By the way, I'm looking for people to use and exploit my knowledge for their own selfish purposes. E-mail me at joe@confucius.gnacademy.org. You might take a look at what I want.

2005 December 25 - NY Times background information on Zhao Yan

There is some context that is missing from the news reports on Zhao Yan, the news reporter for the NY Times who was has been detained and finally formally indicted. One thing about the Chinese legal system is that most of the negotiations and decisions are made before the indictment is issued, and by the time an indictment is issued most of the decisions about the case have been made. The second is that there is a large amount of face involved and it is unlikely that the government would drop all charges once an arrest is made.

Based on how the Chinese government has behaved in similar cases, my prediction is that Zhao Yan will be given a stiff sentence by the Chinese courts, but that this sentence will be suspended most likely for "medical reasons" and he will then be allowed to leave for the United States on medical treatment, at which point the matter will be closed. Given the attention that Zhao Yan has received in the West, it is very unlikely that he is going to be imprisoned for a very long time, since this will just introduce a point of contention for no reason. At the same time, the Chinese government doesn't want to look weak. So a quick trial followed by getting Zhao Yan out of China is going to allow the government not to lose face, while at the same time not opening up a continuing issue.

2005 December 25 - More on the coming non-collapse of China

According to Gordon Chang, the coming year is the year China is supposed to collapse. The idea was that with competition from foreign banks, there would be a run from insolvent state owned banks, which would cause the financial system to collapse. The funny thing is that this doesn't seem to be happening, and foreign banks are buying into the big four banks. Let's go through where Chang got it wrong....

1) The big four banks were insolvent, but they were liquid. One fact about the big four banks was that they had a huge amount of liquidity. About half of their assets were in cash or government bonds, whereas if a Western bank has more than ten percent in cash, something is seriously wrong. The consequence of this is that the big four banks always had enough cash on hand to deal with a sudden increase in withdrawals. This combination of bad loans plus lots of cash is something that you don't see much outside of China, but it is a consequence of the big four's previous role as a cashier for state-owned enterprises.

2) Retail banking is hard. The trouble with retail banking is that you have to set up lots of branch offices, hire lots of tellers, convince people that they should bank with you instead of the bank they've dealt with for the last ten years, etc. etc. This is the main reason that some of the banks are buying into Chinese banks, so they can take advantage of networks that are already there.

3) Big banks don't like to do retail banking with small deposits. As a consequence of being hard, the margins are low. Big banks just don't like to handle small deposits, and they almost have to be legally required to do so through community reinvestment acts. There are just more lucrative and easier ways of making money than to handle small checking accounts, and the banks that are going into China are more interested in things that will make them a large return than to handle Auntie Chang's tiny bit of money.

4) The effects of corruption are limited. A lot of books point out (correctly) how sleazy and corrupt the Chinese political system is, but (incorrectly) conclude that this dooms the system. There are lots of historical examples of sleazy, corrupt political systems which had managed to create huge amounts of economic growth (South Korea 1960, New York City in the 1870's). The trouble with the conclusion that corruption will kill the system is that there are limits to the amount of economic impact that corruption has, and at least in the Chinese case, the basic problems with the banks really aren't the reason of corruption and evil intentions. The 1990's NPL problem cost between US$200 and $400 billion and that is much too much to be the result of greedy officials.

Also in the case of China and the East Asian tigers, corruption is self-limiting in the sense that it makes no sense for a parasite to kill the host. Even the most corrupt officials in China realize that their corrupt gains end if the economy collapses which leads to the final point....

5) Chinese government bureaucrats are not idiots. It's common in a lot of writing is say "China has problem X, Y, and Z, and so the Communist Party is doomed." What ends up usually happening is that "China has problem X, Y, and Z, and so the Communist Party deals with problem X, Y, and Z so they stay in power." The case of non-performing loans is one that could have killed the Party if they sat on their hands and did nothing, so people realized this and did something about it.

2005 December 17 - An example of trying

First read this about the Dongzhou incident...

http://spaces.msn.com/members/uleewang/Blog/cns!1plke0ePVdFBdO0ie_eGo5Gw!608.entry

::Of course, to us journalists, this may be little comfort. But again, damn you if you say we are not trying.

