# What's the benefit to society of stock speculation? \[edited title\] **URL:** \ **Category:** Great Debates\ **Created:** [November 4, 2011, 4:06pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864 "2011-11-04T16:06:06Z")\ **Posts on this page:** 20\ **Page:** 9
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 4:56pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/161 "2011-11-16T16:56:30Z")
> [@aux203](#): > > You cut and paste that from wikipedia, didn’t you? The rest of that page explains a lot of these issues. As usual, this conversation has veered off topic. Initially you expressed concern that the notional value of the derivatives market was so large. This is a common response when people have no real idea of derivatives are or what they do. > > Rand Rover gave an example, here are some more examples for people who are totally lost: > > An example of a derivative might be an option to buy 100 barrels of oil at 100$ at some point in the future. The notional value of this contract is 10,000$. But an option to buy 10,000$ worth of oil is not the same as actually owning 10,000$ worth of oil. Note that multiple derivative contracts can be applied to the same asset. Quite a lot of these contracts in effect cancel each other out. > > A large portion of the derivative market also includes interest rate swaps. Two parties might exchange interest rate cash flows based on some notional principle amount. You might pay a fixed rate to someone else while they pay you a rate that varies. This can be handy to defray risk associated with fluctuating interest rates. It can also be a tool for speculation. This “principle” amount might be 10 million dollars but it’s not as though 10 million dollars is changing hands. It’s merely the number used to calculate the interest. But the notional value of this contract would be 10 million dollars. > > Sigh. Which not to say that derivatives don’t have their problems. But I agree with DragonAsh. The level of financial knowledge on this thread, and this board for that matter, amazes me. I can only assume it’s lower among the general public. Most people don’t have a prayer of understanding even basic finance. I don’t know what the answer is or if we should even try to find one. Everybopdy keep talking about interest rate swaps, currency swaps are by far the greater market and is frequently used for speculative purposes. How do you feel about the situation a few years back when we had oil futures that exceeded actual oil production by several orders of magnitude? ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 6:19pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/162 "2011-11-16T18:19:14Z")
> [@Trom](#): > > Most HFT programs are market makers. In general, market makers aren’t looking at fundamentals at all. They are trading based on order flow, other quotes, volume, statistical relationships to other instruments, etc. That isn’t to say they function outside of the fundamental traders’ view of the market. For example, rather than look at a balance sheet and decide that a stock is underpriced, they observe a barrage of aggressively priced buy orders come to the market, and, using that technical information, adjust their quotes higher. Their “customers” are the fundamental traders - who really move the market. > > I’d actually be surprised if the average holding period is 22 seconds. I would think it would be lower. There’s a lot of potential directional exposure when holding for 22 seconds! I don’t think HFT is all order processing. A lot of it is trading on technicals ---
**Author:** ![aux203](https://avatars.discourse-cdn.com/v4/letter/a/77aa72/32.png) [@aux203](https://boards.straightdope.com/u/aux203)\ **Post date:** [November 16, 2011, 6:32pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/163 "2011-11-16T18:32:36Z")
> [@Evil\_Captor](#): > > I know what derivatives are and what they do. […] If you have a logical argument why derivatives are not disastrously dangerous, bring it. But first explain how they played little or not role in the recent stock market crash, a point many economists and market analysts would strongly disagree with. Perhaps you mean SOME flavors of derivatives are harmless, while others are extremely dangerous. Is that your position? Yes. Derivatives can refer to a whole host of different instruments. Some are more problematic than others. When Warren Buffet referred to derivatives as “weapons of financial mass destruction” he was referring to a subset which were problematic both for being high leveraged and complex. Highly leveraged as in 100% leverage in the case of TRS’s, and so complex he didn’t feel like he had a good handle on the risk involved. These are problematic for obvious reasons. But Warren Buffet still trades in derivatives. We’ll get back to these in a minute. I was responding to your original post, which follows: > [@Evil\_Captor](#): > > The total wealth in the world is calculated at roughly $195 trillion by Credit Suisse as of 2010. (Cite.) > > The total derivatives market is calculated at over $500 trillion. (See the chart entitled world’s wealth vs. world’s derivatives market). > > Don’t ANYBODY see a problem here? How have our busy, busy little financial traders managed to gamble more than the ENTIRE WEALTH OF THE WORLD SEVERAL TIMES OVER? You seemed primarily concerned with the fact that the derivatives market