Slashdot Mirror
Incorporating Human Behavior Into Wall Street Mathematical Models
After watching the stock market struggle for the past year, financial experts from Wall Street and academia are putting more effort into bringing behavioral modeling into their complex financial calculations. "The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn't sufficiently take into account was human behavior, specifically the potential for widespread panic." Analysts are looking at research from other fields to supplement the hard mathematics of risk assessment. "Financial markets, like online communities, are social networks. Researchers are looking at whether the mechanisms and models being developed to explore collective behavior on the Web can be applied to financial markets." Another avenue they're exploring is how we react to the spread of disease. Jon M. Kleinberg, a computer scientist at Cornell, said, "The hope is to take this understanding of contagion and use it as a perspective on how rapid changes of behavior can spread through complex networks at work in financial markets."
Incorporating Human Behavior Into Wall Street Mathematical Models
What? Like morality?
Financial markets ... are anti-social networks
There, fixed that for ya.
But I thought financial markets were an independent entity, not influenced by human social conditions.
....somehow this isn't going to end well.
"The problem with socialism is eventually you run out of other people's money" - Thatcher.
... more miserable failure. Sorry folks, interdisciplinary research does not work. The people who build the financial models will never understand psychological theories; the people doing psychology will not understand (nor care) about financial models. Moreover, what "behavioral models" we are talking about here? I would very much like to see one that actually has predictive power. Alas, most of this so-called research in, say, "web social networks" is merely a collection of useless results designed to get published and raise the academic status of the researcher. Academia is a fraud... la-la-la *blasphemy*
Am I bitter? Yeah.. please, someone prove that I am wrong. I would like to be wrong on this one.
or we burnt the wrong animal at the sacrifice. But let us take this setback as a call to redouble our faith: Soon the saucer will land.
Personally I think this is a terrible sign. Irrational investors should be discouraged from gambling in the markets instead of coddled and encouraged through tax breaks and an extensive regime of inconsistent regulation. Governments and the fraudulent investment advisors they subsidize and fail to regulate have done us all a disservice by suckering the average person into investing in derivatives markets like the stock exchanges. And now instead of letting the market correct the problem all sides are dragging us further down the path of government interference and command economy. They actually have the brazen stupidity to think that a command economy will work if only they can come up with some better computer models of market behaviour.
"I assumed blithely that there were no elves out there in the darkness"
Why is it that these people insist on trying to apply a veneer of respectability to this shit?
Financial engineering is not engineering.
Economics is not a real science.
Finance is not real math.
Prevention is better than cure! It can be averted by less risky behaviour!
Between these revived, yet still pernicious models and Wall Street's darling new death bonds, we look poised to blow another bubble, destroy another decade of growth, and funnel more money into the hands of the obscenely wealthy when the system flies apart.
We cannot allow that to happen. Finance needs to be returned to a staid utility that forms a relatively minor part of our economy. We need to be deeply skeptical of innovation in the financial sector: it's been around for a long time, and we've already explored most of the beneficial ideas. What remains is deception and fraud.
I'm yet to hear a decent explanation on how day trading isn't gambling while poker is.
Both are working on limited information
Both involve you making money off of other people's mistakes
Neither creates wealth and merely shifts it around
Both can cost you fortunes even though you did nothing wrong
Human behavior is the basis for the Austrian school of economic thought. Has been from its roots. Ludwig von Mises, one of the founders of Austrian economics, titled his magnum open "Human Action". The basic idea of Austrian economics is that the study of economics is an a priori discipline. In other words, you can't implement, from both a practical and ethical standpoint, experiments to study economics on a useful scale. Instead, economics must be viewed as a study of human behavior. Humans are the principle actors in an economic system, so their behavior and drives must be the primary focus of economic study. The study of economics can therefore be viewed as a study of groups of self-interested participants working for their own betterment.
Incidentally, Austrian economics also posits that interference with the operations of markets produces a boom-bust business cycle, by promoting misallocation of scarce resources. It's worth noting that many Austrian economists were predicting our current economic crisis well before it occurred, when the more mainstream Keynesians were still calling it a golden age of economic development.
What is being proposed here is to continue to view markets as purely mathematically modelable phenomena. Economic decisions occur on the most local of levels, the individual level. No model accounts for the variability of the individual. For a Keynesian-style planned economy to function requires omniscience.
I really wish wall street would get off their 'risk models' fetish. The financial systems of the world are wildly complex beyond all comprehension. "Risk models" make three, very shitty assumptions and, as a rule, eventually always fail. As we saw with the latest blow up, some times they fail with epic spectaularity. The three shitty assumptions are:
1) That the model has enough information to make predictions in this infinitely complex system
2) The system doesn't change.
3) We will see nothing in the future we have not seen in the past.
