Most people would have witnessed the recent crash of the stock-markets around the world and I am sure our learned friends in the academia would be wondering about modeling the crash (with possible hope of predicting and avoiding the next one) in stochastic terms.
(Before I continue, let me acknowledge an article I read in BBC that inspired me to write this article).
This is what amazed me. The possible exposure to the Sub-prime mortgage (which seems to the most dominant factor in causing the crash) is $100 B while the stock markets around the world lost close to $ 500 B in one day!!!. Does not this sound nonsensical? It defies thermodynamic laws of conservation (who said capitalism is a zero sum game?) and baffles most till you consider an essential ingredient that should go into any modeling of such events: human psyche.
It has been argued that since Hedge funds (with mammoth leverages and exposure) need a certain cash to credit ratio (not sure of the terminology), once the prices of the shares they are holding drops, this ratio also drops, and they need to resort to more selling, which further dips the prices; and this leads to a domino effect thus tumbling the global positions of all trades.
Isn't this somekind of a negative feedback loop attenuating once strong signal? I an not an expert on optimal control and so i am not sure if this kind of model has ever been used for moding this kind of a chain reaction. But, before we model any of this, how can we reliably predict human behavior ? Adam Smith argued that human beings are rational and they necessarily make such choices ?(ever read the story about the old professor and young student and the 10 $ bill?). But, recent economic paradigms are bringing in concepts of dynamical systems and game theory to model these complex phenomenon. But, my fundamental question is "can you capture human behavior using agent based systems"?.
To be continued...
Sunday, August 19, 2007
Monday, August 6, 2007
Murphy, Sod, and Yhprum
A very learned friend of mine once told me about the extension of Murphy's law called Sod's law. I thought it was just another empirical (observational), or pessimistic law made by disappointed human folks who could not find a scape goat for their mistakes? But then, I recently almost had a brush with it.
I flew domestically several times in the past few years, and have never experienced any delays or cancellations. So, now when I had to attend an important occasion which could not be missed I used my "experience" and booked a flight that arrives just before the event starts. I thought the "tail" of airline mishaps is very thin!!! Now, for the first time in my flying experience, the flight gets delayed, and the arrival time in the connecting airport is one minute after my connecting flight leaves. Hello, is this Sod's law? But, then Yhprum's Law comes into the picture and saves the day (the connecting flight also gets delayed !!). I had a hearty laugh at the futility of my well thought and laid plans.
In a similar light, when people say that "Buy and Hold" is the best possible strategy for long term profit making; does that mean that Muphy and Yhprum fight out their best bets resulting in a zero drift, but the game has a positive volatility leading to a long term gain of Yhprum with respect to Murphy?
Are these laws, attempts by pure cynics who do not want to accept responsibility? Or is there some inherent disorganization forces that are coming into the play? The other day I posed this question to my learned friend: "why does Entropy always have to increase". Why can't there be a parallel universe where creation of entropy is difficult and vice versa? Why does not conservation of entropy hold? May be I am missing the entire point of thermodynamics, or maybe I am asking too silly a question?
If we look at Indian mythology, Shiva "the destructor" is the all powerful, and even Brahma, the creator derives his powers from Shiva. Isn't this a contradiction to laws of thermodynamics? Isn't creation of order more time consuming and require sophisticated "rules" as opposed to destruction, which could have countless path independent processes producing the same "ash"?
Adios...
I flew domestically several times in the past few years, and have never experienced any delays or cancellations. So, now when I had to attend an important occasion which could not be missed I used my "experience" and booked a flight that arrives just before the event starts. I thought the "tail" of airline mishaps is very thin!!! Now, for the first time in my flying experience, the flight gets delayed, and the arrival time in the connecting airport is one minute after my connecting flight leaves. Hello, is this Sod's law? But, then Yhprum's Law comes into the picture and saves the day (the connecting flight also gets delayed !!). I had a hearty laugh at the futility of my well thought and laid plans.