Funny thing about today's People Daily website. Today it has a story about the model of guns being issued to the Public Security which allows it to a put a rather picture of a gun on the home page. It has a notice in the story not for other websites not to copy the pictures. Someone at the People's Daily is pretty obviously trying to get around the censorship order that has been issued over Dongzhou.

This story is not going to die down. The most the Chinese government can do is to keep things calm for a few weeks while it figures out what to do, but it is going to have to address the issue of the shootings because it is going to cloud everything that the government does it if doesn't. What is probably happening right now very high in Beijing is that people are in the process of drafting an official version of events which will guide future policy. This might sound sinster since "official version" in Western parlance usually means whitewash, but that's not necessarily the case here, since it may very will be that the official version of history could authorize criminal action against the police.

At the same time the official version of history will need to be something that more or less satisfies the public and also doesn't give demonstrators carte-blanche to use gasoline bombs. The other thing is that it also requires some time for Beijing to figure out what is going on. I suspect that local officials are worried far less about the foreign press finding out what happened than central government officials. But that document has to come out in the next month or so. It might be very quietly released. It that document will be written, and it will be interesting to see what it says.

As far as the silence in the Chinese press. My suspicion is that situation is not quite as one sided as it might first appear. There is really very little that the Chinese government can do to force a newspaper to kill a story. (If you shut down a newspaper and arrest reporters, that doesn't kill a story.) My guess is that the Chinese government has met with the owners of the major websites in China and extracted a promise to remain silent on this issue until the government has time to figure out what happened and issue an official statement. That agreement is going to last for a few weeks at the most, and if the government just sits on its hands and does nothing or if the official statement is a white-wash, all hell is going to break loose, when people start violating censorship orders, and there is nothing that the government can do without bringing more attention to the matter.

I'll have much more to say in a month when the official verdict comes down or if nothing comes down.

2005 December 16 - New China Leadership Monitor

http://www.chinaleadershipmonitor.org/

As usually good stuff.

I do disagree slightly with Li Cheng's article on the status of foreign returnees. He does a census of governors and finds that returning foreign students (hai gui tuan) are underrepresented at the governor and ministerial levels and speculates that this is due to lack of trust of foreign educated returnees.

I'm not so sure that this is the case. The problem is one of timing. The PRC didn't allow foreign students overseas to the West until 1977. For the first few years, there were very few returnees. This means that even in the best case, you wouldn't expect many returnees now at the governor or minister level, but instead would expect them at the vice-minister or assistant governor level which is what you see.

What would be really interesting is to try to go down into the bureaucracy and see what the fraction of returnees is. The other missing thing is to look at the foreign and trade ministries since I suspect that returnees are much more prominent there than in provincial governments.

2005 December 12 - What caused the Great Depression and its relevance to the Chinese economy....

There are basically two hypothesis as to what caused the Great Depression. One is that during the 1920's, there was a bubble economy as factories and credit caused things to be overbuilt. The other says that the blame for the depression lies not with the credit expansion of the 1920's, but rather with the decision by the Federal Reserve to tighten credit in the 1930's after the stock market crashed and with the decision to introduce protectionist tariffs.

Now the relevance to the Chinese economy is that under the last three years or so, China has had a loose credit policy that has resulted in a massive build up of factories and production. If you take the first hypothesis, then the Chinese economy is destined for a sharp slowdown. If you take the second, then it isn't.

Place your bets....

2005 December 12 - What people forget about the Chinese economy

see comments http://simonworld.mu.nu/archives/142749.php

The main thing that people forget about the Chinese economy is how low the level of development is. This makes comparisons with Japan or the Soviet Union 1990 problematic. In the case of Japan or the Soviet Union in 1990, you had economies that were overwhelming industrial, and the only way to increase standards of living is to increase productivity. In the case of China, the vast majority of the population is agricultural, and you can get massive improvements in the standard of living by essentially turning farmers into factory workers.

