Errors in statistics are usefully classified as type 1 and type 2. A type 1 is a false positive or undue credulity and a type 2 error is a false negative or false skepticism. The greater you try to reduce the level of error in one the greater the likelihood of error in the other.

                                          Don't reject             reject

no effect hypothesis true       correct                type 1 error              

no effect hypothesis false      type 2 error          correct

A useful way of considering the decision making is above. Consider for example the no effect hypothesis that a pill is not healthy. if it's not healthy and you say it's healthy you make a type 1. If it's healthy and you don't say it is healthy you make a type 2.

A certain agency that regulates drugs is famous for only considering the type 1 errors, making sure with endless and ruinous double blinds that type 1 errors are minimized to the excessive making of type 2 errors and keeping off magic bullets that would extend life span and health enormously.

There are many areas where these trade-offs between errors occur. For example in spam filters. You can reject good things, that's type 1. You can accept bad things– that's type 2.

Our own field often has trade-offs like this. The hypothesis that a system or set point for a trade is random is a good null hypothesis. If you accept the system, you're just incurring churning for a worthless randomness. If you don't accept the system, and it's good, why then you've lost some good money.

The decision to expand your business or trading is another area that crops up frequently. If you expand it you might get in over the head. If you dont expand it, you might miss the gold. The movement into a new field, or the engagement of an employee or employer is another frequent trade off of type 1 and type 2, gullible reaching versus excessive caution that frequently arises.

The usual way to trade off between the two types of errors is to consider the cost of both errors, and to balance your decisions based on the relative costs. Considerations relative to randomness, and variability must also be considered. Also, the myriad psychological biases that lead us to place too much reliance on avoiding the two types of errors that the cognitives have contrived with their silly experiments on college students et al.

What other trade-offs of type 1 versus type 2 do you see that mite be of use to market people or others and what better way to consider gullibility versus skepticism do you see?

Alan Millhone writes:

This weekend I will travel to Grove City, Pa for a yearly Checker Tournament. While playing I will have choices to make. Sometimes there's only one way to move. Often times there's more than one way to move or jump. Checker players and Market players need to evaluate all moves or trades before executing. In Checkers if you touch a piece you have to move that piece– often with disastrous results. If you trade on line you need to consider your trade carefully before hitting "send". Tom said, "Move in haste— repent in leisure". 

Victor Niederhoffer adds:

Sharif KhanThe trade-off in errors in games like checkers and chess would be someone offers you a seeming advantage. Your null hypothesis is that it's not worth accepting. If you take the gambit or seeming opportunity when it's really no good you're making a type 1 error.

In checkers I've found that no opportunity that looks good, no opportunity to set a trap for example, is worthwhile against a good player, as good players never make mistakes. You were too gullible. If you don't take the opportunity when it would have been good, you're making a type 2 error. You were too skeptical. I find that in checkers the type 1 errors are much more costly than the type 2 errors, but in chess I don't know enough to say. But among the good players, I think they often are too cautious or too skeptical if they wish to win a world championships. They are too likely to go for the draws. In general, I would say if you want to be the best you have to be ready to make the type 2 errors to a greater extent. But then you always risk going belly up.

The situations are not without personal applicability to myself. It's easier in squash. I played an errorless game. Never made a type 1 error of going for broke with very risky shots. Well, it wasn't that bad. i went for about 5 years without losing a game in a match or so. But it wasn't good enough to beat the infernal Sharif Khan as much as I should. I should have played a much more errorful game, being willing to accept the risky shots and confrontations and hitting it on the rise and changing my infernal errorless slice backhand to a top spin so I could belt the ball through the Khans the way the Cubans who played Jai Lai could. In other words, I didn't make as many type 2 errors as I should have. 

Anatoly Veltman comments:

I remember grandpa coaching me at 5 or so: "always believe a man." If it turns out to be a lie, you'll find ways to extricate. But if you distrusted without good reason to begin with, you risk losing a friend– and that's an ultimate loss.

Jim Sogi adds:

Why do smart people make either type 1 or 2 mistakes? Presumably, and by definition, it is not because of stupidity, so some heuristic must be at play. In type 1, the fear and result is that you look and feel stupid. In type 2, there is less risk of looking and feeling stupid, but you end up being frustrated by the loss of opportunity. The joke around here is "which is worse" –you present a bad and a ridiculously bad alternative. Weighing the cost benefit is faulty because of proven heuristics are lopsided towards avoidance rather than gain. Add in marginal utility considerations and the difficulty is even harder. 

