Slightly wonky topic today, but one that is very important. Most of you out there doing financial modelling should already know this (but could do with some reminding) and those looking into this sort of modelling (and bank management who get fed these reports) should know.
For most situations the normal distribution is not the one you should be using for financial modelling.
I’ll say it again in a different way – if you are going to use the normal distribution first prove that it is the correct one to use.
I know that the Basel II Accord mandates its use (even helpfully giving the Excel function “NORMSDIST” in the footnotes) as do many other regulations but there is a mountain of analysis in the academic sphere showing that the normal distribution is not the most correct – understating the probability of the “long tail” or “black swan” events.
Lévy distributions are much more correct – there are particular examples that give much more weight to the long tail than a typical normal distribution does. Work done by Mandelbrot and Taylor (yes, Mandelbrot of the pretty fractal pictures) in the 1960s first showed this and there has been considerable work since then. Just have a wander through Google Scholar for some fascinating reading.
Why then do we keep using the normal distribution? I think that it is just a habit and that we get it drummed into us at university. There has been an enormous amount of work done on the normal distributions, so we also look to leverage off this.
My message to management, then, is this – if a risk assessment comes to you having used the normal distribution the first question you should ask is “Why have you used the normal distribution?” If the answer is something along the lines of “We always use it.” then you should ask them to go back and justify its use. If the answer is “We have been told to do so by the regulators.” then you should tell them “Fine – use it for regulatory numbers. Just give me the real numbers as well.” If the answer is “We have modelled the market and the normal distribution is the best fit after considering the other possible distributions.” then your answer should be “Fine – thanks for that.”
71 comments
8 June, 2009 at 17:17
Penguin
Couldn’t agree more! I remember how shocked I was when I went to an economic capital training course and discovered that everyone used normal distribution for market risk.
One more answer which I have some sympathy with – “I’ve used it to get comparable numbers with the rest of the Group”.
But the trouble with that answer is that it just means that everyone is wrong together.
8 June, 2009 at 18:43
Andrew
Yes – more groupthink. To a great extent this is driven by the old “No-one gets sacked for being wrong – just for being wrong and different”. That’s why I like to encourage a little more knowledge of stats amongst management. It makes them ask the right questions.
9 June, 2009 at 15:50
zk_wong
I totally agree with the idea of the use of non normal distribution, especially for the leptokurtic distribution, for financial modelling. Technical geeks may be facing with the following hurdles:
1) It’s true that everyone knows the use of normal distribution poses numerous inconsistencies in terms of the probability of distribution “tails”. Nevertheless, I got told that it would be even more dangerous if we are fitting any non normal distribution curve for financial modelling, especially for the leptokurtic ones. At least, we are “roughly” right when a normal distribution is used rather than “absolutely” wrong when the leptokurtic ones (by increasing the value of variance, we are still within x% confidence interval! Note that a typical leptokurtic distribution such as student t distribution has very low density around 1 or -1 standard deviation regions given that the second order moment exists). Similar comments from Andrew, we will not be sacked for being wrong (and following the crowd), but we may for being wrong and different.
2) We don’t know whether non-normality results from the sampling property (other than from the “population”) (for skewness please refer to Peiro, 1999). By fitting the non normal distribution curve, it would be difficult to know whether we are capturing the “tail” distribution from the population or sample.
3) The use of some of the non normal distributions, especially for Levy distribution, may not have second moment order moment (even the first order moment). It would be difficult to ensure the estimates to be statistical consistent.
4) When the second order moment does not exist, the end user needs to use a more fundamental concept like density or range of x% of confidence interval to estimate the potential risk. This may be very inconvenient for the non technical people. Although the probability density is risk neutral per se, the use of x% of confidence interval implies certain level of risk aversion. Analysts may find it difficult to prepare every density forecast. Nevertheless, only a few intervals may be used such as 99%, 95%, 90% etc.
10 June, 2009 at 13:49
ABOM
The normal distributin is the WORST possible model to use in financial markets, because there appears to be a correlation between INCREASED VOLATILITY and DEBT. So the probability distribution during periods of high debt is likely to be a “U” shape – with the LEAST likely outcome the long-term mean and the MOST likely outcomes either deflation or high inflation (the extremes on the returns distribution).
What idiot first used the normal distribution in financial markets? They should be shot.