This means that a lot of the concern about the Chinese economy being unable to grow because of inefficiency are misplaced. People are so focused on the lessons of the 1990's that they forget the lessons of the 1950's which is that you can have a frightfully inefficient economy and still get massive economic growth if your development level is low enough. From a productivity point of view, the Soviet Union was abyssmal, but even it managed to grow considerably for a few decades until it started hitting ceilings in the 1970's.

Eventually without productivity increases, you hit a ceiling, but that ceiling is about two or three decades away for China, and a lot of attention to increasing productivity now can make sure that this ceiling disappears long before China gets there.

2005 October 20 - The Party Line

See this page JosephWangPartyLine

2005 October 20 - The difference between authoritarian regimes and totalitarian ones

Communications is sometimes difficult because what is obvious to one person is not obvious to someone else. So let me explain the difference between capitalist authoritarian regimes (such as the PRC-2005) and communist totalitarian ones (such as North Korea and PRC-1975) and why the former is far less objectionable.

In both cases bad things will happen to you if you end up directly challenging the state. It is certainly true that in the PRC-2005, you will end up in jail if you start a movement to overthrow the Party. So there is a point of view that says that PRC-2005 is really no different than PRC-1975 or North Korea. And if you are a political dissident, may be it not that different.

But I don't want to overthrow the government, I just want to ride my bicycle.

Now in a sane society, if I want to ride my bicycle, I go to a bicycle store, pay some money, buy my bicycle and go to the countryside. Maybe my boss at work doesn't like bicycles, and threatens to fire me if I ride a bicycle on the weekends. However, I really like riding bicycles, and I really hate my boss, so maybe I'll quit my job and open a bicycle store or at least leave my current employer and find one that is less unreasonable.

Now this is the way things work in most places, but imagine a communist totalitarian society. For the most part things don't work with money, so you can't just pay someone to build a bicycle. It gets worse. Remember that the state is the only employer, so if your boss at work thinks that you shouldn't go riding bicycles but rather should attend the party demonstration, you can't leave. You don't have the option of opening your own business, and since the state is the only employer you don't have the option of leaving your job to find another one.

Pretty nasty isn't it?

So that's really the difference. There is no real freedom of speech in either authoritarian or totalitarian societies, but in authortarian ones, there is a realm of personal space that the government isn't interfering in. The difference is that authoritarian governments tell you want you CAN'T do. Totalitarian governments tell you want you MUST do.

2005 October 19 - The Renminbi as a consumption asset

There are two types of assets, consumption assets and investment assets. The difference is that if you have a bond, and you can make one penny by selling the bond, you should since the bond has no inherent use to you. However if you are an airline and you have some oil, you might not want to sell it even if you can make some money off of it, and moving oil is not a trivial exercise. Of course if someone is willing to pay you a lot of money for your oil, you might do so. The difference between the market price and what people are willing to pay to hold on to it is something called the convenience yield.

Now in the case of currency, the convenience yield is normally zero, but if you have capital controls, I would argue that the convenience yield is no longer zero. There is some inherent worth for having RMB if you need RMB just like that there is some inherent need for oil if you need oil. Just like an airline can't immediately convert oil to cash, also a holder of RMB can't automatically convert it to dollars.

2005 October 17 - Added sample curve to quantlib

I've added the ability in quantlib to grab the whole curve that is produced in a finite difference calculation.

2005 October 15 - The rear view mirror

One thing that I've seen happen is that people look at China through the rear view mirror. Typically, there is a problem, people address the problem, people solve the problem. This usually takes about five years or so to happen but it can happen a lot more quickly.

I was thinking about the rear view mirror in reading this article....

Reaving up the China Threat - http://www.atimes.com/atimes/China/GJ15Ad02.html

This would have been timely around January, but since then about a dozen things have happened. Just to name a few, the US situation in Iraq is more precarious, China brokered a deal of principles about NK, the RMB has been refloated, there are been a major scandal involving the Kaohsuing subway in Taiwan, you have the Lien-Soong trip, Katrina wiped out New Orleans.

Similarly, I get a bit peeved when you see commentaries talking about the problem of inefficient factories and bank loans to them. Problem seen. Problem fixed. Problem almost solved. Also, the problem with the overheating economy last year. Yes the economy was overheating. Problem seen, fixed, solved.

