http://blogs.reuters.com/justinfox/2010/10/18/why-didn%E2%80%99t-people-in-finance-pay-attention-to-benoit-mandelbrot/
A 1965 article by Mandelbrot in the Chicago B-school’s Journal of Business proved that a rational financial market would be an unpredictable one, providing an essential building block for what soon came to be known as the efficient market hypothesis.
After the 1987 stock market crash, brought on in part by portfolio insurance strategies built upon Black-Scholes, Mandelbrot began paying attention to finance again, and some financial practitioners actually began paying attention to him. So he made a partial comeback. But the reliance on risk-management systems based on the belief that price volatility can be easily measured and predicted has continued, and it has continued to lead the financial system to the brink of disaster every few years.
So why haven’t finance academics and practitioners paid more attention to Mandelbrot’s warnings? I think it’s mainly that he didn’t provide them a handy alternative to Black-Scholes. I can’t pretend to fully understand the practical implications of his fractal view of markets (and yes, I’ve read his book for lay readers on the subject), but it does seem more useful as a critique than as a positive model of market behavior. You can’t haul in big consulting fees or create giant new securitization markets with a critique. So the natural tendency of both scholars and bankers has been to hold on for dear life to the Black-Scholes approach to modeling market risk. They get paid well for doing so, after all.
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At least Benoît Mandelbrot, who died last week, lived long enough to witness his own vindication. The work of the mathematician who disproved the precepts of the efficient markets model half a century ago, well before financiers had started to bet huge sums on products derived from that model, suddenly regained attention once those bets failed in 2007 and 2008.
His insights should have been devastating. The efficient markets hypothesis, and with it modern portfolio theory and the Black-Scholes model for pricing options, all assume that markets reflect all known information and follow a “random walk”, like coin tosses or Brownian motion. That implies that returns should follow the “bell curve” distribution often found in the natural world. But, as the charts show, extreme outliers in currency and stock markets are far more common than the coin-toss model would predict. These outliers make up the bulk of long-run returns.
Investors ignored Mandelbrot’s insights, perhaps because there were no profits in his idea that markets could only be modelled with complex mathematical techniques that do not yet exist. In the absence of more research, his ideas imply an imprecise approach to risk management. Markets do indeed behave as if they are efficient for long periods. Investors can be excused for ignoring Mandelbrot’s ideas but in future they must accept that risk cannot be measured precisely and that “fully invested” will mean holding a higher proportion of cash. Academic economists’ refusal to acknowledge him was scandalous. He believed this was because his ideas meant “a great amount of work, trouble and effort”, while the efficient markets literature promised “capital on which one could live for a while”. Several economists won Nobel prizes by living on that capital: assuming market efficiency. Last year’s award to Paul Krugman was widely interpreted as a rebuke to efficient marketeers. If that was the intention, the award should have gone to Mandelbrot.
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Response by Wbottom
almost 16 years ago
Posts: 2142
Member since: May 2010
what makes you think there is anyone who wants to read all that you "read"?
do you tweet all your personal hygiene events too?
perhaps these post really are, simply, personal hygiene events?
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Response by notadmin
almost 16 years ago
Posts: 3835
Member since: Jul 2008
lmao... a lonely mathematician against millions of baby boomers gambling for resurrection in the real estate mkt after they finally realize they didn't save enough for retirement... good luck with that one!
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Response by stevejhx
almost 16 years ago
Posts: 12656
Member since: Feb 2008
"do you tweet all your personal hygiene events too?"
LMFAO.
In fact, he does: NYC's airwaves are contaminated.
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Response by Riversider
almost 16 years ago
Posts: 13573
Member since: Apr 2009
Mandelbrot was not the only analyst to warn that our financial system was headed for a reckoning. However he zeroed in with unusual specificity on the besetting flaw – models that understated risk – and his conclusions grew out of rich and varied work in the natural sciences. After a career at IBM, Mandelbrot taught at Harvard, Yale and the École Polytechnique. He invented the science of “fractals”, geometric shapes that, if submitted to a simple mathematical operation, generate ever smaller, related shapes and a pattern of increasing complexity. Fractals were just as fruitful in generating metaphors and analogies. In the 1960s, Mandelbrot showed Britain’s coastline could never be measured in a way that would produce a consensus on its length. An inch-long stretch was not necessarily less complex and jagged than the coastline as a whole – it just looked that way. As your instruments got more sophisticated and measured more crannies, the coastline got longer and longer.
Mandelbrot’s argument with quantitative analysts resembles the argument religious people have with scientists. He blamed them for failing to explain absolutely everything. But if the quants really did believe their models were omniscient, then theirs would be some of the weakest theories anyone was ever lionised for debunking. Mandelbrot saw traders did not fully believe in them. They still monitored trading closely and looked for signs of market momentum, which would have been unnecessary if their equations were perfect. We persist with mathematical models, because they capture a lot of reality. But only a fool would believe they capture all of it.
