

How Software Models Doomed Financial Markets - webwright
http://www.sciam.com/article.cfm?id=after-the-crash&sc=DD_20081121

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steveplace
No, they didn't. They helped, but there is no way quant shops caused this sort
of supply/demand imbalance for months.

There _is_ an inherent problem with a lot of financial modeling in that it
assumes normal distributions (technically lognormal), so a lot of the models
are mean-reverting. But financial markets are anything but statistically
normal.

Stop blaming short sellers, the uptick rule, hedge funds etc. If noone wants
to buy something, the price will go down. That's it.

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flashgordon
mate that is not entirely true...

"There investment bankers from the largest institutions pleaded successfully
with Securities and Ex­­change Commission (SEC) officials during a short
meeting in 2004 to lift a rule specifying debt limits and capital reserves
needed for a rainy day."

To me it seems like a lot of the models that the quants came up with were
essentially a way to justify the above line of reasoning and to show that
dependence on mortgage backed securities was sustainable (when in reality it
was a path to a meltdown).. Ofcourse that doesnt mean the quants are to be
blamed, when the directive had come from elsewhere...

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steveplace
Yes, the leverage the banks asked for was a bad idea. Coincidentally, 4/5 of
those banks either don't exist or don't do i-banking.

But quants _along_ with other strats (macro, long/short, etc) all had bad risk
management models. You can't blame only program trading when there was so much
human error.

Also: quants (meaning algorithmic trading) did not show how MBS were good.
That was human error; Moody's and S&P ratings, for example.

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mdasen
The problem isn't the computer models. It's the models that investment houses
have been using generally. Telling a computer to do a workflow doesn't change
the outcome. If it's a good workflow, it's a good workflow.

The problem is that many investment houses simply used bad quantitative data
to evaluate their investments. Whether a computer generates that or a human
calculates and writes it down doesn't change things.

I'm a big fan of trying new models with computers. Google does it all the
time. However, when Google is doing it, the worst case is that the utility of
your search results goes down.

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DaniFong
"radically large market shifts are unlikely and that all price changes are
statistically independent; today’s fluctuations have nothing to do with
tomorrow’s—and one bank’s portfolio is unrelated to the next’s"

Is this actually true? I thought that a number of models at least correlated
price changes at a single point in time, and that agent models were correlated
nonlinearly across time as well...

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tptacek
Isn't this the same thing they said in 1989 about program traders?

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revelude
...but with 20 years of the effects of Moore's Law.

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andrewljohnson
This article was spot on until the author said that airplanes would never fly
solo.

Is he crazy? Of course ALL airplanes will eventually fly solo, and some
already do - like the drones we send to kill militants in Pakistan.

And it will be a better world when airplanes, surgery, tollbooths, and many
other things are done by computers.

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kamidev
"Flying solo" was probably not meant literally.

The article's main argument was that some things are too risky without
multiple supervision. The extreme and current example is letting financial
institutions supervise themselves. How to use computers is just one part of
the problem.

Many things can run unattended - but under what circumstances should they?
What are the necessary safeguards? Pilots on commerical airplanes don't do
much flying, they are onboard to make sure everything is safe and works.

Eventually it's all about acceptable risk. We already know automated trading
can be dangerous. But the danger lies in bad human assumptions, bad human
models and the widespread idea that somehow no human being remains
responsible.

As a complete aside - I worry whenever I hear cheerful talk about "the drones
we send to kill militants". That kind of convenient and unaccountable power
over life and death in other countries is both morally suspect and open to
abuse. Killing by remote is still killing and relying on technological quick-
fixes to "solve" terrorism is a dangerous strategy.

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Dilpil
It's the damn scapegoats!