Right now the bit problem is the gap between rich and poor. My prediction is that now the problem has been identified, people will do something about it, and once they do something about it, the problem will be solved in about five years or so.

2005 October 15 - The Coming Non-Collapse of China

a reply I posted to Brad Setser's blog.

http://www.rgemonitor.com/content/view/104395/86/

In the case of consumer credit, the strategy of the big Western banks has been to buy minority stakes in Chinese banks and perhaps provide some of their own expertise in the mix. But by and large, the Western banks are not setting up their own independent consumer credit operations in the PRC (even though they will be allowed to under WTO rules).

The irony in all of this is that this scenario is the exact opposite that Gordon Chang talked about in the "Coming Collapse of China." His argument was that competition from Western banks would cause Chinese savers to withdraw money from the big four banks and put them into Western banks causing the Chinese banks to collapse. What is actually happening is Western banks are buying into Chinese banks to get at the Chinese consumer credit market, and this is providing a large cash infusion that is letting the banks write off the last of the 1990's non-performing loans.

The thing that I think is going to really be the "big thing" in China are asset-backed securities.

As far as corporate finance goes.... The real problem is that the financial structure of Chinese banks and corporations does not make any sense. You build a factory and you pay for it from bank loans. The trouble is that the bank loans are funded by demand deposits. So you have a long term capital expenditure funded by something that is financed by short term demand deposits.

It makes much more sense to issue a long term bond to fund long term projects.

Also, John Snow's talk about Chinese lack of financial sophistication really rubbed me the wrong way. If you go into Wall Street, there are pretty large numbers of recent immigrants from the PRC that are running things, and the PRC is experiencing a pretty massive "brain gain" as these people go back home and start managing things there.

Part of the reason the PRC is going a little slow on these issues is that the economic policy makers are quite sharp, and they really do understand the dangers involved in making the wrong moves.

Also the talk about international-level hotels in Shanghai is also silly. The really big challenge and the really big money in China is going to come from services for the 800 million poor/middle class and not from the 80 million or so rich people.

2005 October 14 - Upholding the fifth plenary spirit

Whenever Chinese and English versions of the state press diverge, something interesting is up. The top stories in Xinhua and the People's Daily involves "upholding the fifth plenary spirit" which is to move China away from a growth at all costs direction into one that expresses more social and economic equality. We are now very deep in the Hu era, and the "fifth plenary spirit" is Hu's attempt to define an agenda. It's actually quite clever sense it gets around the some of the complaints that marked Jiang's theory of the three representations. The first being that three representations was incoherent, the second being that it was a prototype cult of personality.

Also, it seems that the English People's Daily has started using the term "Taikonaut." ARRRGGHHH!!!!

2005 October 14 - The dumbest waste of paper I've seen

This is just one of those stupid wastes of paper. It goes into hundreds of pages about how the US is losing its competitiveness in science. Yadda. Yadda. Yadda.

http://www.nationalacademies.org/morenews/20051012.html

I have one recommendation to my distinguished colleagues,

* Stop treating young scientists like crap, and may be people will want to be one. *

Good grief almighty, the panel they assembled was the worst possible one that you could imagine for a report like that. People who have won in a system are the worst possible people to figure out how to reform it. Why don't you get some first year post-docs and ask them why no one seems willing to go through ten years of education for nothing.

2005 October 13 - Imperial Chinese Law

The trouble with being curious is that you learn new things which makes you more curious etc. until you get totally exhausted.

I started reading up on Chinese law in the Qing dynasty partly to satisfy a bit of curiosity I had on why trusts are so commonly used in the PRC which came from a discussion on the CHINALAW list. Here you have an item of English common law was grafted onto a system of Roman Civil law, but which seemed surprisingly popular. The question I had was whether the important role taken by trusts in modern PRC law had any ancedents in pre-modern Chinese law. It turns out that in southern China lineage trusts were very common. The question then becomes what was the law of trusts in Qing dynasty China and what impact in modern Chinese law that has.