Bill Egan comments:

I will add a twist to the type 1 error problem. I have seen certain extremely intelligent people simply be unable to conceive they might be wrong. This is a problem that gradually gets worse. They have been right 99% of the time because they are so smart, and as time passes, they make bigger and bigger bets because, 'hey, I've been right.' This isn't quite hubris or arrogance because they really are that good. Finally the odds catch up with them.

Roger Longman writes:

Roger LongmanVic,

Love this.

So seems to me the real challenge is figuring the cost of a type 1 or 2 decision.

In the case of the FDA, the costs of a type 2 error are dramatically higher than the cost of a type 1. Those costs aren't financial, or not primarily financial. There's the substantial humiliation cost, for example, of approving a drug that turns out to have some important side-effect (or a side-effect more important to a group of influential people than its benefit to a group of less influential people) and being dragged in front of a congressional committee (Charles Grassley of Iowa has been the grandmaster of this, but he's got plenty of competition). There's the bureaucratic cost of being passed over for a more visible job, or an interesting review opportunity, if your name is associated with a controversial decision.

All of which is to say: of course the FDA errs more on type 2's. And the growing pharmacopeia (much of which is generic and therefore low- cost) only encourages this bias towards type 2 errors, particularly in regard to follow-on drugs (i.e., new molecular entities in the same class as approved drugs). If — the FDA figures, albeit not publicly
– by instinct, as it were — there is already a good drug that helps a majority of people why take the chance that a second drug in the same class will provide more incremental benefit than incremental risk, which — as I note above — comes with disproportionate institutional costs?

There's also an inherent problem with drug development divorced from serious comparative effectiveness (the current system of purchasing drugs, based as much on rebates retained by payers as medical and economic value provided to patients and employers, actually discourages the kind of comparisons common in most sectors of the consumer economy).

Victor Niederhoffer comments:

Longman was editor of Windhover Information Ventures Biomed and is very knowledgeable about the FDA. I wish he had been at Prof Tabarrok 's talk at junta where the positive case for the FDA going out of business was limned with statistics and current studies on deaths caused by lack of approval.



Gold as a safe investment makes about as much sense to me as The Temptations singing "the only safe place to live is on an Indian reservation."



ClunkersOne of many interesting things about the 'Kash for Klunkers' program is that a quick estimation of the average MPG for the replacement vehicles shows that they barely meet the current government mileage standards and fail to meet those that go into effect for the 2011 model year, which is just one year away.

According to the WSJ [preview only, subscription required for full article], nine of the top ten vehicles are considered passenger cars and they average 29.67 MPG, and that number is biased upward by the Toyota Prius, which is number four on the list at 46 MPG. By comparison, the new standard is 30.2 MPG. The only non-car on the top ten is the Ford Escape, which gets a pitiful 23 MPG, which is less than the 24.1 MPG. While this is an imperfect estimate of either the Top 10 sales or those of the entire K for K program, there are no statistics available on actual sales and unless the sales for the top four vehicles are approximately equal, there is little likelihood that the average mileage of the Top 10 meets next year's standards.

Allan Millhone sees an investment angle:

Companies in the parts business: NAPA, AutoZone, et. al., may benefit in increased sales over time if the "Cash for Clunkers" program continues. Salvage yards are required to keep the clunkers in another area and cannot sell the motors and other parts as they customarily do with the rest of their yard. In time this will create a shortage for many parts that one may now purchase from salvage yards. Aftermarket parts will become scarce and the part stores will benefit while the consumer regrettably will have to pay higher prices.



Internet Radio and Beyond, by Ross Miller.



Ponder this OCLC entry while examining GE's earnings:

Title: Love is the answer.
Publication: General Electric Co.,; 1973.; Made by Gordon/Glyn Productions.
Year: 1973
Description: 20 min.; sd. color.; 16 mm.
Language: English
Standard No: LCCN: 74-700351

Abstract: Designed to increase sales of silicones by presenting a story which compares the way a girl makes her husband's life better with the way silicones improve products.