It is like watching someone try and figure out a way to predict the winner of a game where the rule book takes a library to hold AND the rule books are constantly being swapped out for new rule books. Everyone likes to blame the current recession on greed, evil bankers, and corporate corruption. While all of those things exists, they are not what caused the melt down. What cause the melt down was that a bunch of morons were using a 'risk' model that basically predicted that what happenend could NEVER possibly happen, so don't worry about it. Based upon this bad information, people made some very awesomely bad 'safe' bets. When the "impossible" (as the risk "models called them) happened, those very bad but "safe" bets imploded and you saw the wide spread destruction that happened as a result.
Corret one.
Keep in mind that these things will be securitized, tranched, and then the pieces will be securitized and tranched, greatly magnifying the risk. On top of that, there will be a new, brisk trade in various hedges on these instruments, including the infamous credit default swaps. In this way, a tiny diseases market can metastasize throughout the economy.
if conditions exist that favor making money through "immoral behavior" then that is what will happen.
Some point to (substantial) evidence that the playing field itself could be called as you say, "immoral": http://www.chrismartenson.com/crashcourse/chapter-15-bubbles (ch16 and 17 as well) and some related news: http://www.google.com/search?q=audit+the+fed
to steal a quote, markets can remain irrational long after a rational trader becomes insolivant. This includes rational predictions about human behavior.
If video games influenced behavior the Pac Man generation would be eating pills and running away from their problems.
High math and analytical GRE scores, a degree in psychology, previous work in the speech group at IBM Research, lots of programming and simulation knowledge... :-)
Might as well make a little money out of the market before post-scarcity issues obsolete it. :-)
http://www.pdfernhout.net/post-scarcity-princeton.html
A 21st century issue: the irony of technologies of abundance in the hands of those still thinking in terms of scarcity.
What about widespread greed?
No sig for you!!
( (bunch of lazy quants using numerical recipes in c) * (offshored IT in large banks) / greedy rampant bankers) % ineffectual regulators - backstop of wage slave tax payers = fucked economy > big bank bonuses.
Seriously though - the modelling used in most cases is hopelessly crap, as it only models things in a perfect situation, where we assume we know all variables within certain tolerances, at that given time, and no extraordinary event will take place, and people will be rational, and the market knows best, and such like. Utter rubbish, and I write trading systems that have to use these "models" for pricing, risk and valuations.
often times it was closer to being fraudulent than risky... the current system allows companies to leverage far more capital than they have in assets [fractional reserve banking] that is very dependant on the stability of the money supply... consequently when there are monetary expansions followed by monetary restrictions by the federal reserve we observe a collapse of the system catalysed by panic.
Sigs are too short to say anything truly profound so read the above post instead.
The biggest problem with some economic models is that they don't consider the irrationality of a consumer. This is fine when an economy is based on manufacturing or processing/export of natural resources since that follows more rational processes.
The US economic meltdown was long overdue since the writing was on the wall with housing screaming up in value while any job that could be outsourced overseas was sent regardless of the quality and logistics issues it may create.
A consumer-based economy with jobs for the consumers disappearing is going to fail unless money is being pumped in elsewhere (AKA government welfare through various programs such as low-income assistance, subsidies, stimulus checks, etc.). This itself cannot be sustained and now our government looks for more loans from the countries we made wealthy by sending most of our manufacturing jobs (China).
Increasing taxes for the wealthy and businesses will force people to leave the US or find other ways to evade taxes. This means the middle class will bear more of the tax burden over time. There is a good analogy of beer drink buddies of various incomes splitting the tab based on income that illustrates the tax and spending dilemma.
So my opinion is that human behavior models are long overdue to be applied to economics.
I Cater to the Needs of Stupid People. - from a coffee mug Christmas gift
They're just *now* trying this?
.
Seriously?
Here is a link to that beer analogy for the US tax system.
http://forums.techguy.org/civilized-debate/697617-us-tax-system-described-beer.html
I Cater to the Needs of Stupid People. - from a coffee mug Christmas gift
bringing behavioral modeling into their complex financial calculations.
Am I the only one who read that as 'fictional calculations'? It may be more appropriate ...
Damn, didn't people learn how stupid this was back when they did it to AIDS patients?
Investing in life insurance scams is plain gambling. No wealth is created and the insurance company generally is smart enough to set itself up as "the house". And the house always wins.
So either you lose, or you're taking death benefits from the elderly. Not a position I'd want to be in when somebody decides to do a news piece on it.
"How Did Economists Get It So Wrong? "
http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1&em=&pagewanted=all
Stock markets usually drop during the month of October. People in Europe and the US get back from their summer vacations and have to sell some stock in order to get their bank accounts in the black. This causes stock prices to fall in September, then people get worried and the general gloom of approaching winter does the rest during October.
