Top Theorists Examine Rippling Economic Turbulence

That sums up the entire situation

For anyone out there who doesn’t know.

taleb published two books which told the bankers and economists that their risk models and the assumptions that the mathematical models underpinning their investment strategies and risk systems had anything to do with the real world were wrong.

The mathematics used by banks and countries and companies to analyse past statistics in order to predict future markets and predict risk are about as valid as the complicated mathematical spreadsheets drwan up by gamblers trying to beat the bookies…

Taleb is brilliant.
He saw it coming.

Yeah. Thats what it all comes down to. The assumptions that are decided upon to be the root of the models built up.

It’s a question of epistemology. Here’s a quote from Schumpeter.

“It is impossible to understand statistical figures without understanding how they have been compiled. It is equally impossible to extract information from them or to understand the information that specialists extract for the rest of us without understanding how this is done-and the epistemological backgrounds of these methods…. our stake in these methods is too great for us to leave judgement on the virtue or shortcomings, say, of the variate-difference method to specialists, even if they were unanimous about it.”

I think it’s also true to say that ‘the rest of us’ should also have a proper hand in the ‘assumptions’ that are used by the specialists.

And actually, these assumptions rarely require any technical or specialised knowledge for their understanhding. Just common sense.


His thesis can basically be boiled down to:

  • standard models use a bell curve which discounts mad thing happening
  • mad things happen all the time

To continue the gambling analogy, imagine a horse race that never ends. Bets are placed on horses. Sometimes the horses unseat their riders, but new riders can get on. Sometimes they fall and break a leg and are shot. New horses join the race, but this depends on the level of cash being bet. So what are the chances of a suffragette running under the hooves of one of the horses? Of someone shooting one from the crowd? Of there being weather conditions that stop the running altogether? The riders going on strike? The standard model assumes that the race will be run in near perfect conditions.

Sounds pretty tough on the horses.

There’s a chance the ISPCA might intervene at some stage too…

I postulated my “Iceland is the canary in the mine for western economies theory” to one of my friends in banking and specifically in risk. He complimented me on my analogy and said that it remained to be seen how many governments would be called upon to make good on the guarantees and what effect that might have on the currencies involved.

This might not happen but is certainly a danger

The closer people are to the risk engines and financial modelling at the heart of this crisis the more frightened they are.

Another comment he had was that unauthorised positions are a much bigger issue than people realise.

Is this why there has been so little fallout from €5bn of Soc Gen’s money going up in smoke, the realisation that there is worse out there? plus the scapegoats may be harder to find as they will be closer to the boardroom.

This feeds back once again into the fact that we do not have the information of what the problem really is right now never mind how big it is, because so much of the entanglement between the banks and insurers went on beneath the radar in unregulated “new” financial instruments. All we know for certain is that there is very little lending between banks because they do not trust each other and many of them have assets that are in truth worthless, disregarding bad debts and non performing loans.

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