Wednesday, September 16, 2009

A little hyperbole goes a long way

I very much enjoyed Nassim Taleb's The Black Swan, and so it's probably no surprise that I'm also enjoying Pablo Triana' Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets? Taleb even provides the foreword to this book.

Both books question the use of models for risk and the concept of ex ante measures. Although I'm not far along in Triana's book, yet, it's evident that he very much takes to task many of the models, such as the famed Black-Scholes-Merton option pricing model and Value at Risk. He looks specifically at our most recent market downturn, pointing to the failure of these models to provide their users with any advance notice, so that they could avoid the losses that ensued.

Taleb is not known for his shyness; consequently, his fairly long foreword is replete with much negative commentary on the academic community and the failure of models; even worse, how the models themselves may have contributed to problems that arose. Interestingly, he actually offers a disagreement with Triana on one minor point, which is a tad unusual in forewords, which usually sing the praises of the book for which they were written.

Taleb's suggestion that we encourage our friends to "resign from the various associations, such as the Internal Association of Financial Engineers and the CFA Institute" may be a tad excessive, even for him. Our alleged need to "shame members, humiliate them" is, I believe, inappropriate, though, I would encourage you to read this book and acquaint yourself with the arguments that Triana offers.

As one who often challenges conventional wisdom, it's no surprise that I made this purchase. My questioning of the value of Value at Risk at our 2007 Performance Measurement, Attribution and Risk (PMAR) conference was just one of many such examples. As I move forward through this book I will provide additional insights.

Note: I recently penned another article for the NYSSA journal on VaR, which will appear shortly. I will provide a link once it's done. A follow up article is also planned, so this subject will be getting a lot of attention from me in the coming months.

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