All New Wilmott Jobs Board                     (b)

Quantitative Mein Kampf

Fresh from the Harvard Crimson oven:

"In light of these problems in the risk management process, (Professor Robert) Merton argues for more education in quantitative techniques, instead of shying away from them altogether. “One of the things I think comes out of this is a greater need for modern financial training and knowledge,” he says. “We should be teaching more about modern finance and these tools, not less.” "

With all due respect, this is akin to saying that one of the things that comes out of WWII is a need to translate Mein Kampf into more languages and to open up new Nazi indoctrination offices. When you are proposing as cure a heavier dose of that which caused the malaise, don´t complain if we endow you with the iatrogenist label

Amazon Rankings (Part II)

Now that my Lecturing Birds is out and about I find myself checking my Amazon.com sales rank almost perpetually. The fact that the new work is behaving more amicably than my prior (more technical, more specialized) literary effort dictates that the amount of time spent refreshing the Amazon page has become unbearably unprecedented. I am now officialy obsessed with the rankings and what they truly convey (is #100 equal to a millionaire book, #1000 equal to a global bestseller, #10000 equal to a decent-yet-not-extraordinarily-rewarding performance, #100000 equal to hold-on-to-your-day-job, #1000000 equal to well-at-least-your-mother-bought-a-copy?). Since I recently offloaded my stock portfolio, continuous monitoring of my Amazon run has become the new nail-biting stress-inducing juices-flowing addiction.

And yet, a writer should spend their time, well, writing not obssesing over the onscreen fluctuations of difficult-to-explain data (you might as well not have left the trading floor if that´s how you get your kicks). So, yes, I vow to use my laptop for pontification purposes only from now on. I better return to that unfinished chapter for my new book. But wait, just one last tiny look at my Amazon ranking.

Sudoku Bail-Out

It seems that Taleb´s enemies insist on playing right into his hands and shooting themselves in the foot. If not long ago Merton made some funny remarks during a Harvard roundtable, it is Scholes turn now.

Allow me to highlight the following from his recent q&a in the New York Times: Q: Some economists believe that mathematical models like yours lulled banks into a false sense of security, and I am wondering if you have revised your ideas as a consequence. A: I haven’t changed my ideas. A bank needs models to measure risk. The problem, however, is that any one bank can measure its risk, but it also has to know what the risk taken by other banks in the system happens to be at any particular moment. Q: What good is a theory of risk management if it applies to one tree instead of the forest? A: Most of the time, your risk management works. With a systemic event such as the recent shocks following the collapse of Lehman Brothers, obviously the risk-management system of any one bank appears, after the fact, to be incomplete. We ended up where banks couldn’t liquidate their risk, and the system tended to freeze up.

I guess I don´t need to point how inappropriate/arrogant/ignorant/antisocial it is for Scholes (manufacturer and defender of flawed lethal theories, sinker of two funds) to openly admit that no matter what´s going on out there he is not changing his mind one iota and that risk management works just fine. The globe may be burning, hopelessly engulfed in a sea of VaR-Copula-NonNormal flames, but hey that´s no reason for this standard-bearer of theoretical orthodoxy to change his ideas just a bit. Let hubris keep rolling on, even after disaster has struck!

But again the point of this post is not to enlighten you on the obvious. Rather, I believe that Scholes interview enlightens us on the true defining characteristic of the theoretical finance establishment: utter cynicism, utter disregard, utter mocking, utter counterfeiting, utter conning, utter swindling, utter duping. The definite unveiling of such state of affairs is one of the most significant outcomes from this crisis. We have seen it hard at work among VaR defenders. Now we see it coming, in an even less remorseful fashion, from Nobel winners (btw, the Nobel was awarded for something that can´t work and that caused at least the biggest one-day drop in equity markets history; note to the Swedes: current events, with the final destruction of sigma and Normality, make that "Nobel" appear even more suspect and your misjudgment even more palpable) These theoreticians just don´t care if the theories work or not, if they destroy or not, if they are ridiculed or not. The lesser of them try to change the subject or cling to tired discredited one-liners so that they can go on making a living out of theorizing. The grandees like Scholes (fat bank account, academic tenure, a demonstrable ability to talk others into investing their money with him) engage in these debates just for the fun of it, for the fun of being able to publicly laugh at the world and loudly state with an open smile "I do not give a damn, and will never ever admit to any failings in my thinking; the world is burning? tough luck, and long live VaR"

For theoreticians to not admit failure in light of the latest mess is akin to Nazi officers engaging in Holocaust-denying. Self-serving, yes. Antisocial, yes. Scamming, yes. They take us for fools, yes.