Descriptor: Selling — Silicones.
Class Descrpt: LC: HF5439; Dewey: 668
More Corp Auth: General Electric Company.
Document Type: Visual Material
Entry: 19740419
Update: 20010628
Accession No: OCLC: 5550645



David Byrne 1991The Mojo Cable Channel (formerly INHD) has been showing David Byrne's "True Stories" (1986) in heavy rotation. The movie is a surreal look at the transformation of Texas into a high-tech Mecca that explores life in the fictional town of Virgil. A highpoint of the movie is a dinner table demonstration of the wonders of capitalism by the late Spaulding Gray, who plays the man who brought high-tech industry to Virgil.

While people still do not wear clothing made of Astroturf and vacuuming robots are not yet humanoid, much of the movie was prophetic, as a visit to Austin will confirm. Byrne was clearly torn between the collectivist leanings of his lower Manhattan milieu and the wonders of technology that came from capitalism and made much of his art possible. (One of Byrne's more recent creations is PowerPoint art.) While Byrne clearly mocks the excesses of consumerism, he marvels at technology and the entrepreneurs who brought it to the masses. At one point, a cosmic Steve Jobs pronouncement is directly quoted.

The movie is all about music and features several tunes by Byrne's band at the time, The Talking Heads. Interestingly enough, many old Heads' tunes have received a new lease on life through technology. All the studio recordings have been remixed and re-released in 5.1 surround on DVD-A. I've listened to "Speaking in Tongues" and it is absolutely stunning.

Rating: One invisible hand up.



 I just now decided to have a late night Big Mac and pulled into our local McDonald's and noted they were closing. I hurriedly pulled to the drive through and placed my order. I got to the window to pay and was told the grill was shut down and I could get my # 1 with a Big Mac, but it would be made with a quarter pound of meat. I said that was fine. I got back home and found they had included a second burger at no extra charge.

I like McDonalds anyway, but that little extra tonight is good PR and keeps customers happy and thus helps McDonalds stock.

Many years ago one of the first McDonald's opened up on Hamilton Road in Columbus. My mother's sister and her husband lived in Columbus and took us to this brand new restaurant. I was probably 10 and can still remember the golden arches that I saw for the first time. At that time they had single burgers with ketchup and a pickle for around 29 cents. They came wrapped in paper. Hard to beat that occasional Big Mac, hot fires, and a cold Coke, as American as apple pie.

Ross Miller adds:

Despite Ray Kroc's best efforts, McDonald's quality varies widely from store to store (I am reluctant to use the word "restaurant"). I once considered the better stores to be reasonable places to eat, but my tastes have changed (I hope for the better) over time.

My current favorites in pre-fab food are four regional chains that have settled into the Albany, NY area on an experimental basis. Here are some quickie reviews in descending order of quality:

Carrabba's: Ersatz Soprano eatery. Surprisingly good and an okay "date" restaurant that pegs one with a net worth of under $25 million — so some dates may object. I am a regular so the help knows that I will have them executed in the parking lot if I have to wait for anything.

Nothing but Noodles: A good date restaurant, seemingly from Arizona, for the sexually ambiguous. The name is a misnomer. I'm a regular there too but turnover is so high no one has noticed. Southwestern style noodle dishes are amazing by local standards. Free Wi-Fi, but happily few use it. Don't look too long at the other dinners or a Zoloft/Merlot chaser may be necessary.

Five Guys: Great authentic DC area hamburgers and even better French fries. Not a date restaurant unless your net worth is over $1 billion. Free peanuts are a bonus to attract the hedgie crowd. Now open at National Airport, though eating is the last thing on my mind when I'm staying there so I have no idea how the food is at that outlet.

Moe's: Upstate New York's weak attempt at Una Mas, a great Bay Area burrito place. Makes me miss California a whole lot. I am a regular there and they yell "Happy Monday" whenever I walk in. I am probably their version of Stevie, which is really sad.



 In recent days I have begun to explore the category-based tuning feature of my car's XM radio. (I'm a big fan of XM.) This feature enables one to tune linearly between categories rather than station numbers and it remembers the last station that one was listening to in a category.

Categories are things like "Rock," "Dance," "Hits," "Decades," etc. The proper tuning of stations in category mode requires that one decide on a favorite station within the category that will come on automatically each time. Choosing a station can be tough, either because there are so many contenders — I currently have the 70s as my favorite decade, but I could switch to the 80s at some point — or because there are so few.