was several times the estimated wealth of the world. Is that not accurate? As others have pointed out, that figure isn’t particularly alarming due to the way derivatives are structured. If you want to talk about how CDS and CDOs are a problem, that’s another discussion. > [@Evil\_Captor](#): > > So when a trader makes a derivative wager, all that is at stake is the money his is wagering, the amount of the financial original instrument is irrelevant? Why then were derivatives an issue in the recent market crash? You’re being a little vague here when you say “money his is wagering” and “amount of the financial original instrument”. It’s not like a you’re just betting 50 on black. So let’s go back to some (simplified) examples. Let’s say I make make a bet on the value of the S&P 500 using a put option. Let’s also imagine the current price is 1000 and I make my bet of the value of the S&P in 5 years. If I put up 100 million dollars, that sounds like a lot of money at risk, and it is. But I can only lose that entire investment if the value of the stock market drops to 0. If in five years the value of the S&P is 1200, I’ve made 20 million. If it’s 800 I’ve lost 20 million. In 2008 BH had about 37 billion dollars worth of equity puts in its portfolio. We’ve talked about interest rate swaps before but let’s do it again, hopefully more clearly this time. This is simplified for clarity but I hope the basic idea gets across. If I enter a interest rate swap contract a notional principle is determined. Let’s say its a billion dollars. A simple example would involve one party paying a fixed rate, let’s say 7% to one side, while the other side pays a floating rate to the other, let’s say over the course of the contract it varies between 2-10%. If the floating rate happens to stay at 7% for the length of the contract, no money changes hands. Zip. Let’s say interest rates fall all the way to 0%. In that case party A will essentially be paying party B 70 million and getting nothing in return. That’s bad, but it’s not as though someone is going to get a bill that says 1 billlion dollars at the bottom even in the worst case scenario. BH had about 4 billion dollars worth of these swaps on its balance sheet in 2008. Remember Lehman Bro’s? Initial estimates on the the payout on their CDS were on the order of 300 billion. Final net payments were about 6 billion as parties were both selling and buying protection and many cancelled out in the end. > [@Evil\_Captor](#): > > If you can’t add to the discussion without rolling your eyes at the amount of knowledge other people have on the topic, it would be perfectly all right with me if you did not contribute at all. The amount of self-important chest-puffery in this discussion amazes me. I don’t understand what you are arguing. I thought your initial concern was the size of the overall market was somehow too big? I think most people would say that’s not a major issue for the reasons described above. That you made a post on that issue honestly made me think you didn’t have a good handle on derivatives and what they’re used for. If you think all derivatives are somehow useless or just “gambling”, I would strongly disagree but that’s an entirely different issue than your original post, and a complex one at that. Would you say that hedging, risk management, and the multiple other functions that derivatives are used for are not legitimate? If not, then why not? If you think they are legitimate but their use must be balanced against their drawbacks, namely overleveraged positions, concentration of risk, complexity, need for regulation, etc. well I don’t see that that is very controversial even in financial circles. ---
**Author:** ![aux203](https://avatars.discourse-cdn.com/v4/letter/a/77aa72/32.png) [@aux203](https://boards.straightdope.com/u/aux203)\ **Post date:** [November 16, 2011, 6:47pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/164 "2011-11-16T18:47:57Z")
> [@Damuri\_Ajashi](#): > > Everybopdy keep talking about interest rate swaps, currency swaps are by far the greater market and is frequently used for speculative purposes. > > How do you feel about the situation a few years back when we had oil futures that exceeded actual oil production by several orders of magnitude? Interest rate swaps are just a relatively easy swap to understand as an example, that’s all. As you know it can get byzantine pretty quickly. The size of the futures market didn’t strike me as particularly worrisome in and of itself though I’ll admit I was only peripherally following it at the time. It’ll be interesting to see what effect, if any, the CFTC rules will have on speculation and actual prices. I can’t say I know the answer. I think I’m in good company though. I’m curious why you think short selling should be banned. Only naked? Do you mean for all time? Or specifically in response to the European crisis? We tried it in 2008 and it didn’t seem all that effective. ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [November 16, 2011, 6:49pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/165 "2011-11-16T18:49:03Z")
> [@Fear\_Itself](#): > > That is what dividends are for, to participate in the wealth created by the company. Startups don’t have dividends. Startups are usually not profitable. How many people would invest in a start-up if their money is locked into it until dividends are paid - and dividends mean less reinvestment in the company and thus less growth. Remember Microsoft and Intel didn’t pay dividends until just recently, but early investors in them did quite well, as they should. ---
