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So, I was fretting about underdogs in the last post. This past weekend, the Sunday Times Magazine ran a long interview with Nassim Taleb in which he was described as “now the hottest thinker in the world”, charging up to $60,000 per speaking engagement, with the great and good beating a path to his door — from the world’s leading banks to NASA.

Interestingly, the interview by Bryan Appleyard included lunch and, naturally, had Nassim following Art De Vany‘s dietary prescriptions of evolutionary fitness. Well, some of my most loyal readers will have heard it here first.

For other reasons (and by accident) I found an old email pitch yesterday that I made in 2003 to a magazine on corporate governance; let’s say this was during my ugly duckling phase:-

Also, I have an interview idea which you might be interested in. Have you heard of a book Fooled By Randomness by Nassim Nicholas Taleb–a maths professor and hedge fund trader from the US? He is in town in a few weeks and I thought I might try and get a hold of him. Although his background is in quantitative trading, he has some interesting things to say about luck and probability in a business context, and it has struck me that this could provide some interesting reflections from a corporate governance point of view. The underlying theme would be that over-remunerating senior executives is even more hazardous than we think if both success and failure may owe more to luck than judgement, backed up by a good dose of sound mathematics of course.

Let me know if you think it a bit too outlandish. My owns sense is that Taleb and others are leading market thinkers and their ideas will permeate downwards in due course.

I didn’t get a commission.

Back in those days, even though Fooled By Randomness was a bestseller, you could still turn up at the now-disappeared Financial World Bookshop in Bishopsgate and hear Taleb talk for nothing to a small and select audience of besuited quants and the odd unshaven, head-scratching scribe. And you try and tell that to the young people of today — will they believe you? No.

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Brown Bear, Brown Bear, What Do You See?I was thinking about the geophysicist Didier Sornette the other day. The reason being that (in my counter-factual way) I wondered what the world would look like if research (or a prediction, or an analysis) by people like Sornette were avidly watched — front-page news even. And then I remembered that I’d already written that post a long time ago, in my first blog. Like the other Yogi, it was déjà vu all over again.

Every day that I wake up to more bad news about the credit crunch, I feel slightly nauseated. It’s a bit like when you’re on a boat and the weather is closing in. Or the point that night falls and you’re out of sight of land. Or both. You’ve been there before, but your night vision needs to kick in. Time to hit the chart table, fix your position, re-evaluate how much sail you are carrying. A combination of nerves and trepidation focuses the mind. The concern is not so much for yourself, but for others. You’re in a complex system. Your fear must not guide you. You need to be confident, but careful. You may be master of the ship, but not the elements nor the other seafarers. A wetted finger is not good enough to figure out which way the wind’s really blowing. You need to calculate and apply learned heuristics, the wisdom of ages, one of which is “don’t rely on electronics”.

Finance being the bad-news-of-the-day for months on end is something I’ve never experienced before. I cut my teeth as a journalist during the extended bear market in oil that ended with the First Gulf War. The build-up was virtually a private affair for those of us who were specialists; no-one cared that much that the economy was benefiting from lower oil prices. The inflection point, when it came, was very public and geopolitical. Its consequences are still being worked out. I certainly did not see the Iraqi invasion of Kuwait coming; I was convinced that Saddam Hussein was just posturing. And yet, in retrospect, I vividly remember a conversation I’d had with a wise soul from the Middle East who showed an inexplicable agitation a few weeks before the invasion that you might characterise in the same way that animals are said to become jumpy before an earthquake. What was upsetting him was that he could read the runes whereas his colleagues could not. I was 25, still working below decks, lucky that he would take my call, and lacked the experience to fully engage with what was bothering him. The build-up to the credit crunch has been different and in some ways has already engaged the entire economically active population in psychological and also very concrete ways. The fall-out looks like being just as comprehensive.

It would be helpful if one could feel some sense of vindication, but it just ain’t happening. When you see someone driving recklessly, you don’t know whether it will end in a crash; that you are on the same bit of road — to mix metaphors — means you are inescapably in the same boat.

Getting it wrong is the sine qua non of economic forecasting. As the Stand-up Economist (whose gig on Saturday night at Oxford’s OFS I’ll be attending), says:-

Micro-economists are people who are wrong about specific things, and macro-economists are wrong about things in general … macro-economists have successfully predicted 9 out of the last 5 recessions.

Weather forecasters are often pilloried for getting it wrong. But, of all specialists, behavioural studies have revealed that they are the least confident in their own predictions. Economists and stock analysts, by contrast, are the most cocksure. And yet, the same people who failed consistently to identify the scale of the danger are also asked now to explain what happened. Nice work if you can get it.

Predicting markets is a notoriously tricky business, arguably foolish, and the great criticism that bulls usually level at those bears predicting bubble-bursts is that “even a stopped clock is right twice a day”. But what’s the inverse, exactly? Can’t the same criticism be levelled at the bulls? — precisely how “right” are they the majority of the time? And what’s the consequence of the bulls being very wrong just the once? Think back to Joanna Lumley playing Purdey [sigh] in The New Avengers in the 1970s, having to shoot her way through a kind of paintball training course. She was pleased that she’d scored 99%, marked by a single red dot that represented a bullet. Her sidekick, Gambit, pointed out it’s the 1% that kills you.

