Monday, November 26, 2012

A predictable intrusion

The Commodity Futures Trading Commission (CFTC) today sued the Ireland-based prediction market firms Intrade and TEN effectively shutting them out of the U.S. market. Here is the CFTC's press release. Intrade has this statement posted on the site stating that all U.S. customers should immediately close their positions and their accounts.

Here are two early takes on the matter from John Stossel and Bryan Caplan. I eagerly await Robin Hanson's take on the matter.

To me this is a prime example of government regulatory failure. It is also an argument for Principals-Based Regulation. The law will always be slow to recognize and respond to market evolution and innovation. As a result, we fight yesterday's war by applying rules designed around past practices and transgressions to new creations. Instead of considering or even looking for victims, the regulators look for breaks in the pattern where similar activities are not being equivalently regulated.

In this we also find the arrogance of the aristocratic regulator. But for the watchful eye of the regulator, we the naifs and fools would wonder helplessly into harm. Here is the quotable example from the CFTC rationalizing their actions:
The requirement for on-exchange trading is important for a number of reasons, including that it enables the CFTC to police market activity and protect market integrity.
We continue to live in a world less than what it could be all for our own good. The CFTC gave a conclusive prediction to prediction markets that ran something like this: I'll give you a winter prediction: It's gonna be cold, it's gonna be grey, and it's gonna last you for the rest of your life . . . or at least until we stop bluntly applying invasive regulation to every strange thing we see.

Sunday, November 25, 2012

The difference between winning and losing

Oklahoma football coach Bob Stoops likes to say, "there's a big difference between winning and losing." Generally this in invoked after a narrow victory especially when the opponent was supposedly over matched. Here is an example from the 2002 season describing the 37-27 victory over Alabama where OU had blown a 20-point lead. And here is an example from the 2004 season describing the 42-35 victory over Texas A&M. But here is an example from this season where he is seemingly contradicting the often repeated mantra. Last night's thrilling Bedlam game gave Stoops another chance to claim that the difference between winning and losing is a vast gulf. So far, I don't believe he has.

I am not aiming to indict Bob Stoops for this common but nonetheless faulty reasoning. Many coaches in many sports have said the same. But I do want to take this opportunity to dispute the idea that a narrow victory is a substantial victory, and I will be using OU as my example. I had planned this blog post before last night's game. What an interesting coincidence that the game was a perfect example for the case I will make.

Missed it by that much

Stoops, et al. have it backwards. There is actually a very little difference between winning and losing in general in life and especially in college football. College football outcomes, like in the NFL, are surprisingly largely driven by random chance. For the NFL, Brian Burke estimates that over 50% of the outcome is random. I've made similar calculations to those of Brian to come up with a 60%-70% share of college football outcomes attributable to random chance. That alone should give us pause. If there is a lot of randomness (a large error term) in football outcomes, how much or little credit can we attribute to everything else?

Let's think about the difficulty in evaluating performances ex post without letting the actual outcome bias the appraisal. Consider a comeback against a lesser opponent that falls short versus one that succeeds. Suppose the game ends up being decided by a last second field goal attempted by the team favored to win. Make the field goal, and the commentators will look back on a splendid series of gritty plays that made the difference. Miss it, and the same commentators will describe how inept was the entire performance. This isn't consistent. All of the performance was the same up until that one single play.

So it turns out that a "brilliant" throw by a quarterback threading the needle between two defenders for a touchdown and the same throw being "ill advised" when intercepted can impact both the outcome of a game greatly as well as how we feel about that outcome. The random factors that govern the success of such a high impact, high sensitivity event are probably the critical factors, and they can cut either way. It seems there really is a fine line between stupid and clever.

OU was close, very close, to winning the BCS National Championship in the 2003 and 2008 seasons. A handful of plays against LSU and Florida, respectively, went a long way to determining those championship games' outcomes. But it would be inconsistent to hold that view about those seasons and games while clinging to the Big Difference theory. If the Big Difference is true, OU was a long way away from holding the crystal ball. Similarly, the Sooners were able to ever so narrowly escape numerous tight situations in their 2000 title run. Oklahoma State was a few fingertips away on a last-second, touchdown pass to ending the dream season. But for a few heroics at Texas A&M two weeks before the OSU game and in the Big XII title game against Kansas State, OU would have been out of the hunt. In the championship game itself Florida State came very close to winning.