Most economic theories have a hole you could drive a truck through. They assume people act rationally.
Psychohistory, anyone?
While I dislike how suddenly the financial markets have gotten back into these windfall risky investments, there's little push to stop it, so I guess taking into account the kind of behavior that, you know, actual people would do, is better than nothing.
Most 'risk analyses' done by these things almost go as far as to assume everyone involved acts as Economic Man - the theory that everyone will always act in such a way as to best improve their position, in a 100% rational way. This is a pipe dream put up in economic theory and doesn't always work. If you assume everyone involved acts that way, then some possible outcomes - like the ones we saw in the past year - can't be the slightest bit possible, therefore the models that were being run at the time disregarded them. Of course, the models were wrong - because people don't act that way.
Consider what is sometimes called the Ultimatum Game - everyone's heard of it. Person A has a pile of money to divide between themselves and Person B. They split it, and Person B can either accept the division, in which case each gets their share, or reject it, in which case neither player gets one red cent and the money is lost.
Economic Man theory would say Person A should give the smallest possible amount (let's say 1%) to Person B, and keep 99%, or whatever the maximum share is, and that Person B should then readily accept, because they're better of taking something rather than nothing. In reality, when this "game" is tested, it doesn't work that way - if Person A doesn't offer enough to B (say, 20%), Person B tends to reject it, whether out of spite, or a sense of fairness. The responses change depending on how much money is involved, and culture (different countries and regions have different thresholds) and everyone seems to have their own threshold of course - but very few Person B's say "OK, I'll take one penny and Person A can have $99.99" even if that's what Economic Man would do.
Likewise, Economic Man doesn't see that much of a difference between, say, 10% chance of loss, or a 5% chance of losing double that amount and a 2 1/2% chance of losing quadruple - while real people tend to disregard a small chance of large losses, but be quite averse to a reasonable chance of smaller losses - they'd probably go for the last option, even if percentage wise the "odds" are the same.
Most of these financial models, in essence, assume people are Vulcans, when they're not - they're people, and no amount of economics saying "You should act like Economic Man!" is going to change that.
If they're going to continue using these models, a push to start getting them better is at least some progress.
It didn't work last time, but we know just the tweak to throw in to fix it! Honest! We're gonna get it right this time!
Do the models include variables for investors believing only the mathematical models that tell them what they want to hear?
The human behaviour they should put into those models arent panic or riots, but what humans do when know what those models predict. Thats the biggest problem about predicting what people will do, what if that people know that prediction?
That was the problem, too much people "knowing" what will happen, acting in a big way, and of course, failing because those predictions didnt included that behaviour.
Human behavior is the core of all economic thinking. It either directly or indirectly is the basis of every model and every theory. The problem might be that the behavior assumed is over simplified to 'greed and fear of risk' when it should include something more, but that's nothing new.
This doesn't mean the right thing to do is give up on modeling risk and simply give up and go back to simply letting the king (or the five year plan) decide what is worth funding. Venture capital and stock markets are capitalism's attempt to estimate what technologies and businesses are the most promising and most efficient. Is it wrong? Often. But its wrong less often than other methods.
So, is financial engineering really engineering? It depends how you define both the terms. Marketing guys that add 'engineering' to something to make it sound trustworthy are not, but I'd say that the forecasts financial analysts and economists make can be as legitimate in approach and method as the forecasts civil engineers make about traffic flow, water needs, sewage requirements and infrastructure development. Both are mathematical forecasts of what human behavior will be in the future and both can have good or bad underlying assumptions that drive results. Both can be right or wrong based on the math or the assumptions.
To say nothing of plain old dishonesty.
If you want your life to be different, live it differently.
We all know that modelling human behaviour in software is anything but a trivial task, and that the results have to be taken with quite a grain of salt, but that's a step in the right direction, because for the last few decades economists have considered the market players to be perfectly reasonable, rational and competent, assuming little to no chaos in what actually goes on. If this crisis did anything good, it's given a much needed reality check to economists, particularly west of the Atlantic. I read a great piece on the topic by the way.
There's also something I love about these economists who come up with Nobel prize-worthy equations but fail to see the elephant in the room that is making all these weird assumptions about how markets work. I think of them as smart fools, they're extremely intelligent, but never take a step back to see where they're going. They do very futile and dumb things, but in an extremely sophisticated and brilliant manner. And because they know they're extremely smart and experts in their field, they reject any notion that despite that intellect and expertise they might be fools. Anyone with any common sense and education could see the caveats of what they do, but everybody knows that these guys are smarter than us and experts, so they must be right, even if it's blatantly foolish. This applies to string theorists as well by the way, to a lesser extent.
You just got troll'd!
