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k-man
Gym climber
SCruz
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Jan 16, 2009 - 03:07pm PT
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Woody, haven't you heard? This is the dawning of the age of Aquarius.
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 16, 2009 - 03:29pm PT
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Read the book.
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hobo_dan
Social climber
Minnesota
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Jan 16, 2009 - 03:56pm PT
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I tried and it bored my ass
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Ed Hartouni
Trad climber
Livermore, CA
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Jan 16, 2009 - 04:40pm PT
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I haven't read the book, but there was a recent article in the NYTimes interviewing the author, having followed him around a bit...
The "modeling" done in economics to quantify investment risk was not news to me, and it is apparent upon a very brief study that those models have some very limiting assumptions, a physicist would say "domain of validity." The assumption that economic fluctuation can be modeled by a Gaussian probability distribution function ("pdf" not the document!) has obvious limits... and the parameterizations used to evolve the economic time series is similarly limited.
While the risk models do well to quantify a relatively stable situation, once the situation begins to behave beyond the model, the results of the model will not help you decide on how to respond to that situation.
I draw two conclusions from the current situation: 1) that models not based on "underlying" theory must be used very carefully and 2) the behavior that the economy just underwent will result in better parameterizations that will be incorporated into future models.
Ultimately, however, I despair that economics will ever have an underlying theory which can be used to build a "physical model" with predictive ability.
This is in stark contrast to other, controversial, models discussed on STForum (and other places). I am thinking about climate models. Climate models are more and more becoming the application of physical parameters to the atmosphere-ocean-land systems rather than a paramterization. As we understand the science that is relevant to this system, and make the physical measurements required for the system (the physics/chemistry of cloud nucleation, chemical reaction rates, light absorption rates, etc) the models depend less on the past answer and more on the underlying mechanisms.
The question becomes: has all the science been included?
The answer is by testing the output of the model to reproduce observation, and observation is the derived from recent climactic data as well as proxy data from the historic record. We would test the consistence of the model, and see what its deficiencies are, produce a more sophisticated model and test again.
As this has been going on for decades, the resulting models are better and better, leading to the belief that the models could be used to understand regional climate... Because these models are based on the underlying science, and not on a parameterization of history, the rest on a very solid base.
Further, many of these models can be applied to other atmospheres which can be observed and those observations understood as a result of changing the initial conditions. This could not be done with models based on a parameterization of earth atmospheric behavior. Because the underlying science does not depend on the specific atmosphere it is operating in...
The goal of a general economic model would be to have an underlying "science" that could predict the economies of extraterrestrial societies... as far as I know, there is little about economic theory that would be applicable... unless the economists stole the ideas from ecology, their meta-science...
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WoodySt
Trad climber
Riverside
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Topic Author's Reply - Jan 16, 2009 - 04:57pm PT
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From the layman's--mine--point of view, I don't have much confidence in the "experts" dealing with the present economic crisis. I sense they have all fingers and toes crossed. The world wide economic structure now existing is far more complex and possibly unstable than at any time before in history. Actions now applied are based on past models which don't comfortably fit the contemporary economic emergency. We're sailing on truly foreign seas.
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rmsusa
Trad climber
Boulder
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Jan 16, 2009 - 05:01pm PT
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* I haven't read the book, but... *
I have. It doesn't have a lot to do with models, except in a philosophical sense. Read the book.
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 16, 2009 - 05:31pm PT
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I will repeat the suggestion...
Read the book.
Not to pick on Ed here, but Gaussian? Definitely not. Gaussian is symmetric, prices are not (They stop at zero.) They do like the diffusion equation though - at the simplest levels. But economics is no more "scientificable" than predicting the average annual temperature of the earth's atmosphere in 2100, because they both depend on politics and all manner of other chaotic inputs in highly complex ways (humanity).
Here I do pick on Ed, but for a different reason. There is an asteroid moving around the sun whose position, momentum, etc. we know with fairly high certainty. And we know the physics even better. So why is there any uncertainty of its position in 2036, within plus or minus one earth's diameter?
The answer is because when you iterate forward from time T to time T + 27 years, the uncertainty is huge compared to its uncertainty at T. On top of that, we do not know what the solar output will be over that time, the cumulative effect of which matters.
The book is not only about economics, but questions, knowledgeably, the models used by economists whose fame got them "Economics Nobel Prizes".
Along with that book, get the one I have mentioned previously on disasters with complex systems. No simple models can explain the current economic crisis.