Taleb mentioned Sudoku as a possible alternative occupation for the disavower-in-chief Scholes. It is tempting to argue that the Obama administration should perhaps devote some of that bail-out money to finance the construction of Sudoku houses where financial economists can devote their considerable brain power to activities other than concocting, promoting, and endorsing machinations with a demonstrable power to cause unemployment, poverty, and desperation.

I Am Happy For Gillian Tett

Gillian Tett´s new book on the story of those who first invented the products behind the credit crisis appears to be doing very very well saleswise

I, for one, am quite content about that (disclaimer: GT has been kind enough to endorse my own upcoming Lecturing Birds). Amid all the pomposity surrounding the debate ("capitalism is over", "bring back Lenin", "revamp the World Bank", "build a more inclusive G20", "hang anyone with a pinstripped suit") it is easy to forget what truly happened. None of the me-too pundits is really dealing with the true causes behind the mayhem, instead concentrating on me-too tiredly off-the-mark slogans. This is possibly explained by the fact that the main culprits (CDOs, Gaussian Copula, VaR) are technical in nature and thus their understanding would require either hands-on experience or long hours spent doing research. The typical member of the commentocracy may neither be endowed with the experience or inclined to dig up the info.

Luckily for us, GT has decided to unearth the really important stories. If we don´t want something like the current mayhem to be ever replayed, a healthy step would be the comprehensive comprehension of what truly happened. The pomposity, by distracting us from the relevant truth, does us little good.

Blah VaR Blah

http://blogs.ft.com/ftfmblog/2009/04/01/its-not-me-its-you-says-var/#comments

please note that my beef with quant folk is towards those who stubbornly embrace demonstrably flawed methods that have demonstrably caused demonstrable harm to society; I am sure that plenty of quant-minded people add tons of true value on a dialy basis, but most definitely not those who cling on to deleterious failures as a way to keep their jobs

Why Give Nobel To Financial Economics?

from Felix Salmon(http://www.portfolio.com/views/blogs/market-movers/2008/12/27/why-give-nobels-for-financial-economics):

Pablo Triana sends me an open letter he's written to the Swedish central bank, telling them to please stop giving out Nobel prizes in economics to "flawed, unworldly, and dangerous theoretical finance constructs":

At least two of the theories awarded with the Economics "Nobel" have been behind the very worst financial crises to have afflicted the world since the 1929 crash; Black-Scholes-Merton was the inspiration for the strategies that gave us October 1987´s Black Monday, the most devastating one-day drop in the history of Wall Street (which gravely threatened to sink the system); while Portfolio Theory was the inspiration for the creators and adopters of VaR, which outrageously misguided guidance and capacity for forcing destabilizing liquidations were to blame for the 1998 LTCM crisis and the current malaise (both of which, certainly, put us in great peril).

Triana has co-authored letters with Nassim Taleb in the past, and this is very much consistent with Taleb's views. It's not such a bad idea: right now it's pretty hard to say that, in aggregate, recent advances in financial economics have been, on net, a good thing. So why encourage them with Nobels?

Yes

Reaction to the role the theory-quant stuff played during the crisis:

"The idea of blaming any of this stuff on physicists strikes me as entirely daft. It's true that some people trained in physics went into the trade of financial calculations. At that point they were no longer physicists, just smart people," says science historian Spencer Weart of the American Institute of Physics. "Any sensible person would place the main blame upon any fool who took such calculations as a guide to real-world actions."

