Don Chance from Louisiana State University, Andrei Shynkevich from Kent State University and Tung-Hsiao Yang from National Chung-Hsing University, Taiwan, conducted an experiment using MBA students who were asked to select securities at random. The participants were all familiar with the theory of portfolio diversification and they had been told that the purpose of the experiment was to verify the well-known fact that the volatility of a portfolio declined as the number of stocks increased. Students were free to choose any number of stocks. Logically, the risk of the portfolio should have declined as new stocks were added. But here’s the rub—the study showed that “about 23% of the 30-stock portfolios had greater risk than the five-stock portfolios and about 26% had greater risk than the 10-stock portfolios. About 38% of 30-stock portfolios had greater risk than 15-stock portfolios". In short, the?researchers found that “a significant percentage of individuals, choosing portfolios somewhat randomly, achieved virtually no diversification by adding stocks".

Illustration: Jayachandran / Mint

Politicians at work—The private returns and social costs of political connections, by Federico Cingano and Paolo Pinotti, Banca D’Italia.

Political connections are a very valuable commodity, especially in countries such as Italy and India. Their help in getting licences and contracts and in tweaking policies to one’s advantage is inestimable. Obviously, this private gain also has a social cost. Researchers Federico Cingano and Paolo Pinotti from Banca D’Italia attempt to quantify these returns and costs by poring over the records of Italian firms and identifying people in those firms who held posts in local government. They then try to find out what impact that had on their firms.

Illustration: Jayachandran / Mint

Also, the research says it wasn’t higher productivity that led to the higher returns, but revenues rose because of greater sales to the local government. Cingano and Pinotti add that the returns from political connections gets “larger (up to 25%) in areas characterized by high public expenditure and high levels of corruption. These findings suggest that the gains in market power derive from public demand shifts towards politically connected firms. We estimate such shifts reduce the provision of public goods by approximately 20%".

For India, a mere 5% increase sounds terribly low. Similar research in this country should reveal the “political connection premium" at much higher levels.

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