See this recent research demolishing the normal curve in financial markets:
http://forum.globalhousepricecrash.com/index.php?act=attach&type=post&id=4127
The tragedy is that this mindless, zombie-like application of an inapplicable theoretical model materially contributed to Iceland and the sub-prime bust.
There is a cartoon where Lenin is talking to his advisors as he sees a row of academic economists walk by him in parade. The advisors ask “Where are the parades of nuclear warheads and missiles and the Soviet tanks?”.
Lenin replies “We discovered that Western academic economists are cheaper than nuclear warheads and do much more damage!”
10 June, 2009 at 14:51
Andrew
ABOM,
the first one to do it (AFAIK) was Louis Bachelier in the late 1800s – the first person to use mathematics to model financial markets. To be fair to him the mathematical tools available to him were fairly primitive (no MS Excel, let alone a decent database) to crunch all the data. The difference between a normal and a Lévy distribution is pretty subtle under most circumstances.
Making that mistake these days, though, is less excusable.
10 June, 2009 at 15:17
ABOM
I will call the “U” shaped distribution of returns during periods of high debt and financial stress the “Makian” distribution, after it’s long-maligned founder and rejected visionary.
10 June, 2009 at 15:21
ABOM
To be precise, the Makian distribution during periods of high debt is actually an “M” shape.
But no one understands what the Hell I’m talking about, so I’ll shut up and watch the bond market collapse as a tribute the non-normal distribution of returns in financial markets.
10 June, 2009 at 18:02
ABOM
“…as a tribute to…” (yes Andie, stocks of Macallan 18 year old were recently replenished in case of Armageddon and I’m conducting a taste test of each batch to confirm purity).
For those interested in the economic theory behind the combined deflationary/inflationary high-volatility M-shaped “Makian” distribution, I give you this Austrian School analysis of the modern monetary system, which predicted the financial crisis and also predicted a COMBINED/SIMULTANEOUS deflationary/stagflationary financial crisis from which there will be no escape, other than complete destruction of the monopoly currency and an associated social implosion of the Weimar Republic kind.
http://www.goldensextant.com/SavingtheSystem.html
Sweet dreams….
10 June, 2009 at 18:59
Andrew
I still think you need to go for the Laphroaig…
10 June, 2009 at 21:23
ABOM
We must be made differently. I really can’t stand those peaty single malts.
How can you drink that stuff in preference to the golden, gentle, complex warming loving subtle flavour of The Macallan.
I think this is a sign why you hate Ron Paul. You can’t taste the subtle quality of his timeless message.
11 June, 2009 at 02:02
Andrew
ABOM,
I don’t hate Ron Paul. Like Macallan’s – I just think there is something better.
17 June, 2009 at 15:15
AUSQUANT
A topic close to my heart that I wished I had of joined in sooner. I don’t usually take up this side of the debate but its fun to be contrary. Firstly ABOM is going over the top. While it is known to be wrong and we should be moving away from it there is many good reason the normal distribution is used.
The firstly that the central limit theorem tells us that even if the micro level shocks are not normally distributed we will still get a normally distributed distribution at a larger scale provided the shocks obey some pretty broad conditions. Unforunately they don’t hold but it was a reason thing to try.
The second thing is that for the most part Normal distributions are tractable and allow us to produce answers. The black-scholes equation may be funamentally flawed but its difficult to believe that we could have had the development of derivative markets of the scale that occured over the last few decades without it and the mostly normal based modelling that has followed on from it. In light of recent events some may regard these developments as a negative, but I would disagree I think the net effect has been mostly positive.
The third are related thing is that its all very well to notice that the tails of distributions are fatter than the normal distribution would predict, but closing what levy distribution to use is a far from trivial. The tail exponent is driven by extremely sparse data, and you may easily underestimate it (I think there is a statistical bias on any finite set to do so) and end up with almost as big an error as if you had just used normal in the first place.
VAR at most Australian institutions for example is not run using a normal model but is historically based and will therefore take into accoutn any fat tails in the data set. This doesn’t solve your problems as the even greater issue is that any historical set will not capture all possible risks. The absense of such risks in our risk modelling then encourages traders to take on the very risks that aren’t modelled as these will give the best returns for their measured risk.
So it is easy to say replace normal models the question is with what. Levy models for the most part are difficult to use and calibrate, and that’s when possible to build at all. Far better in my opinion to realise the weaknesses and have supplimentary controls around them. If we can use better models then by all means used them but largely they don’t exist.
