
Nassim Taleb, Absorbent Barriers and House Money - bko
https://medium.com/ml-everything/nassim-taleb-absorbent-barriers-and-house-money-8b21cff2e338
======
chollida1
Wow, the work he did on simulating his payout is almost exactly what I used to
have people do as part of our interviewing.

IMHO It was one of the most telling tests I could give a potential trader, not
necessarily for quants as this should be considered the quant equivalent of
fizzbuzz.

Victor Haghani of Long Term Capital Mangement fame, yep those guys, did a
similar experiment with bet sizing and betting on a loaded coin and sadly even
people who should have known better, math majors, didn't fare very well in his
experiment.

[https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2856963](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2856963)

~~~
21
Taleb has a lot of disdain for the LTCM guys:

"Mr Taleb argues convincingly that the spectacular collapse in 1998 of Long-
Term Capital Management was caused by the inability of the hedge fund's
managers to see a world that lay outside their flawed models. And yet those
models are still widely used today."

"By many’s reckoning, LTCM both defined and emboldened Nassim Taleb. The
episode was a microcosm of everything he eventually stood for and against. His
resentment against economists grew. He became convinced that they totally do
not understand risk. He saw the fragility of the financial system and how
dependent the entire ecosystem is on one another. He became disgusted when
LTCM fund managers, despite the damage they have done, walked away from the
fiasco relatively unscathed and went on to start more funds. He became the
biggest advocate of having Skin in the Game."

~~~
tptacek
Disdain for LTCM isn't exactly an iconoclastic, or even interesting, position
to take. They're among the worst trading catastrophes in history.

A good book has been written about LTCM, but it's not Taleb's; it's
Lowenstein's _When Genius Failed_.

~~~
pdog
_> Disdain for LTCM isn't exactly an iconoclastic, or even interesting,
position to take._

How many people took that position before it blew up?

~~~
tptacek
Famously, Taleb is supposed to have predicted LTCM. I've read FBR and Swan,
but not recently, and took a couple minutes to try to track down the details
of this prediction, with little luck. I found numerous references to his
having predicted the demise of hedge funds "like" LTCM (my clock will also
strike 4:23 at least twice in the next 24 hours). Does anyone have a good cite
for this?

~~~
defen
I'm not sure he called them out by name. If you read `Against VAR` [1] from
1997 (LTCM blew up in 1998) you see basically all the ideas of The Black Swan
/ Fooled By Randomness. LTCM was doing all the things that he says are risky.
The guy who wrote "In Defense of VAR" on that same page subsequently wrote
"Risk Management Lessons from Long-Term Capital Management"[2]. Also in
Taleb's 1997 book "Dynamic Hedging", chapter 9 "Vega and the Volatility
Surface" talks about liquidity as one of the pre-eminent risks of an option
book (as opposed to individual option positions).

[1]
[http://www.derivativesstrategy.com/magazine/archive/1997/049...](http://www.derivativesstrategy.com/magazine/archive/1997/0497fea2.asp)

[2]
[https://merage.uci.edu/~jorion/papers/ltcm.pdf](https://merage.uci.edu/~jorion/papers/ltcm.pdf)

------
OscarCunningham
What Taleb shows is that people should become more willing to bet as they move
away from the "absorbing barrier" of having so little money that they have to
quit the game. But he phrases this in terms of justifying the fact that people
are more willing to bet with "house money" (money that they have already won)
than their own. This is clearly wrong because the starting point is always
higher than the absorbing barrier.

I think Taleb is a bit too eager to criticise others, even when his
mathematics isn't actually applicable to the situation.

~~~
mjb
"A bit too eager to criticize others" is a understatement. Taleb has a lot of
interesting things to say, and some of them are even reasonably novel.
Unfortunately his general "everybody but me is stupid" approach makes his
message much less useful and accessible than it otherwise would be. This is a
good example of that problem.

I find this really unfortunate, because Taleb's message about systems behavior
being dominated by tail behavior, and about the risks systems not being
designed to tolerate that behavior, are very interesting and broadly
applicable. Unfortunately, the medium makes the message less effective.

