How Math Destroyed Wall Street

[Jeemie]

http://www.wired.com/techbiz/it/magazin ... ntPage=all

Fascinating read.

Although math didn't really destroy Wall Street. Only a couple of years in, everyone knew this formula was shit. But they were making money and thought they could get out before it all came crashing down.

Interesting sidelight- Derivatives was the field I almost went into, armed with my FInance/Investment Analysis MBA that specialized in derivatives and risk management.

But this was shortly after 9/11, and my wife forbade me from working in New York City.

So I forgot about high finance and went into business operations in pharma instead.

But I was this close to being hip-deep in this muck.

[etaoin22]

I was already thinking of a hypothesis last year, that the survival and competitiveness of societies correlates best with their ability at mathematics. And unsurvival with inability, perhaps. I don't think I could simplify the relationship down to a single constant,but the current fiasco may provide a great big data point.

[Jeemie]

I was already thinking of a hypothesis last year, that the survival and competitiveness of societies correlates best with their ability at mathematics. And unsurvival with inability, perhaps. I don't think I could simplify the relationship down to a single constant,but the current fiasco may provide a great big data point.

I don't know- I think survival would best correlate with those who understood the limitations of the models we make, and those that do not so heavily discount the future in favor of the present.

That type of thinking enabled us to survive when we had to worry about finding our next meal before we were eaten, but in the complex world we have created with our emergent intelligence, such thinking is a detriment.

The problem is, the environment changes much more quickly than the hard-wiring in our brains.

[wintergreen48]

This is a great article, it really explains everything very clearly. Thanks for posting it.

And it also explains something that has bothered me for years: I consider myself to be a reasonably intelligent, reasonably well-educated person, I've actually studied statistics and did OK, and I've underwritten credit in previous lives, but I could never figure out how this derivative stuff worked. Being the manly sort of man that I am, I am not entirely comfortable asking people to explain things to me, especially manly things like math, but I did manage to screw my courage to the sticking place and I actually asked people who work with this stuff about it, but even when they would try to explain it to me, I still could not understand how it worked. Now, I see that there was a reason for my befuddlement-- it DOESN'T work. Good to know. Too bad the people who were actually working with the stuff-- who, I am sure, also did not understand how it worked-- didn't ask themselves why.

[Jeemie]

This is a great article, it really explains everything very clearly. Thanks for posting it.

And it also explains something that has bothered me for years: I consider myself to be a reasonably intelligent, reasonably well-educated person, I've actually studied statistics and did OK, and I've underwritten credit in previous lives, but I could never figure out how this derivative stuff worked. Being the manly sort of man that I am, I am not entirely comfortable asking people to explain things to me, especially manly things like math, but I did manage to screw my courage to the sticking place and I actually asked people who work with this stuff about it, but even when they would try to explain it to me, I still could not understand how it worked. Now, I see that there was a reason for my befuddlement-- it DOESN'T work. Good to know. Too bad the people who were actually working with the stuff-- who, I am sure, also did not understand how it worked-- didn't ask themselves why.

They did...but it's a human tendency/failing to accept the models they create (and humans are GREAT modellers) as reality, without ever accepting the limits of their models.

And this was compounded by the people involved receiving incredible positive reinforcement (i.e. money, hand over fist), and then, later, even as they were starting to realize what they were doing was unsustainable, getting caught up in a cruel Prisoner's Dilemma- that is, banks and investment houses knew they had to stop, but if they stopped, and their competition didn't, they'd be out of business, because who would want to go to a safe investment that returned a low yield, when they had the illusion of a safe investment that was returning a HIGH yield?

So they didn't stop...until they WERE stopped.

I'm waiting for a friend to send me an article that details how this whole thing came crashing down because investors were given a model that was 95% accurate, and were investing like it was 99.9% acccurate- that is, the model was accurate to two standard deviations, but they invested like it was accurate to 4.

If he sends it in link form, I'll post that here too.

[themanintheseersuckersuit]

Fortunately Al Gore's Climate models do work since we are going to spend more money based on them than these trifling financial products.

[BigDrawMan]

i read this post title several times, and each time I see "how meth destroyed wall st"

ha

i dint read the link to see if the story about Long Term Capital management was in there

those guys won the Nobel Prize
hope they dint sink the prize money into their company

[TheConfessor]

Thanks for the link. It's a good article. I learned some new things from it.