**Author:** ![DragonAsh](https://avatars.discourse-cdn.com/v4/letter/d/db5fbb/32.png) [@DragonAsh](https://boards.straightdope.com/u/DragonAsh)\ **Post date:** [November 16, 2011, 7:59pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/166 "2011-11-16T19:59:41Z")
> [@Fear\_Itself](#): > > That is what dividends are for, to participate in the wealth created by the company. Well, not necessarily - many growth companies, for example, _don’t_ pay dividends. Why? Because there are more attractive growth options out there that would be a better use of any funds on hand. Microsoft is probably the most famous example; it only started paying dividends 7-8 years ago. Incidentally, there is a host of research on dividend policy and possible ‘signaling’ effect on investors. For example, if a company announces that it is going to start paying dividends, some investors might view this as a negative sign, that the company no longer sees any attractive growth opportunities. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 8:02pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/167 "2011-11-16T20:02:06Z")
> [@DragonAsh](#): > > No - why would it be any difference? A bond pays interest. A stock (usually) pays dividends. Either way, it is pretty rare for a bond holder to actually hold a bond to maturity. Excuse me? Lot of institutional investors hold their bonds to maturity. Most corporate bonds are in the 5 to 7 year maturity range and they don’t change hands all that often. > [@](#): > > But even if they were willing to at first, they’d be unwilling to purchase a bond if rates moved significantly against them. Suppose you bought a bond that pays 5%. Then interest rates start rising - which means the price of your bond starts falling. Let’s say rates rise to 10% > > Sure, you could just sit on your 5%…but wouldn’t you rather have your money in something that was generating 10%? Can’t do that if you can’t sell your bond. > > Granted, this is over-simplifying things, but that’s the general idea. Excuse me? Your return doesn’t change because you sell your 5% bond for 60% of face value to buy a smaller bond with a 10% stated interest rate, you just adjust your overall interest rate sensitivity (duration) by accelerating cash flow. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 8:04pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/168 "2011-11-16T20:04:40Z")
> [@Trom](#): > > The amount of money that changes hands in the secondary bond markets daily makes the entire stock market look like a drop in the bucket. Take out government debt, debt issued by financial institutions like fannie mae GICs issued by insurance companies, etc. and say that again. ---
**Author:** ![Trom](https://avatars.discourse-cdn.com/v4/letter/t/958977/32.png) [@Trom](https://boards.straightdope.com/u/Trom)\ **Post date:** [November 16, 2011, 8:14pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/169 "2011-11-16T20:14:10Z")
> [@Damuri\_Ajashi](#): > > Take out government debt, debt issued by financial institutions like fannie mae GICs issued by insurance companies, etc. and say that again. OK…😕 If you don’t count debt, not much debt is traded. You can’t just change the definition of what the bond market is and pretend you’ve made some kind of point. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 9:08pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/170 "2011-11-16T21:08:58Z")
> [@Fear\_Itself](#): > > That is what dividends are for, to participate in the wealth created by the company. It sometimes takes a while before a startup starts paying dividends. Microsoft didn’t pay dividends for decades. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 9:13pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/171 "2011-11-16T21:13:02Z")
> [@Trom](#): > > Egad, no! Short selling is a very valuable part of the market place. When short selling was banned temporarily a few years ago volatility went absolutely bonkers! Studies on the ban show no positive effects from the ban, and quite a few negatives. > > Regarding the current short ban in Europe - a report from EDHEC Business School in Europe: Please explain how short selling moderates volatility? I’ve never understood that. I’ve heard the arguments but at some point it seems to boil down to “more volume and liquidity is good for the market” ---
**Author:** ![Trom](https://avatars.discourse-cdn.com/v4/letter/t/958977/32.png) [@Trom](https://boards.straightdope.com/u/Trom)\ **Post date:** [November 16, 2011, 9:24pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/172 "2011-11-16T21:24:01Z")
> [@Damuri\_Ajashi](#): > > Please explain how short selling moderates volatility? > > I’ve never understood that. I’ve heard the arguments but at some point it seems to boil down to “more volume and liquidity is good for the market” Well, generally more volume and liquidity is good for the market. To quote Charles Jones, professor of finance and economics and chair of the finance and economics division at Columbia: > [@](#): > > “Virtually every piece of empirical evidence in every journal article ever published in finance concludes that without short-sellers, prices are wrong,” I’ve got to leave my office, but what are you looking for exactly? Journal articles? I could google some later. Here’s a book, [Don’t Blame the Shorts](http://www.amazon.com/Dont-Blame-Shorts-Sellers-Repeating/dp/0071636862/ref=sr_1_1?ie=UTF8&qid=1321478487&sr=8-1), that addresses the demonization of short sellers over the decades. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 9:28pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/173 "2011-11-16T21:28:56Z")