A most problematic category is "Christian," which is mysteriously sandwiched between "Hits" and "Rock." While several categories include X-rated fare, for some reason no such choice is available for Christians. Oddly, there is a Christian rock station — odd because everyone know that the underlying beat of rock music is designed for fornication. After contemplating the dilemma of which Christian station to program in without making an explicit decision, I moved on to the "Rock" category. I always have it tuned to "Lucy," the station of classic alternative music, a seemingly contradictory concept. By some miracle the song that was playing was The Pixies 's "Monkey Gone to Heaven." I see the makings of an alternative Christian station. With REM 's "The End of the World as We Know It," Peter Gabriel 's "Your Eyes," and XTC 's "Dear G-d" for starters, there should be an abundance of tunes to choose from.

Must we wait for an XM/Sirius merge to bring us a "Bar Mitzvah and Wedding" channel so that I can hear the music of my youth? Hora or bunny hop, anyone?

Stefan Jovanovich replies:

For what little it may be worth, given what "everyone knows", the Christian women out here in California prefer blues. They think rock music's beat is just another enticement for the men to indulge in what Sarah Jessica Parker's character once described as "jackrabbit s-x". Rock and roll's origins are from rockabilly, which was and still is the ultimate American dance music. Dancing was clearly designed as a path to other things, of course, but as the Georgia Satellites so wonderfully put it, with the women worth chasing the road to fornication always includes a pit stop at the church. 

Stefan Jovanovich replies:

For what little it may be worth, given what "everyone knows", the Christian women out here in California prefer blues. They think rock music's beat is just another enticement for the men to indulge in what Sarah Jessica Parker's character once described as "jackrabbit sex". Rock and roll's origins are from rockabilly, which was and still is the ultimate American dance music. Dancing was clearly designed as a path to other things, of course, but as the Georgia Satellites so wonderfully put it, with the women worth chasing the road to fornication always includes a pit stop at the church. 



 I'm just back from a quick visit to a technology trade show in Boston. My informal market index is the quantity and quality of freebies, known in the industry as "swag," that is given out at such events. At the height of the dot-com bubble, we were awash in swag. I almost had to get a restraining order to stop Compaq from sending me a t-shirt every few weeks. When the bubble burst, the swag went with it.

Well, I'm happy to say that swag is back, but nothing like at a market top. T-shirt quality could be better and companies could be more creative (Microsoft gives out dorky office pens), but the most exciting new item is the 4-in-1–laser pointer, LED light, PDA stylus, and pen. Now I can destroy the retinas of my more unresponsive students. Companies that give out candy as swag are an automatic short.

While I continue to favor value over growth and have no use for tech companies, the state of swag tells me that we are at least a year away from a general market top.



A meaningful understanding of statistics and their proper application is a most rare talent. In my occasional chats with the one known as the future laureate, it is clear that he is possessed of such talent. Other so-called experts, however, would appear to twist statistics for their own devices, especially by reducing everything to a single dimension. Early training in functional analysis would appear essential to making one as comfortable in mathematical worlds of unbounded dimension as in the uni-dimensional one favored by the over simplifiers.



I suggest that learning to play a game (poker, backgammon, chess, checkers or go) might teach far more than studying game theory. The big problem with drawing boards is that there's no opponent, so ideas are never subject to quite the same level of criticism, and they do not have to be quite as relevant to the very serious matter of winning.

Adi Schnytzer comments:

Game theory is not about drawing boards. People do not study game theory to help them in their game playing, believe it or not. They study it in order to understand the process of more perceived importance than board games.

Nigel Davies adds:

Please excuse my ignorance, I am a mere player. So what exactly is 'game theory' good for? And I'm talking a usable practical application that doesn't include getting a salary for teaching it to others. Please be very specific as I am very primitive.

Adi Schnytzer replies:

I recently posted the following note, which will introduce you to game theory and comment on its uses. Since it's written by the masters, it should help you out. There's nothing I can add to their wisdom.

Bob Aumann's Nobel Prize Lecture ("War and Peace") and his piece "On the State of the Art in Game Theory" are both worth reading … He also has a piece called "Consciousness," which is rather nice. These may all be downloaded here … In my view, the least (not non-mathematical) and most intuitive text available is Luce and Raiffa.

Nigel Davies adds:

There is still the problem of practical application which is what I've been going on about from the start.