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Ed Hartouni
Trad climber
Livermore, CA
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Jan 16, 2009 - 07:10pm PT
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Here I do pick on Ed, but for a different reason. There is an asteroid moving around the sun whose position, momentum, etc. we know with fairly high certainty. And we know the physics even better. So why is there any uncertainty of its position in 2036, within plus or minus one earth's diameter?
because we don't know the position and momentum well enough to limit the error of a 27 year extrapolation to smaller than the earth radius. However, the error is incredibly small and the uncertainty can be calculated, rigorously.
We know better as it gets closer. However, I don't believe that we are worried about any large asteroids because we know were they are, and we know a lot about their orbits. So that is not an example of what I believe the subject of "The Black Swan" is: unknown unknowns (perhaps TiG would say unknowable unknowns)... and the Gaussian model is an estimate of the fluctuations of prices... not the price itself but the "noise" in the system.
But I don't know what was written in detail... I'm trying to get my hands on the book.... my criticism is of economic modeling, not of the book, and it isn't so much a condemnation of the modeling, but of those who would use the models to justify their irrational behavior.
"The model made me do it" isn't a good excuse for these models...
The alternatives to models is essentially "Wild Ass Guesses" or WAGs.... throwing hands up and saying "it's too complicated" is really just a cop out. The models work well in a limited area of application. And that is better than nothing.
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Toker Villain
Big Wall climber
Toquerville, Utah
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Jan 16, 2009 - 07:15pm PT
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I'm with Dan.
Its in my library, but it seems like he's trying to milk what should be a magazine article into a book.
Too much repetition, bored me to tears.
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paganmonkeyboy
climber
mars...it's near nevada...
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Jan 16, 2009 - 09:12pm PT
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ok - i haven't read the book, but the underlying problem i see with any sort of economic modeling is how do you model the greed or altruism of the uber-rich ? the actions of the few set the tone for many, one person or corporation can skew the whole thing...
think about it - how can you account for the greed and corruption at enron in a model ? wall street today and the *cough blowme* bailout? i'm not sure you can...
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 16, 2009 - 10:44pm PT
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Ed,
OK, respectfully I would not suggest that my meager understanding from years ago of relativistic quantum electrodynamics would match your complete mastery of the field, experimental or theoretical.
Even if I could, off the top of my head, toss out the equations and even solve a few simple examples today, I would not claim to have the same knowledge as somebody who did this kind of stuff continuously for years.
If you think about it for a few minutes, you are smart enough to know that if the measurement is not Gaussian, the variation of the measurement can not be Gaussian either. (If price is not Gaussian, the variation of price can't be Gaussian.)
You are right about the extrapolation of the orbit. That is exactly my point. There is an uncertainty of position and momentum of the asteroid, the planets and other bodies involved, as well as the solar radiation.
My point with that example of the asteroid is that the uncertainties are known with respect to positions and momentums of the various masses fairly well, the solar flux variations are unpredictable, but the variation (historically) is somewhat known. From this, we think we can extrapolate forward only 27 years and estimate to the hundredth or thousandth of a percent the probability of a collision with the earth.
This is about as perfect (simple) as science gets. We are in agreement that economics is not predictable in the same way.
Hopefully some day you will realize that not only are the physical uncertainties important to atmospheric physics, but for long term atmospheric physics, unknowables are, including politics, but also including the unknowables like whether fusion will ever happen and when, and whether batteries will ever be rechargable in less than 5 minutes.
:-)
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Ed Hartouni
Trad climber
Livermore, CA
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Jan 17, 2009 - 03:34am PT
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you are smart enough to know that if the measurement is not Gaussian, the variation of the measurement can not be Gaussian either. (If price is not Gaussian, the variation of price can't be Gaussian.)
this is not true at all. If your model of the world predicts the "average" price at some time t, for a set of parameters, p we can write the average price P as:
<P> = <P(t;p)>
that is, we have a model of the average price. Now if the fluctuation of the price is distributed in a random fashion with a standard deviation σ, then the probability that the price at some time t is Q would be given by the Gaussian probability:
℘ = 1/√(2πσ²) x exp[(Q(t)-P(t;p))²/(2σ²)]
the variance of the price is not related to the value of the price... but to the underlying mechanism that drives the variance. In this case we constructed it as a Gaussian, even though P(t;p) can be something quite different.
The problem is, P(t;p) has no "fundamental" physical origin in economics. In atmospheric science, or in celestial mechanics, the equivalent of this value DOES have an underlying physical theory. The degree to which unpredictable events like the solar activity can effect the prediction of the asteroid's trajectory can be used to set an uncertainty in the position of the asteroid at some time t, we would usually refer to such an uncertainty as a "systematic" uncertainty to distinguish it from a "random" uncertainty due to stocastic processes, or finite measurement, etc.