17 June, 2009 at 15:24
ABOM
To sum up your comments:
It is better to use a quantifiable mathematical model that is completely useless in real world application (and has been PROVEN to grossly underestimate “black swan” events every time it has been used) than to accept that the real world is not quantifiable and CANNOT be quantified.
I have some 10 and 30 year US Treasury notes that I’d like you to take a look at. The models are showing that the risk of default is minimal on both.
You want a few trillion of them?
17 June, 2009 at 16:31
AUSQUANT
Speak to Taleb. I believe he invests 95% of his money in US treasuries.
Its easy to take the nihilist approach that nothing works.
Back in the real world people want to trade stuff and do business. they need to make estimates for prices. The normal distribution allows us to do this.
18 June, 2009 at 09:25
ABOM
I guarantee Taleb has it all in SHORT-TERM bills not long-term notes, my quant-loving friend. I guarantee it.
Back in the real world, real investors treat egg heads using the normal distribution in financial modelling with the disdain they deserve. (Jim Sinclair, Jim Rogers, George Soros….)
I have a “knockout” response for you:
Q4, 2008.
Ha. Ha. Ha.
3 July, 2009 at 09:52
AUSQUANT
ABOM,
One day you’ll learn to actually argue against the points being made. As I state in my first paragraph the normal distribution is wrong applied to financial markets.
The point being it is virtually impossible to create a better model. Its easy to say Levy distribution, but if you are just calibrating it to historical data then you are still at risk of black swans. Its not clear at all that the improvement you get in having fatter tails actually solves your problems to any great degree.
5 July, 2009 at 15:33
ABOM
Err…and your point is?
I did argue the very point being made, but admit I had fun making it (perhaps you don’t like me having a little fun along the way with the OBVIOUS mindless stupidity ever-present in the world of quantitative financial modelling?).
The fundamental point is that you think a quantifiable model that has been shown not to reflect the dynamics of real markets is still “useful” because it just might (might!) just approximate reality in the short run and does allow quantification (and therefore pricing) of risk. You admit the normal distribution is wrong, but nothing (quantifiable) is better, so we may as well use it IN ORDER to price risk in the financial markets.
I happen to believe the use of the normal distribution is WORSE than useless because it leads the whole financial sector to underestimate volatility during periods of high leverage and debt. An “M-shaped” distribution (which I call the “Makian distribution” for want of a better term) would at least warn people of the impending volatility when leverage hits unprecedented levels.
The technical term for this phenomenon would be “bifurcating bell curves” or ‘bifurcating normal distributions” where, as leverage increases, you actually see a bifurcation of the long term normal distribution into TWO OVERLAPPING normal distributions, which can go either way (deflation or hyperinflation) depending solely on what the central bankers decide to do in the middle of the panic (which in itself cannot EVER be quantified).
Deflation is when they panic one way, and keep the money supply reasonably stable. Hyperinflation is when they panic the other way, and try to “compensate” for lack of liquidity during a credit crunch. But one thing is clear through all the empirical history – whoever is in charge, they ALWAYS panic (as 2008, 2001, 1991, 1987, 1982, 1970s, 1960s, 1930s, 1912, and the whole of the 19th century so clearly shows).
It can go either way. What is actually LEAST LIKELY during these periods of high leverage is the maintanence of steady growth in financial markets consistent with the long-term mean.
Taleb (sort of) understands this by saying that the modelling underestimates extreme events, but even that doesn’t capture what I’m saying. He just worries a lot, but doesn’t replace the normal distribution with anything else. With Taleb, you’re “flying blind” with the distribution really being a horizontal line across the returns spectrum. I don’t think that’s very helpful either.
No one else seems to have the required combination of skills to analyse probability and financial modelling from first principles. The academics built a huge edifice on shaky foundations because none of them studied the PHILOSOPHY of probability. The shoved the normal distribution on to financial markets as a Procustean solution that would never work because they focused on fitting a familiar model onto a messy world. Disaster!
To understand financial modelling you need to have (at minimum) the following attributes: (1) studied Mises on probability (2) studied the philosophy of probability (3) reflected on the inherently subjective nature of probability for non-replicable events in financial markets (4) know SOMETHING (anything!) about Austrian economics (5) be qualified and reasonably competent in financial modelling and mathematical econometrics.
