My Pet Peeve

28 December 2007 at 11:54 pm stevphel 5 comments

| Steve Phelan |

One of my pet peeves is when academics assume that people in industry are a little “dim.” For instance,

It would be churlish to point out that the fact that one should be extremely leery of arguments that diversification radically improves the safety of bond investments was well known back by Edgar L. Smith and others back in 1923.

This quote from Brad De Long here.

I’m not picking on Brad because it happens quite a bit in my experience. The “oh my gosh, we academics have known since 1923 that diversification of bonds does not reduce systematic risk that much, you dumbasses.”

Contrast this view with the fact that the brightest minds in a generation have been taking jobs on Wall Street. So the smartest people are the biggest dumbasses???

In these matters, I prefer to assume plausible deniability. Reducing systematic risk by combining geographically diversified BBB bonds sounds just plausible enough to avoid litigation for fraud and/or negligence. Now that’s smart!

Entry filed under: Business/Economic History, Former Guest Bloggers, Management Theory, Myths and Realities.

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5 Comments Add your own

1. michael webster | 29 December 2007 at 12:33 am

The exact quote used by De Long was: ” By contrast, portfolio diversification did not work for bonds, which were all “subject to the same hazards” which were “not reduced by increasing the number of different bonds held.”

CDO’s were said to be different because according to Felix Salmon, the overcollateralization afforded by the aggregation of sub prime mortgages meant at least some tranches could be A rated.

Edgar Smith wasn’t talking about this type of diversification at all.
2. Steve Phelan | 29 December 2007 at 12:52 am

Does it make it more plausible? ;-)
3. Tom S. | 29 December 2007 at 1:42 am

I doubt DeLong is picking on industry men. Read through to the link DeLong provided in your quote. In the end he uses a quote by Warren Buffett who is picking on academics.
4. Warren Miller | 29 December 2007 at 1:17 pm

A nit, Steve: the correct phrase is “systematic risk,” not “systemic risk.”
5. Steve Phelan | 29 December 2007 at 3:24 pm

Thanks, Warren!