Lets say the people who have the Federal Reserve Board of Governors on speed dial decide that the dollar needs to move in a different direction. So they call up Alan Greenspan and have him dump a few billion in foreign reserves. Exchange rates change, followed by interest rates. Pretty soon, people with marginal mortgages get caught short. Investment banks figure this out and pull the rug out from under mortgage backed securities. Commercial banks' capital ratios collapse. Wall Street sees this and responds. Panic ensues.
But its too late. Understanding the market by analyzing panic is like trying to diagnose diarrhea by looking in the public sewers. The people who initiated the problem have taken their profits and run long ago. Their lackeys have moved on and retired. If you want to know what the market is up to, you're going to have to collect data a lot earlier in the investment cycle.
Have gnu, will travel.
Of COURSE Wall Street's math models fail to take human behavior into account. We as a species don't even know what human behavior *is*, let alone what kind of mathematical equations might describe it. Attempting to model any behavior is doomed to failure as long as the model is incomplete. All humans have their own perceptions, interpretations of events, and people will make money decisions based on information that you can't possibly predict algorithmically.
Only two things are infinite, the universe and human stupidity, and I'm not sure about the former. (Einstein)
... mathematical and econophysical models are simply not powerful enough to model the financial markets in any accurate way. The markets are simply to vast and too complex.
An intriguing solution to a problem that should never have existed in the first place...
that which is mine, and my alone, which I came up with myself yada yada yada....
Here's where the host presents the consensus review: Oh, shut up.
Really? Engineers are the easiest people to dupe with financial numbers. Why, you ask?
Engineers come from a background where the numbers are based upon physical laws - the numbers mean something tangible in the end. Whereas in accounting and in business in general, the can be and usually are several correct answers, and in some cases, the incorrect numbers look more reasonable. Many times, the numbers are assumptions. Numbers that are assumptions are pulled from one's ass; hence assumptions.
It's NOT me! It's the meds! I'm on 1000mg of Fukitol.
We know they're frauds. We know that we're buying a ponzi scheme. They're the only ones who seem to believe their "models" have a basis in reality. Sort of like how facebook "models" my friends.
This is the same bullshit they have been spouting among stock traders all along. Its all just because people are panicing and afraid. Sure the stock market works that way but the real world does not.
It couldn't possibly be that we trade debt and have changed our production system to solely attempting to maximize profit rather than total production. Never that.
A highly liquid economy is NOT a substitute for a solvent one backed by actual tangible assets of innate and functional value. Encouraging people to borrow and spend is NOT better than encouraging them to save and produce.
Yes that is old outdated thinking. From back when the economy was self sustaining, before the past few decades of turning liquid the foundation built by those before us and blowing it.
Informed, rational investors can likely use game theory and an auction model to structure functional investment strategies in efficient markets. Irrational investors likely need to be viewed as lepers and those fleeing lepers. Irrational investors might even be more effectively treated as what they are. They're hunter-gathers with a built in reward system that fuels their investments as something akin to a huge rack of a recent kill nailed to the rec room wall, or, an equally huge rack on their trophy wife.
If irrational investors are seen as irrational and efficient markets must necessarily allow them to play then don't questions arise in terms of interference in efficient markets and the rights of irrational investors when attempts are made to circumscribe their irrational responses?
Lastly, it's been my experience that irrational investors driven by their primitive reward system tend to incorporate any rational response to their activity much as children in a playful frenzy will incorporate any attempt to control their behaviour into their play, or, more drastically, the way a mob fleeing an outbreak of leprosy will trample anyone attempting to instill order. (the last bit about children at play is borrowed from ideas suggested by Gregory Bateson)
ideopath @ play
Mark my words, there's some guy named Hari Seldon to blame for this....
Ludwig Von Mises wrote about that in the early 20th century and now the Keynesians are seeing that most of it its true!
financial experts
You mean snake oil merchants.
Apparently some of these guys pay as little as 20% which is how they can offer the returns they do. The problem is that when a regulator hears that you're ripping off a sick grandma who has trouble even understanding the forms they tend to pass laws. Some of these may invalidate existing agreements or put the companies creating them out of business. When the companies aren't there you run into all sorts of management issues - like the premiums not being paid, paperwork not being filed and payments not forwarded. I think Virginia has laws dictating at least 60% of the face value be paid (not sure on the % - search for viatical settlement for better info).
The other main risk is when the company simply can't find enough suckers as one company now being prosecuted for fraud in Texas found out. They found and took investors money but never bought the life settlements and burned through much of the cash. It could be they never intended to buy them, but I suspect if they could have found them they would have bought them as its a small amount to pay to keep the state off of your back - certainly less than they've lost from being put out of business.