I studied physics and maths in seconday school (had a very “quant” education prior to uni) and could do the “math” in economics standing on my head. It bored me to death because I could see the holes in the models. I was 22 years old.
I did my Honours Thesis on this very issue of the philosophical underpinnings of probability analysis.
In 1991 (over 15 years ago) I was basically laughed out of the academy.
One noted Finance Professor (who was involved in the drafting of the Wallis Report in 1997) said words to the effect “No one at your age should be thinking about and writing about this kind of stuff. This paper is a good reason why Honours students should keep to doing narrow studies on econometrics. I would give this a bare pass. No one should write a ‘philisophical’ paper at your age.”
By the way, that “noted” Professor has recently come out and said words to the effect that de-regulation was a mistake and markets are not efficient and that he made a “mistake” (a mistake!) thinking they were when he wrote the Wallis Report. Oh well…too bad I suppose.
He (frankly) disgusts me in the pathetic shallowness of his analysis of financial markets. I hate to say this, but he had no idea then, in 1991, and he has no idea now (except to acknowledge NOW that he had no idea then… how ironic!)
The thesis (which I spent 8 months of my life on) actually had a crucial page (page 34) MISSING from the version I gave to the Professors for marking – but NO ONE picked it up or commented. That page was crucial to the whole paper. It was clear to me that neither of the two Professors marking the paper had actually read the whole paper. They’d skimmed it and (probably) didn’t see “equations” and didn’t know the area (Austrian School analysis of probability theory) so thought it was rubbish.
I said nothing. I realised at that point they had no idea and I knew it was madness to pursue a PhD in economics in Australia.
This is the kind of quality of teaching in economics we have in Australia, and indeed around the world.
You are also an example of what I would call “Physics Envy” in Economics. You also display “Quantification Arrogange” (“I’m in finance and you’re not which makes my thoughts more valuable than yours”).
In conclusion, I simply repeat my response to your earlier comments:
Q4, 2008.
Ha. Ha. Ha.
5 July, 2009 at 15:45
ABOM
“Arrogance” No doubt this attribute will be on display again in your response. If you do respond.
11 July, 2009 at 05:06
financialart
First of all, congrats with this blog. For a student with an interest in banking and finance, it is great to read these kind of blogs and to get some more insights from ‘high level’ authors with real world experience.
If you allow me, I would like to add two small remarks within the scope of this blog concerning the use of the normal distribution :
(1) The institutional changes that occured after the crisis of 1930 may also be an indirect reason why financial institutions keep on using the normal distribution. Because of the installation of a deposit insurance and lender of last resort mechanism, banks maybe have less incentives to price the tail risks (e.g. when pricing all kind of derivates). In other words, the institutional changes created some kind of moral hazard problem since the banks know that there is a back-up plan when something exceptional occurs.
(2) A Belgian newspaper quoted a banker today : ‘the current crisis is a deviation that normally only occurs once every 7000 years’. Indeed, five standard deviatons away from the mean should only occur once every 7000 years if you consider a normal distribution.
12 July, 2009 at 16:26
Andrew
financialart,
I would agree. The need to price tail risks does drop once you have deposit insurance added into the mix. It is one of the reasons why I have consistently opposed it.
I would not agree, though, that this is a 7,000 year event. In that period you would have to consider events like the Black Plague, major volcanic eruptions and many other catastrophic event. Comments like that from bankers just serve to show that risk analysis can become detached from reality.
13 July, 2009 at 04:10
financialart
I agree that the 7000 years is just a number to say banks couldn’t foresee this situation.
Nevertheless, I also got the number from a document of CEPS (Centre European Policy Studies, http://shop.ceps.eu/BookDetail.php?item_id=1758 ) that says todays events are indeed very exceptional if you consider basic financial theory (that includes normal distribution).
11 July, 2009 at 10:30
ABOM
Agreed. The normal distribution “allows” bankers to gamble, and justify the gamble when they go crying to mommy (the central banks) “We stuffed up, but it was a once in 100,000,000 year event! More money for our busted bets! Pleeaaaaseeee, mommy, pleeeaaaaseeee!”
12 July, 2009 at 16:27
Andrew
ABOM,
If you want to hurl abuse at the banking profession, please do so on other blogs – there are plenty out there that appreciate silly comments. If you have a substantial point, backed up by facts, feel free to post it here.
12 July, 2009 at 17:33
ABOM
I apologise.
