The size of the shadow banking system estimated according to power law

https://medium.com/the-physics-arxiv-blog/5e1dd9d1642

by 666_howitzer • 13 years ago

58 54 13 years ago

quarterto• 13 years ago

TIL: econophysics is an actual thing.

"The shadow banking system is vastly bigger than regulators had thought, say econophysicists who have developed a powerful new way to measure its hidden impact"

I had to read this a couple of times before I realised what was wrong, but apparently "Econophysics" really is a thing:

"Econophysics is an interdisciplinary research field, applying theories and methods originally developed by physicists in order to solve problems in economics, usually those including uncertainty or stochastic processes and nonlinear dynamics. Its application to the study of financial markets has also been termed statistical finance referring to its roots in statistical physics." [1]

[1] http://en.wikipedia.org/wiki/Econophysics

contingencies• 13 years ago

George Soros knows a lot about financial systems. Strong evidence is the fact that he's rich and shares his perspectives, which are better than mainstream perspectives at interpreting market behavior particularly during major crises. My favourite quote of his is the oft-repeated notion that Classical economics is based on a false analogy with Newtonian physics. He generally spends some time either side of that comment making it really clear: there is no mystical market equilibrium of supply and demand, only the behavior of individuals.

pierrealexandre• 13 years ago

In my opinion the following paper is a good and accesible primer on econophysics: JP Bouchaud - The (unfortunate) complexity of the economy http://arxiv.org/abs/0904.0805

diziet2• 13 years ago

One thing about Power Law distributions -- they work really great except at the outliers (ie, top 10). You can't always say that because incumbent #10 is x, #1 is 10x, especially when dealing with organizations that are huge conglomerates of different services, branches and sub-companies.

Look at Market Caps of companies (something that we have public signals about): https://en.wikipedia.org/wiki/List_of_corporations_by_market...

The difference between #1 and #10 is <2x, and #3-#10 all vary by just a few percent. Power Law distributions are great, but they tend to fail at the top end.

diziet2• 13 years ago

I just wanted to present a counter argument to my reasoning: What if the list of companies (which is publicly traded companies) is missing the real head -- the non public companies that are either government owned or are governments themselves? If we look at the list of companies by revenue: https://en.wikipedia.org/wiki/List_of_largest_companies_by_r... it does look like the real head of the Power Law distribution is missing.

arethuza3• 13 years ago

The original paper seems to take the Global 2000 and then re-orders them by asset size, not revenue:

"we find that financial firms dominate the top tail of the firm distribution by asset size"

http://arxiv.org/pdf/1309.2130v2.pdf

pcrh• 13 years ago

Intuitively one would expect that there are reasons why companies cannot be larger than a certain size (to exaggerate, none can be larger than the global economy). As companies approach their theoretical maximum, one would expect the distribution to deviate from the power law, as the actual data in the article demonstrates.

cperciva• 13 years ago

Clearly there must be a Shadow Corporate System and Apple is hiding close to $2T in it.

junto• 13 years ago

This is off topic, but does anyone else have a "This Week’s Top 5 Posts" section smack in the middle of the article?

Is that something new Medium are automatically injecting? If so, I don't like it. I do like the idea of being pushed to more content _after_ I've finished reading, not _during_ the middle.

huhtenberg• 13 years ago

Came here to say the same. This is obnoxious. If it happens again, it'll be the last medium.com visit for me.

aptwebapps• 13 years ago

Whoops, thought that article was a little short ...

jitl• 13 years ago

I think that this "feature" is an arXiv exclusive -- the links point only to their articles. I left an angry comment on the link block:

Is this “This Week’s Top 5 Posts” Medium’s new deal, or is it yours? This is like HuffPost mid-article attention-bait. I can’t stand it.

I’ve previously equivocated Medium with an intense focus on single article content — no distractions. It was very confusing to find this totally unrelated link block here. I thought the article had suddenly ended.

