Risk, Uncertainty, and Financial Markets
24 February 2009 at 5:54 pm Peter G. Klein 6 comments
| Peter Klein |
A quick follow-up to Nicolai’s post on the copula function: See also this item on Gary Gorton’s role in the financial crisis, which includes Warren Buffett’s great line: “Beware of geeks . . . bearing formulas.” And items on Knightian uncertainty here and here.
And there’s this passage from Darren Aronofsky’s cult classic Pi:
Restate my assumptions: One, Mathematics is the language of nature. Two, Everything around us can be represented and understood through numbers. Three: If you graph the numbers of any system, patterns emerge. Therefore, there are patterns everywhere in nature. Evidence: The cycling of disease epidemics;the wax and wane of caribou populations; sun spot cycles; the rise and fall of the Nile. So, what about the stock market? The universe of numbers that represents the global economy. Millions of hands at work, billions of minds. A vast network, screaming with life. An organism. A natural organism. My hypothesis: Within the stock market, there is a pattern as well. . . . Right in front of me . . . hiding behind the numbers. Always has been.
This is before the speaker, the mathematician protagonist Max Cohen, goes literally insane. That’s what quantitative financial modeling can do to you.
Entry filed under: - Klein -, Methods/Methodology/Theory of Science.
Organizations and Markets 
1.
Michael F. Martin | 24 February 2009 at 8:58 pm
Reminds me of a great scene from “Closet Cases of the Nerd Kind” starring weird al:
[Christopher Walken stares at computer screen spitting out numbers. Suddenly man in bunny ears pops up ]
“Excuse me, but I was a scientist before I became a bad actor, and I KNOW what that number means.”
“What is it?”
“It’s….. PI!!!”
http://video.google.com/videosearch?rlz=1C1GPCK_enUS309US309&sourceid=chrome&q=I%20was%20a%20scientist%20before%20I%20became%20a%20bad%20actor%20I%20know%20what%20that&um=1&ie=UTF-8&sa=N&hl=en&tab=wv#q=Closet+cases+of+the+nerd+kind&hl=en&emb=0
2.
Michael F. Martin | 24 February 2009 at 9:02 pm
Whoops. Wrong link above. This one will work.
3.
Michael F. Martin | 25 February 2009 at 12:25 pm
Maybe third try will be the charm ?
4.
srp | 26 February 2009 at 10:36 pm
This reminds me of the LTCM business, where it turned out that the firm really was not doing pure arbitrages with math derived from Merton et al and that the Nobelists were not involved in making the trades that blew up. Here the Wired article explicitly states (near the end) that the quant guys knew about the limitations of the formula but the decision makers didn’t understand the math. The latter then put too much weight on the formula and it collapsed on them.
Blaming the copula for the meltdown is like blaming the original Hubble telescope mirror problem on evil geometric optical theory when the real problem was bad measurement and sloppy operating procedures. If you grind the mirror wrong you’re going to get aberration even if you have the right math to describe how the light focuses.
5.
financial spreadbetting | 29 July 2010 at 12:51 am
I think like Warren I too would be wary.
6.
binaryoptionsweekly | 16 August 2010 at 8:01 am
Actually took a class by Gary Gorton in b-school a few years back, had no clue he was so instrumental in all this. He is/was a big proponent of synthetic structures (mainly derivatives) to generate returns…guess he needed to assess the risks more clearly.