Because the effect of the solar activity on the asteroid is calculable, if we knew what the sun was going to do we could calculate the change in the asteroid's path. Because we don't know exactly, we can form a bound on the paths which represent possible paths, given some model of solar activity... maybe taking the historic minimum and maximum activity for the time period we are projecting the asteroid. Maybe something else. But because the effects are knowable, we can estimate our uncertainty.
if you don't know the underlying physical processes, you have no way of calculating the effects. That is state of the economic models, as far as I understand them.
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 17, 2009 - 10:06am PT
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When the price hits zero, the fluctuation can only go in one direction - it is not symmetric. As the price approaches zero, the randomness is similarly constrained - still not symmetric, and so forth.
The fluctuation can't be random!
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Ed Hartouni
Trad climber
Livermore, CA
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Jan 17, 2009 - 11:02am PT
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I agree with you completely TiG, when the price is so low that the Gaussian pdf doesn't make sense, you have to find the correct pdf to describe the variation of the price. If you don't know what the price depends on, your done, you can't... you might measure it a lot of times and then come up with something...
So if the fluctuations were driven by a very few, discrete, independent events, we would describe the pdf as a Poisson distribution, which is asymmetric and has a finite probability of having a value of zero. That might be the correct pdf...
But the economic models, as they were written, failed long before the pdf became an issue.
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Karl Baba
Trad climber
Yosemite, Ca
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Jan 17, 2009 - 12:37pm PT
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"When the price hits zero, the fluctuation can only go in one direction - it is not symmetric. As the price approaches zero, the randomness is similarly constrained - still not symmetric, and so forth. "
I dunno but these days, it seems when some prices hit zero, some subsidy or bailout is pumped in and for practical purposes you have a negative number
I know that's probably outside our models but the fact that economic models keep failing so miserably means they deserve some skepticism.
What do people say? Economics is the business version of Religion.
Peace
Karl
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WoodySt
Trad climber
Riverside
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Topic Author's Reply - Jan 17, 2009 - 01:55pm PT
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Beware "stagflation". It may be on the way, and we'll all die. Everywhere I look, darkness looms. I think it's time to hide in the closet.
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Redwood
Gym climber
West Sacramento CA
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Jan 17, 2009 - 02:17pm PT
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There might be a significant difference between modeling in the areas of physics and chemistry on the one hand and economics on the other. Physics and chemistry are pretty far away from what might be called a political power nexus. Whereas economics is intimately related to it. That means if anyone were interested in maintaining or directing the course of power -- particularly by means of deception -- that economic theories and models (especially those presented to the outside) might be tainted with distortions necessary for the control effort.
Everybody who considers these affairs hopes they're wrong these days, it seems. I hope I'm wrong, too; but I believe in the collapse model. More: we are at the end of an age. When the asteroid smacked into the earth way back when, causing the extinction of the dinosaurs, that was the end of the age (the Mesozoic). This is going to be like that, or even more so.
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jstan
climber
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Jan 17, 2009 - 03:45pm PT
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I have long thought economics might be modeled as are phase changes. A mixture of statistical mechanics and thermodynamics. It is all driven by perception and that is what has to be modeled. Collective psychology. But it is all going to be fast from here and there is no time for proving out a model.
Right now I am seeing the first questioning as to whether the resources of the Federal Government may become exhausted. It looks like we need to start hedging that eventuality. California is well along that road right now.
Unemployment continues to be the benchmark IMO.
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Lafta
climber
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Jan 17, 2009 - 03:53pm PT
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Wow! Some peeps here are waking up!
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graniteclimber
Trad climber
Nowhere
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Jan 17, 2009 - 04:07pm PT
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" Economics is the business version of Religion."
It's more like weather forcasting.
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Moof
Big Wall climber
A cube at my soul sucking job in Oregon
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Jan 18, 2009 - 12:08am PT
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Listen to a handful of Econtalk podcasts. It will blow your f'ing mind. Them god damn economists are morally twisted mofo's, and don't have a clue how the world works (each contradicts the last). It will truly make you scared as to who we let pass out 350 Billion, and who has the ear of our next president for the next 1-1.3 Trillion worth. We are f*#ked.
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rockermike
Mountain climber
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Jan 18, 2009 - 02:05am PT
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I don't think they are nuts, nor do I think their math is wrong. But in an infinitely complicated world they have to make "simplifying assumptions", and, as Talib points out, some of those assumptions are killers.
A couple of years back I was sent out to Chicago to train on some asset/liability management software - an essential part of treasury management for a bank. The instructors where hard core Un. of Chicago PhD finance guys. They're telling me the short version of what the software does in a theoretical sense - and I naively ask some dumb (at least they implied they were dumb) questions about extreme outliers that the model wasn't capturing.