Here are the lessons to draw from this:
  • It is not the actual outcome of specific close events that matter so much as the entire volume of evidence. 
  • As distasteful to some as it is, margin of victory matters. Prediction models for college football among others are significantly enhanced when margin of victory is included rather than just win-loss results.
  • Whether declaring the strength of the mandate a close election has created for a winning candidate or trumpeting a narrow victory on the gridiron, the logic is flawed. We need to be humble and reasonable in our assessments. That includes working hard to not let the outcome bias the assessment. 
Congratulations to both the Sooners and the Cowboys on a great game filled with wonderful excitement. As a fan I can write that more easily because my team prevailed. I know that my joy is not equal to the pain felt by Cowboy fans, and, perverse as it is, my joy is enhanced knowing they suffer and what that suffering feels like--I've been on the other side. I am very happy the Sooners won. I'm not sure if I wish they could have won 51-0 rather than 51-48, but I am sure a 51-0 outcome would mean a lot more.

Update: edited to correct a few grammatical mistakes.

Tuesday, November 20, 2012

Steal this blog post

I want to discuss my views on the currently trendy topic of copyright and patent law. It seems the more the law tightens its grip, the more innovation slips through its fingers. First it was Napster, et al. and next it is 3-D printing. Are these continued developments a threat to our principals and way of life? It is important to remember Article 1, Section 8, Clause 8 of the U.S. Constitution, which states that Congress has the power:
To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.
As the recently published and almost immediately pulled House Republican Study Committee report noted, this is the purpose of copyright [and patent, I'll add]. Not to simply or necessarily compensate the creator of content [or inventions in the case of patents]. The issue at state is not about what a creator deserves or is owed. It is about promoting the general good of society. Too often the vested interests (Big Mouse, Big Music, Big Drug, Big Computer, etc.) confuse the issue by confusing successful market outcomes (the worthy goal per se) with individual creator or company or industry success (potentially but not necessarily worthy goals).

Copyright and patent are ultimately about special contracts. They are societal contracts that are forced upon us--a government-granted monopoly which casts a do-not-compete clause upon us all. We already should be concerned. But there is logical, principled footing here. I cannot make you share is a good property rights principal. I want to extend it to another, similar concept: You cannot make me not share. That's where I'm heading shortly. But first, some grounding.

Pragmatically and in principal, we want both creativity and sharing. The problem is sharing can hinder creativity because creativity can be costly and sharing can prevent benefits from flowing adequately to the creator who incurred the cost. Hence, we get copyrights and patents as the method to find a happy middle. But we have many reasons to believe we are far from the happy middle.

Briefly, here is my understanding of current law. To claim a copyright an idea must meet three requirements:

  1. The idea must have fixation in some tangible medium of expression.
  2. The idea must be original.
  3. The idea must meet a minimal level of creativity.
To receive a patent an invention must also meet three requirements:
  1. The invention must be novel
  2. The invention must be non obvious.
  3. The invention must be useful.
An easy but perhaps not complete solution to our problem (remember the problem, sharing might hinder creativity) would be to significantly reduce the duration of copyright and patent (C&P). You can complicate this solution and perhaps improve it by differentiating by type of C&P--i.e., pharmaceutics different than software; books different than Internet breaking news stories. Another possibly complementary idea at least for patents would be to make proving the patent case much, much harder. John Duffy at Wired has some very good thoughts on this. Specifically, he suggests we should do a better job defining and enforcing non obviousness. 

I like these solutions, but they don't seem complete. In fact to be critical, Duffy's idea might be too much hand waving and wishful thinking ignoring the public choice problems. What I want ideally is to jointly maximize sharing and creativity--find the happy middle. Let's start by assuming creativity is independent of sharing. In that case I submit the following: 

Principles of Ethical Sharing, Duplication, and Simulation in a World of Costless Creativity

Duplication is a form of sharing. Sharing is ethical. I can listen to my copy of a song with you, I can lend you my physical copy of a song, I can give you my physical copy of a song, and I can duplicate my copy of a song and give or sell the duplication to you. Duplication satisfies two conditions; it must:

1.      Be indistinguishable from the consumer’s point of view.
2.      Be non-rivalrous from the consumer’s point of view.