But I take the stopped clock thing seriously as a criticism of scepticism because it disparagingly suggests inaction and risk-aversion — who would want to be Chicken-Licken, after all? Certainly not the Emperor With No Clothes — and it cropped up in a piece of newspaper coverage about the credit crunch recently. My James Cramer reference the other day bears some reflection too. He would maintain, I believe, that his spiel is aimed at those with spare cash to gamble. But I think, in truth, he has been a cheer-leader for an industry that has been sailing toward the storm carrying every last scrap of sail in the locker.

But then, there is a problem with consistency. It’s generally over-rated. The ability to change one’s mind without shame should be more highly prized. As should be the ability to accept, without regret, that things may turn out better than one fears. Many a fisherman decides to stay in port only to find his catch and income is lost to a storm that doesn’t quite descend. He takes risks for a living, but I’m sure has learned too that it’s better to be wise before the event when so much is at stake. By contrast, a lifeboat man will put to sea in all weathers. But you’re taught at navigation school that he’s not to be confused with the AA man who will come and fill up your tank if you run out of petrol; he should only need to put to sea for the real black swans, not your incompetence. He won’t make that judgement, of course, but will respond to your Mayday anyway.

And so I was looking back at my own adventures as a Jeremiah, thinking about questions of timing. And that’s when I remembered that old post from my earlier blog about Didier Sornette. Sornette has long been on my reading list and in my view is one of the larger anti-heroes of modern finance that comprise my anti-library of unread books. He fits into that category where the Econophysics blog sits. The jacket of his book on markets, like Mandelbrot’s, shows fractal snail-shell patterns: you get the picture. I must buy it some day.

But I did read one or two of Sornette’s papers when they came out. I found them compelling, although the maths was completely impenetrable for me. It would be hard to find a more serious analysis of how vulnerable the markets had become at that point. That was the time to take in sail, batten down the hatches, and prepare (if necessary) to trail warps, spill oil on troubled waters, consider the possibility of removing all sail — what ocean yachtsmen call “bare poles” sailing, in the case of the perfect storm. In finance, it would mean de-leveraging early, not now.

At a very small talk I attended with Nassim Taleb in London way back in 2004, Nassim was asked by a London quant whether he thought the UK property market was in a bubble. Typical of Nassim at that time, I believe, he was confessing to not reading the newspapers so had no idea. The quant persisted that Sornette thought UK housing was in a bubble. Taleb’s response, if I recall correctly was this: “If Sornette thinks there is a bubble, then there is a bubble”. These are things I tend to remember.

Interesting, because Alan Greenspan was defending himself in the financial press the other day — and has done many times before — saying that it’s not possible to identify when markets are in bubbles. It’s a view that the prediction industry likes to repeat. But my understanding of Sornette’s science is that this is just not correct; you can identify bubble conditions from within trading price data using the same approach a seismologist does to gauge the susceptibility of the fault lines between tectonic plates to a sudden shift. I think the mathematical model he applied to the housing markets goes by the name of “log-periodic oscillations”. Predicting when the quake will occur, and with what magnitude, is the problem. That is still a work in progress, but one guesses that Sornette will be at the forefront of it as it unfolds.

Anyway, this is part of what I posted way back in June 2005 in my first, rather arch attempt at blogging called “Not that I’m Biased”:

If one is looking for a truly disinterested expert, and one with the latest knowledge on bubbles, we recommend geophysicist Didier Sornette. The mathematics of Sornette’s discipline is well beyond the lay reader. The essence of it is to show how complex systems work. He is an expert in the study of earthquakes. Stock market and housing crashes are the financial equivalents.

When people think about housing they don’t tend to think of a complex system. They will first think about their own house, those in the neighbourhood, and then a national price index recently described in the press which provides a sense of overall direction. They will probably then invoke a sense of someone who made a killing on property, or whom they saw renovate and sell at a profit on some TV show. From this they will make decisions to buy or sell. There is a strong element of imitation in what motivates them.

These behaviours are definitely part of what makes up a market, but Sornette’s specialism is in analysing them mathematically through study of the price activity of markets. Sornette’s last paper on housing demonstrated that the UK housing market would peak late 2003 or mid 2004, and then be susceptible to a crash. At that time, he did not characterise the US market as a bubble, but in his latest paper he shows that, two years on, the US is in a bubble.

A bubble with a crash in the UK will be one thing, but a serious reversal in the US would be very damaging. It remains to be hoped that the pump priming that occurred in 2000-2001 has not created a greater problem from which the world economy will suffer a more severe hangover.

It is no doubt a symptom of our collective aversion and lack of understanding of mathematics that Sornette’s work is not major news.