> [@aux203](#): > > Interest rate swaps are just a relatively easy swap to understand as an example, that’s all. As you know it can get byzantine pretty quickly. The size of the futures market didn’t strike me as particularly worrisome in and of itself though I’ll admit I was only peripherally following it at the time. It’ll be interesting to see what effect, if any, the CFTC rules will have on speculation and actual prices. I can’t say I know the answer. I think I’m in good company though. > > I’m curious why you think short selling should be banned. Only naked? Do you mean for all time? Or specifically in response to the European crisis? We tried it in 2008 and it didn’t seem all that effective. I have a general opposition to short selling but I can in fact see some merit to permitting them, but they need to enforce enforce delivery requirements with harsh penalties and they need to reinstate the uptick rule. Short selling creates virtual shares of stock in a company and messes up the supply demand equation for the shares of stock in a company. This is especially pronounced in cases where naked short selling is going on. Actually enforcing and imposing fines for naked short selling would make this aspect of short selling less offensive. It provides opportunities for stock price manipulators. True story. Stock operator finds a small or medium cap binary stock with a binary event taht is well off in the future. They short the heck out of the stock and when you beat up the stock enough, everyone readjusts their view of the likelihood of the positive event occurring. Its the opposite of pump and dump but prices of beat up stocks are much stickier than the prices of puffed stocks so you can slowly extract yourself at the lower price well in advance of the binary event occurring. I suppose the uptick rule would make this aspect of short selling less offensive. The primary purpose of the stock market is to provide a liquid stable secondary market for IPOs. We don’t need a shorting mechanism to achieve that. I suppose we need a shorting mechnism to provide hedging opportunities for options market makers (and having options are a fairly necessary in almost any modern securities market) and if we let them people use it for hedging purposes then why not let people use it for speculative purposes as well (well, I guess we don’t actually have to). Besides, shorts are usually playing devils advocate on companies that deserve more scrutiny (see Enron) and since our securities regulators suck (see SEC) and the accounting firms are not sufficiently independent of their clients to ferret out corporate fraud (see list too long for a single post), perhaps we must rely on the skeptical shorts to bring negative facts to our attention. So as long as we reinstate the uptick rule and enforce the delivery requirements, I suppose shorting is tolerable. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 9:41pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/174 "2011-11-16T21:41:02Z")
> [@Trom](#): > > OK…😕 > > If you don’t count debt, not much debt is traded. > > You can’t just change the definition of what the bond market is and pretend you’ve made some kind of point. Sure I have. We don’t really need to encourage secondary markets in government debt and GSE debt. There is enough interbank and otc activity that we don’t need a NYBE the way we need a NYSE. Much of the bond market is not registered and is traded only between isntitutional investors. Oh yeah and bonds have maturity dates while stock does not. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 9:42pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/175 "2011-11-16T21:42:20Z")
> [@septimus](#): > > The graph shows onions spiking in price every March or so, almost like clockwork. Help us out here; is this just showing that onions spoil quickly compared with commodities that can be stored for long periods? Well thats because March is national peanut month and everybody knows that consumption of onions correlates exponentially with the consumption of peanuts. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 9:56pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/176 "2011-11-16T21:56:13Z")