The second part is important: Sharing is duplication only if you and I can enjoy it at the same time separately. The first part is where it gets interesting: Sharing is duplication only if the good or service cannot be distinguished from the authentic from the consumer's point of view—otherwise it is simulation. Simulation is ethical if the consumer in a specific case realized or the reasonable-man consumer in a general sense would be expected to realize the simulated good or service is distinct from the authentic. If this test of simulation fails, we have a case of fraud. Trademark violations are fraud, for example. 

Because we don't live in a world of costless creativity, we are going to need C&P to some extent. My solution is to apply C&P only to cases of duplication--not to simulation and of course not to other forms of sharing. In doing so we GREATLY limit the applicability of C&P. Many inventions currently protected by patent law are no longer eligible as they are cases of simulation (this makes moot most of the software patent wars). 

In this solution C&P would honor first to file but recognize concurrent, independent discovery/creation. This allows for simultaneous C&P protection to multiple parties where the first to file would begin the clock on C&P duration. Copyright would be inexpensive to file commensurate with current practices and fees, but patent filing would require a high fee (high enough to discourage speculative, squatting patent filings). There would also be a very substantial cost indexed to inflation to enforce both C&P. The cost of enforcing C&P would be the cost of bringing suit including a loser-pays rule for plaintiffs only. The standard duration of enforcement would be 5 years. This duration would be extendable by purchasing time in annual increments up to a total of 15 years of protection including the original 5. Extensions would need to be filed prior to within one year remaining of C&P life, and the cost of each additional year should be equal to 1/5 the cost of a new 5-year enforcement initial filing of C&P, respectively. Because willingness to pay for additional protection would be based only on the perceived unrealized value of the idea (NPV of future cash flows) and the assumed ease of duplication, there should be a relatively efficient tradeoff between protection and release.

Sunday, November 18, 2012

Two monkeys walk into the EEOC . . .

A friend sends me this link to a video of research done on Capuchin monkeys concerning payment for learned tasks. The essence of the video comes at the very humorous moment when one monkey discovers that the other monkey is being paid "unequally" for the same task. It is said that the first monkey is "rejecting" the "unequal" pay with the implication that you as a human should do the same. The caption/punchline below the video reads, "If monkeys reject unequal pay, shouldn't you?" We can't really assess from the brief video the meaningfulness of the research. This isn't about the Capuchin, Donnie. But we can comment on the implied call for pay equality and the rather pedestrian approach to the argument.

It would really be something if the second monkey rejected the "unequal" pay (actually getting a more desired grape instead of a less desired cucumber piece). Or if a third monkey went on a hunger strike in protest. The fact that the first monkey only realizes the visible grapes are actually available for payment after the second monkey attains one is impressive (or at least interesting--perhaps this says something about how little we expect of monkeys).  But it is only upon completing the task a second time and then not being awarded a grape that the protest begins. The first monkey didn't connect the "unequal" pay backward to the prior task--she didn't protest immediately upon seeing the second monkey get a grape. Maybe this is the truly remarkable part: The first monkey learned something about the market price for completing the task and appropriately raised her reservation raise.

Higher life forms (those who understand economics like this monkey) understand that the market is a discovery process. It isn't so simple to say what is or is not equal pay. The second monkey seems to get this too in that he doesn't feel ashamed for receiving "unequal" pay. In fact in the human world there are a number of reasons why two people apparently in the same situation presumably performing the same task would in fact receive different compensation. There is nothing inherently unjust or inefficient about it. To assume so is to beg the question about under what circumstances the difference arose.

It seems the first monkey not only understands economics but also understands property rights as well. By reserving her protest for higher wages until after completion of the task a second time, she makes clear that she doesn't believe she deserves the same deal the other monkey got. Rather she is just insisting and aggressively negotiating a new compensation package. She knows that a fair deal isn't "fair" simply and only because it is "equal" to another seemingly identical situation. It is fair if all parties to the deal agree to it freely without force, coercion, or fraud regardless of the comparable deal struck by other parties in another situation. While most monkeys have been diligently working themselves up from nothing into a state of extreme poverty, this one has been studying Locke not Marx.

Yes, I'm reading into this a little too deeply, but live by the exaggerated metaphor, die by the exaggerated metaphor.

If monkeys reject bad economics and faulty understanding of property rights, shouldn't you?

Saturday, November 17, 2012

Arguing against the Infield Fly Rule

Over at the Sports Law Blog, Howard Wasserman continues to try to make the case for the Infield Fly Rule but worries that his four-point test is running into a problem considering the "kneel down" or "victory formation" in football. Here is the essence of his concern:
This will expand on The Atlantic piece. In that essay, I identified four features of the infield fly situation that justify a special rule: 1) The fielding team has a strong incentive to intentionally not do what they are ordinarily expected to do in the game (catch the ball); 2) the fielding team gains a substantial benefit or advantage by intentionally not doing what is ordinarily expected (this is the prong I want to flesh out in economic terms of optimal outcomes, costs incurred, and benefits gained for each team); 3)the play is slow-developing and not fast-moving, so the player has time to think and control what he does; and 4) even doing what is ordinarily expected of them, the opposing players are powerless to stop the play from developing or to prevent the team from gaining this overwhelming advantage.
As I said, I believe the infield fly is the only situation in all of sport that possesses all four features. But in conversations with friends and readers, one situation keeps getting brought up: The kneel down (or "Victory Formation") at the end of football games.
I like his reasoning with the four-point test, but ultimately I believe it fails. I don't like the IFR generally. And I think this test does not sufficiently justify it (or change my mind). Below is the comment I've left on his post. Check out his entire post, and judge for yourself. The Sports Law Blog is a thoughtful source I follow regularly and generally don't quibble with. Messing with those guys is like a sixth grader picking a fight with the entire seventh grade.

My comment:
I really like your reasoning, but I ultimately believe I disagree. 
I think the example of the kneel down is problematic in a few respects. On point one especially but touching on the others, this seems an incorrect or arbitrary description. We should ordinarily expect that an offense is doing its best to continually put its team in the best position to win. This includes running the ball in a play that is unlikely to gain great yardage much less score but that puts the team in a position to score later on. It also includes running to force a trailing opponent to use valuable time outs to stop the clock. It also includes taking a safety rather than give an opponent very good field position for a touchdown opportunity. It also includes (last one, but I think these are progressively important) a defense that intercepts a ball late in a game thrown by a trailing team's offense falling down rather than advancing the ball and risking a fumble. 
If we are to take your four-point test and apply it to football, it seems we must start making a lot of judgment calls restricting these types of plays among others (my apologies for the redundancy, but this is a new point): An offensive team running the ball and falling down in bounds late in the game on 3rd and 20 to force the opponent to use a time out; A team taking a safety on purpose; A defense that is winning late in the game not advancing an interception because of the risk of fumble. My problem with the four-point test is not so much that it will have to be applied to so many other situations potentially, but that I don't find the IFR to be such a problem. It is a bang-bang, during the regular course of play event that happens to create both a situation of advantage (IFF executed properly) for one team as well as the time to execute it. This happens a lot in all sports. Should we prohibit fast breaks in basketball if enough of the defense is not able to contest the play? Should we force a football team on offense, up by one point, with one minute to play, and with no opponent time outs to score a touchdown when they would rather run out the clock and disallow the opposing team's offense from getting the ball back (reference: NY Giants versus NE Patriots in last year's Super Bowl)?

Tuesday, November 13, 2012

The King knew that great inputs were essential

Barry Switzer was one of the greatest college football coaches ever because, among other qualities, he was one of the greatest college football recruiters ever. Great talent building is a necessary component for success in any team sport be it through recruiting, drafting, or trading. The league structure will dictate the form the talent building takes. It is up to the management to maximize the opportunities given constraints. That sounds a lot like choice under scarcity, and it is, and that sounds a lot like something economics can help shine light on, and it is as well.

