Last October, I wrote a post about the Simon-Ehrlich best:
...the famous bet between University of Maryland professor of business administration Julian Simon and Stanford University biology professor (and author of the influential book The Population Bomb) Paul Ehrlich. Ehrlich had argued that resources were becoming scarcer. Simon pointed out that, if increased scarcity were true, then the price of resources would be increasing. He challenged Ehrlich to choose any raw material, and a date more than a year away, and Simon would bet that the price would decrease over that time rather than increasing.
Ehrlich accepted the bet, choosing copper, chromium, nickel, tin, and tungsten as the raw materials on which the bet would be based. The bet was formalised on 29 September 1980, and was evaluated ten years later. The price of all five materials fell between 1980 and 1990, and Simon won the bet.
The purpose of that post was to highlight this 2010 article that demonstrated that Julian Simon might just have gotten lucky. Now, a new article by Ross Emmett (Arizona State University) and Jesse Grabowski (Université Paris 1 Panthéon-Sorbonne), published in the Journal of Ecological Economics (sorry, I don't see an ungated version online) follows up on the question of whether Simon was lucky, using the tools of financial economics. They argue that financial economics is the appropriate way to analyse the bet, because:
...the Simon-Ehrlich bet [can be] recast as an investment portfolio, specifically a forward contract, with Simon in a short position as an investor and Ehrlich in a long position.
In other words, Simon's short position makes money if the value of the commodities decreases (which is what happened), while Ehrlich's long position makes money if the value of the commodities increases. Now, recast as an investment, Emmett and Grabowski employ a number of financial economics tools, including portfolio diversification, market beta, the Sharpe ratio, and mean-variance efficiency. I'm not going to go into detail about what each of those methods entails, but in terms of portfolio diversification, Emmett and Grabowski note that:
...Simon should have proposed a wager against a basket of as many resources as possible, to reap the benefits of portfolio diversification.
Simon's offer to bet on any number of resources opened him up to a lot of risk, since a diversified portfolio of resources is more likely to follow the overall price trend (which he believed was downwards), whereas any single (or five) resources could more easily go against that trend, simply due to luck. On the other hand, from Ehrlich's perspective:
A diversified portfolio would still have lost the bet, but it might have saved Ehrlich a few hundred dollars.
So, Emmett and Grabowski believe that Ehrlich was in trouble regardless of portfolio choice. Moving on to their other methods, Emmett and Grabowski find that:
...Ehrlich’s portfolio did not contain as much market trend exposure, as measured by CAPM beta, as it could have, which is surprising given his boisterous confidence in price trends. Luckily for him, however, an explicit strategy of maximizing portfolio beta ended up in failure. When risk profile was held constant at the level he himself chose, however, we found he could have done better given the information available by moving to a mean-variance efficient portfolio.
So, as they suspected, Simon would have lost the bet almost regardless of which resources he chose. However, that doesn't answer the underlying question of whether Simon was simply lucky. If you look at the final value of a $1000 investment in the five resources, for any ten-year period between 1903 and 2015, you get Figure 4 from Emmett and Grabowski's paper:
The red shaded areas show points in time where if the ten-year period ended then, Simon would win the bet, while the green shaded areas show points in time where Ehrlich would win. It is clear that Ehrlich would have won slightly more often over the past 110 years (similar to the findings in the earlier paper). Emmett and Grabowski then go a step further, creating and running a Monte Carlo simulation of the change in resource prices over time, and find that:
From our simulation, we estimate that, were they able to repeatedly make the same bet, Simon would win only 37% of the time, while Ehrlich would win 63%.
So, I guess we can take this as further (and more detailed) evidence that Julian Simon was just a little bit lucky in the Simon-Ehrlich bet.
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