In 'A Beautiful Mind,' we see that Nash figures that he and his friends should not go for the blonde because they will block each other, and somehow or other this later got him a Nobel Prize. However, it seems that Nash thought up his 'strategy' without any knowledge of the game, and from all indications, he was a virgin at the time. This sums it up - he thought he could win without any knowledge of how the pieces moved.

In a previous discussion, I brought up a similar error by a mathematician who gave a figure on the number of possible chess games. It's obvious to anyone who actually plays and knows the rules that the number has to be infinite. The guy was so arrogant and/or naive that he didn't bother to learn the rules properly before coming up with his number.

Frankly, I have the same problem with Robart Aumann's paper. It's all very well theorizing about peace, but has he actually tried to apply this? I suggest that without knowing the territory, too many assumptions will be wrong.

If it's any consolation, it seems that Lasker had a similar problem with Einstein and the theory of relativity. In Einstein's foreword to Hannak's biography of Lasker, you see that Lasker thought that there was no justification for claiming that the velocity of light in a vacuum would be infinite, unless this had been verified in practice.

This, incidentally, was one of my few moments of agreement with the Elizabethan ghost.

Ross Miller comments:

It is worth noting that the "real" John Nash never did this, just the John Nash invented by a screenwriter who got to write this movie based on his ability to write Batman movie screenplays. The example in the movie is not a Nash equilibrium. In a Nash equilibrium, you do the best you can taking everyone else's actions as given and ignoring responses to your own actions. If everyone else goes for the inferior females, you make a beeline for the superior one in a Nash equilibrium. As stated, this game has no Nash equilibrium if everyone believes that multiple hits on the same target generates no payoff from that target, but a single hit will. Nigel is correct in pointing out that solutions to this game require thinking beyond the game theoretic formalisms.

The best reason for the Nash equilibrium to get a Nobel Prize was that it facilitated the Arrow-Debreu work on a competitive equilibrium. It was because his equilibrium is an intrinsically competitive (and not collusive) concept. The screenwriter is not to be entirely faulted since the book from which the movie was based is full of technical errors and misstatements. Of course, technical correctness does not make for bestsellers and the average moviegoer is never going to understand what Nash did anyway, nor is much of anyone for that matter.

Peter Grieve offers:

My take on game theory (based on long but elementary study) is that:

1. It's not very useful in sequential games like chess, poker, etc. In chess it might help a computer make decisions based on a look ahead tree if the branches have some evaluation number. Game theory can't, of course, actually generate these evaluations, and they are quite important.

2. It's not very useful in games in which anyone has any experience. The simplifying assumptions are too great. Once in a while it could illuminate a connection that would not otherwise be obvious. But as far as selecting a detailed strategy in a real world, complex game, it would be madness to rely on game theory.

Game theory is a lot like the rest of applied mathematics. It's really strong on the simple stuff, things where its many simplifying assumptions are valid. It can act as an initial guide when there is no experience in an area. Occasionally it can suggest something new in known areas (which must then be extensively tested by experience, and often found lacking).

The problems arise when academic folks (who mostly talk to each other) get inflated ideas about the real world strength of their ideas.

An example of a situation where game theory would be valuable is the following. Suppose you where playing a game of Rock-Scissors-Paper with a really smart, vastly superior opponent who knew a lot about your mind. How can you at least break even in this game? Game theory tells us the answer. Roll a die, if it comes up 1-2, choose Rock, if 3-4, Paper, if 5-6, Scissors (roll the die in secret, of course). You can even tell the opponent that you will use this selection method, and it doesn't help him beat you (unless he can guess the way the dice will come up). He can use this same strategy on you, making sure he breaks even, and the game is at equilibrium. This seems intuitively obvious, but what if Rock breaks Scissors wins double? What sort of die should one roll then? Game theory will tell us.

Of course if Nigel reads this, he will immediately think of several possible strategies to bamboozle game theoretically inclined, mammoth brained opponents in Rock-Scissors-Paper. But if he is to win anything, he will have to bluff the opponent out of using the above strategy (perhaps by artfully convincing the opponent that his (Nigel's) mind is "primitive").

During the Cold War, everyone wanted to hire Air Force generals with lots of nuclear war experience, but there were none (General Ripper was long gone). The think tanks used some game theory. Thank goodness we never found out how valuable it was.