One in which current PRC law has no similarity with either Roman law or Common law but is very similar to Imperial Chinese law is in the area of land tenure. In both Roman law and Common law, the bundle of rights associated with land tenure tend to be very simple. You own the land, you have rights to the land. You sell the land, the buyer has rights to the land. However, current PRC law has a very complex system of land use rights. This is usually seen as a transitional system from a socialist economy to a more modern (read European) system of land tenure. However, the Qing dynasty had an arcane and complex system of land tenure in different owners had top-soil and sub-surface rights and which land sales were conditional with the seller retaining residual rights to repurchase the land.

2005 October 12 - The Posse Comitatus Act and the Qing dynasty civil code

I've been reading Philip C.C. Huang's book on Civil Justice in China. The interesting thing about the Qing civil code is that it is formally a criminal and administrative code, but you can derive civil principles from it.

It occurs to me that there is one example in American law where this occurs, and that is the Posse Comitatus Act

:::Whoever, except in cases and under circumstances expressly authorized by the Constitution or Act of Congress, willfully uses any part of the Army or the Air Force as a posse comitatus or otherwise to execute the laws shall be fined under this title or imprisoned not more than two years, or both.

From this criminal law it is possible to derive the principle that the military should not be used for civilian police duties.

An example for the Qing dynasty code is Statute 338

:::Sons or grandsons who did not provide adequately for their parents were liable to punishment by 100 blows with the heavy stick.

From this statue, one can derive the a positive legal principle that sons have a duty to care for their parents.

2005 October 12 - Tashi and the Guardian

Here is information that about the situation in Tashi posted by East South West North blog

http://www.zonaeuropa.com/20050919_1.htm

Also some comments of mine on Rebecca Mackinnon's blog

http://rconversation.blogs.com/rconversation/2005/10/taishi_china_lu.html

2005 October 11 - Up and away

Glad to see someone excited about manned space flight.

http://scitech.people.com.cn/GB/25509/53955/index.html

Manned spaced flight has a special resonance to me, since I was born the year of Apollo 11, and its a big reason that I ended up in astrophysics. It's very important for China to have a strong manned space flight program, because without a strong Chinese manned space program, there won't be a strong American manned space flight program. The worst thing that ever happened to NASA was for it to have "won" the space race against the Russians. Once that happened things went downhill very quickly. With two active manned space programs from economically expanding nations, each will try to one up each other, and keep this decay from occurring.

As far as the question of what good a manned space program is for. Manned space flight is pretty much useless for scientific exploration, and its also not too much in the way of direct industrial spinoffs. However, before writing it off as useless... People used to ask me what good an astrophysics Ph.D. degree was for. The answer that I now have is that an astrophysics degree is useful in development C++ code and also useful in valuing financial derivatives. However, I didn't know about either of these two answers in mind when I actually was studying astrophysics.

The answer to the question is similar. There is no immediate use for manned space flight. However, manned space flight requires that a nation and a planet develop skills and capabilities that will be useful in the future. And if some friendly competition helps to force people to invest in those skills and capabilities, that's a good thing.

2005 October 11 - Stop this taikonaut madness

The Chinese term for astronaut is yuhanyuan. The official English translation of the term used by all Chinese state media and every Chinese source out there is "Chinese astronaut." The term taikonaut was invented on the internet and is not used by anyone that is involved in the Chinese space program.

Good luck on Shenzhou 6.

2005 October 8 - Sniping on Ebay

Two interesting papers on sniping on Ebay.

http://www.tagung05.uni-bonn.de/Papers/Bracht.pdf

http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1024&context=ucscecon

http://ihome.ust.hk/~tanjim/TH_LBB.pdf

Of course the easiest way of ending sniping on Ebay is to set the system so that the end time is random say +/- 10 minutes from the bid time.

The question then becomes should Ebay making harder to stop sniping.

2005 October 8 - Please exploit me

I changed my web page around a bit. It might seem absurd, but I just wanted to highlight the absurdity and irrationality of the global economic and political system.

