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GenXer
Joined: 20 Feb 2009
Posts: 703
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 Posted: Tue Apr 13, 2010 11:45 am GMT Post subject: |
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| mpr wrote: | GenXer I think you have a strange understanding of how models work in the
real world and even in science. (I take all the bromides about buying
responsibly and within your limits as a given). Your argument seems to be that if you cant pin something down with statistics and models then you may as well give up.
A skilled user of a model will use it to illuminate their already existing understanding of events while keeping in mind its limitations. Anything which
is very clearly (and correctly) predicted by everyone's model is likely
to be obvious to everyone anyway and therefore likely to be in the market.
So the most interesting uses are those where you try to quantify some
qualitative scenario.
It may be hard to prove statistically that someone is not just lucky.
(Though there are some examples like Buffet, and I would argue Soros),
but just because you cant *prove* it statistically doesn't mean its not true -
there may be some evidence which points in that direction which stops short
of proof.
I guess you've written before, when pressed, that you would have no
object to someone buying at the height of the bubble as long as their
personal financial metrics allowed it. Well that seems to be nuts since
there were plenty of convincing arguments that there was a bubble,
even if one doesn't know how long it would last.
I mean you cant "prove" mathematically that anything other than hydrogen
(and maybe helium, I dont remember) exists ,
because the equations you get from quantum mechanics are too
complicated to solve. It seems to me that with
GenXer's point of view you would conclude that
1) Quantum mechanics is almost useless.
and
2) Its an open question as to whether heavier elements really exist. |
Having worked with models for quite a while, I can make the following distinctions:
1) Quantum mechanics is predictable compared to the markets. It is described well by Gaussian statistics.
1a) Hard sciences also have a fair share of chaotic random processes, and so many topics such as turbulence have only recently (past 50 or so years) have been discovered to be governed by extreme distributions.
1b) Many physics models are not applicable to finance because physics has convervation laws, finance has nothing of the sort, hence all of such models fail miserably.
2) A model can be completely useless because it fails to account for the low probability high impact events (which is what we have in finance as of today), and the probability of those events is definitely NOT Gaussian (fat-tailed). It is not a matter of replacing the distribution with another and running the model again! But I digress, if you like to understand more, please read Nassim Taleb's 'Fooled by Randomness'.
3) Making predictions based on financial models doesn't work as of today - because none of the models work. Some pretend they do, and thus you have underestimations of risks by orders of magnitude. This is why I prefer to error on the side of caution given the substantial losses that can be incurred if your prediction is wrong.
4) Also, please understand, that real events are not only chaotic, but also a time sensitive random process which can not be bounded (because of its chaotic nature) and much less controlled by us. We are good at deluding ourselves that we are in control when we are not.
5) Because you can't tell luck and skill apart, even if there is such a thing as skill (which I believe there may be, but again, not consistent enough to measure it), the last thing you want to assume is that YOU have the skill to continuously make the right decisions.
6) One reason you don't want to assume skill, EVER, is that it only takes one time to be wrong and because of the chaotic nature of the markets, you can lose everything you've made in the past 20+ years (which is what banks just did - they lost it all and more having made a single mistake - believing their risk models, and trusting in their risk management skills).
I sleep better at night knowing that if the markets hit zero, everybody will be hurt at the same time, and if the markets rise, I will be well-off because I bet on the markets (all of them). In the interim, I'll be happy even if the markets are flat. All of this can be achieved without wasting time to think about what happens next. Just cover all of your bases, and be happy with incremental gains, and let compounding do the rest. |
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GenXer
Joined: 20 Feb 2009
Posts: 703
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| Posted: Tue Apr 13, 2010 11:55 am GMT Post subject: |
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I meant to say 'conservation laws' of physics vs. nothing in economics. This way, we can't even TEST a single model. Doing curve-fitting has been shown to be less than useless because it
1) does not work in the future
2) does not explain what is happening
No economic models can be proven to work mathematically because we can not estimate the errors since we don't know what the TRUTH is except after the fact. If you get your statistics wrong even by a millimeter, your answer can be way off, especially for longer term projections, and we are nowhere near understanding the market statistics.
I didn't want to get into this, but seeing how there are big misconceptions about financial models and their predictive abilities (or lack thereof) I just had to comment.
Why are we so quick to call out skill when luck would suffice? Same flaw of human nature - we'd like to be incontrol, and we'll do anything to appear as if we are. If it hurts more than it helps (i.e. assuming skill vs. luck), then go with what hurts less (assume luck). This will limit risky behavior, and while it would seem overly pessimistic, it is the best way to manage risk when the risk is unknown (and unmeasureable). |
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