YES (but don´t forget that the ex-scientists gladly provided the "scientific" alibi, in many cases surely fully aware of the flawedness of the mathematical constructs; and naturally don´t forget that a lot of those fools had scientific PhDs)

Blue Is Green

For those of you lucky to be in NYC, if you trot from Central Park to Times Sq you will inevitably come face to face with what used to be Lehman Bros hedquarters (nice candy store by the side). Pre-crisis, the lights on the building used to be shiny green, reflecting of course Lehman´s logo. Now, they are blue, reflecting of course Barclays' logo

What´s the difference between a regular (sane) person and a finance theoretician? Simple. The regular fella, when asked about the color of the light, will matter-of-factly answer "blue". The theoretician, on the other hand, will answer "green".

What do you mean green? Yes, green. For you see, according to standard finance theory Lehman is still alive and kicking, healthy as ever, gloriously present. Thus, the building´s logo would still be Lehman´s logo, certainly. Green. For the theorist, Lehman is alive because the credit crisis did not happen. How could it, when the models and the risk measures deny it any chance of ever happening? Such a dark, ebonyish, Negroed, inky, Black Swan is simply not possible in theory-land.

The crisis did not happen. Lehman is alive. The logo is green. We may be able to understand why the theoreticians choose to hallucinate and rabidly Platonize (they make a living out of it...), but why have us regular folks followed them so often for so long? Not just followed them, avidly defended them (remember how lonely Taleb was at the beginning of his crusade?).

And that is a key lesson from the crisis. Self-serving theoreticians will always see green where there is blue. Left to our own devices, we will see blue. But we will see green when accompanied by the theorists. When we walk alone, blue is blue. When we walk with the theorists, blue is green. Such utterly insane, blattantly ridiculous, scandalously degrading hypnosis is the price we pay (or used to pay) for our unconditional self-enslavement to the dictates of a group of people who, equations in hand, pontificate about markets without having ever toiled in them.

Amazon Sales Rankings

My Corporate Derivatives book recently sold three extra copies on Amazon in the space of a few days. This took it from a rank of around 1,200,000 to a more dignified 50,000(Amazon ranks roughly 4,000,000 books). The last copy sold (which rendered the tome out of stock) took me from 750,000 to 50,000

Now, if a single extra unit can take a book that has yet to sell 1,000 copies total (hey, this is a highly specialized tome going for $160; some may say I did quite well in fact!) up 700,000 places the conclusion is obviously inevitable: there are hundreds of thousands (millions) of books out of there that may not sell a single copy for months and months (maybe years and years). In other words, a very blunt confirmation of what we have always known: it´s tough to make money selling books (though not impossible, certainly)

Lots of controversy has gone into reading Amazon´s rankings. After my recent experience I have no doubt that any book not making it into the, say, top 10,000 is not selling explosively (maybe just 5-10 copies every month). Of course, at some historical point that book may have sold quite well, but not currently (particularly given that Amazon seems to afford weighty weight to past performance)

If you make into the top 1,000 and stay there for a while (1-2 years following publication) then you would be considered an utter winner among publishers, someone able to sell many tens of thousands of copies. Notice that being this kind of winner would not imply tremendous monetary rewards either ($100,000 annual maybe).

If you achieve top-100 status for a while, then congrats, you are a literary big swinging dick. You will have no problem getting the next contract, sizeable advance, can make very good living out of writing (seven figures maybe plus flexible dreamy lifestyle)

That´s my half-informed take, at least. Would love to hear from more knowledgeable folks.

Taleb´s Inconvenient Truth

Veteran options trader (and indefatigable skeptic intellectual) Nassim Taleb has ended 2007 as the top bestselling author in the non-fiction book category according to Amazon.com. Taleb´s charts-topping “The Black Swan” glowfully crowns his outrageously successful transition from market player to popular muser. As is well known by now, the book deals with unexpected, rare events that have a profound effect when they do eventually take place. Taleb´s main assertion is that we tend to misunderstand such events, and stubbornly assign very small (even negligible) probabilities to them happening. In real life, “black swans” happen much more often than generally assumed either by conventional perception or by standard statistical methods. This is, of course, particularly true in financial land, where events that are assigned probabilities of one in a million years make a semi-regular appearance every half-decade or so.

