Jump to content
House Price Crash Forum
Sign in to follow this  
interestrateripoff

Wall Street’s Math Wizards Forgot A Few Variables

Recommended Posts

http://www.nytimes.com/2009/09/13/business...ml?ref=business

IN the aftermath of the great meltdown of 2008, Wall Street’s quants have been cast as the financial engineers of profit-driven innovation run amok. They, after all, invented the exotic securities that proved so troublesome.

But the real failure, according to finance experts and economists, was in the quants’ mathematical models of risk that suggested the arcane stuff was safe.

The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn’t sufficiently take into account was human behavior, specifically the potential for widespread panic. When lots of investors got too scared to buy or sell, markets seized up and the models failed.

That failure suggests new frontiers for financial engineering and risk management, including trying to model the mechanics of panic and the patterns of human behavior.

“What wasn’t recognized was the importance of a different species of risk — liquidity risk,†said Stephen Figlewski, a professor of finance at the Leonard N. Stern School of Business at New York University. “When trust in counterparties is lost, and markets freeze up so there are no prices,†he said, it “really showed how different the real world was from our models.â€

In the future, experts say, models need to be opened up to accommodate more variables and more dimensions of uncertainty.

The drive to measure, model and perhaps even predict waves of group behavior is an emerging field of research that can be applied in fields well beyond finance.

Much of the early work has been done tracking online behavior. The Web provides researchers with vast data sets for tracking the spread of all manner of things — news stories, ideas, videos, music, slang and popular fads — through social networks. That research has potential applications in politics, public health, online advertising and Internet commerce. And it is being done by academics and researchers at Google, Microsoft, Yahoo and Facebook.

Financial markets, like online communities, are social networks. Researchers are looking at whether the mechanisms and models being developed to explore collective behavior on the Web can be applied to financial markets. A team of six economists, finance experts and computer scientists at Cornell was recently awarded a grant from the National Science Foundation to pursue that goal.

“The hope is to take this understanding of contagion and use it as a perspective on how rapid changes of behavior can spread through complex networks at work in financial markets,†explained Jon M. Kleinberg, a computer scientist and social network researcher at Cornell.

At the Massachusetts Institute of Technology, Andrew W. Lo, director of the Laboratory for Financial Engineering, is taking a different approach to incorporating human behavior into finance. His research focuses on applying insights from disciplines, including evolutionary biology and cognitive neuroscience, to create a new perspective on how financial markets work, which Mr. Lo calls “the adaptive-markets hypothesis.†It is a departure from the “efficient-market†theory, which asserts that financial markets always get asset prices right given the available information and that people always behave rationally.

Efficient-market theory, of course, has dominated finance and econometric modeling for decades, though it is being sharply questioned in the wake of the financial crisis. “It is not that efficient market theory is wrong, but it’s a very incomplete model,†Mr. Lo said.

For me they are trying to model the impossible because you can never fully understand the variables and how they interact. The models will always work for a time but ultimately something unpredictable will happen that proves the model to be flawed.

Share this post


Link to post
Share on other sites
http://www.nytimes.com/2009/09/13/business...ml?ref=business

For me they are trying to model the impossible because you can never fully understand the variables and how they interact. The models will always work for a time but ultimately something unpredictable will happen that proves the model to be flawed.

The models are feasible when they are based upon a finite ideology, like a gold backed currency.

Derivatives do not obey such silly mathematics.

Share this post


Link to post
Share on other sites

no model can produce more out than it has in...not in reality anyway.

their financial instruments, took payments by mortgage holders, added insurance and a better return...1+1=3

and while holders could pay, increased Q in mortgages would force up the asset prices on which the mortgages were based.

sadly, this is an exponential model......only one exponential exists in the real World, and that is the Big Bang. tends from infinity to 0, so its the wrong way round as well!