Quote from the website: "The Turtles became the most famous experiment in trading history because over the next four years, they earned an aggregate sum of over $100 million dollars."
Read about them here:
http://originalturtles.tradingblox.com/story.htm/
This is not the sig you're looking for.
http://www.foxbusiness.com/story/markets/industries/finance/lazy-portfolios-floor-behavioral-finance-funds/
Ignore the writer talking about his own strategy, and the boxing metaphors, the Nobel prize winning father or Behavioral Investing has had his own Investment funds rated Below Average by Morningstar, and a 2006 study of Behavioral Investing funds found
...in a 2006 research study by three finance professors from Florida State and Central Michigan universities. They analyzed "16 mutual funds that are self-proclaimed or media-identified disciples of behavioral finance," including the two Fuller-Thaler funds. Conclusion: "Behavioral mutual funds are essentially value funds [and] exhibit no ability to time risk-return opportunities" because "investing based on the principles of behavioral finance is indistinguishable from value investing."
In addition to being about the same or worse as a Value Investing strategy, they have high stock turnover, bad for you at tax time and fees tend to be higher, bad for your returns.
i was predicting the economics of my giant penis coming into play, in these types of situations, but something seems to have gone wrong.
judy dear, what could the trouble be?
Did the previous risk models fail? Well then OBVIOUSLY the previous model was were wrong risk model and not complex enough.
Don't fight for your country, if your country does not fight for you.
We've been manipulating and modeling human behavior for decades. We chuckle when economists suddenly realize that humans act in so-called "irrational" (but theoretically and statistically predictable) ways. It's only irrational insofar as economists don't understand it.
Charlie Eppes: Larry, something went wrong, and I don't know what, and now it's like I can't even think.
Larry Fleinhardt: Well, let me guess: you tried to solve a problem involving human behavior, and it blew up in your face.
Charlie Eppes: Yeah, pretty much.
Larry Fleinhardt: Okay, well, Charles, you are a mathematician, you're always looking for the elegant solution. Human behavior is rarely, if ever, elegant. The universe is full of these odd bumps and twists. You know, perhaps you need to make your equation less elegant, more complicated; less precise, more descriptive. It's not going to be as pretty, but it might work a little bit better. Charlie, when you're working on human problems, there's going to be pain and disappointment.You gotta ask yourself, is it worth it?
Another history of the 2007-08 crisis from a credible source. (Not that Krugman's not credible, to a first-level approximation.)
"None are more hopelessly enslaved than those who falsely believe they are free." -- Goethe
The underlying premise of praxeology is that it cannot be mathematically modeled. Once again, they are failing to discount the possibility that they may in fact be idiots.
Slashdot: Playing Favorites Since 1997
So the experts whose models didn't work are now going to make new models. Perhaps we need new experts.
Yeah you fucking richies. Find some new math to fuck the people over with. Better hurry, your heads are gonna be rolling soon.
Where entrenched local criminals and immigrant criminals clash, immigrants often die.
Usually, all they can do is prey on their own fellow immigrants.
Working to avoid government regulation of business activity is just so much easier if your family and friends have lived here for ever and your aunt is married to the sheriff.
Immigrants get caught.
"Kill 'em all and let Root sort 'em out"
The earlier the policyholder dies, the bigger the return -- though if people live longer than expected, investors could get poor returns or even lose money.
So people have an incentive to see other people die as soon as possible. Awesome.
Or if you would rather, "Greed, for a lack of a better term, is good".
No one here has see Wall Street?
Maybe one of the central problems is that these disciplines actually need to be the same? We lack a unified theory of psychology that is evolutionary and ecological in nature, where the basis of the individual is rooted within the group, or tribe. The problems our civilization now face, where the needs of our economic system depend upon growth, contradict the necessity of developing an adaptation to live within the limitations of our ecology. Our current systems of law and history are in flux between an older religious mentality that stresses authority, and a newer one that explores the limits of scientific thinking. The inability of leadership to handle the complexity of the current crisis should be sensed by most of the population, even if they cannot properly articulate it in words. The popular culture has long explored dramatic themes of an apocalyptic future (usually involving nuclear annihilation), and I would guess that this is an expression of massive social anxiety.
The role of deception and economics in facilitating war (i.e. Gulf of Tonkin & The Vietnam War, Chamberlain's 3-Bloc system & pre-WWII Germany, 9/11) remains largely unexplored in popular history, which further exasperates communication problems when intellectuals try to discuss the real world.
Confirmation bias is incredibly widespread, and modern practitioners of older paradigms fail to address the critical short-comings of their views. The classic example goes back the the Copernican Revolution regarding whether the Sun orbits the Earth, or vice-versa. A modern example relates to the Obesity Epidemic. How many nutritionists have seriously considered the scientific implications of Gary Taubes' Good Calories, Bad Calories? I believe Richard Rhodes called it the most important book on diet and nutrition in the past 100 years!
