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Chapter 34 Who does capital move for (4)
Moral Hazard Is Everywhere

The bicycle theft rate of students in a university in the United States is about 10%. Several business-minded students initiated an insurance for bicycles, and the premium was 15% of the insurance target.According to common sense, these few business-minded students should get about 5% of the profits.But after the insurance was in operation for a period of time, these students found that the bicycle theft rate rapidly increased to more than 15%.Why?This is because after the bicycles are insured, the students' safety precautions for bicycles are significantly reduced.The insured students did not fully bear the consequences of the risk of the bicycle being stolen, so they took no action on bicycle safety precautions.And this kind of inaction is moral hazard.

When the economist Stiglitz studied this issue, he found that such examples can be seen everywhere in the market economy. It can be said that as long as the market economy exists, moral hazard is inevitable.

Moral hazard is a concept in the category of economic philosophy proposed by Western economists in the 80s, that is, "people engaged in economic activities take actions that are not beneficial to others while maximizing their own utility." Or in other words: when one party to the contract Selfish behavior that maximizes one's own utility without fully bearing the consequences of the risk.Moral hazard is also called moral crisis, but moral hazard is not equal to moral corruption.

Suppose you extend a $1000 loan to a relative, Uncle Meyer, to use the loan to purchase a word processor in order to start a printing agency that prints term papers for students.However, once you make that loan, Uncle Meyer might not go buy a word processor but go race a horse.If he places your money on a 20-to-1 bet and wins, he can afford to pay back your $1000 loan and live in luxury with the remaining $19000.However, once you lose the bet, you cannot get your money back.And Uncle Meyer lost only his reputation as a reliable, urban uncle.In other words, for Uncle Meyer, the payoff for winning the bet is $19000.The loss of the bet is only his reputation, so he has a strong enough motivation to use this loan to race horses.If you knew Uncle Meyer's next move, you would of course prevent him from using the loan to race horses, and moral hazard would not occur.Information asymmetry is often one of the causes of moral hazard.

Moral hazard occurs after the transaction.Because the borrower has engaged in activities that deviate from the wishes of the lender, the possibility of loan default is increased, causing the lender to bear greater risks.Once the borrower obtains a loan, he may take a relatively large risk because he uses other people's money, because the income will be high in this way, and of course the risk of loss is also great.Since moral hazard reduces the probability of loan repayment, the lender may make a decision that he would rather not lend.

What kind of market is an "efficient market"

A professor and his students were walking on the street. Suddenly, a 100-yuan banknote appeared under their feet. The student bent down to pick it up. It's long gone!" This simple story speaks to a profound theoretical question, which can guide you in your capital investment practice.

The basic theory of the capital market is developed by the effectiveness of the market.The basic theory of capital market has developed into two pillars - market efficiency and behavioral finance.The professor above represents a school of thought: what he's actually saying is that markets are "efficient."The earliest efficient market hypothesis held that the prices of security assets always fully reflect all relevant information.This means that if there is a "good news" in a listed company, the market will immediately react according to the "good news". Therefore, it is unrealistic for investors to use the news to earn profits higher than the market average. In other words, not only the so-called technical analysis in the capital market is of no benefit to you, even the fundamental analysis has no advantages at all. Is this a bit too much? What is the so-called "news"?
What kind of market is an efficient market?What is the "efficient market assumption"?
In the 20s, Eugene Farmer, a financial scientist at the University of Chicago, put forward the famous efficient market hypothesis theory.The hypothesis holds that in a society full of information exchange and information competition, a specific piece of information can be immediately known to investors in the securities market, and then competition in the stock market will drive securities prices to fully and timely reflect this group of information, As a result, investors can only earn risk-adjusted average market rate of return without abnormal returns in transactions based on this set of information.As long as the market fully reflects all the existing information and the market price represents the real value of the securities, such a market is called an efficient market.

