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About LinkBacksInteresting article in the Guardian:
http://www.guardian.co.uk/science/20...ther_multiline
The mathematical equation that caused the banks to crash
Interesting article in the Guardian:
http://www.guardian.co.uk/science/20...ther_multiline
And this is why economists shouldn't be allowed near mathematics.
Originally Posted by Agent
Here's another older article along the same lines if you found that one interesting:
http://www.wired.com/techbiz/it/maga...urrentPage=all
And probably not near real economies either.
"The Age of Instability" by Dave Smith makes interesting (if long winded) reading.
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It works you just need to understand it limitations, would you let a historian practice medicine? the issue isnt the equation its the people using the equation. The equation is just a probability, and the elimination of a risk.
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Ok I'll Bite.
I've in a previous life been a 'Quant' the maths geek. Most of my job was just copying examples from the Hull book really.
Everyone on the desk really understood the theory, the limitations, the article whilst quite well written in avoiding much maths lingo, fails to explain that no one, really uses it in its vanilla form for anything other than quoting prices. (it is useful for this because it removes 'known' items, leaving you with just the implied volatility, this is the guess factor). Almost every business has its own variations on this formula, to try and address the limitations, the more maths orietnated readers would say "but price movements aren't log normal?" they aren't it was just to make it easier, so of course *everyone* uses SABRE model instead.
He rips on derivatives traders, but almost inexplicably fails to meantion LTCM, the firm which involved Black and Scholes and used it, dare I say more fully than any other firm ever has (or probably will!) they were litterally picking up pennies in front of bulldozers, but to get any decent profit they had to do it a lot, an awful lot.
As such I'd put forward that the author has an agenda in peddling his book, and has chosen the BS equation because its very easy to understand, and also very easy to understand how wrong it is.
However it was nothing to do with Black Scholes, the credit crunch I mean, if you had to pin it on one kind of financial mathematics, which is what that link wanted to, its simply got to be the concept of packaging.
The problem that the banks had and most still have, is that of correlation.
If you say, "well looking at home owners there is only a 1 in 100 chance that they will default" then before long some bright spark comes along saying oh this is risky for our customers, rather than selling them one loan, and giving them the payments the borrower makes, they said lets instead sell them a bundle of 100 different loans * (1/100 share of the original loan). This makes sense right? The risk has been shared out.
Then comes the problem of how you value that risk. If you had a 1 in 100 chance before of loosing all your money, then now you would have 100*100*100..... you get the idea. If each one is a seperate random event, you could use statistics that way.
In the same way that the probability of 100 dice all landing on 1, is a lot less likely to happen than one single fair dice landing on 1.
Brilliant, you can give loans to more people, which was something almost all governments were very keen on, as by sharing the risk out this way there is less chance the investor will loose their money right?
Except, correlation.
The fact someone defaults on their house is quite likely to be correlated, sure some people will miss manage their lifes when the economy is good, but in a down turn, its probably not going to be just one person doing it, it will be a whole lot more.
This ment that these bundles rather than spreading the risk in the way people thought.
Black Scholes wasn't used for anything related to these securitisations, as a result, whilst the article is quite good at explaining it simply, and far better than I could manage, in the way its been linked in this thread, the attitude people have about its content once again shows why I dislike that paper, they are doing one tiny amount of analysis only, leaving ignorance for everything else, pretending its really that simple.
There were huge issues in many instutues that exhasibated the financial collapse we saw. But vanilla options , and their trading teams, were not it.
I also REALLY hate the paper for not talking about all the 'real' issues with Black Scholes, such as the Collapse of Long Term Capital Management, the regulatory issues with synthetics/derivs, such as VW and Porche.
So, financial maths, everyone knows its incorrect, but its the best we have, suggesting something better, more stable, that is demonstrably more 'correct', will bring you power, money or academic reward, whatever you want, so do it. Reading the Guardian won't help anything.
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Possibly the problem is that trading purely based on mathematical formulas- however good or bad they may be- is an excercise in making yourself a winner in a zero-sum game?
Surely we should be hoping for a return to good old value investing?
