Friday, April 11, 2014

You Can Profit From Other People's Bias!

In the past week, I've observed several oddities that could be described as market failures, or at the very least as market "bifurcation", where demand appears to have gaps:

1) Long-term unemployed vs. short-term unemployedThis piece from Tim Harford argues that workers who have been out of work for more than 6 months are likely to be marginalized by potential employers for no reason other than the duration of their unemployment. If you want your heartstrings tugged a bit, try this article from the New York Times.

2) Graduates vs. non-graduates. Bryan Caplan, featured on this EconTalk episode, goes through some of the evidence for the signalling model of education. As he notes, it's odd that academics resist a model that is so clearly borne out by personal experience. This holds true even for jobs where university education is completely unnecessary. Just today, I heard a female senior banker tell graduate students that an important element of her career success was always having full-time nannies, but she noted, "I only hire graduates." The point of that, she said, was so that the nanny would be intelligent and proactive enough to deal with mini-crises at home on his/her own without troubling her at work - a perfectly reasonable viewpoint, except that there are lots of intelligent, resourceful people who don't have university degrees, and could probably fill that role quite adequately.

3) Creditworthy vs. non-creditworthy. Some private equity guys I wrote about last week told a conference they were concerned because "banks are only too willing to lend right now." I was too polite to point out in the Q&A session that this kimono-opening was only for those deemed creditworthy by the market. Perhaps Greece's return shows that the bifurcation is being eroded. As most of you know, Greece has returned to international capital markets with a 5-year bond yielding just 4.95%. Consider me skeptical about Greece's prospects, but what's more interesting is that this triumphant return at a (relatively) low yield is occurring in the midst of poor SME lending trends in peripheral Europe. Is the love beginning to be spread across Europe slowly, or have peripheral sovereigns simply been admitted to the cool kids' club?

I understand that there are informational asymmetries in some of these markets that perhaps result in these phenomena (I'm somewhat familiar with the literature on creditworthiness and information asymmetry, but much less so on long-term unemployment/education, and welcome suggestions, if anyone's got them). But of course it's pretty arbitrary as to where those kinks occur. The graduate/non-graduate divide is clear but I wonder about the long-term unemployed. Do we see the same differences at 3, 4 or 5 months? What miraculously happens at 6 months to convince employers that the workers are damaged goods? Furthermore, I sometimes think we can take the information asymmetry argument too far. For example, you often hear undergraduates being taught that job applicants know their qualities as an employee, but employers don't. That's pretty crazy. Unless you're being hired to do the exact same job you've done before, or are being hired for a job that is clearly within your capabilities, you probably have almost as much doubt as your potential employer as to whether you'll succeed. Equally, you can hire someone with a stellar resume, who impressed you in face-to-face interviews, and then find out... nope... it's not working. So "information asymmetry" should not be confused with "uncertainty".

For some, these "gaps" are particularly interesting because there are quasi-arbitrage opportunities. Obviously, if as in case (3), there are two credit instruments with similar creditworthiness and tenor, but different yields, there is a trading opportunity. And of course investors make this sort of judgment every day, particularly with "bruised fruit", where markets over-react to poor, temporary factors and bid securities down below their fundamental values. It would be even more important on a personal level to try and arbitrage numbers (1) and (2). Sometimes this sort of talk makes people uncomfortable. I told a white, liberal, free-market-skeptical friend that there was a terrific opportunity in hiring qualified minority workers who other employers were stupidly ignoring because of prejudice. Of course, the minority workers might not get paid the same amount (by me) as a white worker would in the marketplace, but it seemed to me that we would both be better off - I, for hiring a productive worker at below market rates (meaning I could earn higher margins than competitors), and the worker for having work, wages and experience that he could parlay into another job if he so desired. My friend told me I was being an "exploitative capitalist" (thankfully I'm Indian, or he would've thrown "white" in for good measure). I'm confident, though, that my friend would have far less compunction about paying a higher wage to a college graduate than to a non-graduate, or paying a higher wage to someone who'd been poached from another job rather than "saved" from long-term unemployment. 

I'm always interested to hear about people successfully taking advantage of these market gaps, so I was pleased to see that the NYT covered Robert F. Smith of Vista Partners, whose firm uses a personality test to identify workers with leadership potential and innate analytical abilities. "Not only are many of these workers less expensive than their better-credentialed peers, but to Mr. Smith, they are often more driven to succeed. And employing them, he believes, provides a social good." My friend would call him an exploitative capitalist, I'm sure, but we need more ideas like that to help non-graduates and the long-term unemployed even the playing field. Oh, and what the hell, maybe even peripheral European corporates while we're at it.


  1. it pays to start with the assumption that the market is inefficient until proven otherwise rather trusting efficient market hypothesis

  2. Some markets appear to be inefficient in the short term but efficient in the medium term. Identifying the gap between those two horizons is profitable. Some appear to be perpetually inefficient, e.g. bias against qualified minority workers...