I thought I was accurately and objectively recording the banks’ pleas for govt guarantees in Q4, 2008. The pleas were so loud I could hear them from Canberra. Surely you could too? They were accompanied by pitiful crying and begging by the car industry, and the finance industry as they lined up for bailout after bailout at the public money trough. The noise was plain for all to hear.
And they got what they wanted: Taxpayer-guaranteed bond issuance. As good as AAA – backed by clueless “Joe Public” – who is faced with bankruptcy from the very same banks if his restaurant or small business goes bust. Ha Ha Ha! The irony is so sweet!
This is unprecedented. This is the definition of moral hazard. This is both corrupt and insane.
And you accuse me of “hurling abuse”?
It shows just how corrupted the financial system has become.
By the way, “corrupted” is defined as bailing out one sector TO THE DIRECT DETRIMENT of the broader economy. Technically, it is defined as “moral hazard” in the financial sector.
And we accuse Burma and China and Russia of being cesspools of corruption and oligarchy and bribery. Hilarious!
Nothing is “sillier” than a billion dollar bailout of busted banks. Nothing.
13 July, 2009 at 13:04
Andrew
financialart,
I would agree that these situations are unusual, but they are hardly unprecedented on a 100 year timescale, let alone a 7000 year one. The attempt to use the normal distribution to justify these numbers just show detachment from reality, not good, reasoned analysis.
.
ABOM,
It is not what you are saying that is OTT – it is how you are saying it. Criticising bankers is fine – I do enough of it, but this is not a blog that is here to try to replace the louder efforts of the blogosphere.
13 July, 2009 at 13:41
ABOM
The truth hurts.
A few questions, to bring this discussion back to “civilization” (so to speak):
1. Did you then (in Q4 2008) and do you now support the taxpayer-funded, govt-guaranteed “Australian bank” bailout (where for a certain period Oz banks can issue govt-guranteed bonds)? If “yes”, do you justify this on liquidity grounds, TBTF grounds or simply on the vague ground that the financial sector is such an “integral” part of the economy that we cannot “risk” it freezing up? And, if “yes”, do you then support nationalisation of the banking sector, given that the sector appears “fragile” and vulnerable to regular crises, requiring regular bailouts from Joe Public (if the last 200 years is any guide) and that nationalisation would be the logical conclusion, if you support the bailouts?
2. Do you support Rudd Bank, where property developers get essentially the same deal?
3. Do you support the unprecedented deficit spending by the Rudd govt o support the economy and the financial sector by allowing asset prices in housing and stocks to remain high? Do you think this will “stimulate” the economy out of recession or simply cause further disruptions?
4. Do you support the first home buyers grant being extended? If “yes”, Is this because you like high house prices or really believe this makes housing more affordable for young people? Can you predict when this taxpayer-funded distortion in the property market will be lifted, and if so what the likely effects will be? Do you believe it ever will be lifted? Do you believe this is a good example of a market distorting govt intervention that, once initiated, cannot ever be removed?
5. Do you think we are living in an age of unprecedented monetary fraud the likes of which the world has never seen? Do you believe all fiat monetary systems are inherently fraudulent, oppressive and doomed because of their distorting effects?
6. Do you agree or disagree with this analysis of FRB, and if not, why not:
http://econpapers.repec.org/paper/wpawuwpma/0203005.htm
13 July, 2009 at 13:48
ABOM
This is also a fun read. It gave me a lot of laughs over the weekend:
13 July, 2009 at 13:54
ABOM
This one isn’t quite as funny, but has some interesting stuff on Kennedy and silver certificates:
http://news.goldseek.com/GoldSeek/1192819378.php
13 July, 2009 at 13:56
ABOM
This one is hilarious!
http://www.marketoracle.co.uk/Article4489.html
13 July, 2009 at 13:57
ABOM
And Lew Rockwell is always good for a laugh:
http://mises.org/story/1971
13 July, 2009 at 15:00
ABOM
Andrew?
Fat cats got your tongue?
13 July, 2009 at 15:08
Andrew
I am not always at my computer, ABOM. Sometimes I actually do some work.
1. No. It was also unnecessary.
2. No. It was also unnecessary.
3. No.
4. No.
5. No.
6. No. FRB is not fraud and it does not lead to inflation. Deficit spending and printing new money (under certain circumstances) does.