Psychologists need a much better paradigm if they are going to seriously contribute to solving our current crisis.
Comment removed based on user account deletion
This isn't really correct.
I actually recall a brief foray in a grad thermo class into economic modeling. Thermodynamic models for economics are very popular, but fundamentally they're incorrect, because thermodynamic models rely on conservation (primarily of energy). In economics, though, there is no fundamental conserved quantity.
...take into account someone going psychotic and killing the very people that make these models?
See, 'cuz you can't incorporate human behavior into an algorithm. To even think you can apply mathematics to human behavior or vice-versa is sheer insanity, because human behavior, much like human emotion, is pretty unpredictable. What might make one person happy can make another person go into a murderous rage. These people should be put in an insane asylum.
Still waiting on Serviscope_minor to wake up to fucking reality and realize that Jessica Price isn't going to fuck him.
EVERYTHING IS BOUND, GUIDED, AND MANIPULATED BY THE LAWS OF PHYSICS, EVEN THE ECONOMY.
What, you think the economy is going to magically sustain itself when there's no energy left? It takes energy to move a human, it takes energy to produce fuel, it takes energy to ship things across the globe. AT EVERY SINGLE POINT IN THE MANUFACTURING PROCESS energy is *THE* absolute prerequisite. If you can get past that, you're the smartest person on this entire planet, nay, you're smarter than the fucking laws of nature.
Thermodynamic models are popular because they're more correct than the Keynesian bullshit we're trying right now, it hasn't even been half a goddamned century and our economy has already hit a deep recession. Keynes acts as if the laws of physics doesn't even exist.
Still waiting on Serviscope_minor to wake up to fucking reality and realize that Jessica Price isn't going to fuck him.
I'm all in favor of trying to incorporate ideas such as panic, or non rational behavior into models. But, before you go nuts doing that I suggest you first try to incorporate rational behavior properly. It was BLATANTLY OBVIOUS that house prices had to fall, and fall by a significant amount. The major reason for the debacle is simply that not many people incorporated THAT into their models. The panic, etc that followed after people finally accepted that home prices have to be within a reasonable range of affordability is a small fraction of the overall problem.
I have a PhD in math and over 12 years of experience analyzing agency and non-agency MBS, some CMBS and CDOs. No one wanted to listen to common sense. I was there to witness it.
Isn't the "Keynesian bullshit" just like a battery/capacitor though - save some excess X so we can use it when we are not producing/cannot get enough X when we need it - therefore physics?
The web does not represent "human behavior", it is an environment where a small subset of human social behavior, filtered through some very specific and narrow filters, gets represented in an abstract form, that form itself restricted by the medium. A termite nest, like an online community and a financial market, is a social network. So should they develop a theory about individuals piling their wealth randomly until several end up in the same place, the observation of which sends everyone into a frenzy and they pile everything they can get their hands on on top of the rest?
If they want to include typical human reactions to crisis, they should look up Festinger's Cognitive Dissonance. It was developed after observations of earthquake victims who, instead of being relieved it was over, continued to expect even worse to happen. It explains well how a panic reaction can set in. It can also explain how the opposite can happen, such as why the heads of Enron sat around expecting to get away with it even after it crashed, when they could have liquidated enough just a week sooner to carry on a charter flight and lived comfortably for the rest of their lives. It might even be able to explain how otherwise rational individuals can grasp at one ridiculous concept after another in hopes of finding a predictive model, when every single time they try it, it fails. Oh wait, there's the termite theory.
"I may be synthetic, but I'm not stupid." -- Bishop 341-B
Yes, raising gov't spending in a downturn and cutting gov't spending during booms (and analogous policies) seems to be a fairly standard economic concept.
Never thought about it as a battery, though.
Thing is, no energy-type conversion is 100% efficient.
I listen to both RIAA and non-RIAA stuff if I like the music, tangential business/politics nonwithstanding.
I should be more specific: none of the readily-measurable quantities of interest in economics obey conservation laws required by physical models.
It does no good to make the blanket statement that "everything is bound by the laws of physics". (More so in all caps, which doesn't improve the quality of your argument.) While true, it has no meaning at the level economics deals with. While the physical objects and the atoms in the cells of the people who carry out the economy certainly have to obey energy conservation and the second law of thermodynamics, it doesn't follow that something like "money supply" or "value" do. It's the same as trying to apply conservation of energy to dieting. The system is significantly different, and only has to obey the physical law at a drastically different level than what you're analyzing it at. It may well work (in fact, "eating less" isn't a bad dieting procedure, and thermodynamic models aren't terrible for economics), but the fact that it gives useful results doesn't mean your model is well-founded, and you are almost certainly poorly-modeling some behaviors.