As was to be expected, Taleb´s musings have not been too well received within finance theory circles. He goes hard at the very foundations of financial economics, a discipline that has experienced what seems like an unstoppable process of quantitatification in the past decades. By discrediting the use of the Normal distribution (and associated statistical measures, such as standard deviation) in the markets, Taleb strikes a blow to modern portfolio theory and the Black-Scholes option pricing model, most likely the two key pillars (and crowning achievements) of theoretical finance, both Nobel winners. By negating the possibility that we may be able to forecast when it comes to social sciences, Taleb takes away any practical relevance that financial econometrics (another Nobel-endowed building block) may have. In Taleb´s view, financial theory would not just be essentially useless, but actually quite dangerous, as it provides a very faulty guide and forces people to take actions that may result in enhanced, not reduced, market turmoil.

But, bothered as the most dogmatic of academics surely are, perhaps it is with (many) practitioners that the true displeasure with Taleb´s message lies. This might seem like an odd assertion at first. After all, Taleb has been one of them, and a very prominent one at that. Why would real-world financial players be annoyed by what a twenty-year derivatives veteran has to say? Because, bluntly stated, Taleb´s ruminations threaten to disrupt what has traditionally been a very welcome and cherished resource at the disposal of bankers and market punters. After Taleb, it could become more difficult to use the “unforseeable once-in-a-lifetime rare event” as an excuse for blow-up losses, just as it could become less feasible to peddle products which are heavily (negatively) exposed to the black swan taking place.

Financial dealers make a lot of money by selling and arranging sophisticated devices that can deliver very nice returns for end-users as long as markets don´t turn awry. CDOs are of course the most recent shining example of this, but one can find many other cases, including plain-vanilla interest rate swaps where clients would face huge losses if Libor were to move drastically. Now, for these dealers it is absolutely essential that the probability of the nasty scenario remains somewhat downplayed. After all, not many customers (not even the most recklessly cowboysh) would enter into a transaction where they face large odds of suffering a bloodbath. So, while (honest) bankers would tend to warn as to the potential risks, it certainly helps if no one loudly proclaims that the chances of those risks materializing are far larger than negligible. By doing just that from his highly-visible Black Swan parapet, Taleb could be damaging many a salesman´s prospects.

The same logic would apply to hedge funds. Many of these high-profile players enjoy nothing more than taking positions that bet on the negative black swan (the crash, the meltdown, the defaults) not taking place. For instance, many punters seem to have traditionally been avid option sellers, a great way to generate very tasty returns (in real-income form, to boot) for what could be many years, but of course also a window to a potential devastating blow-up down the road. Here it is again crucial to downplay the possibility of disaster, as not many investors would wire money to an outlet that is perceived to face a non-insignificant chance of going down the toilet. The black swan must be presented and marketed as irrefutably unlikely, perhaps by relentlessly asserting that markets behave normally (fund managers could present tons of academic “scientific backing” in this regard). These days, however, such presentations become less irrefutable, courtesy of Taleb´s incesant contrarian rooftop chatting.

Equally likely to lose credibility becomes financiers´ traditional “unpredictable freaky rarity” excuse when faced with outlandish setbacks due to abnormal market movements.

So, it turns out that Taleb has achieved not just worldwide notoriety and fortune by transforming himself into a crack intellectual, but may actually influence the way market participants interact with each other. This could be a good thing. By acting as “probabilistic cop” Taleb could force pros to be more honest with others, and, crucially, with themselves. This would apply particularly to customers and investors. The subprime mortgage crisis has allowed us to once more witness disgruntled members of those two factions claim their ignorance as to the actual risks of the stuff they took exposures to, in an scenario reminiscent of the mid-1990s corporate derivatives debacles or the early-2000s dot.com massacres. This could change after Taleb. When a book that unremittlingly states that nasty “unexpected” surprises do happen quite often becomes an unmissable bestseller, it becomes much harder not to take a very close look at the rarities lurking in the fat tails of the distribution, and to accept and condone claims of naive ignorance after the fact.

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