Why some people won't stop teaching others how to lose money (or Still Getting Fooled by Randomness)
I wanted to put up a quick blog post about an interesting thing I experienced last week. I went to a presentation by a prominent finance academic (he holds posts in some top programs ... programmes in British English ... in finance, and has written a well known book about quantitative investing). He presented the results of a theoretical paper he wrote extending some of the standard neoclassical financial models in what I hoped would be interesting directions. Instead, this chap seemed to be making some of the same mistakes -- and, in some cases, introducing new errors into already flawed models -- that had been made before by some of the (unfortunately) leading figures in quantitative finance.
I politely asked him how his model related to the types of difficulties we have just faced (i.e., the credit crisis, real estate bubble bursting, Northern Rock, etc.) -- and his model, as advertised, should have had something of substance to say about it. Sadly, he and his cohorts (mildly) dismissed my musings. Their rationale was that their simplistic linear model couldn't cope with the non-linearity of the way real financial markets work (aside: actually, even based on linear type maths -- vector spaces, independence, etc. -- I and a few others doubted that the presenter's model was valid). Rhetorical questions: Isn't that the point? Why claim that you have a model of how financial markets should work when it doesn't and probably won't work that way?
I wanted to respond by saying something like: "Sorry for bringing in a dose of reality and spoiling the fun of building models of fantasy worlds." But, prudently, I didn't say anything of the sort.
But what this incident goes to show is that -- despite a cold slap to the face by the true nature of uncertainty (not continuous, but extremely discrete; not linear, but non-linear) by events that are barely a month old -- there are still people teaching finance to impressionable minds that refuse to incorporate some degree of humility and reality into a subject that can use quite a lot of both.