Fooled by Randomness

[Martinghoul]

Quote from Thunderdog:

Judging by recent history, perhaps the others weren't screaming loud enough? What constructive analysis were they offering?

Well, you have to ask yourself, has Taleb's screaming actually made ANY difference?

Here's some examples of attempts at constructive analysis:
1. Behavioral finance research is all about problems with efficient mkts. Kahneman and Tversky's prospect theory, to name only the seminal contributors to the field.

1. Extreme value theory as applied to finance (GEV and extreme VaR).

1. Something just starting now, afaik, is research into modeling of the ecology and robustness of complex financial agent-based networks, e.g. this: http://www.nature.com/nature/journal/v451/n7181/full/451893a.html

All these are actual attempts, past, present and future, to constructively address the flaws in our current understanding of finance. People doing this don't spend all their time screaming on TV just how sh1t stupid everything and everyone is. They have just been quietly going about their work. In my view, they deserve a lot more respect than NNT could ever hope to garner.

 

[Martinghoul]

Quote from Random.Capital:

I wish this were true. The typical salesman - sorry, "advisor" - servicing retail customers trots that model out on a regular basis. Usually it's not expressed explicitly as "CAPM", but rather as a set of vague principles that just happen to align with the assumptions that go into CAPM.

True, which is why I said I don't mind when Taleb goes on one of his rants about the people who have, intentionally or accidentally, misused the models.

My problem is when he raves about the models themselves, without actually offering any useful alternatives.

 

[FanOfFridays]

Quote from johnny88:
I fail to understand what you guys are talking about. But the CAPM equation is as follows. Risk free rate + Beta(Market Risk Premium). So what does this tell you in accordance with the mayhem we saw in 2008?

Random Capital has answered your question, but just in case you need it, Taleb takes issue with the way the word 'Risk' is (ab)used in the equation you cited. That's the relevance for what we saw in 2008.

By the way, I didn't think Taleb's book was as bad as some think, although it was definitely stretched out and Taleb himself is not exactly loathe to encourage the cult of personality. To his credit, he admits that he's a giant egotist.

 

[Random.Capital]

Quote from Martinghoul:

Extreme value theory...

Taleb himself uses a kind a EVT.

 

[Random.Capital]

Quote from Martinghoul:

My problem is when he raves about the models themselves, without actually offering any useful alternatives.

But he does. Repeatedly. In both books and numerous interviews.

 

[Thunderdog]

Quote from Martinghoul:

Well, you have to ask yourself, has Taleb's screaming actually made ANY difference?

Here's some examples of attempts at constructive analysis:
1. Behavioral finance research is all about problems with efficient mkts. Kahneman and Tversky's prospect theory, to name only the seminal contributors to the field.

1. Extreme value theory as applied to finance (GEV and extreme VaR).

1. Something just starting now, afaik, is research into modeling of the ecology and robustness of complex financial agent-based networks, e.g. this: http://www.nature.com/nature/journal/v451/n7181/full/451893a.html

All these are actual attempts, past, present and future, to constructively address the flaws in our current understanding of finance. People doing this don't spend all their time screaming on TV just how sh1t stupid everything and everyone is. They have just been quietly going about their work. In my view, they deserve a lot more respect than NNT could ever hope to garner.

Okay, I won't pretend that I'm not out of my depth, because I am. I studied CAPM while doing my MBA in the early '80s. At the time, I figured that if this is what it took to operate in the markets, then it was not for me. Although I was able to complete the courses well enough with good grades, it never connected with me. And so I went into corporate banking for the next several years instead. That is why the mere mention of CAPM gets me riled.

As for the other stuff you refer to that I know nothing about, at the end of the day, does it not all come down to predicting human behavior in the face of uncertainty? And, if so, then what kind of robustness can you really even hope for?

 

[Martinghoul]

Quote from Random.Capital:
Taleb himself uses a kind a EVT.

Yes, but whereas EVT at least attempts to be rigorous and systematic, NNT just wrings his hands, dramatically and epistemologically (a word he seems to be particularly fond of).

Quote from Random.Capital:
But he does. Repeatedly. In both books and numerous interviews.

I have personally not seen NNT offer anything productive. Most of what he says (incl the infamous 10 principles: http://www.fooledbyrandomness.com/tenprinciples.pdf) is either hand-waving or "thou shalt not" commandments. We all know the proscriptive bits, it's the prescriptive that's difficult.

 

[Martinghoul]

Quote from Thunderdog:

Okay, I won't pretend that I'm not out of my depth, because I am. I studied CAPM while doing my MBA in the early '80s. At the time, I figured that if this is what it took to operate in the markets, then it was not for me. Although I was able to complete the courses well enough with good grades, it never connected with me. And so I went into corporate banking for the next several years instead. That is why the mere mention of CAPM gets me riled.

As for the other stuff you refer to that I know nothing about, at the end of the day, does it not all come down to predicting human behavior in the face of uncertainty? And, if so, then what kind of robustness can you really even hope for?

I have no problem with CAPM proponents or opponents, like yourself. People in behavioral finance (my personal favorite field) have been poking holes in CAPM and trying to come up with its alternatives for years. I have a problem with Taleb because, compared to the 'unsung heroes' I mentioned, he offers so very little to the debate.

Yes, you're right, it's all about trying to understand human behavior. I don't know what sort of robustness I am hoping for, but I'll let you know when/if I see it. What are you suggesting? That study of human behavior is futile, because it's inherently beyond our understanding? Maybe it is, but, then again, history is full of examples where phenomena that were thought beyond understanding suddenly got explained and understood. That's scientific progress and I am a fan.

 

[trendlover]

Maybe Thunderdog is saying human behavior is not predictable in time, so no model can be made.

 

[trefoil]

Too many assumptions. The world simply is not constructed the way these guys would like.
The below letter appeared in today's FT in re an article written by folks following the assumptions in CAPM and Black Scholes and all that, and addresses this:

Assume a can opener and the rest will follow

Published: August 20 2009 03:00 | Last updated: August 20 2009 03:00

From Mr Alistair Milne.

Sir, The views of Robert Kaplan, Robert Merton and Scott Richard on fair value accounting (“Disclose the fair value of complex securities”, August 18) remind me of the old joke about a physicist, a chemist and an economist trapped on a desert island. All they have to eat are cans of beans. Finally, after fruitless attempts by the scientists to open them, the economist identifies a solution: “Assume we had a can opener ... ”
Suppose it were really true, as Profs Kaplan, Merton and Richard assert, that “financial assets, even complex pools of assets, trade continuously in markets”. Then there would be no debate about fair value accounting, no problem with resolving distressed financial institutions, and indeed no financial crisis. In practice, financial assets, even simple ones, do not trade continuously and in current markets many financial assets rarely trade at all. The consequence is that we can have many different valid valuations of the same asset.
There are at least four different measures of current market prices: transaction prices; offered prices; opinions of market participants on what a price would be if a trade were observed; and models of market prices using estimates of other market prices as inputs. In addition, there are “fundamental” estimates of the present discounted value of the future value of cash flows that will eventually be generated by the financial asset, and when markets are distressed these fundamental values can be substantially higher than any measure of current market price.
The rather fruitless debate about fair value accounting will only make progress when we recognise that there is no such thing as a single correct valuation of every asset. Companies should present both market and fundamental values, stating clearly how they have been obtained and subject to external validation. This way investors can assess companies' financial position using a range of approaches.
Provided all this information is publicly available, then which particular measure is incorporated into the construction of profit and loss and balance sheet becomes relatively unimportant.

http://www.ft.com/cms/s/0/2b1f32fa-8d20-11de-a540-00144feabdc0.html