Mandelbrot had no better method for picking winners and losers. “I agree with the orthodox economists that stock prices are probably not predictable in any useful sense of the term,” he wrote. His gripe, rather, was with the system. All algorithms tended to underestimate the risks of investing. Mandelbrot distinguished between “Joseph” effects and “Noah” effects. Joseph effects – seven fat years here, seven lean years there – occurred when markets were evolving gradually and continuously. Noah effects were cataclysms – the Flood, or the week of September 11 2001, when the New York Stock Exchange closed for five days and dropped 7.5 per cent on re-opening.
http://www.ft.com/cms/s/3/2b6ddeb2-da8d-11df-81b0-00144feabdc0.html
At least Benoît Mandelbrot, who died last week, lived long enough to witness his own vindication. The work of the mathematician who disproved the precepts of the efficient markets model half a century ago, well before financiers had started to bet huge sums on products derived from that model, suddenly regained attention once those bets failed in 2007 and 2008.
His insights should have been devastating. The efficient markets hypothesis, and with it modern portfolio theory and the Black-Scholes model for pricing options, all assume that markets reflect all known information and follow a “random walk”, like coin tosses or Brownian motion. That implies that returns should follow the “bell curve” distribution often found in the natural world. But, as the charts show, extreme outliers in currency and stock markets are far more common than the coin-toss model would predict. These outliers make up the bulk of long-run returns.
Investors ignored Mandelbrot’s insights, perhaps because there were no profits in his idea that markets could only be modelled with complex mathematical techniques that do not yet exist. In the absence of more research, his ideas imply an imprecise approach to risk management. Markets do indeed behave as if they are efficient for long periods. Investors can be excused for ignoring Mandelbrot’s ideas but in future they must accept that risk cannot be measured precisely and that “fully invested” will mean holding a higher proportion of cash. Academic economists’ refusal to acknowledge him was scandalous. He believed this was because his ideas meant “a great amount of work, trouble and effort”, while the efficient markets literature promised “capital on which one could live for a while”. Several economists won Nobel prizes by living on that capital: assuming market efficiency. Last year’s award to Paul Krugman was widely interpreted as a rebuke to efficient marketeers. If that was the intention, the award should have gone to Mandelbrot.
what makes you think there is anyone who wants to read all that you "read"?
do you tweet all your personal hygiene events too?
perhaps these post really are, simply, personal hygiene events?
lmao... a lonely mathematician against millions of baby boomers gambling for resurrection in the real estate mkt after they finally realize they didn't save enough for retirement... good luck with that one!
"do you tweet all your personal hygiene events too?"
LMFAO.
In fact, he does: NYC's airwaves are contaminated.
Mandelbrot was not the only analyst to warn that our financial system was headed for a reckoning. However he zeroed in with unusual specificity on the besetting flaw – models that understated risk – and his conclusions grew out of rich and varied work in the natural sciences. After a career at IBM, Mandelbrot taught at Harvard, Yale and the École Polytechnique. He invented the science of “fractals”, geometric shapes that, if submitted to a simple mathematical operation, generate ever smaller, related shapes and a pattern of increasing complexity. Fractals were just as fruitful in generating metaphors and analogies. In the 1960s, Mandelbrot showed Britain’s coastline could never be measured in a way that would produce a consensus on its length. An inch-long stretch was not necessarily less complex and jagged than the coastline as a whole – it just looked that way. As your instruments got more sophisticated and measured more crannies, the coastline got longer and longer.
Mandelbrot’s argument with quantitative analysts resembles the argument religious people have with scientists. He blamed them for failing to explain absolutely everything. But if the quants really did believe their models were omniscient, then theirs would be some of the weakest theories anyone was ever lionised for debunking. Mandelbrot saw traders did not fully believe in them. They still monitored trading closely and looked for signs of market momentum, which would have been unnecessary if their equations were perfect. We persist with mathematical models, because they capture a lot of reality. But only a fool would believe they capture all of it.
Mandelbrot had no better method for picking winners and losers. “I agree with the orthodox economists that stock prices are probably not predictable in any useful sense of the term,” he wrote. His gripe, rather, was with the system. All algorithms tended to underestimate the risks of investing. Mandelbrot distinguished between “Joseph” effects and “Noah” effects. Joseph effects – seven fat years here, seven lean years there – occurred when markets were evolving gradually and continuously. Noah effects were cataclysms – the Flood, or the week of September 11 2001, when the New York Stock Exchange closed for five days and dropped 7.5 per cent on re-opening.
http://www.ft.com/cms/s/0/0d0da878-de0f-11df-88cc-00144feabdc0.html