I’m currently reading Mandebrot’s “The misbehavior of markets” which in time I will write a review of, but about 100 pages in I have to say I’m pretty tired of him stating every couple of pages how he discovered fat tails in market prices forty years ago, and has known the whole time that Modern Portfolio Theory, Black-Scholes etc was based on the wrong assumption of a normal distribution all that time. There appears to be some interesting stuff in the book, and there is no doubt some of the basic assumptions of finance theory need a look at and possibly re-grounding, but its not like no one in the past forty years hasn’t been dealing with this.

Even though it’s very much ad hoc, markets already attempt to account for the fact that Black-Scholes is flawed, by pricing in an implied volatility smile. Similarly fat tails have been used in risk models pretty widely by now. Neither are completely satisfactory but are both clear signs that market participants at least realised the flaws in the models being used, and have tried to adjust accordingly while retaining some framework that actually lets you get on with things. Certainly this is not the impression you get from the early parts of this book where it seems keen to show that Mandelbrot is virtually alone in appreciating the problems.

There is a maxim in creative writing that an author should “show not tell” as in you reveal the abstract qualities of personality etc by showing the details not telling the abstractions directly. It would be well for non-fiction authors to realise that they will come off much better by showing us how smart they are by revealing the genius of their arguments and discoveries rather than by telling us how smart they are every couple of pages.

[…] This implies that rather than extreme market moves being so unlikely that they make little contribution to the overall evolution, they instead come to have a very significant contribution. In a normally distributed market, crashes and booms are vanishingly rare, in a pareto-levy one crashes occur and are a significant component of the final outcome. It has taken years for this to be taken seriously, and in the mean time financial theory has gone on using the assumption of normally distributed returns to derive such results as the Black-Scholes option pricing equation, ultimately winning an Nobel Prize in Economics for the discoverers Scholes and Merton (Black having already died), not to mention Modern Portfolio theory (also winning Nobels). That modern finance ignored Mandelbrot’s discovery and went onto honor those working under assumptions shown to be false has clearly annoyed Mandelbrot immensely and as mentioned previously he spends much of the book telling us of his prior discoveries and how he was ignored. […]

I totally agree! It seems like Mandelbrot has accepted Nassim Taleb as a sidekick because Taleb has wide appeal — being direct, simple, and acrid in his invective — unlike an academic. Too little, too late, his expression says in this video, but at least now I’m getting some the fame I deserve.

I also noticed Mandelbrot’s bitterness in his article on multifractal cartoons in finance. (Can’t find it right now.)

A friend of mine is getting a Ph.D. in biophysics (trendy!) and his dad works in a Swiss bank. He made the point clearest to me:

academics are in it for the fame

. There’s no money on the line, nobody who can sue you if you’re wrong, just making your ideas sexy to others. If Douglas Hofstadter says you’re right, you’re right — whether he’s right or not.

[…] This implies that rather than extreme market moves being so unlikely that they make little contribution to the overall evolution, they instead come to have a very significant contribution. In a normally distributed market, crashes and booms are vanishingly rare, in a pareto-levy one crashes occur and are a significant component of the final outcome. It has taken years for this to be taken seriously, and in the mean time financial theory has gone on using the assumption of normally distributed returns to derive such results as the Black-Scholes option pricing equation, ultimately winning an Nobel Prize in Economics for the discoverers Scholes and Merton (Black having already died), not to mention Modern Portfolio theory (also winning Nobels). That modern finance ignored Mandelbrot’s discovery and went onto honor those working under assumptions shown to be false has clearly annoyed Mandelbrot immensely and as mentioned previously he spends much of the book telling us of his prior discoveries and how he was ignored. […]

I totally agree! It seems like Mandelbrot has accepted Nassim Taleb as a sidekick because Taleb has wide appeal — being direct, simple, and acrid in his invective — unlike an academic. Too little, too late, his expression says in this video, but at least now I’m getting some the fame I deserve.

I also noticed Mandelbrot’s bitterness in his article on multifractal cartoons in finance. (Can’t find it right now.)

A friend of mine is getting a Ph.D. in biophysics (trendy!) and his dad works in a Swiss bank. He made the point clearest to me:

academics are in it for the fame

. There’s no money on the line, nobody who can sue you if you’re wrong, just making your ideas sexy to others. If Douglas Hofstadter says you’re right, you’re right — whether he’s right or not.

Why do I bother canillg up people when I can just read this!