The Hindu Business Line : Investment Nuggets

For investment buffs, here is James Tobin, the Nobel laureate who has made groundbreaking contributions to investment and financial market analysis. Tobin's Q, the valuation ratio named after him, established the link between the market value of an investment and its cost. This helps in gauging whether the specific company/stock is under valued or overvalued.

Tobin's work on portfolio selection helped increase the understanding of an investor's willingness to hold various assets. During times of inflation, for instance, he found them less willing to hold stock or cash, turning instead to bonds or physical assets such as real-estate.

Outside of academia, Tobin became widely known for his suggestion of a tax on foreign exchange transactions, now known as the `Tobin tax.'

This was designed to reduce speculation on currency markets, which he saw as unproductive. His creative and extensive work on financial markets and monetary policy won him the Nobel Prize in 1981. Here are a few excerpts from his articles and autobiography:

"When my prize was announced in Stockholm in 1981, the first reports that reached this country mentioned portfolio theory. The fact that one of the available assets in the model of my paper was risk-less turned out to have interesting consequences. I felt somewhat uneasy and apologetic that I was pairing the safe asset with just one risky asset to represent everything else. This aggregation followed Keynes, who also used `the interest rate' to refer to the common yield on all non-money assets and debts. I proved that my results would apply even if any number of risky assets were available, each with different return and risk. The choice of a risky portfolio, the relative weights of the various risky assets within it, would be independent of the decision how much to put into risky assets relative to the safe asset, money."

"One cannot predict the effect of monetary policy on output and unemployment simply by knowing the interest rate or the rate of growth of the money supply. Monetary policy has its effect, by affecting capital investment, whether in plant and equipment or in consumer durables. And although interest rates are an important factor in capital investment, they are not the only factor. The ratio between the market value of an asset and its replacement cost could predict whether capital investment would increase or decrease."

"The theory of risk avoiding behaviour provides the basis for liquidity preference of investors and there exists an inverse relationship between the demand for cash and the rate of interest. This theory of risk-avoiding behaviour does not depend on inelasticity of expectations of future interest rates but proceeds from the assumption that the expected value of capital gain or loss from holding interest-bearing assets is always zero."

"I studied economics and made it my career for two reasons. The subject was and is intellectually fascinating and challenging, particularly to someone with taste and talent for theoretical reasoning and quantitative analysis. At the same time it offered the hope, as it still does, that improved understanding could better the lot of mankind. For me, growing up in the 1930s, the two motivations powerfully reinforced each other."

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