Avik’s Ruminations

I’ve been reading him for over a decade, but Nassim Taleb is probably the most re-discovered personality of the financial crisis (maybe along with Nouriel Roubini).

So its not suprising to see him pop up in the news cycle quite often these days. Two recent sightings are however particularly interesting given the state of our world. 

First, at the New Yorker Summit, he made the provocative point that the interconnected-ness in the world today makes it less likely to tolerate leverage. 

We have to be a lot more careful going forward, because we have globalization, the internet, and operational efficiency — which cannot accommodate debt.

Second, there is his recent paper that postulates that large financial institutions are more susceptible to ‘black swans’, the large but improbable risks. It uses a non-linear loss function to show that the risks of aggregation are usually hidden but often  outweigh the classical economies of scale.

Alan Greenspan wrote last week in the FT about how the risk management discipline derived from Markowitz has cracked recently, with the crisis coming from unanticipated directions that were not diversified away. He concludes the need for greater financial cushions, and therefore advises significant increases in bank capital requirements. 

David Bau takes the idea further arguing that blind adherence to Markowitz has created a culture where Wall Street believes that all risks are unsystematic and unknowable and that a bank’s primary mission is to hedge them away, rather than take real risks based on the idea that  they could identify sound businesses and genius ideas better than their peers.

There may be an element of over-generalization in that analysis, but have to agree with the essence of his argument that:

Once everybody believes you can’t beat the market, the market becomes stupid

J R Varma has a commentary on CBOT’s new “Fed Fund Binary Options“:. There’s been an “FT article“: yesterday on these.

The interesting bit is, the underlying risk can sometimes be discontinous if you believe Fed Fund target as a driver of risk appetite in other markets. This makes the discontinous and unhedgeable greeks of binary options moot.

A Keynian takes three hours of work to buy a Big Mac in his country, while an American can afford one with only ten minutes of work. “This analysis”:http://www.economist.com/markets/displayStory.cfm?story_id=2054313 based on its “Big Mac Index”:http://www.economist.com/markets/Bigmac/Index.cfm, appears in latest edition of “The Economist”:http://www.economist.com. Its a really effective illustration of the disparities in today’s world — much better than, say, the per capita income, as a measure of differences in the standard of living.