Much as Talib explains all their modeling assumed smooth small step movements in interest rates and predictable relationships and liquid markets. I foolishly wanted to know "well, what if those relationships don't hold up?" Wrong question - lets get back to basic operational stuff and leave the theory aside. ha
But what else can they do? No one can "model" major financial earthquakes. The best they can do - or senior execs should do - is be aware of the distant possibility of such things and keep a thick cushion of equity. But more equity means lower return to shareholders means investors dump your stock to buy the next bank's, which means you lose your job. The game is rigged to incent bad behavior.
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 18, 2009 - 10:52am PT
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A man's gotta know its limitations.
Applies to physical models as well as economic ones.
The problem is distinguishing when you are approaching the boarders of the limitations of the models.
Aside:
I was taking a little mini-course on currency trading back in spring of 2007 given by professor of Finance with the NY Institute of Finance.
He started explaining the utility of using currency swaps for international trade. Without getting into the details, the idea is that you set up an opposite position in the future to an actual trade in your business to convert customer currency into your currency at today's price so that you do not risk a losing deal due to currency fluctuations (or a windfall profit).
I pointed out that the trade was not riskless, but rather that it was transferring currency risk to credit (counter-party) risk. He explained that the trades were only done with really large banks so that counter-party risk was not material.
Fast forward to today. I know a guy just out of college working for a hedge firm. He is working 12 hours a day reversing currency swaps. He says some of his buddies are doing similar things 14 hours per day.
A man's gotta know the limitations of models, trading strategies, trading partners, and his own firms capitals and risk profile.
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Karl Baba
Trad climber
Yosemite, Ca
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Jan 18, 2009 - 12:51pm PT
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The absolute hell that we have only begun to experience is proof.
The failure of the smartest guys in the country to consistently beat market indexes despite having the most detailed and long term quantitative statistics concerning a vast array of variables is proof.
Economics is more like Religion than science. (perhaps we might grant it a place next to anthropology and sociology)
Some of the biggest companies in the history of the world have either gone down or been saved from going down by massive government bailouts.
Bill Frist claims the lives of 10 million Africans was saved by a 15 billion dollar investment by George Bush and yet we spend 100 Billion to save AIG. Chew on that.
Every turn of the road to where we are has been quantified and analyzed every step of the way by people who could handsomely profit from knowing the future, and yet many practical people have seen this coming including ignorant people like me.
So economics is either a deeply flawed farce utilized by corrupt greedy people to believe what they choose to believe, or it's a farce utilized by corrupt greedy people to transfer wealth through bubbles and crashes. You tell me which.
Because it doesn't take a medical professor to tell a guy that if he goes on an 8 year bender of cocaine, heroin, and speed, which is paid for by borrowing money from loan sharks, that he's going to need serious rehab when his dealer leaves town, and protection from bill collectors as well. He still might get hurt.
Peace
Karl
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Karl Baba
Trad climber
Yosemite, Ca
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Jan 18, 2009 - 01:59pm PT
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Thanks Skip
I was aware that this was a bit of stretch on that point, except that of course, nearly every investment professional tries anyway, and rich, smart people pay them a big premium over index funds to try. (fatty will see the opportunity to chime in with his wares here, why not?) The guys who boss around piles of these not-index-fund-beating losers earn 500 million over 5 years and then become treasury secretary.
and since we have economic data up the ying-yang and all these economic models, it should be plain and clear that the market was going to tank and yet these clowns lose money anyway. (because we can bet on the market going down as well)
Which goes to show my basic point, that economics is as good as witch-doctoring in some very basic ways.
Imagine if climbing topos were like economics.
"Topo says it's a 5.9 crack that's 2 inches for first 20 feet, 1.5 inches for 40 feet, has good rock, a fixed anchor on top with 1/2 bolts, and has been ascended by 400 5.7 climbers, 600 5.8 climbers, and 55 5.6 climbers. Your climbing handicap gives you a 99% probability of sending if the difficulty doesn't somehow change radically. There are 10 pound of loose rock on the top of the crag but it's 10 inches from the edge."
You get on the rock and the crack somehow squeezes to 1/4 inch in an earthquake, crushing your hand, you have to bite off that hand to grab a government fixed line with the other hand, but you find the line wasn't lowered to you, but your government befriended belayer who needs to get back down the approach trail to go on a government paid patagonia expedition. You bleed to death at the base.
PEace
karl
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Karl Baba
Trad climber
Yosemite, Ca
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Jan 18, 2009 - 03:24pm PT
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Thanks Skip
All analogies have their flaws and the climbing one was mostly for humor.
In my opinion, we are all sitting in a giant stinking pile of proof of the limitations of economics.
