Finance & Economics Department

Finance and Economics Professor Daniel Weaver participated in a panel discussion hosted by The Wall Street Journal on the subject of financial markets. The following are exchanges between WSJ and Prof. Weaver.

WSJ: What does high-frequency trading mean? What are these firms doing, and to what extent have they replicated the role of floor traders?

Prof. Weaver: The average high-frequency trader's profit is 10 cents on 100 shares traded. When you have a machine, it becomes scalable and very profitable to make very small profits per trade.

WSJ: How does it affect individual investors?

Prof. Weaver: Whether or not there is more volatility in the marketplace is the issue. It's not clear whether more volatility is being caused by high-frequency traders. Certainly there are tighter spreads, more liquidity. But there's more price impact, and there may be more volatility in the market as well.

WSJ: Should retail investors be concerned?

Prof. Weaver: They should stay away from short-term trading strategies. They are going to go up against computers and lose. But put it in perspective. IBM shares traded at about $80 on Feb. 28, 2006. If you ended up paying an extra 25 cents a share due to volatility, then you paid an extra 25 cents per share. Over the next five years IBM doubled, which impacts returns much more than the 25 cents. Investors should worry about the long-term price appreciation of stocks, not small volatilities.

WSJ: What about the impact high-frequency trading has on exchanges' trading networks?

Prof. Weaver: We have to worry about stresses on the system. The Tokyo Stock Exchange had to shut down twice in the past six years because their systems could not handle the volume of traffic. As high-frequency traders scale up, we're going to need more improvements to the structure of exchange backbones. If we don't have that, we could have a crash precipitated just because the exchanges couldn't handle the message traffic.

WSJ: Electronic traders are often portrayed as secretive and predatory. What can they do to improve their public image?

Prof. Weaver: If they have nothing to hide, then show us the data. It'll have to be coded so that we can't identify any individual firm and replicate their trading activities. But there are ways, which Nasdaq has done, to release the data without the high-frequency-trading firms fearing that their trading strategies can be discerned by looking at the data.

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Though often criticized as frivolous and lacking economic benefit, new research by finance and accounting professors at Rutgers and Emory universities' business schools finds that class action lawsuits are a strong deterrent to misrepresenting corporate financial results and other wrongdoing.  And, in many instances class actions are a stronger deterrent that SEC enforcement actions.

"Our research found statistically and economically significant deterrence associated with both SEC enforcement and class action lawsuits," said Simi Kedia, Ph.D., MBA, associate professor of finance at Rutgers University Business School in an interview with The Investor Advocate.  "We looked at firms in the same industry as the enforcement target and found that the average peer firm subject to SEC action and/or litigation reduces discretionary accruals (i.e., reporting as sales transactions for which payment has not been received) equivalent to 14 percent to 22 percent of the media return on assets in the aftermath of such enforcement."

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Demographics are destiny

The year 1948, just after the second world war, may seem like a different era. In fact, alternative yields from fixed income of 60 years ago were comparably meagre. The prime rate then, at 2% in August 1948, was lower than it is today, at 3.25%.

Or one might argue that the structure of American retirement investment funds has radically altered, shifting from corporate pension plans toward self-directed 401(k) vehicles and Individual Retirement Accounts. Do these contemporary structures manoeuvre savers into stocks?

The opposite is more likely. These 401(k)s offer employees a menu of choices, including equities, bonds and money market funds. Investors can choose for themselves, thereby controlling their own cash positions, unlike the traditional pension plans of 30 years ago.

Mutual fund managers, by contrast, rarely keep more than a modest percentage in cash. John Longo, a finance professor at Rutgers Business School and chief investment officer of the MDE Group wealth management firm, says: “These investors, who generally have no financial training, are still responsible for managing their retirements. Typical investors lack good advice and are more likely to be subject to psychological whims. That means they get nervous when the market goes down and sell.”

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The best thing to be said of the recent stomach-churning turmoil on Wall Street is that it’s taking place in August, a time of year when many people are lounging at the beach or camping in the woods and not paying attention to stocks. But for everyone else not on a ‘stockation,’ watching the markets rise and fall like giant ocean swells has been an unnerving experience that some finance professionals worry could reshape investor behaviour for months and years to come.

“There’s a different dynamic now because of the pervasiveness of high-frequency traders and hedge funds,” says John Longo, chief investment strategist at MDE Group, which manages USD 1.3 billion in assets. Longo, also a finance professor at Rutgers Business School in New Jersey, adds: “The down-5% one day, up-5% the next day volatility wouldn’t have happened in the past.”

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Finance and Economics Professor John Longo was recently interviewed on Bloomberg Radio. Please click here to listen to the interview.

Businesses aren’t spending for the same reasons families are canceling vacations and delaying the purchase of a new minivan: the future is scary.

"For companies, the outlook has been bleak," said Farrokh Langdana, Rutgers Business School professor of finance and economics. "They’ve been sitting on sacks of money for a while now because there’s uncertainty."

Langdana said companies are unnerved by possible costs of tax changes as well as new regulations that add to expenses. The lack of spending by businesses is in itself a drag on the economy, which poses a chicken and egg paradox, according to experts.

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To the Editor:

The S.&P. debt rating cut is certainly not good news for the United States, as it reflects a dim view of our economy by a respected analyst. However, in general, ratings for bonds and other securities mainly reflect default probabilities, and some research, including my own, shows that S.&P. may systematically err in its assessments. Moreover, the United States, technically, never has to default on its debt.

There is a fundamental difference in that respect between, say, Greece and the United States. Our external debt, as well as all our domestic obligations, are denominated in dollars. And our government can print dollars.

Greece, on the other hand, owes euros both domestically and internationally but cannot print euros. Therefore, Greece may actually not have enough euros to pay off its obligations whereas the United States can always print more dollars.

Of course, I am not advocating wiping out our national debt with runaway inflation (which is the usual consequence of heavy printing of money). This is also not to say that we do not have a recession, a serious debt burden, high unemployment and low growth.

But it is important that we are very clear about what a downgrade means.

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By competing with universities from Italy, Thailand and California in the global finals of the CFA Institute's Global Investment Challenge, Rutgers Business School (RBS) symbolized the Rutgers mantra "Jersey Roots, Global Reach." The RBS team consisting of a mix of undergrad and MBA students from Newark and New Brunswick was runner-up along with the Thai team from Thammasat University and the University of Southern California to the winning Italian team from Politecnico di Milano.

In the wake of the world’s second-worst nuclear disaster, confidence in what had been one of the most promising forms of alternative energy has faded, but talk of nuclear energy’s demise has been greatly exaggerated.

Japan’s disasters “blasted the industry back to where it was pre-2007,” said Christopher Ecclestone, mining strategist at Hallgarten & Co. “It cut off at the knees the nuclear spring and has produced an eternal autumn.”

But the outlook for the nuclear industry — and the uranium needed to fuel it — isn’t all that bleak.

“The momentum that had been building in nuclear power prior to the accident in Japan has been derailed, but nuclear will continue to be an important part of the long-term energy solution,” said John Longo, professor of finance at Rutgers Business School in Newark.

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