The Fear Factor: What Happens When Fear Grips Wall Street

244 Pages·2009·1.537 MB·English

by  Colin Read (auth.)

The Fear Factor
Also by Colin Read
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The Fear Factor
What Happens When Fear Grips
Wall Street
Colin Read
© Colin Read 2009
Softcover reprint of the hardcover 1st edition 2009 978-0-230-22846-7
All rights reserved. No reproduction, copy or transmission of this
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permitting limited copying issued by the Copyright Licensing Agency,
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in accordance with the Copyright, Designs and Patents Act 1988.
First published 2009 by
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registered in England, company number 785998, of Houndmills, Basingstoke,
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ISBN 978-1-349-31007-4 ISBN 978-0-230-25086-4 (eBook)
DOI 10.1057/9780230250864
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I dedicate this book to my fiancé and wonderful partner, Natalie, and
my mother, Gail
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Contents
List of Figures ix
Preface x
About the Author xi
Introduction 1
Part I The Nature of Risk 5
1 The Biology and Psychology of Fear 7
2 An Economic Definition of Fear and Risk 16
Part II The Supply and Demand of Loanable Funds 19
3 The Demand Side 21
4 The Supply Side 32
5 Balance of Capital 44
Part III Measurement of Risk 51
6 The Risk Premium – How Risk Affects Expected Returns 53
7 The Fear Premium 59
8 The Demographics of Risk and Fear 67
9 The Microeconomics of Risk Aversion 76
Part IV The Problems with Risk 83
10 Moral Hazard 85
11 Privatized Gains and Socialized Losses 93
12 Adverse Selection and Imperfect Information 105
13 Risk, Uncertainty, Fear, and Gambling 112
Part V Risk and the Market 119
14 Market Volatility and Returns 121
vii
viii Contents
15 Fear, Panic, and Market Returns 126
16 The Fear Factor 132
Part VI A History of Panics 137
17 A Brief History of the Fear-Gripped Market 139
18 The Roaring Twenties and the Great Crash 151
19 The Depression-Gripped Economy 156
20 Along Comes Keynes 162
Part VII Coordination Failures 171
21 The Market for Lemmings, or A Tale of Two Cultures 173
22 The Role of Machines and Programmed Trading 179
23 The Ratings Agencies – More Perfect Information? 184
Part VIII Social Responsibility as an Antidote to Fear 189
24 Where Were the Regulators 191
25 Ethics and Social Responsibility 202
26 Wall Street, Main Street, and the Social Contract 207
Part IX Institutions That Ameliorate or Amplify Fear 213
27 The Media as an Antidote to Fear 215
28 Politics That Fan the Flames of Fear 221
29 Is There More to Fear than Fear Itself? 223
Part X Solutions to an Economic Quagmire 227
30 Economic Leadership as an Antidote to Fear 229
31 A Dozen Prescriptions to Take Back the Markets 232
Conclusions 239
Notes 241
Glossary 244
Index 247
Figures
3.1 An Upward Sloping Utility Curve 22
3.2 Demand Curve 24
3.3 Aggregate Demand 25
3.4 Demand for Loanable Funds 26
5.1 U.S. Imports, Exports, and the Trade Deficit 1960–2007 46
6.1 Average Utility 54
6.2 Decreasing Risk Aversion with Higher Consumption and
Income 56
6.3 Much Smaller Risk Premium if Risk Is Spread over Two Periods 57
7.1 Utility Curve with Decreasing Marginal Utility 60
7.2 Fair Gambles of $5,000 on a $10,000 Income 60
7.3 Comparison of Gambles with a Certainty Equivalent 60
7.4 Gambles and the Cost of Risk 61
7.5 Increasing Levels of a Fair Gamble 61
7.6 Increasing Fear and Risk Premium with Larger Fair Gambles 62
8.1 The Pattern of Savings over a Life Cycle 73
9.1 The Portfolio of Possible Returns and Risk 79
9.2 The Efficient Portfolio Frontier and the Risk-Free Return 80
9.3 The Capital Allocation Line 80
9.4 Varying Return/Risk Trade-offs for Different Individuals 81
9.5 Different Return/Risk Trade-off Points for the Same Individual
Facing Different Investment Opportunities 82
9.6 Different Portfolio Choices for Low and High Risk Tolerance
Investors 82
14.1 Different Portfolio Choices for Low and High Risk Tolerance
Investors 122
14.2 The Effects of an Increasingly Risky Market 122
15.1 The New York Times Panic Index 1928–2008 127
15.2 NY Times Panic Index and DJIA Returns 1929–2008 128
15.3 NY Times Panic Index and DJIA Returns 1991–2008 128
15.4 NY Times Panic Index and the VIX Fear Index 1990–2008 129
15.5 NY Times Panic Index and Changes in the VIX Fear Index
1991–2008 130
15.6 Changes in the NY Times Panic Index and the VIX Fear Index
1991–2008 130
16.1 The Fear Index and DJIA Returns 1997–2008 133
16.2 Changes in Volatility (VIX) and Financial Profits 1991–2008 134
ix