I often think of Taleb as a sort of counter-example when thinking about how to
teach and communicate difficult concepts.

~~~
User23
Contrariwise, many people find his communication style refreshing and
entertaining with his book sales being a solid exhibit in favor of that.

Also, most people are stupid compared to Mr. Taleb, that's just a simple
function of his observably high intelligence. That said, I've never seen him
treat someone as stupid who doesn't first act stupid, and he's demonstrably
willing to engage with people publicly on fair terms.

It's a good test though: do personalities like Taleb and Dijkstra entertain
you or do they offend you? Introspecting on why they do or don't is a great
opportunity for personal growth.

~~~
exolymph
I suspect that you may not be aware of this, so I'm commenting (partially with
the hope that someone will figure out a nicer, more effective way to say
this): You come across as condescending in a similarly offputting way to Taleb
himself.

~~~
User23
I do take my own advice about introspection and thank you for your concern.

Much like Mr. Taleb, I just don't see it as a problem. If my personality
allows me to appreciate a communication style others have trouble with,
without restricting me from appreciating other communications styles that they
do not, then I have access to a broader and more diverse set of knowledge and
interactions. I find the trade-off acceptable.

------
njarboe
The interesting thing I got out of this analysis is that, if you have a slight
edge of 1%, having the constant percentage betting strategy is much better, if
you have a large (100,000) number of bets. Having a log scale would be nice to
see approximately where the two strategies returns diverge.

This got me thinking. One thing that is not discussed is that in real life
trading one does not know what percentage advantage one has. Many successful
traders rely on subconscious processes for part of their trading strategy that
they have no way of examining, but seems to work(sometimes). If the only way
to find out what your expected return is(your edge), is to bet and see what
happens (maybe this is really the reason one needs "skin in the game") then
ramping up your betting when you are winning is a really good idea. When you
are losing money it is likely your expected return is negative and you should
start scaling back your bets until you find an edge again.

It would be interesting to run this code with variable rates of return over
time, including negative ones, where one scales the bet size not on your net
capital but on (the percentage win on the last n bets)*(capital).

I'm sure this is all in some book written in the 18th century as people have
been trading in markets for a long time.

~~~
jbp
Don't know about 18th century, but some what similar strategy is already
mentioned by Taleb in the interview: Kelly Criterion.

~~~
njarboe
I thought what I was saying was quite a bit different. If one is using the
Kelly Criterion, one needs to know what the probability of winning and odds
paid for a win. Traders generally don't know these at all and only can find
them out by making the trade and seeing what happens.

Of course when the Kelly Criterion is known and constant, one can make the
optimal bets and get rich, but those situations don't exist in real life
(unless there is some kind of monopoly or external force being used to make
people take the other (loosing side) of the bet). The iterative thinking of
the the Kelly Criterion must be part of a traders mindset, but markets never
understood well enough to where this formula can be strictly applied.

A bit strange to see Taleb talk about a casino situation to explain his
thinking. Elsewhere he mocks such "casino odds" view of the world as very
unrealistic an bemoans that such a view will cause one grief if you use those
ideas with "skin in the game".

ps. I've only read "Anti-Fragile" and some of his blog essays.

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apo
The author quotes Taleb:

 _...Unless you engage in strategies designed by traders and rediscovered by
every single surviving trader, very similar to what we call, something called
the Kelly Criterion, which is to play with the house money. ..._

And later restates:

 _What Taleb said is we should be more aggressive with the house money._

AFAICT, the Kelly Criterion has nothing to do with playing with house money.
Instead, Kelly tells you _how much_ of your wallet to wager given the payout
and probability of winning. The source of the money you stake is irrelevant.
Dice don't care whether your wager came from the house or your 401k.

For example, in a coin toss biased 60% to heads with a 2x payout for win, you
should bet 20% of your wallet on heads and keep doing that no matter which way
the flips go (2p - 1 = 2*0.6 - 1 = 0.2). If p ≤ 0.5, don't bet.

[https://en.wikipedia.org/wiki/Kelly_criterion](https://en.wikipedia.org/wiki/Kelly_criterion)

[https://www.youtube.com/watch?v=d4yzXbdq2DA](https://www.youtube.com/watch?v=d4yzXbdq2DA)

Playing this strategy optimizes your return and ensures you can never go bust,
thereby missing out on the guaranteed payout over enough bets.