14 July, 2009 at 01:33
Andrew
Just in case you are in any doubt on this (now I have some time) most of these I have covered before – mostly around 18 months ago, but deposit insurance I have been going on for about 2 years at least. Samples:
1. This was a form of deposit insurance – so look here.
2. Nothing specific on this, but I think the stuff in 1 above partially covers it.
3. Nothing specific on this.
4. Home ownership incentives here.
5. Fiat monetary systems here.
6. A few on FRB. One of the early ones.
14 July, 2009 at 09:36
ABOM
1. Not quite on point. Your earlier comment on Costello’s ridiculous plan doesn’t cut it. No DIRECT denounciation of the Rudd govt guarantee of private bank bond issuance. It’s slightly more subtle than deposit insurance (which is a recipe for moral hazard) but it will be virtually impossible to extract ourselves from the guarantee when the time comes. I predict it will be extended in some form (perhaps indefinitely).
By the way, did you know that “idiot” Costello sold 2/3 of OUR gold at around 1/3 of the price it is today? The UK had Brown. We had Abbott and Costello.
2. No it doesn’t.
3. Noted.
4. Spot on and I acknowledge you hit the target on this topic. You hit the ball out of the ballpark. Then again the short-term populist idiocy of this policy was rather unsubtle.
5. Not any better than anyone else’s attempt at this incredibly complex topic. For my “money” (excuse the pun), these are all more interesting/informative/provocative/contemporary:
http://www.webofdebt.com/
http://www.moneyasdebt.net
http://www.cfoss.com/grip.html
http://mises.org/Books/mysteryofbanking.pdf
6. Weak, shallow, naive analysis. Credit is money in the modern age so FRB has terribly distorting effects on the real economy (check out exponential housing price growth over the last 30 years). Check out this excellent, detailed article on WP:
http://en.wikipedia.org/wiki/Criticism_of_fractional-reserve_banking
Note in particular this article from Yves Smith (Naked Capitalism) referring to Steve Keen’s excellent piece, “Roving Cavaliers of Credit”:
http://en.wikipedia.org/wiki/Criticism_of_fractional-reserve_banking
14 July, 2009 at 09:40
ABOM
Apologies, Yves Smith piece is below:
http://www.nakedcapitalism.com/2009/02/steve-keen-roving-cavaliers-of-credit.html
14 July, 2009 at 10:07
ABOM
And just a follow up on this topic, there is an absolutely rivetting, fascinating debate between deflationists and inflationists going on in the blogsphere:
http://www.marketoracle.co.uk/Article11999.html
I’d be interested in your comments. I prefer Mish’s analysis to North’s but then you may not have a comment on this stuff because it’s too “controversial”.
This “debate” appears to confirm my near-20 year old thesis:
Bifuracting Bell Curves causing simultaneous deflation and inflation, due to simultaneous credit collapse and debt-sourced deficit spending.
I personally predict the decades-old, govt/banker-created misallocation of resources will ultimately lead to government bankruptcy, forex chaos and mass, worldwide starvation as the means of exchange in the major world economies is completely debased. Once oil prices spike, food prices will spike or actual, sudden food shortages willl appear – either way it will be ugly for poor countries (or those “rich” countries with no arable land – like Japan and Korea). There will be a veritable holocaust when food shortages really become chronic.
Am I mad?
Well, I received virtually every award possible in Economics at the undergrad level, scored top marks (or second top marks) in virtually every subject in my Honours year (including financial analysis), but received very poor marks on my Honours Thesis, which caused me to stop pursuing a PhD in financial economics in Australia. Ironically, I spent minimal time on all the “regular” (boring, useless) subjects and a full 8 months on my “first love”, my Honours Thesis (a subjectivisit Austian analysis of probability theory).
The more I studied, the worse my marks. How’s that for a negative correlation?
The more confident I am in my predictions of chaos, the more violent the negative response from the Establishment. How’s that for a negative correlation?
The higher residential house prices, the more fertile arable land is destroyed in Australia and the US. How’s that for a negative correlation?
14 July, 2009 at 14:56
ABOM
Andrew, are you going to “release” the earlier piece from limbo? Or just leave it to fester in purgatory?
14 July, 2009 at 14:57
Andrew
To be frank, ABOM, I could not care less if you think I am ideologically pure enough or not. I am clear on government guarantees and deposit insurance and if you cannot see they are virtually identical, well – so be it.
