"Trading as a Business" quant interview, highly recommended

The Daiquiri Smile
Posted At : April 14, 2008 8:05 PM | Posted By : Pablo Triana
Related Categories: Black-Scholes
Few people seem to understand that when you fudge the vol parameter in BSM (assuming that you are using BSM to price options) it no longer is BSM. It´s simple: the instructions did not say anything about vol fudging, vol is not supposed to be fudged with, vol is supposed to be independent of strike, if you fudge vol is not the same construct anymore it´s something else.
Let me provide what could be seen as a clarifying analogy (or, perhaps, as a complete waste of time). The Daiquiri cocktail was apparently invented by American engineer Jennings Cox in 1905. What could be deemed Cox´s drink is supposed to contain 4,5 cl of white rum, 2 cl of lime juice, and 0,5 cl of gomme syrup. That´s what Cox had in mind when coming up with the invention. Those were the instructions. Very precise.

Now, imagine that in real life you begin to observe that barmen all over the country are mixing it up differently. Depending on the room temperature, they would fudge the lime juice ingredient so as to obtain a more realistic output. If we plotted temperature and lime juice amounts we would get a smiling shape: the lime juice variable would be assigned higher values by barmen the more extreme the room temperature. That is, implied lime juice would smile at us.

Could we still call such real-world daiquiries Cox´s daiquiri? Of course not. Cox said nothing (I hope!) about fudging the lime juice figure. It was supposed to be constant, unaltered. If we do alter it, the final output can´t be called Cox´s daiquiri. It´s something else (Hemingway´s daiquiri?)

If you are given a toy with very precise instructions and you choose to violate such instructions through shameless manipulation, you are betraying the original spirit of the inventors, so much that it no longer is the invention that those original inventors devised.
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Quote from HiddenAgenda:

. .. and can we hear from someone who had bought Google at around the IPO price, the ultimate forecaster?
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Your question shows a fundamental misunderstanding of the issue with quantitative analysis, and the current scientification of financial education.

Quants are not employed to make predictions. That is a myth. Most are just well paid glorified IT guys,

What quants & their ilk are guilty of is formulating risk models that can't withstand outlying events. This is the reason that mild events cause such huge ripples in the market.
 
Quote from pedro01:

Not at all.

Even now, the idiots that devised all of these clever formulas that got everyone selling at the same time are advocating a fix with smarter formulas.

The reliance on bad math is getting us into more and more trouble in the financial world. We are relying on smart guys that never placed a trade to tell us what the risk is.
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You're just being silly again, pedro... You can't abdicate responsibility for your decisions by saying that you relied on some smart guy's opinion. Personally, my risk is everywhere and always my personal responsibility, nobody else's.
The most usual fundamental flaw in their models is that the models don't take into account he impact of people acting on the model.
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A model is a model. It never promises to be a perfect representation of a very complicated, messy reality. Again, it's nobody's fault but yours for not realizing that.
How much more suffering should we withstand at the hands of smart idiots who think that the world of finance can be quantified and who can't realise that the 5th time you see a 100 year storm in a year that it is no longer a 100 year storm ?

Of course, some blame goes on the shoulders of the people that took excessive risk because these 'smart' guys told them their risk was low - but to be honest - if it came down to the guy in the corner shop and a Quant telling me what the next big thing was - I think I'd go with the corner shop guy.
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That is EXACTLY the point. The CHOICE IS YOURS. It's up to you to choose to withstand 'suffering at the hands of smart idiots' or 'go to the corner shop guy'. Either one might prove to be wrong, but guess who bears the ultimate responsibility? It's neither the 'smart idiot', nor is it the 'corner shop guy'. It's the person who makes the decision.
 
Quote from pedro01:

It is beyond the scope of what we can post on this forum to discuss the complex formulas that keep causing massive crashes in the market.

Should we start with 1987, Black Scholes & Portfolio insurance ?

Are you in denial that the whole crash was caused by people following rules devised by mathematicians that told them to sell when the market moved against them ?
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Before making wild assumptions about what caused the crash of 1987, you need to have a basic grasp of economics.

As I recall, interest rates were doing wild things that year prior to the crash, that precipitated it. I don't have the 87 bond or index charts up, but I believe that was the year that happened. It was not a surprise at all, and had little to do with quants or mathematicians.

I made $5K that day, by loading up on mutual funds at EOD prices. I figured it was a serious overreaction, and I cashed in.

But your analysis is seriously weak. As I said before, unsupported opinions are fertilizer.
 
Quote from pedro01:

Do you realise that quants are responsible for all of the stock market crashes since 87 ?
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Do you realise that newbie posters are responsible for a lot of poor thought and many garbage opinions brought into ET, yours especially included? :D
 
Quote from TraderZones:
I made $5K that day, by loading up on mutual funds at EOD prices. I figured it was a serious overreaction, and I cashed in.

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To TraderZone: I think your lying. Almost no body could get their orders filled that day. Big Fido quit answering their phones early that morning......... Post a copy of your P/L for "loading up" ... A whole $5k? Your big wad musta shook the market..
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You make a good point Pedro01.. 15 post in 5 years but worth reading... ag
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Quote from Martinghoul:

You're just being silly again, pedro... You can't abdicate responsibility for your decisions by saying that you relied on some smart guy's opinion. Personally, my risk is everywhere and always my personal responsibility, nobody else's.

A model is a model. It never promises to be a perfect representation of a very complicated, messy reality. Again, it's nobody's fault but yours for not realizing that.

That is EXACTLY the point. The CHOICE IS YOURS. It's up to you to choose to withstand 'suffering at the hands of smart idiots' or 'go to the corner shop guy'. Either one might prove to be wrong, but guess who bears the ultimate responsibility? It's neither the 'smart idiot', nor is it the 'corner shop guy'. It's the person who makes the decision.
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That last statement is not true.

The Value at Risk at Bear Stearns was just over $60M the day before the value of Bear Stears was wiped out to the tune of $8bn.

How is it my choice that people in huge financial institutions rely on flawed mathematical concepts to take huge risk ?
 
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