annually.