> [@Trom](#): > > Well, generally more volume and liquidity is good for the market. To quote Charles Jones, professor of finance and economics and chair of the finance and economics division at Columbia: Prices are wrong? A lot of people think that price is pretty accurately determined by supply and demand. Shorting introduces supply tthan actually exists in the market. Is the argument that this is necessary because the holders of the stock are emotionally attached to them so they value their stock more highly than their correct value? > [@](#): > > I’ve got to leave my office, but what are you looking for exactly? Journal articles? I could google some later. Here’s a book, [Don’t Blame the Shorts](http://www.amazon.com/Dont-Blame-Shorts-Sellers-Repeating/dp/0071636862/ref=sr_1_1?ie=UTF8&qid=1321478487&sr=8-1), that addresses the demonization of short sellers over the decades. I can think of case where there were the short interst was several times the float so an investor bought the float and requested physical delivery. He held certificates for the entire float and the stock continued to trade several times the flioat over the next few weeks. Another time a company plagued by shortselling repurchased their entire float but the trading in the stock simply continued. The market simply hasn’t done a good job of proving that they can keep their books in order when we introduce shorting for speculative purposes. For the record, I’m not blaming the shorts for the crisis (I think I might blame them for drving a sick Lehman into the grave but maybe that would have happened anyways), I simply wonder whether any benefit the practice provides is worth keeping the practice around. I used to short quite a bit to hedge all sorts of risks and to speculate. I don’t think there is anything immoral about it, it just seems to me that this sort of specualtion is not necessary to fulfill the primary function of the stock market to provide a vinrant secondary market for IPOs. ---
**Author:** ![aux203](https://avatars.discourse-cdn.com/v4/letter/a/77aa72/32.png) [@aux203](https://boards.straightdope.com/u/aux203)\ **Post date:** [November 16, 2011, 11:01pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/177 "2011-11-16T23:01:42Z")
> [@Damuri\_Ajashi](#): > > Prices are wrong? A lot of people think that price is pretty accurately determined by supply and demand. Shorting introduces supply tthan actually exists in the market. Is the argument that this is necessary because the holders of the stock are emotionally attached to them so they value their stock more highly than their correct value? The basic argument, dating back to Miller, is that in the absence of shorting, securities are going to be overvalued routinely. For those reading along, a (highly simplified but hopefully enlightening) example: pretend for the moment Microsoft is trading at 100/share. Assume also that the world is divided equally into optimists, who think it’s worth 120 and pessimists who think it’s worth 80. 100 seems about right, so far. The problem is only the optimists will buy, driving up the price, whereas the pessimists will not. But the pessimists don’t want 0 shares of Microsoft. They really want to own negative shares of Microsoft. By eliminating short sales, you lose the pessimists’ perspective and the security becomes overvalued, because only the optimists’ opinions are being accounted for. That’s the theory at least. The more difficult it is to short sell and the wider the divergence of opinion about a particular security, the larger this effect becomes. Boehme’s analysis suggests it may be as much as 10% or more in certain circumstances. Boehme’s paper: > **[Redirect Notice](https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CDsQFjAA&url=http%3A%2F%2Fwww.rdboehme.com%2FPapers%2Fjfqa_final.pdf&ei=lzrETvjCE-eRsALtzb2yCw&usg=AFQjCNEakJYiH8ydEmD4HnTtrvWIXuIfsg&sig2=qnqBQYIZV-l3E1fKYMTSLA)** > [@Damuri\_Ajashi](#): > > I can think of case where there were the short interst was several times the float so an investor bought the float and requested physical delivery. He held certificates for the entire float and the stock continued to trade several times the flioat over the next few weeks. Another time a company plagued by shortselling repurchased their entire float but the trading in the stock simply continued. > > The market simply hasn’t done a good job of proving that they can keep their books in order when we introduce shorting for speculative purposes. > > For the record, I’m not blaming the shorts for the crisis (I think I might blame them for drving a sick Lehman into the grave but maybe that would have happened anyways), I simply wonder whether any benefit the practice provides is worth keeping the practice around. I used to short quite a bit to hedge all sorts of risks and to speculate. I don’t think there is anything immoral about it, it just seems to me that this sort of specualtion is not necessary to fulfill the primary function of the stock market to provide a vinrant secondary market for IPOs. Several authors have pointed out that short sellers get blamed, often unfairly, when markets decline. It’s rather similar to how speculators get dinged when oil prices rise, come to think of it. While there’s no doubt some manipulation going on, It’s worth noting that dedicated short positions are \<1% of the hedge fund market. Most short sales are part of long-short strategies. Would you ban the latter with the former? ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [November 16, 2011, 11:15pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/178 "2011-11-16T23:15:40Z")