The establishment of an efficient market must meet the following four conditions: 1. The effectiveness of information disclosure, that is, all information about each financial product can be disclosed in the market in a sufficient, true and timely manner; Effectiveness, that is, the above-mentioned disclosed information can be fully, accurately, and timely obtained by investors who pay attention to the financial product; 2. The validity of the information receiver’s judgment on the obtained information, that is, every Investors can make consistent, reasonable and timely value judgments based on the information they get; 3. The recipients of the information can judge the effectiveness of the investment according to their judgments, that is, every investor who pays attention to the product can use their judgments, Take accurate and timely action.

Rational Expectations: The Optimal Prediction of Information

When Jocomte hits the road during off-peak hours, the drive to work sometimes takes 35 minutes, sometimes 25 minutes, but on average, it takes 30 minutes to drive to work during off-peak hours.However, if Joe leaves the house during rush hour, the drive to work will take an average of 10 minutes longer, and assuming he leaves during rush hour, the best estimate of the drive time, the optimal forecast, is 40 minutes.

If before leaving the house, the only information Joe knows that affects his driving time is that he will be leaving during rush hour.According to rational expectations theory, Joe's best estimate of the driving time is 40 minutes.

Assume that on day 2, under the same conditions and with the same expectations, it took Joe 45 minutes to get to work due to more red lights than usual, while on day 3, due to all the green lights, Joe's drive time was only 35 minutes.Do these deviations mean that Joe's previous 40-minute expectations were irrational?No, an expected drive time of 40 minutes is still reasonable.In the latter two cases, the deviation of the forecast is 5 minutes, and the expectation is not completely accurate.Rational expectations, however, are the most likely estimates after considering all available information, not perfectly precise estimates.That is to say, rational expectations are correct on average, and the 40-minute expectation meets this requirement. No matter what the situation is, there are many accidental factors in Joe's driving time, and the optimal prediction cannot be completely precise.

This case illustrates a key point of rational expectations theory: that is, rational expectations are equal to the optimal forecast based on all available information, but the forecast result is not completely accurate.

The idea of ​​rational expectations was first proposed by the American economist Muth in the article "Reasonable Expectations and The Theory of Price Changes", and further developed by Lucas of the University of Chicago and Sargent and Wallace of the University of Minnesota in the 70s development, and gradually formed the school of rational expectations.

Rational expectations theory is based on two premises:

1. The expectation of each economic agent on future events is reasonable.That is to say, consumers regard obtaining the maximum utility of consumption as the criterion of action, and producers regard the maximization of profit as the criterion of action, and the future situation predicted by any economic actor when making the current decision always fully and accurately conforms to what actually happens in the future.

2. As long as the market mechanism is allowed to play its full role, the prices of various products and production factors will change through supply and demand, and eventually the respective supply and demand will reach equilibrium.At this time, it is also in a balanced full employment state, and the actual unemployment is limited to frictional unemployment, structural unemployment and voluntary unemployment.The employment rate determined by the amount of employment in which the supply and demand of labor are consistent is called the natural employment rate.The size of the natural employment rate depends on a country's technical level, customs and habits, the amount of resources, etc., and has nothing to do with monetary factors.Actual employment in a capitalist society is often greater or less than the natural rate of employment, depending on the difference between the actual rate of inflation and the expected rate of inflation.If the former is greater than the latter, the employment volume is greater than the natural employment rate, and vice versa.

This gap is caused by people's misunderstanding of the price level in the short term. For example, commodity dealers see an increase in the price of their commodities and mistakenly believe that the demand has increased, which will require more labor.But this misunderstanding disappears in the long run, and one sees the prices of all commodities rise, thereby restoring the quantity of labor to its original level.Therefore, rational expectations believe that the capitalist social economy has a tendency to make employment equal to or tend to the natural rate.According to this theory, there is no trade-off between inflation and unemployment, as the Keynesians say.The sudden nature of macroeconomic policy can only lead to expected results under conditions where people's expectations are wrong.If it is assumed that the government's policies are regular, people will accurately predict the expected results and take corresponding measures to offset the effects of government policies.