As for the rest, find an economist who wants to discuss this in depth. With th enumber of links you have put in you should be able to find someone.
14 July, 2009 at 15:00
ABOM
Apologies. It appears the beast has been unleashed. Thanks. Look forward to your comments on the deflation/inflation debate. This is where we look back in 12 months and see what positions we staked out and where we ended up. Reputations are made and lost on such bets. North bets one way. Mish the other. Which way do you want to bet, on the biggest bet in 80 years? Deflation or inflation?
Will we be Zimbabwe or will we be Japan?
http://online.barrons.com/article/SB124216547946012487.html
14 July, 2009 at 16:23
ABOM
Your last comment indicates you’ve hit your “intellectual” glass ceiling. Information overload, eh?
Sad.
I’m out here in deflation/inflation limbo, on my own again….
14 July, 2009 at 17:28
Andrew
No, I just am not particularly interested in games of “I am more (insert appropriate talent here) than you.”
I did my degree and have been involved in practical issues ever since. I am not particularly interested in making bets. I prefer to control my personal risks and those of my clients and let the market wander where it may.
14 July, 2009 at 17:43
ABOM
I only mention my qualifications and past “run-ins” with the Anglican pin-up boy from the Wallis Report (1) to prove these are not the rantings of an unqualified madman (note: I don’t deny I’m mad, but I strenuously deny I’m unqualified) (2) as a serious plea for all quant modelling geeks to reconsider the use of the bell curve in short AND long term financial modelling and (3) to advise your clients to buy some physical gold and silver and food and water.
All the best.
15 July, 2009 at 09:09
ABOM
Brilliant summation of my research of 20 years ago below. I can die a happy man now that at least a few other people “get it”:
http://www.marketoracle.co.uk/Article12022.html
15 July, 2009 at 11:23
Andrew
Strangely enough, I would tend to agree with you on this – but I am not sure I would classify this as being a summation of your research. The limits to national debt, even when denominated in your own currency, are well known.
BTW – he is a little bit down on likely peak debt. The usual figure I see bandied around is $54 trillion, not the $33 trillion he was using, but really, given the health and pension liabilities, the number could be almost anything – as long as it is big.
15 July, 2009 at 11:40
ABOM
How the Hell would you know whether this is a brilliant summation of my research? It is. I’m not saying it’s derivative, I’m simply saying it reflects my many years of thinking on this profoundly important topic.
I’ve hidden this stuff for years and like to keep it that way, because I see dead people in my dreams my friend. Starving. Dead. People. With. Huge. Debts. And. No. Arable. Farm. Land. (and no fish in the sea either). I have to spell it out for you because it’s too much for most people to handle. But it’s so damn obvious, even a non-economist like Michael Rowbotham can see it coming so clearly.
Sometimes I like to scare stupid people by showing them the future.
But mostly I keep it deep within me.
I like to laugh a lot.
15 July, 2009 at 11:44
Andrew
All I am saying is that th source could have been other than your research – I do not know where he got his thoughts from. Nothing personal.
15 July, 2009 at 11:55
ABOM
If he got any of his thoughts from the link below it would have been derivative. But who’s to say?
http://en.wikipedia.org/wiki/Criticism_of_fractional-reserve_banking
15 July, 2009 at 18:28
ABOM
And when I recommend buying gold and silver I mean doing so in the next 120 days:
http://news.goldseek.com/DollarCollapse/1247638020.php
20 July, 2009 at 15:34
ABOM
Can you believe I actually did that thesis in 1989, not 1991? I graduated with the double degree in 1991, but actually the thesis was written in 1989.
It really is the 20 year anniversary of my thesis on subjectivist probability theory which in turns underlies the “mad” theory of Bifurcating Bell Curves!
How funny is that? Especially when Anglican “pin up boy” Harper is now doing a public mea culpa for the Wallis Report, repudiating the validity of EMH.
It takes a damn long time to be vindicated and even then there’s no reward. You’re hated and despised anyway, just for being right all along!
Ha Ha Ha!
20 July, 2009 at 15:56
Andrew
ABOM,
20 years on and you are still behaving like a juvenile.
20 July, 2009 at 16:50
ABOM
I know. I can’t help it.
But remember, nearly all financial market participants around the Western world are sucking at the teat of the central banks RIGHT NOW. Heat that sucking sound? That’s the sound of bankers sucking on YOUR TAXES.
They’re babies.
At least I’m half-way to adulthood.