> [@aux203](#): > > The basic argument, dating back to Miller, is that in the absence of shorting, securities are going to be overvalued routinely. For those reading along, a (highly simplified but hopefully enlightening) example: pretend for the moment Microsoft is trading at 100/share. Assume also that the world is divided equally into optimists, who think it’s worth 120 and pessimists who think it’s worth 80. 100 seems about right, so far. The problem is only the optimists will buy, driving up the price, whereas the pessimists will not. But the pessimists don’t want 0 shares of Microsoft. They really want to own negative shares of Microsoft. By eliminating short sales, you lose the pessimists’ perspective and the security becomes overvalued, because only the optimists’ opinions are being accounted for. > > That’s the theory at least. The more difficult it is to short sell and the wider the divergence of opinion about a particular security, the larger this effect becomes. Boehme’s analysis suggests it may be as much as 10% or more in certain circumstances. > > Boehme’s paper: > [Redirect Notice](http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0CDsQFjAA&url=http%3A%2F%2Fwww.rdboehme.com%2FPapers%2Fjfqa_final.pdf&ei=lzrETvjCE-eRsALtzb2yCw&usg=AFQjCNEakJYiH8ydEmD4HnTtrvWIXuIfsg&sig2=qnqBQYIZV-l3E1fKYMTSLA) The hypo doesn’t really work well because of its binary nature. I can agree that getting rid of shorts (people who create phantom shares and sell them into the market) will raise the price of the shares but I’m not seeing the distortion. People buy stock absed on what they think its value is. As time passes, they will generally sell the stock to someone who thinks the stock is worth more than they do. Thsi coule be the result of the price of the stock rising past the level that the invstor thnks is the corect price or it could be the result of the investor reevaluating what he thinks the correct price is. > [@](#): > > Several authors have pointed out that short sellers get blamed, often unfairly, when markets decline. It’s rather similar to how speculators get dinged when oil prices rise, come to think of it. While there’s no doubt some manipulation going on, It’s worth noting that dedicated short positions are \<1% of the hedge fund market. Most short sales are part of long-short strategies. Would you ban the latter with the former? Like I said, I’m not blaming short sellers for the crisis, except that I think that they might have led to the untimely demise of Lehman. I do think that speculation can lead to bubbles and market distortions. Do you havea cite for the notion that hedge funds hold less than 1% in directional short positions? I don’t think most hedge funds use shorting to hedge their long exposure to the sort of degree t6hat you think they do. They go long on oil and short on computer manufacturers not long on Gm and short on a basket of car manufacturers. ---
**Author:** ![aux203](https://avatars.discourse-cdn.com/v4/letter/a/77aa72/32.png) [@aux203](https://boards.straightdope.com/u/aux203)\ **Post date:** [November 16, 2011, 11:39pm UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/179 "2011-11-16T23:39:31Z")
> [@Damuri\_Ajashi](#): > > The hypo doesn’t really work well because of its binary nature. > > I can agree that getting rid of shorts (people who create phantom shares and sell them into the market) will raise the price of the shares but I’m not seeing the distortion. > > People buy stock absed on what they think its value is. As time passes, they will generally sell the stock to someone who thinks the stock is worth more than they do. Thsi coule be the result of the price of the stock rising past the level that the invstor thnks is the corect price or it could be the result of the investor reevaluating what he thinks the correct price is. The binary nature was just for illustration purposes. Obviously there will be a distribution. But the point is if only optimists are trading the stock will be overvalued because the pessimists viewpoint isn’t factored in if they aren’t able to short a stock. You don’t see how that’s a distortion if only optimists are setting prices? The paper goes into the details of exactly what effect this has on returns. Do you disagree with their conclusions? > [@Damuri\_Ajashi](#): > > Like I said, I’m not blaming short sellers for the crisis, except that I think that they might have led to the untimely demise of Lehman. I do think that speculation can lead to bubbles and market distortions. > > Do you havea cite for the notion that hedge funds hold less than 1% in directional short positions? I don’t think most hedge funds use shorting to hedge their long exposure to the sort of degree t6hat you think they do. They go long on oil and short on computer manufacturers not long on Gm and short on a basket of car manufacturers. CREDIT SUISSE, 2008. Nice table on page 5, with a bit of explanation on page 3: > **[Redirect Notice](https://www.google.com/url?sa=t&rct=j&q=credit%20suisse%2C%20what%20happened%20when%20traders%E2%80%99%20shorts%20were%20pulled%20down%205%20%282008%29&source=web&cd=2&ved=0CCMQFjAB&url=https%3A%2F%2Ftradeview.csfb.com%2Fedge%2Fpublic%2Fbulletin%2FServefile.aspx%3FFileID%3D11181%26m%3D-1730413896&ei=00fETvObNrCnsAKswviyCw&usg=AFQjCNFjcTvyN2lvkjqIH4GoraEQ86NaHw)** ---
**Author:** ![Trom](https://avatars.discourse-cdn.com/v4/letter/t/958977/32.png) [@Trom](https://boards.straightdope.com/u/Trom)\ **Post date:** [November 17, 2011, 12:35am UTC](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864/180 "2011-11-17T00:35:59Z")
Do you understand the difference between short selling and naked short selling? [Previous page](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864.md?page=8) [Next page](https://boards.straightdope.com/t/whats-the-benefit-to-society-of-stock-speculation-edited-title/601864.md?page=10)