Share this post


Link to post
Share on other sites
Guest skullingtonjoe
no model can produce more out than it has in...not in reality anyway.

their financial instruments, took payments by mortgage holders, added insurance and a better return...1+1=3

and while holders could pay, increased Q in mortgages would force up the asset prices on which the mortgages were based.

sadly, this is an exponential model......only one exponential exists in the real World, and that is the Big Bang. tends from infinity to 0, so its the wrong way round as well!

Theory and practice... :rolleyes:

Share this post


Link to post
Share on other sites
If you knew what the market was going to be like tomorrow - it wouldn't be like that tomorrow if you acted on it.

It would if you were the only person who knew what tomorrow would bring.

Share this post


Link to post
Share on other sites
Understanding the effects is important to designing your business model...not necessarily to 'model' it statistically with quants.

For instance, if you decide that liquidity can dry up and that when that happens as it inevitably must from time to time, the effect of borrowing short to lend long becomes immediately apparent.

By law the Building Societies had to match exactly the maturity profiles of the lending and borrowing to avoid this precise problem.

An alternative may be to say that the government must automatically step in with no quibbles to provide liquidity as it eventually did but only after the Northern Rock and others failed.

If the real issue is bad debts, then again a plan before the event can be put in place to deal with it - or even stop it happenning in the first place by restricting leverage.

It is not exactly rocket science is it?

neither is employing a PHD to convince others they are too stupid to understand. AAA ratings have a funny effect on buyers...they think it safe to invest with no thought....they rely on the raters to have understood and rated the risks.....

Share this post


Link to post
Share on other sites
It would if you were the only person who knew what tomorrow would bring.

Nope- because you are acting in a physical universe and all actions effect all others in impossible to track ways.

In fact the only way you could model something as complex as the real world is by building an exact copy, another universe. :)

The largest problem all modellers have is that they use maths - and maths is inaccurate before it sets off. Still the best they have though.

Share this post


Link to post
Share on other sites
http://www.nytimes.com/2009/09/13/business...ml?ref=business

For me they are trying to model the impossible because you can never fully understand the variables and how they interact. The models will always work for a time but ultimately something unpredictable will happen that proves the model to be flawed.

have to agree - the arrogance, and refusal to consider limited knowledge, of a lot of people who 'made it' in the bom years - quants, bankers, whatever - is galling and depressing

Share this post


Link to post
Share on other sites
Easily solved. The banks must keep the lending on their books. The bond holders merely have to buy bonds from the bank and trust them - not the information mismatch between the originator of securities and the purchaser - with the purchaser taking on the default risk.

They are already looking at the European covered bond market as a possible solution whereby the bank retains default risk increasing the keenness of bank lending departments to get their lending right.

The conmen will simply lie and the honest will be hamstrung.

You cannot regulate and get the result you want, it simply doesn't work.

Never has, never will.

Share this post


Link to post
Share on other sites
Easily solved. The banks must keep the lending on their books. The bond holders merely have to buy bonds from the bank and trust them - not the information mismatch between the originator of securities and the purchaser - with the purchaser taking on the default risk.

They are already looking at the European covered bond market as a possible solution whereby the bank retains default risk increasing the keenness of bank lending departments to get their lending right.

my own take is that addressing detailed market processes is fine, but that the higher issue of human nature and greed will still intrude in the longer run

Share this post


Link to post
Share on other sites
Easily solved. The banks must keep the lending on their books. The bond holders merely have to buy bonds from the bank and trust them - not the information mismatch between the originator of securities and the purchaser - with the purchaser taking on the default risk.

They are already looking at the European covered bond market as a possible solution whereby the bank retains default risk increasing the keenness of bank lending departments to get their lending right.

Ponzi had all his stuff on his books too.

He even had offices in Wall Street IIRC.

the difference between ponzi and the bankers is that ponzi wasnt a banker.

Share this post


Link to post
Share on other sites
Ponzi had all his stuff on his books too.

He even had offices in Wall Street IIRC.

the difference between ponzi and the bankers is that ponzi wasnt a banker.

+1

The italian state employed him after he was caught.

All regulation does is make a state backed monopoly out of whatever it is you want to stop.