~~~
tomp
Is he actually arguing that "house money" is different from "your money" or is
he just reusing existing terminology? IIRC, the idea of "house money" was
invented by earlier researchers who tried to explain why people would bet more
after winning. Obviously "keeping score of your wealth" explains the effect
just as well as "playing with house money".

~~~
apo
I'm using the definition of house in wide use: the profits you make on
gambling or a trade. See:

[https://www.quora.com/What-does-Im-playing-with-house-
money-...](https://www.quora.com/What-does-Im-playing-with-house-money-mean)

The idea that one should factor the origin of the money put into a bet is
ridiculous. It's your money either way.

> IIRC, the idea of "house money" was invented by earlier researchers who
> tried to explain why people would bet more after winning.

These guys, I think:

[https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1424076](https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1424076)

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root_crontab
I see too many of these. Write code to simulate something and obtain an
inconclusive version of a result you can simply derive and prove definitively
using statistics.

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ikeboy
I believe the response to this is that the actual increased willingness to bet
is way higher than could possibly be justified by the paltry amounts won.

If e.g. your net worth is 10k, you win 500, and suddenly you're twice as
willing to bet 500, something is off.

------
jerf
This idea has a lot of legs if you examine it. One of the more interesting
points I've heard from Jordan Peterson in one of his criticisms of
postmodernism is this: Postmodernism observes that after centuries of trying,
we don't seem to have an objective standard for ethics or philosophy (or at
least one that we can all agree on). Postmodernism, to the extent that one can
refer to the whole movement in a short sentence, then tends to assume that
therefore there are no distinctions between moral frames or perspectives, and
from there proceeds to go in a different direction and analyzes everything
simply in terms of power, because they decided that's the only thing that
matters since moralities and philosophies otherwise have no meaning.

Don't get too tied up in the details of that summary; I'm well aware of just
how brutal that summary is. But the details of the summary aren't what's
important; what's important is the observation that there are absorbent
barriers in philosophy and especially morality. You can't pursue a morality
that results in your death, especially if it results in a quick death. There's
some others too, but that's biggest and the most obvious. Civilizational death
is another one; more abstract, but also a rich vein of observations.

For example, there's a lot more people living people advocating for humanity
to be killed off for the planet than dead people advocating for humanity to be
killed off for the planet's sake. It is impossible for the living to observe
any other outcome.

This does not lead us via simple, universally-agreeable philosophical steps to
a universally-agreed upon morality. But it _does_ create distinctions between
different moralities and philosophies, and once you admit that into the world,
it once again becomes valid to study different philosophies and moralities
again without having to accept the postmodernistic "throw your hands in the
air and give up ever being able to determine anything, and then go study
something else instead". It's still nowhere near a mathematically rigorous
world by any means, but it's no longer hopeless.

(Bonus observation 1: No, this is not simply utilitarianism. Consider
utilitarianism as a spectrum of "how concerned am I about 'utility'".
Utilitarianism is the idea that we should be very far to the side of
considering that, if not considering it solely; on a spectrum from 0 to 1,
utilitarianism is that we should be close to or on 1. This observation is the
complementary observation that we can _not_ be close to or on 0. But we might
still be on, say, 0.5, which is not "utilitarianism" but may be enough to
create philosophies that still keep us alive. This observation also does not
depend on "valuing" life over death, because it is on a far more primal and
brutal level than that. It is the factual observation that if you hit one of
these absorbing barriers you are no longer a participant in philosophy, not a
normative statement about whether that is or is not a good thing.)

(Bonus observation 2: This is the beginning of the path, not the end.)

~~~
typon
> postmodernistic "throw your hands in the air and give up ever being able to
> determine anything, and then go study something else instead"

You're arguing against a strawman understanding of postmodern ethics

~~~
jerf
Your criticism would sting more if I hadn't labeled it as such.

If you'd like another example of an "absorbing barrier", an HN comment has a
limit on how long it is permitted to be. Therefore, all comments that would be
longer than that are comments that can not be made. It is probably not
unreasonable to state that even a slightly adequate summary of an entire
philosophy would not fit within that limit. Therefore, no Hacker News comment
can contain a true summary of an entire philosophy. Therefore it is not
reasonable to expect a Hacker News comment to contain an accurate summary of
an entire philosophy.

Besides, there's another "absorbing barrier" in that I'm not interested in
writing that long of a summary anyhow, when they already exist.

Finally, postmodernism's very nature allows it to be a bit of a moving target,
where any time someone makes any criticism of it a postmodernist can say with
a straight face that that is not what postmodernism is, and no matter what you
point at, nope, that's not where postmodernism is. I reject that. What I said
may not be the totality of postmodernism, but it is accurate, in that there
are definitely postmodernists who operate under the beliefs I described, and
the existence of even a branch of postmodernism that believes what I said is
sufficient for the point to be an interesting and valid criticism of those
beliefs. Personally it is my considered opinion that this is a foundational
belief of the entire philosophy and it falls apart entirely if it is
destroyed, and there's just varying levels of how obfuscated they manage to
make the fact that this is a foundational belief of theirs, but your mileage
may vary.