What sort of click-through statistics are they trying to drive here? They don't have pageviews to pump on Medium (do they?), so what's the play?

cousin_it• 13 years ago

Good point. It seems that if you wish to create value for end users, you should avoid middlemen, because middlemen will bundle your product with something obnoxious that adds value only for themselves. The more valuable your product is for end users, the more obnoxious stuff will be added by middlemen.

dredmorbius2• 13 years ago

In my increasingly reflexive editing of website CSS:

- I disable ALL nags. If there's a modal, slider, fixed bar, or fixed social element, I nuke it.

- If it moves, I nuke it.

- If anything is labled "viral", "tease", "nag", or "social" there's really good odds it's getting nuked. Really, stuff like that just makes it too easy, and I may add some wildcards to my default CSS.

- Unless it's a premier site (e.g., NY Times, the Guardian), I'll nuke the "Recommended", "Trending", "Most Viral", etc., columns.

- I'll strip any 3-column (or otherwise multi-column) format into a single column of body text, generally about 40-50 ems (about 850-1000px) wide. The LH column generally becomes a full-width header, the RH column a full-width footer. If they survive at all.

- Bump all fonts to 15pt (body text), 14pt (usually for overview pages), 10-12pt for most navigation elements.

- Backgrounds to to white or very close to it, text to black or very close. #fffff4 background, #222 foreground, is about as much as I'll push either.

I've noticed that the result is much more soothing reading experiences, with far fewer distractions. It literally affects my ability to focus and peace of mind. Had my stylesheet manager (Stylebot) blow up on me a week or so back, having to deal with The Web As Published ... just drove me nuts. Most site's design simply sucks.

I've got over 500 sites styled to my preferences (many are just very quick and light changes, a few more involved). The results are ... mostly pretty nice.

Among my favorites:

Buzzfeed: https://plus.google.com/photos/104092656004159577193/albums/...

Unbuzzed: https://plus.google.com/photos/104092656004159577193/albums/...

A 3-column to 1-column design:

3 cols: https://plus.google.com/photos/104092656004159577193/albums/...

1 col: https://plus.google.com/photos/104092656004159577193/albums/...

And this seems to kill the "Top 5 posts" bits:

blockquote.pullquote, blockquote.pullquote + p, blockquote.pullquote + p + p, blockquote.pullquote + p + p + p, blockquote.pullquote + p + p + p + p, blockquote.pullquote + p + p + p + p + p, blockquote.pullquote + p + p + p + p + p + hr { display: none; }

d4nt2• 13 years ago

Have you considered maintaining a [paid] chrome add-in with all this stuff in?

ronaldx• 13 years ago

I lost the flow of the article and closed the tab at this point.

crntaylor• 13 years ago

The approach seems to be along the following lines:

1. Fit a model (in the case Zipf's law) to a semi-related field (the size of non-financial companies).

2. Find that the model doesn't fit reality in the field you're interested in (financial companies).

3. Posit that your model is correct and reality is wrong, and invent over $30 trillion worth of invisible activity to account for the difference.

Alternatively... your model is just wrong?

jasonwatkinspdx3• 13 years ago

This is an obvious and accurate criticism. But it's also worth considering that large financial firms are both the best equiped and most motivated to obscure their transaction activity, so I don't think it should be dismissed trivially.

The question is: how could one find evidence that justifies or refutes the idea that the scale of firms does in fact fit zipf and that measure is being obscured at the tail?

Also, I'd point out that the original post did not differentiate between financial and non financial companies in the way you do between points 1 and 2, so your characterization of what fields are related or "semi-related" is your own creation and not part of the original claim.

gee_totes• 13 years ago

The question is: how could one find evidence that justifies or refutes the idea that the scale of firms does in fact fit zipf and that measure is being obscured at the tail?

Well, I think to find that evidence, you would have to take a measurement of the amount of shadow banking from one of these firms. Objectively, you can't do that, since there is no agreed upon definition of what the term shadow banking means.

loup-vaillant• 13 years ago

Posit that your model is correct and reality is wrong

Cough cough… The correct word is not "reality", but "currently well established models".

This is less obvious than you make it out to be.

raverbashing• 13 years ago

Or better, it's not "reality" wrong, but "financial records of certain institutions"

It's a world of difference

VLM2• 13 years ago

It seems much, much worse. He's not defining "size" very well. If I interpreted him correctly, he's claiming the assets don't follow the power law, therefore transaction volume is much higher, because of course transaction speed "money velocity" must be constant because he didn't consider it.

