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"A demon in our own design, markets, hedge funds and perils of our own innovation”, is a financial book that was written by the Wall Street veteran risk management consultant Richard Boockstabber about as suggested by the title,
In this book, Boockstabber discuses the very important role that asset liquidity plays in the markets, which is not always fully appreciated, and also present a theory, normal accidents that lead to very high complexities and tight coupling. He uses the following in his review:
All these accidents were what can be categorized as normal accidents, yet they had infinitesimally small chances of occurring and had abnormally large financial implications. It would not have been possible for a risk manager to foresee the accidents; they can only be accommodated in the chaos theory, small seemingly insignificant conditions with far reaching financial implications. They are the butterfly effect.
In this book, Boockstabber also attacks the efficient market hypothesis; a theory that it is not possible to “beat the market” stock. This is due to the fact that, the efficiency of the stock market is responsible for the fact that the prices of the shares reflect and incorporate all relevant information. That is to say that, it is not possible for investors to either purchase or sell shares whose proper value has either been inflated or deflated. The implication of this is that the investor can only get higher returns for his or her investment. This can be achieved by trading making investments that are at significantly higher risks of failure, which fends off competition)
Boockstabber attacks this theory using biological and evolutionary analogies “One of the curious aspects of worsening market crises and financial instability is that these events do not mirror the underlying real economy. In fact, while risk has increased for the capital markets, the real economy, the one we live in, has experienced the opposite. In recent decades the world has progressively become a less risky place, at least when it comes to economics. In the United States, the variability in gross domestic product (GDP) has dropped steadily. Year by year, GDP varies half as much as it did 50 years ago. The same holds for disposable personal income, with greater stability in economic productivity and earnings, and with greater and broader access to borrowing the personal income of the average worker have considerably become stable in the recent years.” (Bookstaber, 2007; 16).
If the system is self deterministic, why Boockstabber asks, the financial contradictions that exist? Is it possible that an investment can gain value steadily at a very fast rate and simply deflate as fast once it catches the public eye? What led to the Japanese stock bubble, the Nikkei index tripled in the period between 1986 to early 1990, the halved over the following nine months? In the USA, there was the internet bubble that saw the value of the NASDAQ rise fourth fold in a little more than a year and then decline by a similarly amount the following year. Did the market values of these increase and then decrease in such a short period? Was this brought about by market forces?
Boockstabber also applies the argument that, in a real efficient market the returns accrued by the ordinary average investor should be the same as those accrued by the Wall Street investor since they are all on the same footing in terms of taking risks. An average person can make the observation that this is not what happens.
However, Boockstabber concedes that the trend has been improving in the recent past.
The main puzzle in this book is; if trading technology and financial economics devoted into the field of modern economics are so big, why does the financial market occasionally get out of control? Why are there recessions? Why are these recessions not foreseeable?
Boockstabber places the blame on the conduct of the institutional investor’s employees. First, the regulations hinder them from doing rational things and secondly, the hardships of the structures often motivate them to do wrong things (Turner, BA., 1978).
The author of the book “A Demon of Our Own Design” claims to have been around when the market clash of 1987 occurred. He also witnessed the 1998 market fund debacle, and he has also been working in the Wall Street risk management business. Yet with all this accolades, he was unable to foresee the 2007 financial recession, which occurred the very same year that his book sent to publication. If he is the flawless risk manager that he claims to be, at least he should have seen this one coming. However, to his credit, he was able to foresee some future financial crisis, though he did not place this supposed crisis. One can even go as far as claim that he only predicted this calamity to make the book more appealing (Deming, 1989).
In conclusion, Boockstabber argues that, liquidating moves the market; however, a lot of scholars disagree. Their main point being that the main factors that drive the markets of the capitalist economies are greed and fear. Greed leads to the taking of unrealistic risks while fear is known to keep the investors from good opportunities. However, a good investor is one who possesses both elements in the right quantities. He neither takes too big a risk nor shies away from a good opportunity.