~~~
bbctol
What postmodernist books have you read?

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bluecalm
>>So, if you look at the world as repetition of bets, under condition of
survival, then mental accounting is not only not irrational but is necessary.
Any other strategy would be effectively irrational.

No, it's still irrational and it doesn't matter if there is repetition of bets
or just one available. Depending on your total net worth, living conditions
and values you have there are good bets and bad bets. A good bet is a bet
which maximizes expected utility of your money. It changes depending on your
net worth of course. It doesn't matter if you have just won or lost (this is
mental accounting) it matters what's your total net worth is at given time.

>>Actually, what I’m saying is even stronger. I am saying that even if you
have the edge, in the presence of the probability of ruin, you will be ruined.
Even if you had the edge … If you play long enough.

He wouldn't pass 1st year college math course with that one.

>>Unless you engage in strategies designed by traders and rediscovered by
every single surviving trader, very similar to what we call, something called
the Kelly Criterion, which is to play with the house money

He doesn't grok what Kelly Criterion is either. Kelly Criterion determines a
size of the bet which maximizes utility of money modeled as a logarithmic
funciton. That's it. It doesn't matter if there is string of bets available or
just one bet. If you have just won or lost doesn't matter either (only your
total net worth at given point).

>>And this is called, playing with the market money or playing with the house
money.

It's called being confused about basic math and economic concepts and then
criticizing people who worked on those.

Typical Taleb: confused, wrong, having no new insights to offer but making up
for those with new terms (absorbent barriers, really?) and a lot of words.

~~~
cardmagic
>> Actually, what I’m saying is even stronger. I am saying that even if you
have the edge, in the presence of the probability of ruin, you will be ruined.
Even if you had the edge … If you play long enough.

> He wouldn't pass 1st year college math course with that one.

Seems pretty straightforward to me. Let's say you play a game with an edge
where you win 2x your money 99% of the time. But if you lose once, you lose
all your money (1% risk of ruin). If you play this game 70 times, you are very
likely to end up ruined.

It’s a lot like smoking. One cigarette won’t kill you, but add up the
probability cigarette after cigarette, pack after pack, year after year and
the probability starts to skyrocket.

~~~
bluecalm
>>Seems pretty straightforward to me. Let's say you play a game with an edge
where you win 2x your money 99% of the time. But if you lose once, you lose
all your money (1% risk of ruin). If you play this game 70 times, you are very
likely to end up ruined

No one sane plays a game like that with all their money on the line. This is
not because there are future bets available but simply expected utility of
such a bet is negative. If you play for example with constant sizing your risk
of ruin is higher than 0 but lower than 1. It's very often very close to 0.

>>It’s a lot like smoking. One cigarette won’t kill you, but add up the
probability cigarette after cigarette, pack after pack, year after year and
the probability starts to skyrocket.

But it's not like that. Risk of ruin doesn't skyrocket even if your plan is to
make infinitely many bets. That is unless you do something very silly like
double the bet amount every time you win.

~~~
cardmagic
First of all, some people do play games like that. But put that aside for a
moment because it’s immaterial. Look at what Taleb is essentially saying: if
there is a chance you will be ruined, and you play long enough, you will
eventually be ruined. Even if that chance is 1%, probabilities add over time.
1.01 __70 = 2. If the chance of ruin is 1% then after 70 plays the chance of
ruin is 100%.

~~~
bllguo
What kind of math is that? In your contrived example it should be 1 - .99^70.
It's hard not to question your background in probability when you're involving
1.01 and 2..

~~~
cardmagic
Nice ad hominem attempt, but even though I accidentally switched a minus for a
plus, the point the math teaches is the same: risk of ruin accumulates with
the number of bets.

For more information check "Risk of Ruin"
[https://en.wikipedia.org/wiki/Risk_of_ruin](https://en.wikipedia.org/wiki/Risk_of_ruin)