In a similar light, when people say that "Buy and Hold" is the best possible strategy for long term profit making; does that mean that Muphy and Yhprum fight out their best bets resulting in a zero drift, but the game has a positive volatility leading to a long term gain of Yhprum with respect to Murphy?
Are these laws, attempts by pure cynics who do not want to accept responsibility? Or is there some inherent disorganization forces that are coming into the play? The other day I posed this question to my learned friend: "why does Entropy always have to increase". Why can't there be a parallel universe where creation of entropy is difficult and vice versa? Why does not conservation of entropy hold? May be I am missing the entire point of thermodynamics, or maybe I am asking too silly a question?
If we look at Indian mythology, Shiva "the destructor" is the all powerful, and even Brahma, the creator derives his powers from Shiva. Isn't this a contradiction to laws of thermodynamics? Isn't creation of order more time consuming and require sophisticated "rules" as opposed to destruction, which could have countless path independent processes producing the same "ash"?
Adios...
Sunday, June 10, 2007
Uncertainity
Why is uncertainty so painful? I look around, and find that people are most unhappy when they are not sure of the outcome. Is it because of tug of war that happens in the mind between the alternatives? Isn't uncertainty the most ubiquitous thing in this universe? yet, why does human mind find it so hard to accept this fact? I think people want money/wealth/power so as to minimize this uncertainty in life. Yet it seems to appear in new forms as soon as the previous issue gets resolved; like a parasite attaching itself to a host as soon as the previous host dies, and yet we try in vain to kill the host while the parasite lives on.
I also observed that uncertainty was perhaps the most dominating factor of global economics. Why should interest rate be proportional to the perceived risk? (is it because of Equivalent Martingale Measure). Why do investors and Quants (finance wizards) get goosebumps when told about the possibility of a thick tail (of a probability density function)?.
I used to ponder a lot whether this world is really deterministic (Karma driven) or probabilistic (complex interaction of chance events). But somehow, the idea of a Karma driven world seems to explain things better than its counterpart. I have often debated the meaning of the phrase "Buddhi Karmanusarine" (Intellect follows Destiny); now I have accepted it. No matter how many arguments you come up against the above statement we can trivially form a counter argument. Perhaps this is one of the statements which can neither be proved nor disproved.
Perhaps it is the chance events that drive the Universe, from galactic formations to self organization, to mutation? Perhaps there is order that sits above (or below?) the apparent chaos that seems to be present in both human mind as well as the universe? As Smith says in "The Matrix": "The initial several matrices (plural of matrix) were created to be perfect; but human mind would not accept the notion of a perfect world". Is it because creativity blossoms under uncertainty? As an example, look at the productivity of a free market economy vs. a socialist state controlled economy. I am still debating on this and your thoughts are welcome.
Adios,
Mico
PS: Listening to a compilation in ragam Natai, "Jagadanandakaraka" by Sri. Thyagaraja.
I also observed that uncertainty was perhaps the most dominating factor of global economics. Why should interest rate be proportional to the perceived risk? (is it because of Equivalent Martingale Measure). Why do investors and Quants (finance wizards) get goosebumps when told about the possibility of a thick tail (of a probability density function)?.
I used to ponder a lot whether this world is really deterministic (Karma driven) or probabilistic (complex interaction of chance events). But somehow, the idea of a Karma driven world seems to explain things better than its counterpart. I have often debated the meaning of the phrase "Buddhi Karmanusarine" (Intellect follows Destiny); now I have accepted it. No matter how many arguments you come up against the above statement we can trivially form a counter argument. Perhaps this is one of the statements which can neither be proved nor disproved.
Perhaps it is the chance events that drive the Universe, from galactic formations to self organization, to mutation? Perhaps there is order that sits above (or below?) the apparent chaos that seems to be present in both human mind as well as the universe? As Smith says in "The Matrix": "The initial several matrices (plural of matrix) were created to be perfect; but human mind would not accept the notion of a perfect world". Is it because creativity blossoms under uncertainty? As an example, look at the productivity of a free market economy vs. a socialist state controlled economy. I am still debating on this and your thoughts are welcome.
Adios,
Mico
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