Share this post


Link to post
Share on other sites

the offbalance sheet MBS/SIV/CDO scam was clearly ponzi in nature, designed to bypass contemporary capital controls.

How else could so much be leveraged from such a low money base.

bypassing the rules to skim more money is what bankers are paid to do...not by their investors, but by themselves, using investors money.

Banking now has a self serving directive it appears....benefits to the rest? well, they take it or leave it, but leaving it will destroy them...so the bankers threaten that is.

Share this post


Link to post
Share on other sites
My point is that for every problem there is a solution, if not a number of solutions.

The trick is in identifying and defining the problem to be solved.

You have now gone up a level and said it is because it is a ponzi...probably going all the way back to the money supply. If that is the case, I fundamentally believe it is not beyond the wit of man to re-design the workings of the money supply - the most human of inventions.

Or even it is 'animal spirits' - are you saying there is absolutely no way to contain this in relation to property or commodity markets? Certainly limiting speculation and leverage by law can help you know.

Not to try is defeatist and pointless.

There is a much better way than design - letting things take their natural course.

People cannot design anything as complex and dynamic as a market - thats why they are so needed. You have no idea what you will want for dinner in a fortnight - these modellers think they can tell what everyone will want for dinner for years in the future - if they just get the right equation.

It isn't defeatist to accept reality - but it is hopelessly optimistic to think that regulation and a few humans planning can match billions of humans acting on their own values. (Money isn't invented, btw - it's a discovery once people are freely trading. Whatever they trade most in becomes money and nothing else.)

Share this post


Link to post
Share on other sites
For me they are trying to model the impossible because you can never fully understand the variables and how they interact. The models will always work for a time but ultimately something unpredictable will happen that proves the model to be flawed.

Economic models based on observation fail as soon as you[1] use them as a basis for investment. Because in doing so, you invalidate their basic observations.

That should be even more obvious than the observation that historians and commentators (like Marx, Orwell, or Parkinson, to name a few distinguished examples) can influence the world by the mere act of describing it.

[1] for any "you" big enough to be noticed.

Share this post


Link to post
Share on other sites
http://www.nytimes.com/2009/09/13/business...ml?ref=business

For me they are trying to model the impossible because you can never fully understand the variables and how they interact. The models will always work for a time but ultimately something unpredictable will happen that proves the model to be flawed.

For me the article was nosh. I got as far as

"They, after all, invented the exotic securities that proved so troublesome."

And realised that it was balls. I couldn't read the rest.

Share this post


Link to post
Share on other sites
Guest absolutezero
Nope- because you are acting in a physical universe and all actions effect all others in impossible to track ways.

In fact the only way you could model something as complex as the real world is by building an exact copy, another universe. :)

The largest problem all modellers have is that they use maths - and maths is inaccurate before it sets off. Still the best they have though.

Is that what you've done? ;)

Is this one the copy or the real one?

Share this post


Link to post
Share on other sites
For me the article was nosh. I got as far as

"They, after all, invented the exotic securities that proved so troublesome."

And realised that it was balls. I couldn't read the rest.

which bit, they, Invented, secure, or troublesome, is the balls?

Share this post


Link to post
Share on other sites
What do they use for money? Atoms?

Usually a sort of sugary water based thing, oxygen, carbon dioxide and so on.

Put it all together and it's called life.

What we currently have is a very, very over egoistic brain thinking it can run everything consciously.

Share this post


Link to post
Share on other sites
As is the misinformed genitus being spouted on here most of the time

Dismissing in this way assumes authority in the subject that the listener is waiting for voluntarily or needs to hear, either earned or imagined - on the internet you don't have any authority.

Perhaps some more facts and reasoned argument would help your cause.

If you have any, of course.

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.

  • The Prime Minister stated that there were three Brexit options available to the UK:   296 members have voted

    1. 1. Which of the Prime Minister's options would you choose?


      • Leave with the negotiated deal
      • Remain
      • Leave with no deal

    Please sign in or register to vote in this poll. View topic


×

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.