Are Securities Brokers Trustworthy?
Once upon a time, an excellent Hollywood film "Happiness Knocks on the Door?" moved countless people silently. It told the story of a stockbroker.

Adapted from real people, this film tells the struggle story of American investment expert Chris Gardler.

A middle-aged man, despite his hard work, is still poor, unable to pay taxes, parking fees, his wife left because he couldn't bear it, leaving him and his five-year-old son.He also lives on the streets because he cannot pay the rent.When I was at my worst, I only had 21 dollars left on me.In order to survive, they lived in relief stations, subway toilets, and struggled to survive by selling a few medical equipment.Relying on his intelligence, Chris won the opportunity of being an intern at the famous Werther Securities Company, and with his extraordinary diligence, he finally became a securities broker with an annual salary of 80 US dollars. In 1987, he founded Gardner investment company.

The meticulous characterization and many touching details in "Happiness Comes Knocking on the Door" can't help but make people feel good about the role of a stockbroker.But when you stand in front of them as an investor, you can't help but wonder: Are stockbrokers really trustworthy?
A securities broker refers to a securities firm that accepts customer orders to buy and sell securities on the stock exchange, acts as an intermediary between the two parties and collects commissions.In the securities market, the proportion of securities brokers is not a minority, and their role to investors and financial institutions cannot be underestimated.Brokers have the professional quality of risk management and insurance claims, which can promote the insurance companies they cooperate with to improve risk awareness and risk management level, and help protect the interests of customers.They generally have skilled professional knowledge, good manners and temperament, and they have enviable careers.

There are three types of stockbrokers: commission brokers, two-dollar brokers, and bond brokers.

The duty of a securities broker is to act as an agent for clients to buy and sell securities in securities transactions and engage in intermediary business.That is to say, in securities trading, the majority of securities investors do not buy and sell securities directly with each other, but buy and sell securities through securities brokers.As an intermediary between buyers and sellers, a securities broker acts as an agent for customers to buy and sell securities: it inquires about the buying and selling prices of both buyers and sellers of securities, and according to the customer's entrustment, truthfully reports the customer's instructions to the stock exchange, and through the stock exchange , when the buying price and selling price are the same, facilitate the transaction of securities trading between the two parties, and charge the transaction fee (commission) to both parties.

It is worth noting that there is a difference between a securities broker and a securities dealer.Dealers hold inventories of securities and profit by selling them at a price slightly above the bid price, that is, the "spread" between the bid and ask prices.Since the price of securities may rise or fall, traders bear greater risks in buying and selling, while brokers, on the other hand, do not own the securities involved in the transaction, so there is no risk.So some firms that specialize in bond trading can go bankrupt, but brokerage firms don't take those risks.

What we need to know is, is the information provided by the securities broker reliable?Can their words be trusted?
Suppose your broker tells you that a certain company A has just developed a new product that can heal athletes' feet, its stock will definitely rise, and it is recommended that you buy the company's stock.Should you follow his advice?
According to the efficient market hypothesis, you should be skeptical of such news.If the stock market is efficient, this news is already reflected in the stock price of Company A, and its expected return equals the equilibrium return.This gossip has no special value, nor can it help you earn extra high returns.

Of course, as you might suspect, this tidbit could be the latest news, and in doing so, you'd have an edge that other market participants don't have.If other market participants get the news before you, the answer is no.Once word of this spreads widely, the untapped profit opportunity it presents can quickly disappear.The stock price will already have this news built in, and all you get is the equilibrium rate of return.But if you're one of the first to hear about it, it does pay you off.If you are one of the lucky ones, you will get extra high returns by buying the shares of Company A.As investors, we should have certain securities knowledge. Although we don't need to "do everything by ourselves" in investment, we should also increase our risk awareness.For us, securities brokers should be our helpers in investment and financial management. We need to use our own wisdom to decide on appropriate investments.

(End of this chapter)