Adi Schnytzer comments:

Three points only:
1. Game Theory was used successfully to win a battle in the Pacific during WW2, though I don't have the details on hand.
2. Without game theory, a simple dumb computer would never have beaten the World Chess Champion!
3. Aumann's insights on war are useful, but make sense only to those living somewhere nuts like the Middle East. Those in cocoons who believe that the problem rests in a failure to love their fellow man (read: "Liberal Europe At Large") will never understand.

Nigel Davies adds:

Without game theory, a simple dumb computer would never have beaten the World Chess Champion!

How do you come to the conclusion that 'game theory' should take the credit? Why not Faraday, Edison or Graham Bell? As far as I know, none of the programmers studied game theory, but there were a few chess players on the Deep Blue team. If game theorists are claiming this, then by the same token shouldn't one be able to claim that the big bang was only possible thanks to physics professors? Now that would really be a feather in their cap - they might get two Nobel prizes!

Aumann's insights on war are useful, but make sense only to those living somewhere nuts like the Middle East. Those in cocoons who believe that the problem rests in a failure to love their fellow man (read: "Liberal Europe At Large") will never understand.

Ghengis Khan would probably have sorted the Middle East out in no time - old Ghengis was a good player in his day. OK, I guess you're going to claim that the Mongolian hordes had their own 'game theory' which enabled them to win their battles etc. So the academics can take the credit after all …

Game Theory was used successfully to win a battle in the Pacific during WW2, though I don't have the details on hand.

As should be clear from the above, I think specifics are needed in order to see why game theorists are taking credit for this one and why it's good shooting with one's howitzers, or even luck. And how many battles were lost by the way? Or weren't these retrospectively scored?

Stefan Jovanovich adds: 

There are only two reasons why the Americans had any chance in the Battle of Midway:

(1) Admiral Nimitz trusted his Navy code breakers and their analysis of the limited decryptions they had under Commander Rochefort. By translating messages and studying operational patterns, the code breakers predicted future Japanese operations. Relying on those predictions, Nimitz sent to sea the only three American carriers he had at Pearl Harbor and positioned them on the flank of the predicted Japanese line of attack.

(2) When an American scout plane sighted the Japanese fleet, Admiral Spruance put all of the American planes in the air for an all-out attack. In terms of conventional doctrine at the time, this was a highly suspect move, and its initial results were terrible. The Japanese fleet's air cover fighters and anti-aircraft gunnery annihilated the attacks by the Marine Corps scout bombers, Navy torpedo bombers, and U.S. Army Air Force torpedo-carrying "Marauder" bombers. The Army Air Force "Flying Fortress" high altitude bombers also failed but did not suffer any losses. The next attack by Navy torpedo bombers was literally wiped out; there were no planes and only one pilot survived. Only the last attack - by Navy dive bombers - succeeded.

If "game theory" includes cryptographic analysis, then its contribution to the Pacific War effort was, indeed, invaluable; but it required the willingness of Admiral Spruance to go "all in."

Adi Schnytzer replies: 

Thanks Stefan. No, it wasn't the cryptography I had in mind. According to Careers in Mathematics,

Game theory, a part of operations research, was used to select a strategy for the Battle of Midway, a turning point in the Pacific arena during World War II. The U.S. Navy was on one side of Midway Island, and the Japanese Navy on the other. We calculated our probability of winning in the four cases of our going north of the island or south of it, and the same for the Japanese. Game theory was then used to select the winning strategy.

As I recall, breaking the codes told the U.S. where the Japanese fleet was going, and game theory told them how to place their limited resources optimally. But since this isn't nearly as important as winning a chess game, why are we bothering?



I am in Tucson at the moment and was out doing some research for future Adventures in Retailing, when I dropped into a Circuit City store. Tucson appears to have a severe labor shortage and this manifests itself in a lower quality labor force. I was looking at a giant bank of HDTVs to get a closer look at what’s been driving the retail market of late, when I noticed that the grass on the field in whatever bowl game was being televised didn’t look like grass at all. It didn’t even look like grass in a good DVD transfer. It was green clumpy stuff.

The 12-year-old kid who was posing as a salesman came over to me and asked if I had any questions. I asked (politely, of course), “What is the source of the signal on all these TVs? You do know that grass doesn’t look anything like that?” There was actually a time when Tucson didn’t have grass, but now it does. Too much of it. He seemed perplexed, but answered, “DirecTV” and then got away from me as quickly as possible.