I was going over my resume, and I was thinking to myself. Gee, with the knowledge I have in my head surely someone can think of a way to use and exploit me to make themselves filthy rich. I mean with the my skills, someone surely could figure out a way of making millions if not billions of dollars off of me. It's not as if I'm going to demand much of that. But that doesn't seem to be happening. Somehow there is a bit of inflexibility in the system, that keeps me from being fully exploited in the Marxist sense.

http://facweb.furman.edu/~dstanford/relecon/exploita.htm - for a good background of exploitation

2005 October 4 - Richard Bush and some misperceptions

Pretty good analysis.

http://www.brookings.edu/views/testimony/fellows/bush20050915.htm

Read with some interest on Richard Bush's comments on the Taiwan situation. It's calmed down quite a bit, but Mr. Bush has a basic misunderstanding that was pretty dangerous. It's this idea that Lee Teng-Hui and Chen Shui-Bian just want to keep the defacto situation with the Republic of China. The truth of the matter is that Lee wanted to deliberately provoke confrontation with the PRC to create a dejure Republic of Taiwan, and there is a substantial fraction of Chen's supporters (although probably Chen himself) who feel the same way. This isn't a conspiracy theory. Just read the Liberty Times, read anything that Lee Tenghui has said, or talk with any deep green supporter. The reason things have calmed down is that both the PRC and the United States have made it pretty clear that declaring independence or getting rid of the ROC is unacceptable.

Confidence-building only works if there is confidence to be built, and Chen is been pretty untrustworthy. For there to be a major breakthrough in PRC-Taiwan relations Chen would have to pull an Ariel Sharon and stare down his strongest supporters and make peace with the opposition. That seems highly unlikely.

Also, I think he far overestimates the chances of a split in the KMT (keep in mind that Ma won the leadership post with 70% of the vote, and the ethnic differences don't always coincide with political splits as some of the waishengren political heavyweights actually opposed Ma.) It is true that one mustn't underestimate the DPP, it's also true that people have continually predicted the demise of the KMT. Even if the DPP wins in 2008, it will be with a new President and there is a chance there to start fresh.

2005 October 3 - More about CDO's

I really need to respond to some of the e-mails on the quantlib list, but thinking about CDO's is kind of fun. O.K. the basic fact about CDO's is that you have a pot of stuff and then are spliting up that pot into pieces. Before we get fancy-smancy lets think a bit about the global constraints on CDO pricing.

So lets go to CandyLand^? where Mr. Rabbit creates a SPV with 100 mortgages he pools his rabbit hole business. He splits it into two tranches. Let's make things easy and assume that Mr. Rabbit's CDO's are zero-coupon and assume that there is zero risk-free interest in Candyland (or else instead of valuing our items in carrots, we use Candyland treasury bonds as our numeraire). Mr. Rabbit then takes his degree from the Rabbit School of Mathematics and then describes the most general formula for calculating defaults from the little bunny rabbits who are paying for their warm cozy burrows.

Now lets forget for a moment there are possibly very complex interactions between all of these factors. Just based on the fact that we have one pool of things which we are splitting into two, what can we say about the value of Mr. Rabbit's CDO's.

Let's try it a different way.

Mr. Rabbit and Mr. Owl both issue securities. The probability of defaults on Mr. Rabbit's securities is out of . The probability of a default in Mr. Owl's securities is is . The probability of default on a portfolio of both Rabbit and Owl securities is

Let be the price of a security with probablity p of default. To make it easy let f(0) = 1.0 and f(1.0) = 0.0. There is a functional equation here somewhere. f has to be a linear function of p.

2005 October 3 - CDO's, defaults and interest rates.

Looking over CDO models, I noticed that they don't seem to connect defaults with the value of interest rates. This could be a bad thing. If things go into a recession, interest rates go up, value of bonds go down, defaults go up, double whammy on the equity tranche.

2005 October 3 - Are Chinese savings a reverse-Giffin good?

I've been wondering if Chinese savings are a reverse-Giffin good. A Giffin good is a commodity whose demand rises as a function of price. When the price rises people normally demand less of an item, but because the price rise causes people to be poorer increasing demand for an inferior good.