The proof is in the chocolate pudding.....wait, economics said it was chocolate but really its.........
;-)
Karl
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jstan
climber
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Jan 18, 2009 - 06:08pm PT
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Lafta:
Search on "Greenspan" and you will find a long history of interest in this subject. As chance will have it on Sept. 17,2007( now considered the start of the prime meltdown) I complained about what is presently taken to be a major cause.
Lot of people have been awake for a long time.
On another subject.
The Black Swan is not alone in pointing out that many of the modern factors such as rapid communications and globalization contribute to increased volatility and danger. I believe there is another.
Have you noticed there is now a remarkable similarity in different peoples's responses to external stimuli? You talk conservative politics and immediately you are dealing with angry people. Not logical or analytical. Just angry.
To understand this I think you need to go to the major revolution now taking place in what used to be called psychology. Evolutionary Psychology is changing that field from disconnected observations made by long haired people standing around a campfire while handling bones. It will shortly become a true science where theories may be tested. I would refer you to work by Bass and some of Dawkins' work.
Its premise is that groups of people evolve, in the Darwinian sense, particular responses and behaviors to deal with externalities (problems). The incredible speed of modern communication has decreased by orders of magnitude the time it takes for this to happen. Followers of a particular political thought very quickly pick up which responses are acceptable and make them members of the group. So it is when a particular "spin" has been launched or a response like anger has been stamped as acceptable it becomes widespread almost overnight. You don't have to be an "elite" to pick up on this.
Now when you apply this phenomenology to behaviors associated with economics you can see the danger. When people who perceive a problem are also preconditioned to have the same response - you have a bonafide "panic". It is pre-constructed. It becomes inevitable.
This tendency to "panic" will also open new methodologies for profiteering. Just go left anytime you can predict everyone else will be going right.
You need only be able to predict.
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Karl Baba
Trad climber
Yosemite, Ca
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Jan 18, 2009 - 10:26pm PT
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Finally watched the video.
Seems like "Turbulence" is where we're at and why nobody really knows how to save us.
Feels like a storm on the way.
Peace
Karl
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 18, 2009 - 10:41pm PT
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What jstan means is you "only have to be able to predict" about the future.
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Karl Baba
Trad climber
Yosemite, Ca
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Jan 18, 2009 - 11:01pm PT
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Skip
I never think anything is "always."
and the government is never out of the picture as it is a large part of the picture.
anywhere in the world, throughout industrial history.
A more nuanced approach to actual reality will trump idealism.
(although a lot of reality is being marginalized by the label "idealism" (climate change, oil depletion)
Which gives me hope that Obama is our best bet.
Peace
Karl
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TradIsGood
Chalkless climber
the Gunks end of the country
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Jan 19, 2009 - 06:52pm PT
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Ed,
My Life as a Quant: Reflections on Physics and Finance, Emanuel Derman.
I picked this up for Roger. Just read the intro and chapter 1. You might find it interesting. Derman is one of the authors of the Black, Derman, Toy models for interest rate derivatives.
Got his Ph.D. in Theoretical Physics from Columbia in 1973. You might know him or of him since his work was in particle physics.
Interestingly enough, he and I each worked for the same man, at different times. I had not known that.
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TGT
Social climber
So Cal
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Jan 19, 2009 - 11:54pm PT
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Read Mandelbrot's The (Mis)Behavior of Markets a fewe years ago.
The Ten Heresies of Finance chapter is particularly important especialy Heresy #1. Markets are Turbulent.
In the video, he looked worried!
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WoodySt
Trad climber
Riverside
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Topic Author's Reply - Jan 20, 2009 - 11:32am PT
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Well, I'm off to MT. Lemmon. I expect you guys to have the economy fixed by my return.
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Ed Hartouni
Trad climber
Livermore, CA
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OK, I just finished the book. I've got to say it was a slog, Taleb provides a long string of one off stories, largely to convince the reader that unanticipated events can have a very large effect on our lives.
That's not a new idea.
Specifically about economics, however, he derides the mainstream approach of modeling, including the attempt to quantify risk. What is maddening is the lack of description of what is done, and what Taleb's criticism is... basically it is a rant. I found it rather unilluminating, though I think I agree with what I think is the main point of his criticism, which is basically: there is no model.
Ask yourself what the historic rate-of-return is for the stock market. You'll get various answers somewhere in the neighborhood of 7% per year. That's not bad... probably better than anything else you could do.
Your assumption, is of course, that the stock market will behave the same way as it has, historically, over the time period of your investment. But that's not a model.
You could get more sophisticated and project the time series return for a set of investments into the future, and try to guess the deviation. If you do this, you find the "standard deviation" of the historic rate of return to be something like 18%... which should set off all sorts of alarm bells for you assumption above, that's larger than the value, which means, basically, it could be anything.