Evidence based on assets capped at a lower value than the power law implies probably implies either regulation is limiting asset size or otherwise distorting the market, OR the books are cooked and assets are considerably higher but accounting games are being played. Perhaps thats a good idea for future financial planning if many of the "hidden assets" are actually worthless unrealized mortgage loan losses. Or maybe they're just crooks.

Anyway its a pretty big leap to go from unusually low assets to therefore total aggregate transaction volume must be artificially low.

For those who can't tell the difference between assets and transaction volume, this is a slight simplification but the assets of the car lot at my car dealer are about 200 cars, varies a bit, but they're all of probably about the same order. Now the total transactional volume is totally different at each dealer, some sell one car per day and some sell ten cars per day. The total annual transaction volume better closely match the total annual car production. However the assets on hand merely equal a simple division problem and don't mean a whole heck of a lot. Its like comparing apples and oranges or OSes and DMBSes. They're kinda sorta related but not the same thing.

phryk• 13 years ago

What happened to labeled axes? Is it not cool anymore to tell people what BOTH axes are supposed to be?

lotsofcows2• 13 years ago

econophysicists? Wtf?

If you want to avoid the term "economics" because most people associate it with "made up financial bollocks based on applying completely inappropriate models from unrelated disciplines", then why include the "econo" part.

Also, you appear to be trying to be modelling a financial phenomenon by applying a completely inappropriate model from an unrelated discipline.

jasonwatkinspdx3• 13 years ago

Derivatives trading is now dominated by quants with a background in the methods of computational physics. Aspects of gauge theory, etc are clearly and directly relevant. Don't reject this idea out of hand because it is unfamiliar to you. It may be proven a fad eventually, but that's not at all obvious now.

As a concrete example: the Higgs result depends both on machine learning in the form of decision trees to minimize the data, as well as monte carlo simulation to generate theoretical data for comparison to what is measured. Experimental particle physics is very much now an exercise in machine learning and probabilistic simulation.

andyjohnson02• 13 years ago

Physical laws exist. Objects in the real world have to follow those laws. I accept (I think) your point that ML and simulation can be used to "discover" those laws in some inductive sense.

What I'm having a hard time with is the idea that markets necessarily have "laws" that are "discoverable" in the same way (which is what I think you're saying). They might do, and clearly some smarter people than me believe that they do, but where is the justification for this?

@contingencies mentioned [1] a George Soros quote about classical economics being based on a false analogy with Newtonian physics and markets are just the behaviour of individuals. Observations of particles tell you the behaviour of the particles, but the behaviour is fully determined by underlying physical laws. I don't see how this is true of behaviour of actors in economics, except in the obvious respect that the bodies of traders and the hardware of trading systems are subject to the laws of physics. What am I missing here?

I also wonder if there is a danger of building automated trading systems that are based on ideas from econophysics, and using their resulting behaviour are proof that the ideas were correct in the first place.

[1] https://news.ycombinator.com/item?id=6481663

lotsofcows2• 13 years ago

As with most market cycles, if you get enough people following a common philosophy, the market will conform to the philosophy... for a while.

In the past 100 or so years economics has completely failed to define itself as a science. You're using the wrong tense.

Anyway, we're drifting off-topic - I was bitching mainly about the title and a little about the misuse of Zipf's law. If the article was written in reverse, finishing with "this closely matches a power curve from which we can estimate x" then I would only have had a problem with the title "econophysicists".

axus• 13 years ago

Reminded me of "psycho-historians" :)

polskibus2• 13 years ago

Under the broad meaning of Shadow Banking System, everyone speculating in any of the securities market would be a member of it. In my opinion this is very misleading and not really targeting the core feature, which is being a borrower and a lender of higher forms of money (reserves or deposits, not securities).

polskibus2• 13 years ago

Why has this been downvoted? Can anyone share their view on Shadow Banking System definition?

scotch_drinker2• 13 years ago

"On the Forbes Global 2000 list of the world’s largest companies, the first non-financial firm is General Electric, which ranks 44th."