Normally when interest rates rise, people save more. But that might not be the case with the PRC. Most of the savings is driven by consumer savings in trying to maintain a financial cushion for emergencies. So if interest rates rise, one could have a situation in which people feel that they have to save less in order keep their savings intact.

There is also a credit effect. Basically when interest rates rise it becomes possible to loan to people with poorer credit. This could create a situation in which a rise in interest rates results in a rise in money supply rather than a fall.

2005 October 1 - Tastes Great / Less filling

There is an American beer commercial from a few years back where people argue whether Miller Light Tastes Great or is Less filling. The point of the commercial is that beer doesn't have to be one or the other.

I'm reminded of that commercial after reading this article on Hu Jintao

http://taiwansecurity.org/Reu/2005/Reuters-280905.htm

which argues whether he is a closet liberal or ultra-conservative. Why does he have to be one or the other? He could be neither or both.

2005 October 1 - The fundamental interconnectedness of all things

One of the reasons I like to look at things from the PDE point of view is that it reveals the fundamental interconnectedness of all things. Basically there are not that many ways of writing a PDE or of solving a PDE, and if it turns out that two things are written with the same type of PDE, that means that in some fundamental way they behave the same way.

I'm starting to suspect that the probablility that the share holders in a Chinese company will reject a tradable/non-tradable plan can be modelled as a default process.

2005 September 30 - Method to my madness

Some potential employers might be put off by the fact that it looks like I'm working on a million different problems and it might look like that I have a lack of focus. Actually keep in mind that I'm not getting paid to do any of this so I'm going to be working on things that 1) amuse me and 2) are most likely to result in skills that can be turned into money in the future. This means that I'm going to be working on a whole bunch of different things. Now if you dump a whole bunch of money in front of me to work on one problem, of course I'm going to work on that problem.

But there is a rachet effect. Suppose I spend 15 minutes reading a paper on CDO valuation, I'm better off than I was 15 minutes before. So I do work on a lot of different things, but I try to arrange it so that none of it is wasted effort.

Speaking of CDO's, one of the things that seems to have happened in financial mathematics is that people are moving away from PDE's. This seems a shame since it seems that a lot what I've been reading in CDO valuations would be handled better using PDE finite differencing methods.

2005 September 30

Installed twiki latex plugin Started blathering on JosephWangStockReformQuant.

2005 Septemer 30

I have written the first perl quantlib program in the history of the universe. It's in CVS.

Also, I've been trying to think of ways of cleaning up the PDE code in quantlib. Partial differential equation methods are hugely underused in quantitative finance in favor for the binomial tree model which is vastly inferior numerically. The problem with PDE methods is a pedagological one in that the binomial model is very easy to explain whereas no one has written a clear introduction to finite differencing. This isn't to say one can't be written, just that no one has done so.

Right now I'm trying to modify quantlib to take advantage of one very good aspect of finite differencing which is to say that you can calculate the entire pricing curve in one calculation, which is something you can't do with tree models.

2005 September 30 - Perl and SWIG

I checked in quantlib, some wrappers that will interface quantlib with perl through SWIG. The point of this is that I'd like to do some calculations to see if my thinking on Chinese convertible bonds is correct, and it seemed easier to teach QuantLib^? perl than to teach me Python. Besides I already have a bunch of perl scripts that download information from the Shanghai stock exchange.

My books on Monte Carlo arrived today. I've also looked at some papers talking about CDO's and their valuation and I'm trying to understand what a coupla is. It seems that every bank has their favorite CDO priorietary engine, and things haven't gotten more or less standardized the way that fixed income pricing has gotten with Libor market models.

I've been looking at the corporate plans on Chinese stock reforms.

2005 September 29 - Asset backed securities

The real financial boom is going to be in asset-backed securities. The PRC has a huge amount of pent up demand with lots of newly middle class people intending on borrowing money for their mortgage or their cars. This has been mediated with bank loans, but banks need a way of managing risk and raising money to loan out. The medium of choice outside of the PRC are asset-backed securities.

These will pay more than bank loans, but will carry higher risk, but also will allow people to pool risk. If one real estate development goes bad, then you lose a little of your investment rather than all of it.

