Visit to discover Indian blogs Blog Directory Entertainment Mind Trends - Blogged MindTrends: Ignoramus...It is Randomness .....of Course !!

Saturday, January 22, 2011

Ignoramus...It is Randomness .....of Course !!

This is a sort of read back of fooled by randomness by Taleb. I had a read through, sometime back and now am reading through it again, only this time it seems to make a different set of sense altogether.

Let me take for example, one statement of his.
“Outcome cannot be judged, merely by the efficacy of the output, in fact it needs to be judged by the cost of the alternates”.

Now the obvious reference to this statement given by him was that of trading. However my mind, went to look for alternates (Aha, I am judging the efficacy of his example by looking at alternate examples!!).

I am rich, is the output, ok so the next obvious question is that how rich you are. Never is the question judging the cost of alternate of rich that is poor, how less poor you are.

Another example I could think off, is of course related to my little head and of late all the arguments I counter to Amma.I am married is the outcome, good the judgment of the outcome is who are you married to, what does she do, where do you put up, blah blah.

Never is the outcome judged to the cost of alternates, that is now all your weekends are not your own, you have an additional responsibility, you are tied to one post for ad infinitum, you can’t blow a bundle in one night on a hooker (oops!!).

Anyways now back to randomness.

Similar is the case with the reference of buying a call or a put option. Similarly when you made money, using a particular trade, they are assumed causal, the alternate of the trade is not know that is how much money you would have lost if you had not executed the trade.(gain is not equal to loss here, so says Sirjee)

There was an excellent example, in it. One person, asked a trader to create an alternate trading strategy, if the building which housed them was gutted down by fire in an hour.

Now admittedly the possibility of these events is minuscule, but what these events lack in frequency they make up in magnitude and impact, (the same volume margin funda!!) Building on this he says it is a wiser path to lose small a mounts of money, and by the same logic make an obscene amount just once. (Incidentally he seems to be one of the guys who mad money in the sub-prime).

The flaw in current methods is that we just put the occurrence of random events in one bracket of error, noise or probability.

I am not a mathematician nor a finance guy, but with what little finance I have read the current methods ( say Black-Scholes) does not assign a correct impact value to it. That is you just take each action, drill down a binary outcome, assign a value to each outcome, and to the final value of outcome add some error percentage to get an estimated value, which by the above analysis seems to be wrong.

No comments: