Now there is a footballing analogy to this – the Jesus Navas style. Those of you who watched either Spain’s game with Honduras or the second half of their loss to Switzerland would’ve noticed that Spain effectively followed two lines of attack. The first was the traditional way – attack down the middle in a series of slow passes and build-up. Five of Spain’s front six players would get involved in this attack down the centre, almost rendering their game one-dimensional. And then there was Navas.

I haven’t confirmed this stat but in the game and half that he has played Navas has completed more crosses than anyone else in the tournament. He would strike it on his own down the Spanish right flank, hug the touchline, beat the full back and put in crosses. Minute in and minute out. Sometimes with a little help from full back Sergio Ramos, but mostly alone. It was fantastic to watch.

What this ended up doing was to divert the attention of the opposing defenders to cover Navas. If everyone were to have been attacking down the centre, the defending team could’ve just parked their bus in front of their centre and prevented any scoring. Spain letting free this one guy to take a different route meant that the opposition needed to cover that also leading to insufficient cover in the centre (it is another matter that Spain failed to score against Switzerland. But they did get so many more chances after Navas came on).

I’ve always been fascinated by such strategies at work, in business. You have a bunch of guys who try to attack the problem front-on, in the conventional way, working together, passing to each other frequently. And then there is this one guy who has been left out of this clique who attacks the problem “from the flank”. In his own way, without fear of failure. He knows that he is only an auxiliary solver, that he has nothing to lose (Navas lost his place in the XI after the Honduras match but I don’t think he had expected to ever play at all), and he can just go for it. The option value of letting one guy in the team loose in order to search for alternate solutions while everyone else is building up down the middle is immense, I think.

This is similar to Nassim Taleb’s “barbell investment strategy”. Acccording to that, he parks some 90% of his assets in ultra-risk government securities. They don’t give spectacular returns but his money is safe. And the rest of the 10% he uses to punt by buying stuff like out-of-the-money options. If they expire worthlessly, he hasn’t lost much of his wealth. The optionality (here, literally) of that additional 10% is, however, immense, and there is potential for spectacular returns from this strategy. with losses being capped.

Let us suppose Alice’s liking for Bob is a continuous variable between 0 and 1. However, Alice never directly states to Bob how much she likes him. Instead, Bob will have to infer this based on Alice’s actions. Based on a current state of the relationship (also defined as a continuous variable between 0 and 1) and on Alice’s latest action, Bob infers how much Alice likes him. There are a variety of reasons why Bob might want to use this information, but let us not go into that now. I’m sure you can come up with quite a few yourself.

Now, my hypothesis is that the relationship state (which takes into account all past information regarding Alice’s and Bob’s actions towards each other) can be modelled as an exponentially-smoothed variable of the time series of Alice’s historical liking for Bob. To restate in English, consider the last few occasions when Alice and Bob have interacted, and consider the data of how much Alice actually liked Bob during each of these rounds. What I say is that the “current level” that I defined in the earlier paragraph can be estimated using this data on how much Alice liked Bob in the last few interactions. By exponentially smoothed, I mean that the last interaction has greater weight than the one prior to that which has more weight than the interaction three steps back, and so on.

So essentially Alice’s liking for Bob cannot be determined by her latest action alone. You use the latest action in conjunction with her last few actions in order to determine how much she likes Bob. If you think of inter-personal romantic relationships, I suppose you can appreciate this better.

Now that you’ve taken a moment to think about how my above hypotheses work in the context of human romantic relationships, and having convinced yourself that this is the right model, we can move on. To simplify all that I’ve said so far, the same action by Alice towards Bob can indicate several different things about how much she now likes him. For example, Alice putting her arm around Bob’s waist when they hardly knew each other meant a completely different thing from her putting her arm around his waist now that they have been married for six months. I suppose you get the drift.

So what I’m trying to imply here is that if you are going through a rough patch, you will need to try harder and send stronger signals. When the last few interactions haven’t gone well, the “state function of the relationship” (defined a few paragraphs above) will be at a generally low level, and the other party will have a tendency to under-guess your liking for them based on your greatest actions. What might normally be seen as a statement of immense love might be seen as an apology of an apology when things aren’t so good.

It is just like an economy in depression. If the government sits back claiming business-as-usual it is likely that the economy might just get worse. What the economy needs in terms of depression is a strong Keynesian stimulus. It is similar with bilateral relationships. When the value function is low, and the relationship is effectively going through a depression, you need to give it a strong stimulus. When Alice and Bob’s state function is low, Alice will have to do something really really extraordinary to Bob in order to send out a message that she really likes him.

And just one round of Keynesian stimulus is unlikely to save the economy. There is a danger that given the low state function, the economy might fall back into depression. Similarly when you are trying to get a relationship out of a “depressed” state, you will need to do something awesome in the next few rounds of interaction in order to make an impact. If you, like Little Bo Peep, decide that “leave ‘em alone, they will come home”, you are in danger of becoming like Japan in the 90s when absolute stagnation happened.

Quoting

According to a BBMP official, TDR is an instrument through which the Palike facilitates landlosers to construct additional floor or building in the remaining portion of the property or anywhere in the City.

…

The BBMP would issue a Development Rights Certificate (DRC), which can be either be utilised for personal need or can be sold to anyone who wants to construct an extra floor. The owner gets the right to construct a built up area 1.5 times over and above of that the property acquired for development. For instance, if 600 sq ft built-up area is given up to the BBMP, the property owner will receive a DRC for 900 sq ft built-up area.

This is interesting on several counts. Firstly, do you realize that what the BBMP is paying for the land is effectively an option? A TDR is nothing but an OPTION to construct more than what would normally have been permitted. The valuation of this option hinges upon the fact that current building laws are highly restrictive (in terms of the built up area as a proportion of the site area) and so the option of constructing more will actually be valuable.

It would be interesting to see how these options get valued. You can trust that there will be a lot of litigation concerning this since you can expect most people to have problem with the valuation. First of all valuation of financial options is itself so tough, you can imagine how hard valuing these TDRs can be.

Then, there is the whole supply aspect. The whole model of these TDRs will hinge upon the unwritten promise that more such rights will not be given away any time in the near future, since that will cause the value of existing TDRs to drop sharply. Given that there is one single agency (the BBMP) that controls the supply of such rights, and that the potential supply of such rights is infinite, there is a chance that valuation of these rights might be depressed.

One important thing the BBMP needs to take into account while issuing these rights is to make sure there are no transaction costs for trading these rights. The “transferable” bit needs to be emphasized in order for the value of these rights to be truly unlocked. I can see a large number of individuals who will be compensated with these rights who will want to trade them away, since they are unlikely to possess another site to utilize them. And given the number of big buildings coming up on small sites, I can foresee there being a decent demand for it.

I do hope that investment banks (or their equivalent) come forward in order to make markets in these rights. I’m sure banks won’t miss opportunity to step in here, but the important thing is for regulation that will enable such intermediation. It is in the interests of the BBMP to keep these transaction costs low, since that is going to have a positive impact on the valuation of these rights, and eventually less such rights can be given.

Postscript: It would be interesting to study the impact of these rights on bribery rates of BBMP officials. I’m sure that currently a lot of money is made in illegally granting rights for buildings that don’t conform to regulations. Since there will now be a legal way of getting similar favours (I’m told that the Akrama-Sakrama scheme has similar intentions) it would be useful to see if bribes do drop.

I’m just trying to illustrate this concept from another angle. Let’s say you donate Rs. 10000 to a charity that has gives a “100% tax free” receipt. So effectively your taxable income goes down by Rs. 10000. And considering a 10% marginal tax rate (ignoring cess, surcharges, etc.) your tax payable comes down by Rs. 3000. So effectively, you have donated ONLY Rs. 7000 to this charity and forced the government to pay the balance Rs. 3000.

Do you see the catch in this tax-break scheme? Essentially the government is forced to pay money to charity at the behest of a single citizen! By granting this “tax free status” to a charitable organization, the government is making itself liable to commit unlimited funds to this particular charity (of course I suppose that it isn’t easy to get such breaks for your organization, and considerable greasing of palms is involved. But considering that a small charity run by my extended family gets 50% tax break it may not be very hard after all).

So yeah, I’m sure the numbers will be available somewhere but i’m too lazy to find it. But I’m interested in finding out the aggregate deduction sought by all taxpayers put together under this section 80G (the one where you get tax exemption for donations). And then see where the government’s forced charity is headed!

The thing with booze is that it increases the volatility of your state of mind. This means that it will flatten out the curve according to which your mental state moves. So after you’ve had a drink or few, you are unlikely to remain in the same state that you were in that you started off at. You end up feeling either significantly better or significantly worse – and the chances of both these go up tremendously when you drink.

I know I have been so far acting based on one data point that went adversely, but I don’t know what causes the selection bias in people who have been through both sides significantly! Of feeling much worse and feeling much better after having some drinks. Why is it that even though all of them would’ve been through significantly worse after drinking at some point of time or the other, they tend to forget about it and only think of the times when they’ve felt better?