There have been two barriers to issuing ABS's in China. The first is that you have to have to get the banking system is somewhat reasonable shape and that has been done. The second is that you have get a whole mess of legal things straightened out. For example, typically asset backed securities are issued by what is known as a special purpose vehicle (SPV) which is a special thing whose sole purpose is to issue this debt. In the US, it is trivial to form a corporation to do this. In the PRC, it is hard to form a corporation to do this (minimum capitalrequirements for example). The People's Bank of China has just issued trialregulations that see trusts as the means to do this.

There is also the issue of "bankruptcy remote." Good Mortgage Bonds based on an assets from Bad Company. Bad Company goes under. You don't want to be in a situation where during the bankruptcy of Bad Company, the liquidators can seize assets from Good Mortgage Bonds that have nothing to do with Bad Company. At the same time you don't want Bad Company to be able to escape its creditors by creating Fake Mortage Bond Company. What are the rules for this?

From my point of view. Once you have asset backed securities, you have the need for lots of mathematical people to calculate how much those securities are worth. Which means a job for me.

If you really want to read the gory details in Chinese, here is a good website.

http://www.chinasecuritization.com/

2005 September 29 - PRC stock market reform

This is the hot topic in the PRC right now. The problem is that PRC shares are currently divided into shares that you can trade on an exchange, shares which are owned by institutional investors, and shares which are owned by the government. This is a major problem for a number of reasons, one of which is that the "tradable shares" are too expensive and there is no chance that the owners of tradable shares could take over the company and kick out to he management. Also this is bad for the owners of the non-tradable shares. Since they can't sell them, they can't make money if the company is managed well and don't really care if the management behaves well or not.

So the idea is to take all 1600 listed companies, make all of the shares tradable. If you did this via a big bang, the overvalued tradable shares would drop (since all of the money is in the tradables) so the idea is that each company will come up with a plan which is acceptable to both tradable and non-tradable share holders. Right now this applies only to domestic A shares. They aren't quite sure what to do with the B-shares, H-shares, and N-shares.

Most companies seem to intend to just issue more shares to holders of tradable shares which will increase their ownership of the company and set the value of their shares to reasonable levels.

The implications of this are huge. Once the reforms are done, the valuation of the companies on Shanghai and Shenzhen should start to go down to reasonable levels and Shanghai and Shenzhen ought to start acting like real stock exchanges.

The thing that gets me is that absolutely no one is covering this in the English language. One of the things that I'm starting to notice is that things in China are moving very, very fast and the conventional wisdom gets out of date very quickly. People in the West tend to regard the Shanghai and Shenzhen stock exchanges as a joke, but that is based on information which is two or three years old, and very out of date.

The problem with Shanghai and Shenzhen was too much money over too few companies. If this stock reform succeeds and with the huge drop in the value of stocks (painful but necessary to remind people that you can lose money in the market) then you are likely to see a boom in the PRC financial services industry once this is straightened out and the government starts allowing new companies to come into being.

However, the boom in stocks is going to be nothing compared to the boom in asset-backed securities that is about to happen.

2005 September 29

Restarting the blog on this page. I'm going to change the focus of this blog away from general Chinese news which is well covered elsewhere, to my what is my main focus now which is using quantitative methods to understand Greater China markets particularly those of Shanghai and Shenzhen.

I'm probably not going into a blow-by-blow account of Mainland-Taiwan relations anymore, since Chen Shui-Bian has so utterly mismanaged things on Taiwan that at this point the question is no longer whether Taiwan will unify with the Mainland, but when and under what conditions. He's basically completely annoyed his American allies, and his mismanaged Taiwan to the point where the center of gravity of the economic system is now moving onto the Mainland. I'm not a fan of Chen or his politics, but I like to think that I admire competence whenever I see it, and Chen's total incompetence is astounding.

I'm actually also no longer very worried about a war breaking out in the Taiwan straits. At this point, things are so integrated that a war over Taiwan is going to destroy the world economic system.

What I am going to focus on is my work on QuantLib^? www.quantlib.org, my efforts to get a job in quantitative finance on Wall Street, and the drastically under covered news of what is going on with PRC securities.