Obviously, a college football team would ideally be composed of the top 25 players by position to be drafted by the NFL each and every successive year. Well, that isn't actually obvious. Many of those players don't work out so well for reasons including the NFL isn't perfect in drafting the top performers in order. Tom Brady was a sixth-round pick in 2000 and was the sixth quarterback selected that year. Already we have a knowledge problem, and that is before we get to competition for resources and other factors driving scarcity. It is important to note at this time that the knowledge problem has two dimensions: (1) how well a player can play, and (2) how well a player will play. Neither is fully knowable even by the player himself. The player may think he coulda been a contender, but believing that does not prove it to be so.

Here is how I break the two dimensions down. The first I generalize under the heading "athletic talent". The second I generalize under the heading "grit". Each encompass many components.

Athletic Talent would include:
  • Athletic skills within the sport
  • Athletic skills in general
  • Intelligence
Grit would include:
  • Ability to be motivated
  • Ability to motivate
  • Desire
  • Work ethic
  • Attitude
Notice that a basic level of both groups of attributes are necessary. Notice also that each should complement the qualities of teammates and the team where the whole is greater than the sum of the parts, but grit probably plays a bigger role here than does athletic talent. This gets us to the tradeoff aspect. Here is where economics comes in.

The first dimension is higher profile and more easily observable, albeit with a significantly large standard deviation. The recruiting services don't give stars for determination to succeed. Their recognition is much more closely aligned with record-setting stats. From the start coaches will be biased toward recruiting with a heavy emphasis on the first dimension. The fan, donor, administration, and peer group will expect it up through accepting it as an excuse when a player under performs.

The best examples I have where a player exhibits the extreme case of having a lot of one dimension and a little of the other are Marcus Dupree with extremely high athletic talent but little grit and Wes Welker with slightly above average athletic talent and extremely high grit. A better example than Wes Welker would be a player with the grit but who failed because of a lack of talent. But that player doesn't exist because of the factors mentioned in the prior paragraph. In recent years Boise State had a lot more grit but probably one level less athletic talent than did Texas. The players recruited into each program most likely had a lot to do with this. Of course there were other contributing factors, but the point remains.

My simplistic approach to recruiting for the realistic ideal college football team is a great quarterback (extremely high levels of both dimensions) surrounded by above average athletic talent and highly above average grit. Yes, I said it was simplistic--probably should have said obvious too. But I don't think the process employed by many or any college football programs actually works this way. I think the process is actually a great or above average quarterback surrounded by highly above average athletic talent and average grit. And these are in all cases the goals of which a program will fall short in varying degrees of magnitude. Categorize this under the heading educated conjecture. I am sketching out an argument and theory not finalizing a thesis.

If we were to approach college football recruiting for a Moneyball angle, I believe this would be it. Athletic talent is the expensive input; grit is much less well paid. Where possible, trade athletic talent for grit at the margin. What this would mean in practice is being not very choosy when looking at players high in athletic talent--a three-star and a five-star might be nearly equivalent. You'd be looking for indications of grit where a little goes a long way to make up for relative athletic talent shortcomings. The first and most basic filter would be athletic talent. Get that out of the way quickly, and then focus the majority of your resources filtering on the dimension of grit.

Saturday, November 10, 2012

A little something for the readers

Just to prove this isn't all about me, I am announcing my intention to add something to every blog post. From now on I will try to incorporate a reference to a movie, usually a line of dialogue, in every blog post. I've already done this in at least a couple (there may be more, I do this so often and naturally in my everyday life that I lose track myself).

This should give you something to savor everyday. A reason for living perhaps. Or at least a reason to check in daily. Every time you find the reference, you win. Add the points up and keep track. At the end of the year you'll have a total. That total can be redeemed for merchandise in the Magnitude Matters general store (location and merchandise pending). You know, it's all about merchandising. Merchandising, merchandising, where the real money from the movie is made.

Yes, these references will be biased toward my taste in movies. So if you have bad taste in movies, you probably won't be cashing in for a set of steak knives at month end.