Even goldsmiths back in the day used fractional reserve banking. Most service industries use it as well (internet, phone, electricity).
I am shocked that the writings of Nassim Taleb have not been mentioned in this thread. His books (e.g., Fooled by Randomness and The Black Swan) address many of the shortcomings of conventional financial models. He is a trader who has rejected many of the standard models used by most traders as well as the models used by economists. The arguments advanced by Neoclassical and Keynesian economists are largely irrelevant to the risks identified by Taleb.
would be proud. Psychohistory lives!
US taxes on the rich are FAR LOWER than the rest of the world, and SIGNIFICANTLY LOWER than they used to be just a few decades ago. I didn't see rich people leaving the US when taxes on the highest income bracket were much higher.
Seriously get a grip on reality please.
I challenge you to name one Austrian economist who predicted our current economic crisis. In fact, the free-marketeers who worship Friedman (I know that's Chicago school, not Austrian, but bear with me) ignored the potential for the current crisis while Keynesians like Krugman, in point of fact, predicted it. And Keynesianism hasn't been mainstream (in the US) for decades, so I don't know where you're getting the idea to say "the more mainstream Keynesians". The trend has been to trust markets more and more, and the very deregulation that the Greenspans and Bernankes of the world championed created the crisis on a fundamental level.
( http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1 is one of many good articles on this subject)
Besides which, Austrian economics claims to deduce all of economics a priori, which fundamentally contradicts your premise that it takes account of human behavior. Human behavior is known a posteriori from observing humans. If some "a priori" deduction about human behavior contradicts empirical observation of human behavior, then we must conclude the a priori deduction describes not human behavior but some abstract concept of how a human ought to behave. Likewise, Austrian school economics is powerless to describe a real economy, because when it contradicts empirical observation, it says, in essence, "fie upon empirical observation!", but by doing so, describes not a real economy but an abstract conception of how economies should behave
"I don't care about the Constitution!" --Bill O'Reilly, November 17, 2009
If the rich were to leave the US, where would they go? Most of the developed world has much higher taxes than the US, which is defined as a tax haven. And as most of the US mega-rich make their money off the backs of the US markets, they wouldn't be able to dodge American taxation anyway.
Anyway, considering the vast, spirally inequality in the US, the mega-rich leaving might not be such a bad thing. It may well leave a much more stable economy where the proceeds of growth are shared more equitably, not hoarded at the top whilst a few crumbs 'trickle down' to the workers. There'd be more social mobility, and less crime.
That beer analogy is a dilemma, but not about the taxes, it's the fact that the rich guy has all the money in the first place. How do pretty much all other first world economies function without handing over all the wealth to a few traders, land-owners and executives who don't actually do anything?
Obviously, if the new model does show good predictive power, and an increasing number of investors start using it, it will create a bubble (everybody doing the same thing). Unless it so good to also predicts this, in which case I guess it will generate wildly obscillating predictions and possibly become unstable.
I wonder if that proves that predictive economic models are unfeasible.
Cheers,
alf
This cannot possibly work because "any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes" and Danielsson's corollary "A risk model breaks down when used for regulatory purposes".
The very moment any model - regardless how cleverly designed - is published and started to be used to make money on a significant scale, peolple will start gaming the system. This will necessarily destroy any information carrying correlation. Why? Because, as it is impossible to generally directly predict economic success except after the fact any more than it is possible generally to predict whether a given program will halt or not w/o running it, you have to use proxies. These proxies are always easier to manipulate on purpose than they are by influencing them as a side effect to a different purpose.
A good example is the number of papers published as a measure for scientific excellence and predictor of future academic success. A good indicator - but only as long a nobody counts them and uses it to direct money flows. The moment you do that, researches will see publication as an end in itself, and not as a byproduct of successful research and the measure will lose most of its predictive power.
In economics, it's even worse, as money made on speculation spends exactly the same as money earned by building value: Charts of stock prices would be an excellent predictor as market prices in theory should aggregate all available information - but only as long nobody uses them to estimate value or predict future prices. With chart analysis used by many market actors and companies being allowed to manipulate their own stock price (vie buy-backs, option programs, etc.) you get so many artificial feedback effects into the system that they dominate the system's dynamics and the actual signal gets lost in the noise.
How about some backup? I mean, we're talking the word of J. Random Slashdot Moron vs. a published and awarded economist. I think you are a bit mistaken in what 'credible' means.
Mart
"I know I will be modded down for this": where's the option '-1, Asking for it'?
http://www.valuebasedmanagement.net/
check nagaiah portfolio to buy or sell financial assets in bombay stock exchange
Did not they already incorporate human behaviour? I mean they incorporated their personal greedy fingers to manipulate the models to fit their own needs.
