Misbehavior of Markets: Mandelbrot

26 September, 2006

In 1963 Mandelbrot published research into the distribution of cotton prices based on a very long time series which found that, contrary to the general assumption that these price movements were normally distributed, they instead followed a pareto-levy distribution. While on the surface these two distributions don’t appear to be terribly different, (many small movements, and a few large ones), the implications are significantly different, most notably the pareto-levy distribution has an infinite variance.

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.
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Benoit Mandelbrot: Annoyingly full of himself.

4 September, 2006

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.

The ethics of what we eat – Part III

2 September, 2006

In the earlier parts of this I discussed what I see as the problems with the book from an Australian perspective and my discussion of the issues they have with factory farming.

The later sections of the book concentrate on “conscientious omnivores”, essentially people who still eat meat but make a conscious effort to buy such things as “free range”, “organic” and “locally grown” produce. Then finally, veganism.

Firstly they discuss the fact that many of the labels that indicate humanely grown or similar produce are not probably what they expect. In some cases only very token efforts have been made to gain these labels. I didn’t find this unexpected. Whatever the system is people will be trying to game it for their own advantage.

On the other hand they visit a number of farms that do practice legitimate free range production, and as expected, the animals have happier lives. We’ll never really know how much happier but pretty clearly happier. In the low density flocks many of the practices that are routine for factory farms such as debeaking chickens and tail docking pigs are not necessary.
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Harry Potter’s success explained

1 September, 2006

The reasons for the success of the Harry Potter books is apparently something other than good writing and a fun story. Something more sinister lies behind that lightning bolt scar on Harry’s forehead.

“Behind Harry Potter hides the signature of the king of the darkness, the devil,” Father Gabriele Amorth, the Pope’s “caster-out of demons”, said.

The books contained many positive references to the satanic art, falsely drawing a distinction between black and white magic, he told the Daily Mail in London. Father Amorth also said he was convinced that Joseph Stalin and Adolf Hitler were possessed by the devil.

Father Amorth is a little bit of a marginalised figure in the church, with the idea of exorcism not quite so popular as it once was. Although it should be noted that Ratzinger in his pre-pope days also thought Harry was a corrupting influence.

I always wonder why they even feel the need to comment on the books.

Fooled by Randomness

22 August, 2006

I’ve just finished reading Fooled by Randomness by Nassim Nicholas Taleb (2nd edition). Its a good book which makes some great points, but also has plenty of stuff that is annoying in it. The style as he describes it is not mathematical but literary-philosophical, which I don’t have issue with but I did find the author’s sneering and arrogance sometimes a little overwhelming.

The book is structured as a series of essays about the nature of probability and randomness, and how people can deal with it. Taleb is a derivatives trader who worked on Wall Street for many years and now runs a hedge fund of his own. As the heading quote on his website states:

My major hobby is teasing people who take themselves & the quality of their knowledge too seriously & those who don’t have the guts to sometimes say: I don’t know….

and much of the book is just this, mocking all those who make predictions, well beyond their knowledge. Journalists and others who ascribe causal relationships to random outcomes also get considerable attention. He makes much of the way that survivor bias distorts our opinions on things. We look at someone who had been extraordinarily successful in some activity and assume it relates to skill without asking how many people who did something similar failed. Are they good and we have something to learn from them, or are they just the lucky 1-in-32 who got five heads in a row? Without knowing how many people started in the endeavour and whether the successes have survived longer than we would expect in a random environment is the only way of having some confidence.

More than anything else Taleb’s focus is on what he calls “Black Swans”, the rare occurrences that inductive reasoning will never tell you about. His points are coloured particularly by two experiences. Growing up in Lebanon in the early 80’s war and by his experience of highly successful traders who, after years of success, lost everything they had made and much more in less than one month including their jobs by the Russian default in 1998. In the aftermath many would claim that such an event was completely unusual and unexpected, Taleb argues that our past experience will never be a good guide to such things and we will always run into these outlier events.
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The Ethics of What We Eat – part II

20 August, 2006

In the first part of this I dicussed what I saw as shortcomings from an Australian perspective, here I’ll actually discuss the book.

The book itself it is divided into roughly three sections, the first being a typical American family, who on analysis eat food that mostly comes from “factory farms”. The second family are “conscientious omnivores”, they are more discriminating the father is vegetarian and the meat that is bought is mostly free range. They also purchase on the basis on such concepts as buying locally, fair trade and organic food. The third family are vegan family, their main ethical concerns are about avoiding GM eating organic food and the question of whether it is ethical to raise children as vegans.

The attempt is made to trace where the food they purchase in each situation comes from, how that food is produced and what are the effects of producing it.
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The Ethics of What We Eat – Part I

15 August, 2006

I’ve just finished reading “The Ethics of What We Eat” by Peter Singer and Jim Mason (apparently called “The Way We Eat: Why Our Food Choices Matter” in the US). Not the sort of thing I usually read, but I was offered it by a vegetarian friend of mine who thought it would turn you off eating meat. I thought I might as well read it and, if the arguments really were that persuasive, well so be it (not likely but I would give it a go). Anyway what I have to say about it was getting long so I am cutting it into a few pieces so I actually get it out.

My wife commented that if someone sees you reading this book they’ll think you are a vegan (and possibly smelly), and I think she’s right. It’s a bit sad that people will assume that you read to confirm your beliefs rather than challenge them, but its probably what people mostly do. Certainly when I searched for reviews it seems that they are mostly done by people sympathetic to the general thrust of the arguments.

Over all I enjoyed the book, although I have numerous objections. In general I think the ethical logic is pretty well argued, its just I’m starting from some different precepts. I’ll come right out now and say it hasn’t convinced me to stop eating meat, but perhaps in one or two issues has swayed me a little into thinking about what food I should buy. In the end though I just plain disagree with the authors on the degree we should care about animal’s welfare. I value the suffering of the cow I eat my way through every 5-6 years less than my enjoyment of eating meat. Sounds a little heartless but I’ll elaborate later on.
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