Taleb would argue that this is right for the wrong reasons... but I would argue that this is not a model of behavior.
In my mind, a model is based on a quantitative explanation of the activity.
Let's take the sun rising tomorrow. I can take a time series and say that tomorrow will be like it has been in the past. I'll get a pretty good prediction, but it isn't a model.
If I take as the model the idea that the earth rotates on its axis, and measure the rotational period of the earth, I can calculate the sun rise. I have to put in the rotational speed of the earth. Of course, I also learn that the earth is tipped out of its orbital plane, so I have to modify my model to account for that. I can predict the sunrise, but the more accurately I do that, the more I find that additional factors have to be taken into account, like the wobble of the axis, that fact that the earth's orbital velocity and rotational velocity are changing, etc...
But doing this provides increasingly accurate predictions of the sunrise.
Now for the stock market... it is said that "fundamentals" are what generate the historic rate of return, but this is not a quantitatively described concept... basically, there is no "model" that tells us what the stock market should do. There are no parameters to input that has the value pop out...
... what is done instead is just extend the time-sequence into the future.
Taleb says that events that cannot be predicted can completely destroy these "models," and the various quantities that are calculated from them, like risk. These events, he calls them "Black Swans" are important, perhaps more important, than the apparent historic stability of the markets.
There are many examples of this, many beyond what are displayed in the book.
The book makes a convincing argument, but it left me with a feeling that really all this investment stuff is essentially like going to Vegas and gambling the cash away... the only difference is that I can calculate the chances of winning in Vegas (pretty slim over the long run, a time relatively short) where as I cannot calculate my chances of "winning" in the stock market.
Given the current state of the economy, and the debacle of judgement that we just went through where greed essentially undid market, I feel I could probably do just well enough with the money I have extracted into a 401(k) as putting into the market.... especially since having broke even is considered to be good, I think I did better than breaking even, but I won't claim it is because of anything I did... rather it was Debbie's risk averseness...
And actually the "mortgage bubble" was hardly unforeseen, rather, people just didn't understand that housing "value" could not keep increasing in an unlimited fashion, at some point, the price of housing just overwhelms the ability of people to pay. Yet few could resist buying into the market... they were making so much money, and projections of the past performance into the future pointed the way to even more return.
Because the reason for the increased return was not understood, and I use the word "understood" in a physics sense (calculable, predictable, limitations understood), it was easy to forget relatively elementary limitations to the "model."
So I ask those of you out there who know: why should anyone use the "historic return rate" of the stock market to project any future return?
Indeed, why should one invest in the market at all?
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Ksolem
Trad climber
Monrovia, California
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You scientists are a trip.
"When the price hits zero, the fluctuation can only go in one direction - it is not symmetric. As the price approaches zero, the randomness is similarly constrained - still not symmetric, and so forth.
The fluctuation can't be random!"
The price of real estate, when upside down, is way below zero. Or any other investment which is worth less now than what you bought it for.
Sorry, no Gaussian or Nebulistian terms from me, but upside down is less than zero.
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Ed Hartouni
Trad climber
Livermore, CA
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so I wrote the above post over a year ago, and right now, the investment markets are all pretty much broken...
if you have savings, you are lucky to be making 1% on interest (see NYTimes today, e.g. http://www.nytimes.com/2010/09/09/business/economy/09rates.html);, the current interest rates make it attractive to take out more loans, and refinance old ones... but what would you do with the money you save?
Obviously, if you were conservative in your planning and assumed that you would only get a 5% return on your savings, you're currently hosed (this in spite of everyone accusing you of being an idiot to assume such a "low" rate of return).
The financial markets, at this point, really look like an open gambling game, that is, one where there is no "house" but obviously winners and losers, with the winners having the necessary connections to push legislation through favoring their position, and the losers being the ones putting up the skin for the winners (that would be the US Gov, and the taxpayers)...
...yes, anyone can play, but just like going to Vegas, the game is staked against you. SOMEONE MUST LOSE in order for someone to gain.
Growth in financial value should track the growth in the markets, and the markets can only grow so fast, limited by people to buy the stuff, and are only so big (limited by people, again). You'd expect that growth rate to be not much more than the population increase, and the rate of growth in standard of living. Right now it's an interesting race to see if the resources run out before the demand is met... the "carrying capacity" of the planet... which is estimated to be around 9 billion people (http://atlas.aaas.org/index.php?part=1&sec=trends); ...
Not everyone can win...
...I ask again, why invest in the markets? What possible model explains the market's behavior...