This is even scarier than the apparent fact that econophysics is a real thing. I'd like to know the history of the Forbes Global 2000 to get an idea over time of how dominant financial companies have been. I have a hunch they have always had a part (JP Morgan Chase anyone?) but surely this is a new phenomenon to be so dominated by companies that don't actually produce much.

effn• 13 years ago

If something seems scary/spectacular/surprising it's usually a good idea to do some fact checking. In this case it's very easy, since the authoritative source (Forbes) is available online.

GE is 4th, not 44th. It seems to be a typo.

http://www.forbes.com/global2000/

puzzlingcaptcha• 13 years ago

If you sort by Assets it is 44th alright.

scotch_drinker2• 13 years ago

So I'm guessing it's not a typo but instead a way to shape the data to fit the assumptions. Saying GE is 44th on the list is misleading at best and disingenuous for sure. From the wikipedia page on the Forbes list, it's clear that the rankings are based on all four of the measured statistics, not just assets.

It is interesting to me that 5 of the top 10 and all of the top 3 are financial institutions. By comparison to 2012, Only 4 of the top 10 were financial companies and ExxonMobil led the list.

http://en.wikipedia.org/wiki/Forbes_Global_2000

lucozade• 13 years ago

The study takes on-balancesheet assets as a proxy for company size and fits a model to it that largely works. Fine so far.

But the implication that this works at the top end is either that the companies are hugely mis-stating their on-balancesheet assets or that there are other companies, much bigger than FNMA, that have balancesheets with multiples of the GDP of the States.

Neither of these explanations are plausible even if you believe that they're all lying, thieving scumbags. The numbers are just too big.

However, there is another explanation. That on-balancesheet assets isn't a good proxy for size for big financial institutions. And all of a sudden the problem is solved because on-balancesheet assets isn't a good proxy for size for big financial institutions.

Apart from anything else many of them run huge assets and liabilities off-balancesheet. BTW that doesn't make them secret, they hit the accounts just the same, it just means that the proxy in the study won't work.

And for what it's worth, this is wholly orthogonal to the size of Shadow Banking, how much stuff is hidden in the Caymans etc etc. Fascinating and worrying subjects in themselves.

userulluipeste2• 13 years ago

See the "Inside Job" (2010) documentary movie - (at least in USA) there were attempts to regulate the now unregulated banking activities. The banks' lobby was just too powerful and in result not only the banks remained unregulated, but the regulation system was reduced in staff and weakened.

onebaddude2• 13 years ago

Or, people could read about how and what the shadow banking system is instead of watching a popular, slanted - albeit good, documentary. The "shadow banking system" aren't banks, that's the point.

People underestimate just how regulated the banking system is, despite all the talk about more regulation.

userulluipeste2• 13 years ago

"People underestimate just how regulated the banking system is, despite all the talk about more regulation."

I agree with you about underestimation, but I think that the surplus of the regulations that we're talking about here is more to keep the member circle small, therefore it is in the benefit of the incumbent banks. So there is: 1. strong regulation if you want to get in and 2. weak regulation (at least for some banking activities) for keeping you in check afterwards.

ChristianMarks• 13 years ago

It may be that the scale-free preferential attachment model doesn't hold in the generality claimed. The modeling technique of Doyle and Willinger may be more relevant [1].

1. Walter Willinger , David Alderson , John C. Doyle. Mathematics and the Internet: A Source of Enormous Confusion and Great Potential. Notices of the AMS. Volume 56, Number 5. May 2009. http://www.ams.org/notices/200905/rtx090500586p.pdf

acro• 13 years ago

Banks are generally regulated, they have to have certain amount of assets to work. They cannot have the same distribution as normal companies do.

chernevik• 13 years ago

I've got a fun mathematical model supporting controversial assertions about banks. Yes, I could test those assertions against fact by reading the contingent liabilities sections of large banks' financial reports. But accounting is boring. And, let's face it, we all know that I'd just deal with negating evidence by arguing "accounting trickery" is just hiding Truth.

The size of the shadow banking system estimated according to power law

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