Last week I did an ‘investing basics’ tip about hedge funds. This was in part because this week I wanted to share a little information from a talk I attended a few weeks ago. Myron Scholes is one of the creators of the Black-Scholes options pricing model, for which he won the Nobel prize in economics in 1997. He is heavily involved in the hedge fund arena, serving on the board of Oak Hill Capital Management, a hedge fund in Northern California. His talk was about the role of hedge funds in providing liquidity.
The primary thrust of his talk, was about liquidity. His idea, is that the need for liquidity changes during different periods of time. Specifically, that when there are ‘shocks’ to the system (i.e. a war in Iraq) that the demand for liquidity increases. He felt this is where there was a lot of profit opportunity. By providing liquidity to those who need it, and by leveraging that investment, hedge funds give people a way to get out of an investment quickly. The profit opportunity comes for those who can have a longer time horizon with that investment.
I think this is an interesting idea, as it explains how things like arbitrage opportunities can exist in an ‘efficient’ market. It also would explain in part why stock prices fluctuate with no significant news. The news is the same, but people’s liquidity needs are changing. It’s an interesting idea, and gives a little different way to think about ‘random’ stock prices. Consider it, the next time your stocks start jumping around for ‘no reason’.
During his talk he also mentioned that he didn’t think the internet stock collapse in 2000 was a classic ‘bubble’. When I asked him why, he said because he didn’t think the market at that time was a glorified pyramid scheme, which is what a bubble market is. He felt people had expectations that the internet miracle would be born out and so it was a rational, but misguided expectation (Personally I disagree, but I wanted to share his idea about it).