Is it that whether you feel good or not is some kind of a binary payoff depending upon the level of the state of mind (basically state of mind < cutoff => “bad”; state of mind >= cutoff implies “good”)? If this is true, then whenever you are “out of the money” (feeling bad), you dont’ really care if you go even more out of the money – your overall feeling doesn’t change by much. And so you don’t really mind the cases when the alcohol starts making you feel significantly worse. But then the barrier is ahead of you so by increasing volatility, you are giving yourself a better chance of surmounting the barrier so drinking makes sense! But then under this condition it doesn’t make sense to drink at all when you’re already feeling good!

Are there any other reasons you can think of for this selection bias? Why do people give more benefits to positive movement in state of mind as a function of drinking than to negative movement in state of mind? Or is it that volatility is a non-intuitive concept and “there’s a better chance you’ll feel better if you drink” is a simple way of communicating it? And let me know your experience about drink making you feel worse..

I’ve messed up. Due to a combination of reasons I haven’t yet filed my tax returns for last year (2008-09) and now my tax advisor tells me I have two weeks to do it. And calculating the tax payable for the umpteenth time, I now notice that there has been an error in all my previous calculations. And the additional tax that I need to pay (has to be paid along with a fine for paying late) is not insubstantial.

TDS is a necessary system in order to enforce compliance and putting in checks and balances into the system. It helps the government get its finances on time and save a large part of trouble in revenue collection. What it does, however, is to obscure the amount of tax that is being deducted. A clever method, I think, devised by governments to take away a large part of your money from you without you noticing it!

Of course this is accompanied by this ritual called filing tax returns when you do get a chance to see how much the government has taken away from you, but considering that for most people most of their taxes would’ve been accurately deducted, most people would just go through the process mechanically and few would actually look carefully at the numbers!

The next time you are doing your returns, I strongly urge you to look at the numbers carefully. Look at how much you have actually earned, and how much of it is being taken away by the government without you really noticing it! Open the calculator in your mobile phone and calculate the proportion of time you work every year for someone else – for someone called the sarkaar. There’s a good chance you’ll start demanding more from the government after that.

Here is HDFC Bank:

Notice the discontinuity? About how for a couple of randomly chosen dates the interest rates suddenly shoot up?

Similarly with ICICI Bank:

Again same story. On certain “magical” days, interest rates shoot up. The degree of increase in rates here is much less dramatic, though. Nevertheless this is extremely interesting, and I wonder why. I remember last year going to Karnataka Bank and asking for a 1 year deposit, and they asked me to make one for 400 days saying that I’ll get 0.5% per annum better for that.

This morning I went to State Bank of India and found that they don’t offer these special rates. I had a friend check at another nationalized bank and found that they too don’t offer special rates. Wonder why the private banks are offering it, though. Why it makes that big a difference to them that the deposit is for 990 days as against 991 or 889. Or is it some way to prevent early closure?

In other news, SBI is offering teaser rates for home and auto loans. Their ads have been there all over the airwaves for the last few weeks. They offer 8% for first year, 8.5% for second and third years and then what they call as “normal rates” after that. If SBI is getting into teaser rates, god only save Indian finance.

Just to give you a quick overview of accounting, the annual statement typically has two major components – the P&L statement which reflects what happened between the last release of the statement and the currrent point, and the balance sheet which reflects the position of the company at the point of time of release of the statement.

I think Bryan Caplan had made this point in one of his posts, but I’m not able to find it and hence not able to link it. The point is that you should look at relationships on a wholesome basis, and not just judge it based on the last action. The whole point is that there is volatility (what we refer to in my office as “the dW term”) and so there are obviously going to be time periods during which you record a loss. And if on each of these occasions you were to take your next course of action based on this loss alone, you are likely to be the loser.

I’m not saying that you should ignore the loss-making periods and just move on. You do need to introspect and figure out what you need to do in the next accounting period in order to prevent this kind of a loss from repeating. You will need to “work the loss”, not make a judgment to break the relationship based on it. I think a large part of the problems in this world (yeah, here goes another grand plan) stems from people using one-period losses in order to take judgments on relationships.

Another thing is not to generate the accounting statements on a shorter time period. This is similar to one funda I’d put long ago about how you shouldn’t review your investments at extremely short intervals since that will lead to a domination of the volatility term (dW) and thus cause unnecessary headache. You might notice that corporates rarely release their accounts statements more frequently than once a quarter – this has more to do with volatility than with the difficulty in generating these statements.It is similar in the case of interpersonal relationships. Don’t judge too often – the noise term will end up dominating.