What they should do is incorporate the institutionalized corporate and personal greed into their models. That would have predicted most of things, but they know that and will not incorporate the "greed" element into the models.
In short, I believe that these people are greedy lying bastards. And for some reason they want us to believe their models, that exist only to line their pockets and prop up their egos.
You think Warren Buffett http://en.wikipedia.org/wiki/Warren_Buffett uses any of this stuff? In the words of Ben Graham, smart investing doesn't involve higher maths.
"After watching the stock market struggle for the past year, financial experts from Wall Street and academia are putting more effort into bringing behavioral modeling into their complex financial calculations"
This from the same people that caused the financial meltdown. The sub-prime mortgage fiasco enabled by greed stupidity and the Black-Scholes magic numbers formula. Black-Scholes a variation of a differential equation, borrowed from physics, so it must be true. Nothing but a gigantic shell game thought up by Wall Street, dedicated to getting you dummies to give them your hard earned money.
Look you can't predict the stock market like a physical system as the sample data set alters its behaviour depending on its opinion as to the validity of the call. For instances, the Fed announces confidence in the market and advised everyone to go on a buying spree. If the market believes you then they buy and the stock goes up. If the market loses confidence in you, then they sell, the market collapses and they hire on a new head of the FED. In olden days once the God-King is revealed to have no real magic, they would have flung him off a cliff.
You will now subtly be suaded not to look at this comment. Nothing to see here, move along...
In the events leading to the last crash, we saw things like companies refusing to believe what their models said because that would interfere with grabbing as much money as fast as possible, and financial people optimizing their behavior to the models in a way that guaranteed a catastrophe. Neither of those will be changed with better models.
Better silver bullets through technology are always tempting, as they remove any need to do uncomfortable things like unlearn things or change our behavior or take responsibility for our actions. The real problem lies in the people who apply the models.
"When you have eliminated the unacceptable, whatever is left, however improbable, must be the truthiness" - Holmes
No, it couldn't have been that the whole thing was a pyramid scheme, designed to rake money out of the unsuspecting.
It certainly wasn't the fact that the leverage on the underlying monies (you know, the *actual things that had value*) was past ludicrous and well into plaid.
It must have been the fact that people "panicked" when they realized they were standing on thin air, like the coyote in road runner cartoons.
Yeah, that's the ticket.
Securitization tranching assumed financial disasters were statistically independent. In a panic they are not. They teach this in Probability Statistics 101. Goldman Sachs realized this and made a fortune off the the so-called junk-tranches.
they develop a model and use it with great results (=earn money) until the next cycle begins and they have to re-evaluate their model and change it so it works for another cycle. i would say move on to the next article but this slashdot discussion and especially this rare topic on slashdot is very interesting. thanks to all for responses :)
The repeal of Glass-Steagall was the beginning of a more corrupt than historically had been trend on Wall Street. All information emanating to the average investor is suspect if not outright BS and insiders benefit more than ever while handing the taxpayer the bill since the cozy relationship between Wall Street and the US Govt is more cozy than ever.
Boom and Bust cycles are not natural, they are intentional and at first build the balloon until the top tier manipulators pop it to reap profit.
Wall Street is a Casino of which the odds are not only stacked against you naturally but purposefully with intended malice , wake the fuck up.
as it's the best response to Trepidity's argument against the original post, and also clarifies the rather profound stance that Austrian economics takes: recognizing that people are different, with different motivations and goals, and that anyone trying to create a once-and-for-all model of The Economy and How to Grow It is doomed to failure. The actions of billions of people cannot be accurately predicted by a few thousand, and while nine times out of ten it doesn't make a difference, the tenth one is a doozy.
Wall Street Mathematical Models are a variant of Liar's poker, a bar game that combines statistical reasoning with bluffing.
check nagaiah portfolio to buy or sell financial assets in bombay stock exchange
Do you think Economists have been ignoring this idea? If so, you haven't heard of, say, Gary Becker.
Despite his (at least) great work, it can be summed up this way:
I can calculate the motions of the heavenly bodies, but not the madness of people.
-Isaac Newton
This is just insane pseudo science. It would be just plain funny if it wasn't for the fact that these guys are actually ruling the world. They keep adding more and more layers of insanity in an attempt to hold the grip of our society. These guys are the modern priests, burning everyone who doesn't want to "believe" on them.
The problem with the Adam Smith view of the market is they assume everyone is 1) rational and 2) completely informed. When you add in incomplete information, i.e. the person is rational about what he knows but he can only see 3 or 4 levels of transactions, then you get the 1/f power curve which demonstrates continual fluctuations at all scales, including huge economic bubbles and depressions. a lot like real life,