International Law

Taleb Mad at Economists

I have been mildly critical of Taleb Nassim in the past for not making it clear exactly what he was arguing for, as opposed to what he is against. But, in this video Nassim is passionate about exposing a fatal conceit he believes that financial economists have engaged in: phony rigour in their risk management theories.

Unfortunately, the nudity of the emperor is not being acknowledged by those who are responsible for managing financial risk.

Joe Nocera's article in the New York Times makes a point that even the defenders of the current risk management tool, value at risk, are concerned:

"Guldimann, the great VaR proselytizer, sounded almost mournful when he talked about what he saw as another of VaR's shortcomings.

To him, the big problem was that it turned out that VaR could be gamed. That is what happened when banks began reporting their VaRs.

To motivate managers, the banks began to compensate them not just for making big profits but also for making profits with low risks. That sounds good in principle, but managers began to manipulate the VaR by loading up on what Guldimann calls "asymmetric risk positions."

These are products or contracts that, in general, generate small gains and very rarely have losses. But when they do have losses, they are huge."

Now, we are getting somewhere. The debate is about how risk management governance rewarded people for making bets with other people's money: heads they win, tails you lose.

It is not about the future not looking like the past, the skewness of a probability distribution, non gaussian distributions, or any other mathematical curiousity. It is about regulating the depths of human guile, gaming incentive systems, and aligning agency costs.

Not sure that I feel better about this conclusion, however.

Full post as published by Misleading Advertising Law on January 05, 2009 (boomark / email).