One caveat though – very occasionally the last loss may be so bad that it more than wipes out the balance sheet and takes to zero (or even less) the value of the firm. In that kind of a situation, there is no option but to shut down the firm (or break the relationship) and move on. Once again, however, the clincher in the decision to break up has to be the balance sheet which has gone to zero (or negative) and not just simply the magnitude of the last loss.

Life based on a balance sheet view is a balanced life.

The relationship between the doctor and the patient is extremely asymmetric. It is to do with the number of counterparties, and with the diversification. If you take a “medical case”, it represents only a small proportion of the doctor’s total responsibility – it is likely that at any given point of time he is seeing about a hundred patients, and each case takes only a small part of his mind space. On the other hand, the same case represents 100% for the patient, and his/her family. So say 1% on one side and 100% on the other, and you know where the problem is.

The medical profession works on averages. They usually give a treatment with “95% confidence”. I don’t know how they come up with such confidence limits, and whether they explicitly state it out, but it is a fact that no disease has a 100% sure shot cure. From the doctor’s point of view, if he is administering a 95% confidence treatment, he will be happy as long as his success rate is over that. The people for whom the treatment was unsuccessful are just “statistics”. After all, given the large number of patients a doctor sees, there is nothing better he can do.

The problem on the patient’s side is that it’s like Schrodinger’s measurement. Once a case has been handled, from the patient’s perspective it collapses to either 1 or 0. There is no concept of probabilistic success in his case. The process has either succeeded or it has failed. If it is the latter, it is simply due to his own bad luck. Of ending up on the wrong side of the doctor’s coin. On the other hand, given the laws of aggregation and large numbers, doctors can come up with a “success rate” (ok now I don’t kn0w why this suddenly reminds me of CDOs (collateralized debt obligations)).

There is a fair bit of randomness in the medical profession. Every visit to the doctor, every process, every course of treatment is like a toin coss. Probabilities vary from one process to another but nothing is risk-free. Some people might define high-confidence procedures as “risk-free” but they are essentially making the same mistakes as the people in investment banks who relied too much on VaR (value at risk). And when things go wrong, the doctor is the easiest to blame.

It is unfortunate that a number of coins have fallen wrong side up when I’ve tossed them. The consequences of this have been huge, and it is chilling to try and understand what a few toin cosses can do to you. The non-linearity of the whole situation is overwhelming, and depressing. But then this random aspect of the medical profession won’t go away too easily, and all you can hope for when someone close to you goes to the doctor is that the coin falls the right way.

I was thinking of this kind of arrangement as a financial product. Actually, the movie has what I call as the “European version”. More complicated is the “American version” which I describe here. Basically I give you the OPTION to marry me on any day before my 28th birthday (6th Dec 2010). That would be simple enough to “price” (or “value”, to put it in layman’s terms) – it is a standard American option. However, let me add this twist into it. I also reserve the right to withdraw this option on any day before expiry or exercise.

So basically some day before my 28th birthday I can wake up and cancel this option that I’ve given you. Now the challenge is to price this. One thing that is obvious is that the value of this is now less than the value of the pure American option. But pricing it is a challenge (though, thinking about it carefully, it shouldn’t be too hard to solve. I think we can use option-on-option fundaes in order to price it, but still it’s nontrvial).

The European option, of course (as it is done in My Best Friend’s Wedding) easier to price. Basically, there are two events that need to happen on the day of expiry for the option (ok technically it isn’t an option since if these two events happen, then the parties are forced to execute the contract) and so it can be easily modeled using a two-factor model. The American, as we discussed, is tougher (though I’m sure that if I were to present this problem to my colleagues, they’d solve it in a jiffy).

So the reason I’m writing this is that I’m planning to enter this kind of a deal with someone. And I’m wondering if it’s better to enter into a European deal or into an American. Remember that if it is the “American” deal, I’ll be giving away the option (to marry me before either my 28th birthday or I withdraw the option) for free. Considering this, under what conditions should I try to sign the European contract, and under what conditions should I give away the American?

Also, how does the pricing of the American option change if I’m allowed to give it away to more than one person (with the understanding that as soon as one person exercises the option, I withdraw the option from all the other people I’ve given it to). And typically, will I be able to get more benefit in total by giving away this American option to a number of people than if I give it away to one person (assuming I’m indiffernet between all these people with respect to marriage).

Ok it’s late in the night and it’ s my third post in the last 1 hour, so it might be a bit muddled up. Also, you might find it a bit too technical (remember that I’m a quant). Nevertheless, I hope I’ve been able to communicate what I wanted to communicate. And am looking forward to your advice on this.