Several weeks ago I received a review copy of the book Street Freak by Jared Dillian. [note: I have no connection with and have never met Dillian, his publisher, his publicist, etc.]. My review will be slightly different from many of the reviews I have seen, in part because of my interest in finance and the recent financial crisis, and in part because of my background and training.
I was particularly intrigued by Dillian's perceptions and reactions to The Efficient Markets Hypothesis, [EMH]. I think the EMH is correct in the sense that markets tend toward its implications even if not instantaneously. For perhaps a better explanation of the EMH, see this. My own take on the EMH is this:
The general idea (for me) of EMH is that schmucks like me are unlikely to be able to beat the market consistently because by the time I receive new information and by the time I figure out what to do about that information, others who are much smarter and much more actively involved in the markets (e.g. people like Dillian) will have already taken advantage of that information.
And we see this theme emerging time and again in Street Freak. Early on, Dillian questions the validity of the hypothesis,
Theories on market efficiency had killed people's work ethic. If you can't beat the market, then why try? But you can win, I thought. The market can be beaten. ... This was the most passive, spoiled, unmotivated group of [people] I had ever come into contact with. [p 16. In all quoted passages, emphasis in the original, expletives altered in brackets].
Dillian was in a major investment bank (Lehman Brothers), where traders had up-to-date nano-second information on multiple terminals about the markets. That's a little different from the folks with a single terminal and a two-second delay in receiving information from the financial centres.
And Dillian would probably subscribe to some form of the weak EMH, as is clear from this:
... I was relieved that index arbitrage involved actual skill. This meant that the markets were, for the most part, efficient. ... Other index arbs around the street were bidding and offering futures, conspiring to limit the arbitrage profits of the other players. [p62]
Smart guys with up-to-date information bidding and playing against each other, driving prices to efficient points. But it is a process, not a fixed equilibrium. New information and new analyses move the equilibrium all the time.
I mentioned nano seconds above. Here is a good example of how Dillian exploited those time differences (thus forcing markets in the direction of the EMH all the more quickly):
Efficient market theory says that the arrival of news in the marketplace is immediately and perfectly disseminated, and no one person acting independently can get ahead of it. But I'd spent days watching this. The number would come out --- boink --- and for a split second, nothing would happen. This tiny period of time, a half second, maybe, was enough of a window for me to send out an arb basket and move the market before anyone else did. It was a delay that could be exploited (let alone discovered) only by someone with exceptionally fast reflexes and exceptionally acute concentration. [pp 89-90]
Of course once the arbitrage possibility became known, it was programmable. Computers could make the trades even faster, thus driving the market toward new equilibria that incorporate the information even faster. As Dillian says,
I realized that I was becoming a victim of technology. If both futures and stocks are traded electronically, you can replace labor with capital. You can instruct a computer to do a human's job. It would be a very basic program, one that an intern could write.
... The pit was becoming increasingly irrlevant. I was becoming increasingly irrlevant. I'd just gotten a job making buggy whips as the first automobile was rolling off the assembly line. [p140]
... It was clear that the arb had been turned into a robot trade, and we were the last holdouts trying to do it by hand [p145].
As long as there are people looking for opportunities, then deviations from the EMH tend to be narrowed. As an example,
I'd arrive at the floor in complete darkness, the streets deserted, and I'd check trades for breaks, buy/sell errors, and [goof]-ups.
It's hard to believe markets do not tend toward efficiency with traders like Dillian around.
Further support of the EMH comes from Dillian's work in the small cap [small firms] segment of the market:
...[There were] basically penny stocks that would issue a press release about some new government contract, and the stock would be up 1,000 percent in a single day.
[We] noticed that before these stocks would spike, there would be a small but noticeable increase in volume. We figured that this was dirty insider buying. [Stuff] like this happened all the time; it was not uncommon for there to be a small increase in volume before a major news event.
Economists and others have long been aware of this phenomenon. And he is absolutely right. What is more, as he and others exploit this knowledge, markets move toward even the semi-strong variant of the EMH.
My point with all this is that with traders throughout the market looking for angles to exploit, and with computers operating at the speed of light to execute the trades, it isn't surprising that many traders with access to quick information and gi-normous computing power can beat the rest of us in the market. Further, those same traders may sneer at concepts of the Efficient Markets Hypothesis, but they are the very ones, competing with each other, who drive us relentlessly toward it.
Of course that doesn't mean the EMH explains everything. I love contemplating how such a massive financial crisis like the last one could be consistent with the EMH. It just doesn't make sense. And I conclude that the EMH indicates tendencies, but it certainly is not the end all and be all of finance.
- - - - -
What about the rest of the book, though? I loved a couple of lines. For example,
Most people know thre NYSE as the friendly trading floor that they see on television, but what they do not know is that it is also a mean-spirited regulatory bureaucracy. [p207]
and
Human beings are not well-equipped to deal with randomness. [p263]
But overall the book was off-putting. It is an amazing story of a driven man who was non-Ivy-League but who became increasingly successful on Wall Street as a trader. His insights rival those of Michael Lewis in Liar's Poker. But Liar's Poker is much better written.
To be blunt, Dillian comes off as a bully, not as a careful chronicler. Even if he was a Street Freak during his days with Lehman, he shouldn't have written in that style for this book. Maybe it's just the academic in me, and the language and style of the writing evoked a kind of revulsion I didn't expect to find within myself. I know people talk like the quotes in the book. But Dillian isn't content just to quote all the expletives. He uses them at a high rate in his writing between the quotes, too. This style may capture Dillian's personality, but it is also distracting or worse [this all said despite the fact that I sometimes talk like that, even in my lectures, and I have been known to break a phone or two in anger, as Dillian seems to have done with some regularity]. If anything, I think this style is what put me off the book the most.
At the same time, there is a straight-forward tale of his growing difficulties due to his bipolar condition and his obsessive-compulsive behaviour. Dillian's challenges as he worked his way through these conditions are insightful and touching. His wife must be an angel to have put up with his behaviour. But to start the book with a completely confusing rendition of his obsessive-compulsive behaviour is another turn-off.
Despite these criticisms of the book, the story is good. And it is especially intriguing in light of the recent UBS $2.3billion losses resulting from actions of an index trader.
The energy, the crises, the challenges all make good drama. I expect this would make a tremendous film. The language would be appropriate there, as would the transitions. I fully expect the film rights to this book to be worth quite a bit. I just hope they get good writers and a good director.
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[note: both of these books are available in e-book format, my preferred method of reading these days.]
I don't know how Kindles work, never having seen one in person (see below), but I never learned as much from my textbooks if I didn't write in them... argue with the author, write questions, try out ideas, etc. I'm not keen on electronic texts of any sort if this feature is lacking. What I am trying to say is that students should consider more than just the comparative net present value of the options when deciding whether to buy a Kindle, and the value of the learning experience is one of those additional things deserving consideration.