I can't claim to be immune, my new hobby is 'trading' football on Betfair- and I'm up about 40 quid in two weeks, using small stakes of 5-10 quid a time. But the simple fact is that some other people are now down a total of 42 quid after Betfair's 5% commission- that's not money I've made, merely money I've taken off other people. It's also money that I stand to lose if I carry on and luck goes against me!
One important thing to remember is that the trading of many of these financial products such as derivatives isn't always bad for the economy etc. They may have helped lead up to the giant mess commonly labelled as the credit crunch but options are extremely helpful for real businesses that actually produce useful output (such as a farm) to keep a stable income.
I'll use the farm example:
A farmer wants to know how much money he'll get for his grain harvest next year and doesn't want to risk a price collapse. He's also not greedy do isn't bothered about losing potential profits if the price skyrockets.
The farmer sells futures for the 100 tonnes of grain at £100 per tonne at today's price that expire next year.
If the price of grain collapses, it makes no difference. The futures are all ready sold.
Provided the farmer can produce those 100 tonnes, he is guaranteed today's price for them. If the farmer also purchases insurance for crop devastation, he then knows his income over the next year and can plan based on that.
Without these products, there would probably be less small businesses that produce commodities.
Last edited by badass; 27-02-2012 at 10:30 AM. Reason: Used the wrong derivative for the situation.
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Yes and no its about spreading risk and reward. In the case of the football market it is not going to shape the game at all or how it is played.
But say the options market can be used to hedge against prices in a commodity such as oil, very handy if you want to book airline tickets 6 months in advance.
However its not all a zero sum game in the same way as a gambling book is, for example when the price of oil sky rockets we see it becoming economically viable to extract oil from harder to get places. These places start to become tapped when the futures markets hits the right prices. Without the futures, it would in fact get higher because it takes time to bring these other fields on line.
This is how a derivivative can in fact change the production underneath.
I hate the phrase, 'exact science' as nothing is (exception creationisim, by definition), but economics definately is not. Its more about trying to join the dots, and sometimes it makes 'the bear' constalation look well defined. But it is really fascinitating, and whichever does a better job, should in thoery win out. http://money.cnn.com/2008/06/27/news...irger.fortune/ so long as governments and people who think they know better don't get in the way.
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Not an 'exact science' is something of an understatement when it comes to economics. Voodoonomics would be a better term for it, economists certainly don't give a toss about the ecology around them beyond what they can exploit from it.
And the collateral damage they leave in their wake is coincidental, right? Who cares that millions are losing their homes, there's profit to be had!
Government did get out of the way, and those who 'know better' ran the world economy into the ground. When your 'science' is really just taking a wild stab in the dark, everybody is qualified. Some are simply more ethical than others and seek to minimise harm, rather than maximise profits, appeal to greed, and otherwise glorify psychopathy.
If the current economics approach was a genuine theory from science, peers would have taken it out back and shot it dead a long long time ago. What it really is, is a vehicle to promote psychopathic ideals for the advantage of the few up top and dress it up in the language of science to give it an air of legitimacy to people who are ignorant about science (i.e. politicians, general public, etc).
Its something which is needed, in the same way that medical science frequently harms those it intdends to help doesn't mean such quackery is without a need.
I'll hazard a guess that you know nothing about the subject matter, its really quite fascinating, the flaws, the drawbacks are normally prominently declared.
There is also a big difference between economists and traders. Some economists exist soley to devise methods to measure and quantify populations, observe patterns. I would really suggest that reading the Freakonomics or The Undercover Econnomist or hell even the Tiger That Isn't is enjoyable! It allows you to observe human behaviour, what people actually do, how they appear to behave, without the hassle of what they say they do.Yes, millions have. Again I'd go back to medical science, throughout its troubled evolution we've killed millions, experimented compeltely un-ethically, rushed drugs to market. Use of economic theory is no differen't.
The question is what is the net gain, are we better off with out?
No economist I've ever read or met, no trader I've ever worked with thinks these things are correct, its about getting better, and striving for something more accurate and efficent. As if you'd bothered to read some of the things I've spoken about or linked in this thread, you'd get the drift, see onion volatility! (if you want to know why such vol is a problem, post!)How awfully idealistic! minimise harm. How do you do that? Did the Greenspan Puts miminise harm? They were designed too, or did they really create harm?
