Wall Street’s Math Wizards Forgot a Few Variables(nytimes.com)
nytimes.com
Wall Street’s Math Wizards Forgot a Few Variables
http://www.nytimes.com/2009/09/13/business/13unboxed.html
12 comments
i have yet to meet a quant who understands what curve fitting is and why it's bad.
Alright, alright, how many quants have you met, and did you quiz them?
I don't know, more than 5. Yes, I always quiz them.
Oh you've got me started...
A whole of array individuals and idea-systems bare blame for the bubble. From the Quants' model to Alan Greenspan's ideology to the to mark-to-market-accounting to the repeal of Glass-Steagal and onward, they justified what was effectively the largest bubble in history. And given its size, the blame can go many places...
Moreover, you're acting like the crisis was just the bankruptcy of a few companies - the ones conveniently without Quants. The crisis has, in fact, hit the entire economy. And moreover, all of Wall Street was effectively bankrupt at the point when Lehman failed. The Fed just chose to throw some trading houses to the wolves and bailed out the rest. If the bailed-out houses thought like you, I wish they'd let them go too.
And further, you are not in the least addressing the points in this and other articles, the problems with Black-scholes, the Gaussian Copula and so-forth.
A whole of array individuals and idea-systems bare blame for the bubble. From the Quants' model to Alan Greenspan's ideology to the to mark-to-market-accounting to the repeal of Glass-Steagal and onward, they justified what was effectively the largest bubble in history. And given its size, the blame can go many places...
Moreover, you're acting like the crisis was just the bankruptcy of a few companies - the ones conveniently without Quants. The crisis has, in fact, hit the entire economy. And moreover, all of Wall Street was effectively bankrupt at the point when Lehman failed. The Fed just chose to throw some trading houses to the wolves and bailed out the rest. If the bailed-out houses thought like you, I wish they'd let them go too.
And further, you are not in the least addressing the points in this and other articles, the problems with Black-scholes, the Gaussian Copula and so-forth.
Accidentally bad math or intentionally bad math? I recall the great article posted here, written by the self identified godfather of the software to slice and repackage risk. And I always wondered, did he understand the difference between correlated and uncorrelated probabilities?
Good call. There is plenty of blame to go around. The models the quants used served their purpose of recording "profits" "right now". I think being short sighted was intentional or at least "unconsciously intentional".
Yes, "They either didn't understand that, or intentionally ignored the possibility that, the random variables they were working with would eventually be correlated" is great summary of math BS for laymen.
However, I think that the "art" of the whole affair was looking at a domain just complex enough that even they themselves couldn't sure whether they were lying or just "being clever".
However, I think that the "art" of the whole affair was looking at a domain just complex enough that even they themselves couldn't sure whether they were lying or just "being clever".
Thought experiment:
You find an algorithm that is very reliable for forecasting the near-term prices of an asset. Your algorithm only works in contemporary, or at least recent, markets. You notice that by building a basket of many assets, you can increase your leverage as you have a reduced the volatility of returns. You DO UNDERSTAND that there is a possibility of major failure, but you assign it a low probability and decide to let it ride for the time being. After all, after a certain level of profit, you can scale back the risk. The profits are too good, so you never scale back. Thus, you are the one standing when the music stops.
The end.
You find an algorithm that is very reliable for forecasting the near-term prices of an asset. Your algorithm only works in contemporary, or at least recent, markets. You notice that by building a basket of many assets, you can increase your leverage as you have a reduced the volatility of returns. You DO UNDERSTAND that there is a possibility of major failure, but you assign it a low probability and decide to let it ride for the time being. After all, after a certain level of profit, you can scale back the risk. The profits are too good, so you never scale back. Thus, you are the one standing when the music stops.
The end.
Ah, but you don't have to even be that clever...
If you just come up with an algorithm that mostly says 'buy', then you can look good for as long as a secular bull market lasts. And if your algorithm sounds amazing, then you can get lots of leverage without otherwise doing anything.
Of course, this story ends the same way, you're left standing when the music stops (along with most of Wall Street) - but with luck, the Fed will buy your toxic assets...
If you just come up with an algorithm that mostly says 'buy', then you can look good for as long as a secular bull market lasts. And if your algorithm sounds amazing, then you can get lots of leverage without otherwise doing anything.
Of course, this story ends the same way, you're left standing when the music stops (along with most of Wall Street) - but with luck, the Fed will buy your toxic assets...
Left standing ? I am not sure.
http://www.nakedcapitalism.com/2009/09/ny-times-lehman-post-...
http://www.nakedcapitalism.com/2009/09/ny-times-lehman-post-...
Not sure what you mean but while Lehman might indeed have been the most clueless Wall Street house and thus the obvious one to fail, we have to remember the whole edifice would have collapsed if not for the Fed. IE, Goldman would be bankrupt too if AIG hadn't been supported by the Fed but the sequence "Kill Lehman, prop up AIG" just happened to make Goldman look good. Coincidence? Who can say but while all the houses had influence, the Treasury Secretary just happened to be...
Remember, "Left standing when the music stops" is an expression from musical chairs. It means the opposite - you will not be left standing...
Remember, "Left standing when the music stops" is an expression from musical chairs. It means the opposite - you will not be left standing...
This is a very popular sentiment, yet utterly false. The companies that failed hardest- Lehman, Sterns, Fannie/Freddie, rating agencies- are (were) notoriously non quantitative. They are frequently made fun of in Quant circles in fact. Were any of these companies run by Math Wizards? No. Most of them have (once again, had) zero Quants in their upper management. You cannot blame the failure of such institutions on Quants.