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HighTraverse
Trad climber
Bay Area
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What possible model explains the market's behavior... I assume the "..." implies you think the solution space is nil.
I have a few personal observations: In My Not So Humble Opinion
1: "the market" is a shibboleth that misleads us into thinking it's a "thing" or a "process" and therefore can be modeled with mathematical constructs.
2: "the market" is merely the aggregate "behavior" of a massive number of human and corporate decisions (including the algorithms that participate in automatic trading).
3: Humans are not entirely predictable.
4: Most Corporations have zero altruistic motives. They are in business to maximize return on investment. Human cost is irrelevant until it affects the bottom line. Corporations do not make decisions based upon the interests of people, not even their consumers.
5: Corporate Officers and Boards of Directors can be incredibly stupid. Their decisions can directly affect tens of thousands of employees and stockholders overnight. HP stock dropped 25% nearly overnight when they fired Hurd and hasn't started rising yet.
6: In America, corporations have two sometimes out of phase forces: the Quarterly returns vs the Annual returns. What saves a Corporation's ass for this quarter may not be in the long term interest of the Company nor its investors. European and Asian companies are not so impatient.
7: True Republicans (as distinct from true conservatives), Libertarians and other such idiots (Alan Greenspan, Milton Friedman) profess to believe the a "free market" (as if such a thing could possibly exist) is a Holy Thing. Mistaking the shibboleth for the reality.
8: In classical terms "the market" assumes a large number of relatively equal players. This assumption is crucial to believing the market can be statistically modeled. It works fine to describe millions of people choosing between dozens of breakfast cereals in thousands of retail stores.
9: The real "market" is not #4 (obviously).
10: The only people who can directly control the decisions that result in market changes are the Federal Reserve, Politicians and Really Big Capitalists (GM, Morgan Stanley, Bank of America).
11: Trade Unions have only a minor direct influence on control decisions. Or in modeling terms, their decisions are very low gain inputs compared to the inputs from #10.
that leaves
12: The control decisions are not made by the people who generate capital by their labor.
13: "the market" when it is stable, by definition follows statistical models (ipso facto).
14: "the market" when it becomes unstable behaves more chaotically than statistically.
15: when chaotic, the results of macro-economic inputs (stimulus packages, tax changes) cannot be predicted with numerical certainty.
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Ed Hartouni
Trad climber
Livermore, CA
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the time series doesn't tell you anything at all,
the current disaster is the result of extrapolating the time series into the indefinite future, assuming that what was will be... that was the entirety of the model.
Using a model like that you have only yourself to blame when the past isn't an indication of the future.
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hooblie
climber
from where the anecdotes roam
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talk about butterfly effect:
michael lewis, on the ground in greece, portrays the greek economy, and goes on to interview the monks that scored a real estate deal that tipped the electoral scales that led to spilling of the beans on greek debt ... that dumped the euro on it's head.
i'm of the mind that before it's over all debtor nations will default.
http://www.vanityfair.com/business/features/2010/10/greeks-bearing-bonds-201010
i liked the part about huge tolerance for almost universal system gaming. until ...
outsiders got one over on the system. how are you going to model that mentality?
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bergbryce
Mountain climber
Oakland
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Haven't most economists admitted that beyond a few things, the best they can ever do is make educated guesses? Economics isn't like other sciences with un-debatable standards, but rather a mish-mash of very difficult to account for parameters. It's a crap shoot and some economists are just better than others at "predicting" what is going to happen.
The ones with author-like talent and the most extreme ideas sell the most books though.
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Ed Hartouni
Trad climber
Livermore, CA
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so if you invest, you don't worry about understanding what would effect your investments...
you're saying it really is just rolling the dice, or giving your money to someone who rolls them for you...
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HighTraverse
Trad climber
Bay Area
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the time series doesn't tell you anything at all Unless extrapolated backwards. Then its uselessness becomes apparent.
I'd guess none of the models can deal with the global economics in flux.
Or at least $1 trillion dollars for wars in Iraq and Afghanistan so far. Joseph Stiglitz estimates as much as $3 trillion in Iraq before we're done. $9630 per US resident (2008 population)
A massive transfer of wealth from the US taxpayer. But to where? Accounted for in which economic models?
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bergbryce
Mountain climber
Oakland
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so if you invest, you don't worry about understanding what would effect your investments...
you're saying it really is just rolling the dice, or giving your money to someone who rolls them for you...
I don't consider "financial advisors" or whatever those parasites call themselves (the people who get a cut of my investment earnings for "managing" my accounts) economists. I do put thought/time into where my investments go and choose accordingly and I am no economist. I'm thinking more along the lines of policy makers, the people who analyze the big picture and have the ear of the real movers and shakers.
