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Why didn’t people in finance pay attention to Benoit Mandelbrot?

blogs.reuters.com

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Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#41

Post by yummyfajitas »

wazoox wrote: post #32
yummyfajitas wrote: post #14

My suggestion why people didn't pay attention? He had no real theory. I've read a couple of his books, here is the general formula: "Look, gaussian's don't fit the market well. Aha, I've made a graph that looks visually correct!" Now, it's absolutely true that gaussian's don't fit the market well - they only work sometimes. The thing is, everyone knows this, and tacks on additional features to explain the other pheno…

This would be fine, except that the short, rare, unpredictable spikes are overall responsible for as much variation in value as the "predictable" movements, which more or less makes all the exercise quite pointless.

How does the fact that a model has two features make understanding one of them pointless?

If you are seeking a grand unified theory of everything, maybe it's pointless. Black Scholes is just a model. If you are seeking to make money, Black Scholes is one tool that can help you do that. And make no mistake - people do make billions trading models which incorporate elements of Black Scholes.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#42

Post by yummyfajitas »

joe_the_user wrote: post #23
cdavid wrote: post #15

Earlier quoted context omitted.

I think the standard model also tells you that you cannot do much, no ? The efficient market hypothesis from Fama somewhat boils down to the fact that you cannot beat the market unless you have information that other don't have. Another reason for the "conventional" methods success seems to be related to their empirical testability, at a certain period of time. The best article on Mandelbrot and the link with finance…

I think the standard model also tells you that you cannot do much, no? Well, as a matter of fact... --- No, not true. The "standard model" predicts a kind of randomness which is fundamentally tractable. It comes down to Gaussian versus non-Gaussian stable distribitions. A Gaussian model predicts that total market changes mostly come from day-to-day, small incremental changes - ie, a Gaussian model is equivalent to Br…

No, he was right. The standard model does tell you you can't make money. You are addressing a completely separate issue (hedging risk) in the rest of your post.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#43

Post by eru »

Natsu wrote: post #35
joe_the_user wrote: post #22

Earlier quoted context omitted.

Who wants to listen to a party pooper like that? Yes, yes, yes! The exact correct point. Mandlebrot's finance papers, in published in the 1960's, refute Black and Schole's Nobel Prize winning theories of the 1990's. Who wants to hear that ? Does Mandlebrot rate a Nobel himself? Why of course not... Mandlebrot pointed the way to "another country", one which marketing can not describe...

Actually, I thought I read about someone who bought a certain position in the market such that, if everything was priced correctly, they would lose a known amount of money each day. But every time a "black swan" sort of event occurs, they'd make big money. It was on TV, so I don't have a citation handy, but I suppose that they could be said to be making money off of the assumption that people can't correctly price th…

I'd like to know that position. Because then I could try to invert it (i.e. turn longs into shorts and vice versa).

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#44

Post by eru »

T_S_ wrote: post #19

They didn't ignore him. Fat tails and jumps are just really hard to estimate in finance. More interesting is that the unstated premise for these link-bait titles (aka great headlines) is "If only they had listened to Mandelbrot, we could have avoided all these problems." It is nearly absurd on the face of it, but worth a comment. Like Louis Bachelier's description of stochastic processes in 1900, mathematicians like…

Or just look at banks.

If we did not have deposit insurance from the state, banks would probably be much more pro-active in disclosing all their positions (including liabilities), so that people still trust them. Some banks showed their liabilities in the crisis, but this was way too late for people to pick them apart, so it did not help with the trust.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#46

Post by konad »

Natsu wrote: post #35
joe_the_user wrote: post #22

Earlier quoted context omitted.

Who wants to listen to a party pooper like that? Yes, yes, yes! The exact correct point. Mandlebrot's finance papers, in published in the 1960's, refute Black and Schole's Nobel Prize winning theories of the 1990's. Who wants to hear that ? Does Mandlebrot rate a Nobel himself? Why of course not... Mandlebrot pointed the way to "another country", one which marketing can not describe...

Actually, I thought I read about someone who bought a certain position in the market such that, if everything was priced correctly, they would lose a known amount of money each day. But every time a "black swan" sort of event occurs, they'd make big money. It was on TV, so I don't have a citation handy, but I suppose that they could be said to be making money off of the assumption that people can't correctly price th…

If you'd searched for "Black Swan" it would have told you all you need to know.

Betting $1 at 1,000,000:1 that today something unlikely will happen is pretty much the same as playing the lottery.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#47

Post by charlief »

spolsky wrote: post #13

One of them did -- Nassim "Black Swan" Taleb was great friends with Mandelbrot.

Mandelbrot had qualitative and quantitative insight, but I am not sure Nassim applied fractal brownian motion modeling/simulation to position himself for tail events, but more simply had the qualitative understanding of where tail event risks were greatly under-priced in the system at the time before anyone else.

In terms of fractal brownian motion vs black-scholes-merton, it is a question of practicality. It is really easy to hedge very complex portfolios with large positions using BSM, especially after adding a few considerations to extreme possibilities in volatility. Without BSM, we'd still be in the dark ages with Option Seller(Writer) firms scalping buyers with option prices 10 times higher inflation-adjusted than today. Mandelbrot doesn't offer a practical alternative, and this is the part that people didn't listen to Mandelbrot on, but that doesn't mean Mandelbrot is not awesome.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#48

Post by T_S_ »

eru wrote: post #44
T_S_ wrote: post #19

They didn't ignore him. Fat tails and jumps are just really hard to estimate in finance. More interesting is that the unstated premise for these link-bait titles (aka great headlines) is "If only they had listened to Mandelbrot, we could have avoided all these problems." It is nearly absurd on the face of it, but worth a comment. Like Louis Bachelier's description of stochastic processes in 1900, mathematicians like…

Or just look at banks. If we did not have deposit insurance from the state, banks would probably be much more pro-active in disclosing all their positions (including liabilities), so that people still trust them. Some banks showed their liabilities in the crisis, but this was way too late for people to pick them apart, so it did not help with the trust.

Excellent point. Instead we trust the regulators to make sure banks are a-ok. We would do well to "crowdsource" bank regulation by requiring banks to stream their positions to the public.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#49

Post by eru »

T_S_ wrote: post #48
eru wrote: post #44

Earlier quoted context omitted.

Or just look at banks. If we did not have deposit insurance from the state, banks would probably be much more pro-active in disclosing all their positions (including liabilities), so that people still trust them. Some banks showed their liabilities in the crisis, but this was way too late for people to pick them apart, so it did not help with the trust.

Excellent point. Instead we trust the regulators to make sure banks are a-ok. We would do well to "crowdsource" bank regulation by requiring banks to stream their positions to the public.

Yes, and just don't offer deposit insurance, so that the public scrutiny has some bite. Similar to how the `bond market vigilantes" the Economist is so fond of keep the yield on government debt in line with the governments' fiscal and monetary policies.

Re: Why didn’t people in finance pay attention to Benoit Mandelbrot?

#50

Post by wazoox »

yummyfajitas wrote: post #41
wazoox wrote: post #32

Earlier quoted context omitted.

This would be fine, except that the short, rare, unpredictable spikes are overall responsible for as much variation in value as the "predictable" movements, which more or less makes all the exercise quite pointless.

How does the fact that a model has two features make understanding one of them pointless? If you are seeking a grand unified theory of everything, maybe it's pointless. Black Scholes is just a model. If you are seeking to make money, Black Scholes is one tool that can help you do that. And make no mistake - people do make billions trading models which incorporate elements of Black Scholes.

They make billions for some time, then all their profits are wiped out by some "black swan". Fortunately, our governments are here to save the day...
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