Financial Mathematics
razib | March 6, 2010Icelanders reject deal to repay British and Dutch:
The outcome of the referendum had not been in doubt since Iceland had recently been offered better repayment terms than those contained in the deal on which residents were voting.
Partial referendum results from around a third of the cast votes showed 93 percent opposed the deal and less than 2 percent supported it. The rest cast invalid votes.
But the rejection will still have major repercussions, keeping financial aid on hold and threatening to undermine the center-left government of Prime Minister Johanna Sigurdardottir.
"This has no…
razib | January 15, 2010The Price of Casino-Like Finance Is Higher Than We Think:
However, Maxine suspects that the longest term and most severe damage from the finance casino will not be from government deficits required to shore up too-big-to-fail banks and insurers. It will be from two powerful, long-standing price distortions that have distorted the composition of our labor force and the mix of human capital within it. The first distortion is the past diversion of some our best technical and mathematical minds away from physics, engineering, biology, chemistry, and, yes, even economics, to financial modeling,…
razib | September 13, 2009I'm reading Justin Fox's The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street, which is on many "To Read" lists because of its topical relevance. I think it is especially illuminating when examined in light of another work, Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith. As made clear by the title Fox's stance is generally skeptical of the efficient-market hypothesis (though Fox does often distinguish between weak and strong forms of the hypothesis, and is naturally not as hostile to the former as the latter). In…
razib | July 20, 2009Felix Salmon has been at the center of a discussion on the merits and value-add of financial innovation. He notes:
Then there's the more purely financial innovation. There are good things here too -- fractional reserve banking, factoring, common-stock limited-liability companies, tradable fungible bonds, stock-market index funds, that sort of thing. But on this front I think the low-hanging fruit was plucked decades if not centuries ago, and that we've long since entered a world of diminishing returns when it comes to the positive developments. Meanwhile, the negative developments, from…
razib | July 13, 2009Interesting Q & A on the "shadow banking" system over at The Atlantic. The last answer is illustrative of a major distinction between physical and social systems:
I use the term "Credit Insurer of Last Resort." And here's the idea: The Bagehot Rule - lend freely, at a high rate, in a crisis - dates from 1873. That was a good enough rule for the 19th century British economy, an economy that ran on short term commercial bills of exchange, 90-day paper. You can see for the new capital markets banking system we have a problem. We have 30-year mortgages that are the underlying asset that are…
razib | May 20, 2009Check out this Felix Salmon's interview (video) with Gillian Tett, author of Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe (the reference to "Tribe" is a wink to Tett's background as an anthropologist). Also, she was recently on NPR.
razib | March 21, 2009Needed for AIG and the TARP: Silicon Valley Compensation Schemes:
The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed--in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. And the engineers of…
razib | February 25, 2009How bank bonuses let us all down:
...Because banking is not about true risks but perceived volatility of returns: you earn a stream of steady bonuses for seven or eight years, then when the losses take place, you are not asked to disburse anything. You might even start again, after blaming a "systemic crisis" or a "black swan" for your losses. As you do not disgorge previous compensation, the incentive is to engage in trades that explode rarely, after a period of steady gains.
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If capitalism is about incentives, it should be about true incentives, those resistant to blow-ups. And there…
razib | February 23, 2009Recipe for Disaster: The Formula That Killed Wall Street:
In hindsight, ignoring those warnings looks foolhardy. But at the time, it was easy. Banks dismissed them, partly because the managers empowered to apply the brakes didn't understand the arguments between various arms of the quant universe. Besides, they were making too much money to stop.
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They didn't know, or didn't ask. One reason was that the outputs came from "black box" computer models and were hard to subject to a commonsense smell test. Another was that the quants, who should have been more aware of the copula's weaknesses,…