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rockermike
Trad climber
Berkeley
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I'm pretty familiar with money management theory, and I've worked a good bit with with interest rate risk models (perhaps models isn't the right word? ha) used by big banks. In both cases they are packed with simplifying assumptions that mean they are good for no more than general guidance. The quant guys that run and program these models are well aware of their limitations, but at the end of the day its "the board" that makes the decisions. And they in turn are strongly incented to simply ignore outliers and maximize relatively short-term profits.
The problem in my mind isn't the models in themselves - as long as they are recognized for what they are - but the fact that smart guys see the weakness of the models and invent ways to game the system. Any fool could tell you that AIG and friends were gambling way beyond their capital levels, but the politicians don't have the stomach to take these guys on and meanwhile lots of money was pocketed before the inevitable failure.
By the way, most of the quant guys on wall street are drop-out physicists. Either not smart enough to make it in their field, or smart enough to know where the real rewards are. Perhaps both. lol
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Ed Hartouni
Trad climber
Livermore, CA
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Sep 10, 2010 - 12:05am PT
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we all got recruited hard at Columbia, and very smart guys went to Wall St. instead of staying on in physics...
...those smart guys knew how to find other smart guys. Don't think that was the problem. Just different people with different views of a career...
I think I'm looking for something very simple, or it ought to be very simple:
what is the "thing" that makes people quote a "historical return" of 5% or 7% or whatever...
I think there is not such "thing"
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Steve L
Gym climber
SUR
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Sep 10, 2010 - 12:19am PT
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There is no one "thing", rather there are many "things". When was the last time you saw the methodology behind historical returns? There are plenty of ways to start with a result and work backwards.
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Ed Hartouni
Trad climber
Livermore, CA
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Sep 10, 2010 - 12:23am PT
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I think my premise is stated above, that at best you can break even in a thermodynamic sense... human "values" get mixed up in this but in the end, I think it is difficult to justify very large increases on a return on investment, especially if you account for all the winners and losers...
I have no doubt that people make money on the markets, they are doing it because others are losing money...
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Steve L
Gym climber
SUR
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Sep 10, 2010 - 12:47am PT
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Very, very few people make money over time on asset price appreciation or depreciation. The best managers are only the best for a given time sample. They all revert to the mean. The largest and most consistent sums of money made in the markets are made on management fees and transactions costs.
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jstan
climber
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Sep 10, 2010 - 01:04am PT
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A few weeks ago I got a book for $4 at Borders. The Great Depression Ahead by H Dent. He goes on at great length about using periodicities to do his analysis and predictions but it's his focus on fundamentals and demographics that sounds more germane to me. If you look at the fundamentals for the US position in global trade and technology development/investment you can't explain why one would feel we are going to have growth even vaguely like that of the past. Dent says returns will be low at least till 2020.
Presently we have sustained ourselves at a level higher than is supportable ( I think) because our economy has been bloated through our going outrageously into debt. We are big and our currency is the primary reserve currency - artificially. All of this is changing.
I was just about convinced we have gone through a phase change even before getting this book. The cost of labor in the US has to move closer to the planetary mean, seems to me.
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hooblie
climber
from where the anecdotes roam
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Sep 10, 2010 - 06:10am PT
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disaster, death, bad news? change should carry such a burden? are we so invested in status quo and it's continuation that a black swan should be such a dour sight?
i hope we're at a point of inflection, bad news if we aren't. i question whether investors are so entitled to a "set it and forget it" return that unsustainable growth should be perpetuated on their behalf. adapt already because it's a trader's market these days.
it's doubtful the quants will ever properly account for the neurobiology of trust, or the market dynamics that result from a crowd's fear of change, when change is clearly called for. granted there's more soul to be found in the physics department than in accounting.
the market would have punished any investment banks that muddled along with the old risk models, underperfoming relative to the others until every member of the board fully grasped the implications of the derivative business. make allowance for discovery.
there's nothing cynical in the phrase "known unknowns, and unknown unknowns."
we can't lose our taste for adventure, if that's what you call responding by retooling.
especially when the planet demands it
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jstan
climber
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Sep 10, 2010 - 11:43am PT
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Stock market predictions are like eating a pizza.
You leave the fishies.
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Reilly
Mountain climber
The Other Monrovia- CA
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Sep 10, 2010 - 11:52am PT
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jstan noted that "If you look at the fundamentals for the US position in global trade and technology development/investment you can't explain why one would feel we are going to have growth even vaguely like that of the past."
Hard to see much growth in our future with an economy based on service and
credit. Our latest 12 month trade balance of -592 billion doesn't look so hot
compared to Germany's +211 billion. It would seem there is still a demand
for manufacturing as long as it done well.
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