Quick web research indicates that DirecTV is facing legal action for their degraded signal, and Circuit City is down about 25% relative to Best Buy over the past year. The executive at Circuit City who decided to use DirecTV to feed his sets should be jailed as an economic criminal for probably knocking a good several bips off the GDP. The folks who actually know what grass looks like, went out and looked in the stores, and did the pairs trade (BBY vs. CC) months ago. And are now sitting fat and happy.

To boost the local economy, I bought a rather expensive CD that contains what I have decided is the ‘Second Greatest Song of All Time.’ I’ll be writing about that at some later date.

Circuit City aside, Tucson has got lots of great retailing. And I visited a Waffle House. None of the patrons had on any of the $360 men’s shirts that they were hawking at the new luxury shopping mall. The waffle house sucked, but (as always) Tucson has got amazing food and it is much cheaper than the fake Manhattan version of the same stuff.

P.S. I caught a few minutes of Cramer on CNBC in my hotel room. Not bad. Good stuff on limit orders. He also praised speculation while disembowelling a stuffed bird. I guess I’m late to that party, too.



One underappreciated aspect bond investing is that for long term debt, the reinvestment rate of the coupon stream dominates the total return profile. So there is short-rate risk built-in to long term debt portfolios.

Prof. Ross Miller explains:

I cannot emphasize enough how important this comment of George’s is. In teaching fixed income to students (including my intro MBA class), I make a major distinction between instruments with bullet cash flows and those with multiple cash flows (for example, bonds). I point out, though I doubt students grasp it, that all numbers associated with “bonds” are bogus because of the unrealistic implicit assumptions made about the reinvestment of the coupon payments. I highlight this by pointing out the “future value” of a bullet security is obvious (it’s the amount of the bullet payment), but the future value of a bond a maturity is unknowable because what happens to all the coupon payments before the bond matures is outside the model. Finance textbooks gloss over this because it undermines the use of their most sacred of tools, NPV. They do bring up the reinvestment issue with respect to IRR, which they delight in bashing, but usually fail to note adequately that NPV has a similar problem, because this is much too subtle and disturbing a point for most finance professors.

Let me provide the following example:

Consider a 2-year T-note trading at par on issuance date.

Its PV (under assumptions that are often taken for granted) is 100.

The FV of the embedded principal strips in two years is 100.

The FV of the bond is 100 + last coupon payment + future value of the three coupon payments made prior to maturity.

In a world with no uncertainty about future interest rates (of which the permanently flat yield-curve world that is implicit in most textbook models is a special case) these future values can be readily computed by projecting the coupon payment into the future at the fixed interest rate. In a world with a stochastic yield curve, like the one that we live in, the future value is dependent on how one models the stochasticity and, in any case, the typical result is arguably a meaningless number.



Some of Ben Bernanke’s minions at the Fed (and to a lesser extent Ben himself) understand that they may have failed to plunge the stake through inflation’s heart. Anyone who has played serious golf (or, better yet, serious miniature golf, with or without vampires) can understand the problem that inflation presents.

What does golf have to do with inflation? It is simple. When putting, one has the best chance of making a putt if one aims to get the ball past the hole rather than to get the ball as close to the hole as possible. That is because the ball cannot go into the hole unless it travels a minimum of the distance to the hole. The downside of the intentional overshoot strategy is that when one misses, the next putt will, on average, be longer. Interestingly enough, this means that the most critical part of one’s golf game is the ability to make putts in the three to six foot range. Not coincidentally, this is one category in which Tiger Woods truly excels. If you are going to be a Tiger, you cannot always expect to have a tap-in for par.

Ben Bernanke is not yet in Tiger mode. He appears to be going for the perfect putt that makes its last rotation as it falls into the hole. The problem that he faces is that if the putt does not reach the hole, it may well roll all the way back to his feet and he will have to do things all over again. During the present pause, everyone is watching the ball roll toward the hole and we are waiting to see it if goes in. If the ball does not go far enough, Ben may have a much tougher second putt than he bargained for, windmill or no windmill.



IBM had an e-commerce group in its Watson Research Center back in the mid-1990s before anyone had heard of e-commerce. The group was organized as a patent mill, with everyone’s compensation directly tied to the number of patents they ground out. People would brainstorm and come up with some truly bizarre things, but overall it is hard to imagine an area of e-commerce where IBM did not get to the patent office well before anyone else with something that can stick .


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