When the Asian tsunami hit, there was much hand-wringing about why the cooperation required to create an early warning system had failed. And yet, we know that events of that size are indeed extremely rare black swans, even though they appear to live in the folk memory of some of the coast-dwellers on Africa’s eastern seaboard. Financial shocks are coming with increasing frequency, but financial institutions, governments and the regulatory authorities — let alone the critical faculties of the media, — do not seem to be prioritising really listening to the complexity folks, despite the increasing volumes of accessible literature they have been generating in the past several years. It’s something I discussed yesterday with Brooke Harrington from the Max Planck Institute after her talk at the RSA. But that may have to wait for another post.

Photo credit: BrittneyBush

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Tweet A friend sent me this story, which has Nassim eating dim sum somewhere in London with Bloomberg. For those who did not think my own coverage (almost a year ago now) contained enough finance, this more than makes up for it. But then, I think we now know that bad things happen big time […]

In 2005, I came 9,405th in the London Marathon in just under four hours (3:55:36, to be precise). Last year I had a plan that I would do better, and would cover it as a freelance journalist too. The organisers obliged, and I realised I’d better start a blog. The Knackered Hack was born to track my exploration of endurance fitness, and some of the issues sports can reveal to us as amateurs: something like the professional lessons of Ed Smith’s book, which I reviewed only the other day.

But I lost eight weeks of training from the first 10 of 2007 to two viruses. Thus my hopes of running a marathon were in shreds. That was a lesson in itself. And it was about that time that Nassim Taleb contacted me so that his publishers could send me a copy of The Black Swan to review. The rest, as they say, is path dependence

Last week, Guy Kawasaki listed The Knackered Hack as one of the web’s leading journalism blogs at his newly-launched aggregation site: Alltop.com.

Not all of you will be familiar with Guy. That’s OK, because the patron saint of us uncertain folks is Herbert Simon, who some will know coined the term “bounded rationality”, which incorporates the idea that you can’t know everything. Admitting as much did not stop Simon from winning a Nobel Memorial Prize.

But I digress. Guy was one of the early Mac team, he is a venture capitalist, and renowned speaker. And Alltop.com is aimed at us head-scratchers, who don’t quite know where to start sometimes. His company is also called Garage Technology Ventures. QED.

I’m bound to say that Alltop.com is a great site, and if you start using it you’ll be an early adopter because Guy and colleagues only really announced it a few weeks ago. Although I’m no expert in these things, some of you may find that the concept is broadly similar to popurls.com. What Guy is doing is taking a non-Google, non-quant view at the web, looking for influencers and connectors, especially through the prism of Twitter and the trust networks it is both generating and reflecting.

alltopjpg

Here is what Guy said about it on his blog:-

A good metaphor is that Alltop is an “online magazine rack” that displays the news from the top publications and blogs. Our goal is to satisfy the information needs of the 99% of Internet users who will never use an RSS feed reader or create a custom page. Think of it as ‘aggregation without the aggravation.’”

If I’m allowed to say one thing I really like about it, it is the clean way that the first few lines of each news or blog entry open up as floating text (see above) and allow you a quick preview of the contents. There are other technologies that try to do something like that, but this reminds me of something I wanted way back in the 1990s as a way to allow the reporter to mask explanations of complex terms that would get in the way of readability or the patience of cognoscenti. Like many bloggers, I use Wikipedia for that these days in most instances, but it does involve opening up a new window/tab. So it will be great when that technology finds its way into more general use.

The week before last was Annie Hall week at home here, which contains Woody Allen’s paraphrased reference to the Groucho Marx joke: “I would never want to belong to any club that would have someone like me for a member”. It was not my intention to start a journalism blog, and I’m not doing this for the brethren, but I’m grateful for the recognition. Of course, I do think journalism is important, and I do write about journalism frequently on this blog. And just so that there’s no doubt that this IS a journalism blog (amongst other things), I’ve decided to celebrate my Alltop accolade with the introduction of a new category on the right there: “journalism”. As I’m learning more and more, there are two certainties in this new world of ours: death and taxonomy.

And before we get carried away that we’ve reached the A-list, Guy shares some interesting ideas about influence from different sources on his blog here and here, that further explains perhaps our apparent non-linear rise out of the Long Tail‘s long tail.

Of course, for regular readers of KH, especially those who’ve subscribed to the email, or feed or follow the marginal entertainment of my Twitter service, you can feel especially vindicated for your loyalty and encouragement of this tired soul ;-) . Thank you.

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I don’t want to take full credit for coining the term “Magoo Finance”, because others have already attached the name to the person of former Fed Chairman Alan Greenspan well before I did (see earlier). But I wonder if it might now serve as a useful shorthand for my colleagues in Big Media to characterise the kind of blind or short-sighted risk-taking that has been a feature of the past several years.

I thought it was noteworthy that the expression Value at Risk yields no useful information when punched into the BBC news archive, The [London] Times, or Daily Telegraph. The Guardian, Independent and New York Times all make mention of it, but in no systematic way, normally simply in relation to bank earnings. (The NYT yields a review of Taleb’s second book Fooled by Randomness, that is less than complementary.)

VaR is used by the banks to determine how much the bank would lose in a given day on its assets under management given a certain fall in the markets. Banks use it to calibrate their risk management. It is a pillar of the modern banking regulatory regime. Continue reading ‘magoo finance III’

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