The problem comes that economics is about efficency, there is no goal, its about the process.
So just think that through, its about making an efficent process.
A government, a well wisher, an idealistic ignorant type comes along and tries to get an outcome they want. They fail to understand the consiquences of their actions. A classic example of such stupidity was the tax on dividends for pensions. Before they even became law, hedge funds had figured a way of getting round the tax by creating two synthetics. Instead of loosing a third, they'd charge a tenth for that. Government tried to take more money from peoples savings without them noticing, it generated work for hedge funds.
As such to claim to be moral on such things is really hard. What has to happen is strict legal frameworks that focus on outcomes, not the process, as efficency is blind to morality!You do know its a peer reviewed right?
Think you can do better? Then do it! Submit a paper on part of this theory of yours for how it can be something that isn't 'a vehicle to promote psychopathic ideals for the advantage of the few up top and dress it up in the language of science to give it an air of legitimacy to people who are ignorant about science'. What is stopping you?
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Amateur
One of our clients would comfortably make £10k+ on a big hourse racing event (by laying instead of backing mostly), but he was quite involved with the racing and knew things like form, going, horse age, jockey experience, ratings, weights etc (and did occasionally lose big)
Never trust anyone to tell you the truth when they gamble. Gamblers only tell you of their wins, not their losses.Amateur
One of our clients would comfortably make £10k+ on a big hourse racing event (by laying instead of backing mostly), but he was quite involved with the racing and knew things like form, going, horse age, jockey experience, ratings, weights etc (and did occasionally lose big)
Anyways 10k... bloody amateur
Nope, in the threads on this forum in the past I'm always very honest about losses I've had to endure! My personal best ranges into the half million territory, thankfully, that wasn't a) my money and b) was all winnings anyway. But still. Trading I find is bad for my health, since I have stopped mostly, I only buy 1/5th as much single malt....
Right now I'm a bit peeved because some money isn't doing as well as it could if I keep it in this product, however I know I'll need it in 6 months.
I also know that there isn't any maths to solve this issue for me as the model would have to be too complex
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I do know, and the fact that economic peers not only failed to anticipate the disastrous results of the deregulation they screamed for, but use their failure as an argument to push for more deregulation (rather than accept it as evidence that the reality of deregulation does not meet with the rhetoric) and to re-establish the exact same proven to fail system all over again is solid evidence that either a) their lack of introspection means they're emotively operating by self-rewarding rhetoric rather than coming up with natural laws, or b) are intentionally robbing everyone blind. Which is true is irrelevant, the effect is the same. Everything beyond that is irrelevant marketing and brow beating dissenters with a torrent of bare assertions.
Intellectually bankrupt peers? As long as they're only interested in confirmation bias and keep blindly shouting down any evidence and hypothesises which alters the status quo to the disadvantage of themselves or their wealthy cronies, nothing will change, regardless of how much evidence is stacked against it. Because lets face it, there's already been well over 5,000 years of capitalist centric evidence showing constant busts, appalling human rights violations, poverty, famine, death, etc, and they ignore it and continue to harp on and praise it as the best thing since sliced bread. Hell, they're still acting like unlimited expansion is possible, and the global recession is just a pesky bump getting in the way.
Any 'science' which continues to vaunt proven to be failed ideas is no science at all. You simply can't reason with that kind of wilful ignorance mentality.
I am more inclined to believe him when he runs his own local betting exchange shop and knows on a personal level people at Centurion, bet72.com and a number of betting exchanges and gave a talk at BetfairNever trust anyone to tell you the truth when they gamble. Gamblers only tell you of their wins, not their losses.
Anyways 10k... bloody amateur
He also was our chief contributor for the sports analysis/betting site I was lead dev on so worked with him closely, especially for the side of UI and getting some of the algorithms right.
10k was at one event, so horse racing on one day... in his spare time from running his shop. He was quite open about when he lost £6k on a meeting though
There was a blog from a lad who worked in the city and took a year out to do this on a serious level and made a good £100+k in a year, I think it was
http://thebetfairtrader.blogspot.com...k-to-101k.html
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