
Nassim Nicholas Taleb: the prophet of boom and doom - gaika
http://business.timesonline.co.uk/tol/business/economics/article4022091.ece
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ctkrohn
Taleb makes some valid points but it's a little ridiculous to blithely assume
that everyone always underestimates the probability of rare events and thus
all mathematical finance is useless. There's a whole field of study --
behavioral finance -- dedicated to discovering and understanding the facets of
human nature that cause us to over and underestimate probabilities. Financial
models often make simplifying assumptions that can make users complacent --
e.g. log-normal distribution of prices -- but they can also lead to a good
number of useful facts and methods if you're aware of the dangers of the
assumptions.

I think Taleb is taking the easy way out. Rather than doing the hard work of
modeling fat-tailed probability distributions, or studying how people
mismanage risk, or building new financial models with more realistic
assumptions, he throws up his hands and says that the future cannot be
modeled. To his credit, he did once run a hedge fund based on his principles
(called Empirica), but it was forced to close. Whether this was due to a lack
of rare events or to mismanagement, no one can really know.

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1gor
>Rather than doing the hard work of modeling fat-tailed probability
distributions.... or building new financial models with more realistic
assumptions...

Unfortunately, you are wrong and Taleb is right.

The future of a dynamical system such as market cannot be predicted any better
than a weather can be predicted one month from now.

You could try to 'model' the temporal structure of the market (trying to find
and describe its 'strange attractor'), but this is pointless because this
market system has too many dimensions and your measurements of the system are
too noisy and incomplete.

The best you can do is to run some 'local' predictor. Like simply build a
black box model based on the system's past and predict tomorrow based on what
you've seen in the past. This works quite well but only for the very short
term horizon. And it is not the 'model' you are thinking about.

You should dispose of the traditional statistics altogether. It simply does
not work in real life and all of the kludges developed to save it (like ARMA
models etc) are pointless.

As far as his fund is concerned, I would think he has done right by stopping
trading in times when his strategy did not work. His strategy was to buy out
of money options. Well, we had almost ten years of falling volatility and he
would bleed to death in such an environment. A log of smart traders also went
out of the market (Soros etc), some are coming back now.

Taleb is not even such an innovative thinker. All of the stuff he is talking
about has been an active field of scientific study, but he is valuable for
being a popularizer of these ideas.

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ctkrohn
I'm not saying that you should try to predict the future of the market. I
would agree with you that in many cases, this is a fool's errand.

Mathematical finance is about a lot more than prediction, however. Risk
management is even more important, since there are so many market participants
who find themselves exposed to risks that they must hedge. Even your
neighborhood mortgage banker is exposed to interest rate risk -- both the
level of rates and the volatility of rates. Any multinational corporation is
exposed to foreign exchange risk. An option trading desk will often find
itself exposed to volatility and correlation risks. It would be foolish to
leave these unhedged, and without some sort of a model you're forced to. The
right way to approach this isn't to treat markets as some inscrutable thing,
but to propose the best method you can and be aware of the risks you remain
exposed to.

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1gor
The only true hedging is - you got an asset - you sell it forward. You are
hedged.

What passes for hedging and 'risk management' today in the financial industry
is something different. You measure how one instrument has correlated with
another instrument (or a basket) in the past build an offsetting portfolio
based on these correlation matrices -- and voila!

But your assumptions that those correlations between assets will stay the same
in the future (including volatility etc) are baseless. As you see, it is also
predicting the future. And it is wrong.

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ctkrohn
It's often impossible to sell an asset forward, especially an illiquid one.
Suppose you are a trading desk that makes markets in corporate bonds. If a
client comes to you and wants to sell a given company's bonds, chances are
that you will not be able to immediately find a buyer. You will probably be
forced to hold on to the bonds for a bit. Now you're exposed to interest rate
and credit risks. What do you do? You can hedge some of the interest rate risk
by paying on interest rate swaps, and you can hedge some of the credit risk by
buying protection in the credit default swap market. But without some kind of
model, it's going to be impossible to determine how to use these tools to
hedge your risks. Your only other options are to guess, or to do nothing. If
you are a large player in the markets, this is extremely dangerous.

Certainly, it's foolish to assume that you are ever perfectly hedged. In this
example, several things could go wrong: e.g. credit default swap traders could
have a different view of a company's creditworthiness than corporate bond
traders, forcing you to pay exorbitant prices for protection on the bonds. But
this is a smaller risk than holding the bonds outright.

In short: models can be helpful in risk management, as long as you are aware
of the residual risks you are exposed to. Just don't allow them to make you
complacent or overconfident.

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riklomas
The tips on the last page of that article are great.

If you've not read The Black Swan already, I would highly recommend it, it's a
fascinating book.

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Tichy
Is it better than "Fooled By Randomness"? That one was an enjoyable read, but
it wasn't really a well structured book. It seemed more like "random"
ramblings, all with essential the same theme. Still enjoyable, as I said, but
I expect Black Swan to be just the same, so I did pass on it so far.

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menloparkbum
Black Swan is written in the same style and has the same content to rambling
ratio. Same points made, too. Not required reading. Makes a good "I have a 2
hour flight" book.

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bgutierrez
I listened to Taleb speak at the Long Now and all he really said was, "The
future is hard to predict." He was either underestimating the crowd and
pulling his punches, or he had very little to say in the first place. Either
way, I'm passing on The Black Swan.

~~~
eugenejen
He actually has not much to say.

All his point in fact is just "Instead of trying to predict future, how about
let's just prepare for worst first?" So instead of computing probability of
stock market index rising or falling in june 2009. The strategy is just "if
all our current holdings dropped 75% in values? what is our protection against
such happening". Instead of trying to bet on probablity, he just tries to
hedge when black swan happens.

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eugenejen
A very nice interview. I found the long lost intellectual delight when I read
NNT's "fooled by randomness" and "black swan" last year.

Two writers that I admire most lately are PG and Taleb. I feel amused when
their writings sometime just create a storm because most readers feel so upset
from what they write.

One most interesting part from this interview is about Taleb's fitness
program. PG's "You weren't meant to have a boss" just popped out from my mind.
It looks like both of them though walking down different paths in life have
found the same reality that rest of the world seems unaware of or long
forgotten.

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nir
I'm reading his book now, and it's excellent. And I rarely enjoy non-fiction
'meme of the day' type books.

His book is like conversation with an older, intelligent person who has the
kind of wisdom you get from life experience. It's also _very_ relevant to
anyone working in a startup.

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mynameishere
It doesn't seem like he's saying much more than any other market bear, of
which there are many.

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twak
starts getting interesting on the second page, worth a read for the fantastic
quote:

“Scientists don’t know what they are talking about when they talk about
religion. Religion has nothing to do with belief, and I don’t believe it has
any negative impact on people’s lives outside of intolerance. Why do I go to
church? It’s like asking, why did you marry that woman? You make up reasons,
but it’s probably just smell. I love the smell of candles. It’s an aesthetic
thing.”

