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Market Mulligans


Ross M. Miller
Miller Risk Advisors
October 10, 2005

I am writing this commentary while taking a short break from writing an invited article for a reputable, but slightly eccentric, economics journal. The article is vaguely about how automated markets will one day rule the world and the title of this commentary is one of nearly a dozen titles that I rejected for that article.

Although I doubt that any of what is in this commentary will get into the final version of the article (typically less than a third of what I write for print publication makes my internal cut), it dawned on me while thinking about the paper that the rules for the game of golf might serve as a useful paradigm for the designers of automated markets. The most striking aspect of the rules of golf to me is the extremely limited scope for doing a shot over without penaltya legal mulligan, so to speak.

Consider the following situation. If a drunken penguin wanders onto the fairway while you are playing golf, picks up your ball while it is still in motion as a result of your having struck it, sits on it, and squawks at you when you try to retrieve it, you cannot just write off the ball and take the shot over as if nothing happened. If he is not in your group as either player or caddie, the penguin constitutes an outside agency and there are a slew of golf rules that then apply to the situation. I don't known enough about the rules of golf to tell you exactly what would happen in this hypothetical situation, I just know that if you do decide to take the shot over, it would cost you a stroke. Indeed, the only obvious situation in which you can receive a USGA/R&A sanctioned mulligan is when, according to Rule 19-1b, the above penguin drama occurs while you are putting on the green. (Although the interfering animal need not be a penguin, insects and worms do not count, although spiders and small snakes presumably rate with penguins. There is also a variant on this rule, where if the penguin is caddying for your opponent and causes the flagstick to mess up your putt you get to do it over. The flagstick has special status, like insects and worms and unlike the penguin, so it gets its own rule in the rulebook, Rule 17.) I guess the thinking goes that you might have made the putt without the interference of the outside agency and getting a free drop (and another stroke) is not equitable when it was possible that you could have holed the putt in the penguin's absence; however, there rule is a bit arbitrary because there are certainly chips from off the green that are more likely to be holed than longer or trickier putts. From what I remember seeing on television between erectile dysfunction commercials, local rules can also allow for do-overs in certain situations, such as when low-hanging power lines can unduly interfere with tee shots. (Low-hanging trees, however, are "natural" and so they are considered a part of the course.)

Why, you may wonder, should the rules of golf have anything to do with markets? Think kilts and bogs. Both of them (golf and markets, not kilts and bog), in their modern form come from Edinburgh and are products of the Scottish Enlightenment. The first formal rules of golf, all thirteen of them, actually date from the early days of the Enlightenment, possibly before anyone recognized that they were being enlightened. Adam Smith and free markets popped up toward the end just before all the enlightened folk discovered that clothing-optional beaches were not going to make it in Scotland and headed south.

The rules of golf, now thirty-four in number, may well be the most successful formal system currently in place on planet Earthvastly more successful than constitutional democracy, free markets, or any other single religion. (Golf should technically be a religion. A demographic factoid that I once saw indicated that in the U.S. the "bible belt" and the "golf belt" show virtually no overlap when plotted on a map, apparently because it is impossible to both attend church and play golf on Sunday morning.) Golf has been played, after a fashion, on the moon, and is thriving in North Korea, where Kim Jong Il is reported to make Tiger Woods look like Ray Romano. (I challenge the FCC to revoke every CBS network affiliates' broadcast license for showing even one second of Ray at Pebble Beach. At least, Bill Murray can be a good golfer when he feels like it and is funny.) Although free markets are clearly endangered on this planet, it is a safe bet that in a thousand years that even if the only inhabitants of Earth look like shopvacs or penguins, they will be playing some form of golf.

With so many rules, one would think that there would be many situations when something odd happens (despite the best efforts to keep the penguins off the course) and you are allowed to take a shot over. Being a Scottish game through and through; however, stubbornness prevails. A guiding principle of golf (and part of one of the original thirteen rules) is to play the ball as it lies. While this principle is taken to its absurdist extremes in Three Stooges shorts, modern golfers are considered too valuable to risk injury from taking shots off the cart path and so elaborate that allow for improving one's lie have evolved.

The mulligan exception for penguin interference while putting would appear to be the result of an even more fundamental principle than "play it as it lies," which is that you actually have to get the ball into the cup in order to complete a hole in stroke play (or when your opponent insists in match play). A reasonable person (or a tournament official) cannot declare that if not for the freaking penguin that your putt would have gone into the hole. (By the way, golf is a very environmentally conscious sport and so attacking the penguin with your golf club can be considered a serious breach of etiquette even when is not your opponent's caddie.)

So, enough of the penguins, what does this have to do with markets? Like golf, markets (except possibly for the Nasdaq), have this thing about enforcing trades once they have been executed. An online perusal the NYSE rules comes up with nothing remotely resembling a mulligan, although I suspect that there is an escape clause somewhere that lets them do whatever they want, like pay their chairman gazillions of dollars. You can cancel an order (although any juicy miscue will be gobbled up by the market long before you can take it back), but once an order before one side of a trade, you have to know someone really important to get it undone. (It used to be that you could "DK" your broker and have him eat it under certain circumstances, but now conversations with brokers are taped and online traders had trouble claiming that their pet penguin became enamored of the keyboard and sold 10,000 shares of Mr. Softie short.)

My takeaway is that any system of rules that sanctions do-overs except when no other alternative remedy is available will not be evolutionarily fit. Allowing Mulligans as a general rule would undermine the integrity of any formal system and allowing them under special circumstances only opens the door to corruption. On the not-so-rare occasions when the Nasdaq computers screw things up and a bunch of trades are seemingly arbitrarily cancelled (sometimes leaving trades with unintentional, unsanctioned short positions), there is very loud unhappiness to say the least. A mindless computer for which undoing a trade may be literally impossible, may be "dumb," but it might have better survival characteristics than a "smarter" system run by humans who can exercise the judgment to determine which trades are worthy of mulligans.

Since the leaves up here are finally changing color and fluttering to the ground, it is once again time to inflict the Google challenge on my MBA students in its new, possibly improved, form. Next time, I will again comment on the wonders of Google in "Google Again."

Copyright 2005 by Miller Risk Advisors. Permission granted to forward by electronic means and to excerpt or broadcast 250 words or less provided a citation is made to