Friday, November 9, 2012

2012 Election is in the books, Obamney wins/loses!

So that happened. And a status quo, lame duck session begins. I forecast whip-lashing, headline risk as we endure the race to do nothing significant about the fiscal cliff. Let's prognosticate, shall we...

Winners, Losers, and Trends:

Immigration reform and liberalization seems likely to be a winner. It is clear the Republicans lost critical votes on net from the hard-line positioning the party took from the primaries on regarding immigration. This may make a lot of the bad winners in this election worth it all. And who'da thunk it from the victory of the president responsible for a record number of deportations.

Data crunching a la Sabermetrics is a winner. The Obama team took it to new heights, and Nate Silver showed just how powerful a nerd and some numbers can be.

Generally, social freedom was a winner as marijuana legalization at the state as well as the municipal level continued its success and marriage equality lept forward.

Economic freedom probably took a hit on net; although, that remains to be seen and unseen . . . so we'll never quite know. The chances for good tax reform including simplification ebbed some I believe.

The politics of envy and distrust were winners.

One-size-fits-all social policies defeated one-size-fits-all social mores.

Central planning by good intentions won out over fiscal planning by good intentions.

Count also bailouts and TBTF as continued winners. While Romney/Ryan didn't have a sterling record on this front, they promised better in rhetoric. That at least gave a small rational expectation to believe they would be better.

Defense contractors were probably losers while every other conceivable beneficiary of government largess was victorious on net.

Speaking of "defense", war was probably given a change of venue. Iran is a less likely destination for our restless drones but they still may get to vacation in the sunny Middle East in Syria.

There is a good chance I add to or edit this list.

Thursday, November 1, 2012

United versus Southwest

My wife is about to take a short trip up to Denver. She is flying up on Southwest Airlines and back home on United Air Lines. Because she is taking our five-month old, she needs to arrange with the airline that she has an infant lap child.

She called Southwest first. She immediately spoke with a person, was never put on hold, and quickly relayed the information. The agent of Southwest said it was taken care of and thanked her. Easy as that.

She then called United. She was greeted by a recording: (I paraphrase) "Thank you for calling United Air Lines. We are currently experiencing extreme telephone congestion due to the recent events from Hurricane Sandy. We are unable at this time to take any additional calls or to place you on hold. Good bye." And with that they hung up.

The story reminded me of this post from Bryan Caplan re: John Cochrane's recent essay, "After the ACA: Freeing the Market for Health Care"

This passage has the direct point (emphasis added):
The fact that so much cost reduction comes from new entrants, not reform at the old companies, is testament to the painfulness of this process, and the ability of incumbents to protect the status quo. The big 3 still take 40 hours to build a car relative to Toyota's 30. And two of them went bankrupt, while Toyota sits on a cash reserve. American and United are still struggling to match Southwest's efficiencies, after 30 years. The parts of Kodak invested in film simply couldn't let the company exploit its technical knowledge in optics and electronics. Chicago's teacher unions are fighting charter schools tooth and nail. And a quick look at a modern hospital, and its suppliers, suggests just how wrenching the same transformations will be.

How far we have yet to come

It is shameful and amazing that as far as we have come as a society, we not only still have legislation on the books like this, but we have politicians who gain favor by promoting it. It would be bad enough if anti-price gouging law was legacy law left over from a bygone age. It is far worse that this harmful nonsense is actively supported.

Look here (from a "leftist" economist), here (the maximum temperature analogy), here (directly refuting the other side), here (a roundup with videos), here (Cowen reminds us that the current owners of resources, shopkeepers, are also the competition), and here (interference with economic triage) for some wisdom on the topic.

To those who support anti-price gouging: The price increase you find distasteful is a symptom of the distasteful (big understatement) events that have transpired. Don't blame the price messenger. He is one of your greatest allies.

Mantis versus Moth

I was walking in the backyard and noticed a fluttering sound coming from the flower garden in the back corner. Upon inspection, I found an amazing sight right out of wild kingdom. A 4-inch-long preying mantis had captured a very large moth in its front legs. It was proceeding to basically eat the moth's face. Despite the moth's intense struggle, it could not free itself. The mantis was basically strong enough to hold down the moth's attempt to fly away. Below are some pictures and a link to a video I shot.