20 July, 2009 at 16:51
ABOM
Heat or “hear”? The heat’s on in this debate, and I think I’m winning.
Ha Ha Ha!
21 July, 2009 at 01:16
Models, Distributions: preamble « ozrisk.net
[…] Risk Management | Tags: distribution, Levy, model, Normal | by Clive Some contributions on the Normal vs Levy thread suggest that wider musings on modelling issues may be […]
28 July, 2009 at 23:49
Is the future like the past? « ozrisk.net
[…] July, 2009 in Risk Management | Tags: model | by Clive .. continuing a ramble prompted by the Normal / Levy thread […]
29 July, 2009 at 08:15
ABOM
This is also obliquely relevant to this discussion:
http://mises.org/story/3582
10 August, 2009 at 15:46
ABOM
EMH RIP:
http://www.marketoracle.co.uk/Article12604.html
20 October, 2009 at 08:37
ABOM
“Once oil prices spike, food prices will spike or actual, sudden food shortages willl appear – either way it will be ugly for poor countries (or those “rich” countries with no arable land – like Japan and Korea). There will be a veritable holocaust when food shortages really become chronic.
Am I mad?”
Apparently not…
http://www.lewrockwell.com/rogers-j/rogers-j46.1.html
http://www.marketoracle.co.uk/Article14335.html
20 October, 2009 at 09:44
ABOM
When insane zealots get Nobel Prizes, you know that death of an economy is certain and that in the end it’s ALL “fat tail”…
“History is strewn with enough collapses, worthless currencies and social upheaval that I find it ridiculous that the inflationists would today be taking shots at sound money and Credit. It is the inflationists Clinging to Misguided Monetary Mentalities. The principle of sound money and Credit has no reason to have to defend itself.
Inflationism doctrine is riddled with failings: Easy Credit distorts system pricing mechanisms; foments destabilizing speculation; spurs societal wealth transfer; distorts the underlying economic structure; fosters financial fragility; and debases the currency – to name just a few. History – including recent history – validates this analysis.
Yet there are two particular facets of today’s inflationism that make “Keynesian” policymaking extraordinarily dangerous. First, the global backdrop is one of unchecked Credit and the absence of any disciplining global monetary regime. Policy mistakes are free to run longer and with enormous global financial and economic consequences. Second, policymakers and pundits herald incredible post-Bubble policy responses, while failing to recognize that aggressive stimulus is, once again, fostering problematic Bubbles. For too long the inflationists have been negligent in their disregard for Bubble dynamics.
From Dr. Krugman: “Consider first the current uproar over the declining international value of the dollar. The truth is that the falling dollar is good news. For one thing, it’s mainly the result of rising confidence…”
While confidence in the global reflationary backdrop may be rising, the dollar is in trouble. And many dollar apologists will claim the greenback has no immediate replacement and thus will retain its status as the world’s reserve currency. This line of reasoning misses the key point: the dollar reserve global monetary “regime” has broken down as a mechanism for supporting stable global Credit and economic performance. Unchecked global finance now rules, a consequence of the massive and ongoing devaluation of the world’s reserve currency.
Only the inflationists could argue the dollar’s current predicament is “good news.” I don’t see it. I don’t view a world economy rebalancing or becoming more stable. Instead, we’re witnessing the unleashing of another furious global boom and bust cycle. Crude oil traded above $78 this week as gold responded to the weak dollar by surging to an all-time record high. U.S. wealth is being shifted overseas, and Americans’ savings are being devalued. We are losing financial power by the day. Good news? More easy Credit to the rescue?
The inflationists are keen to argue that, with “inflation” remaining so low, policymakers enjoy unusual latitude to stimulate. By this point, haven’t we learned that rising CPI is not a primary contemporary risk associated with ultra-loose monetary policy? The mispricing of risk, unchecked speculation, asset-Bubbles, financial fragility, and economic maladjustment have already proven themselves as deleterious effects of loose money. I group these types of responses to unstable finance (“money and Credit”) as “Monetary Disorder.” Anyone watching global markets these days must recognize that Monetary Disorder remains powerfully entrenched.
Krugman Concludes: “We do seem to have avoided a second Great Depression. But giving in to a modern version of our grandfathers’ prejudices would be a very good way to ensure the next worst thing: a prolonged era of sluggish growth and very high unemployment.”
The first Great Depression was triggered by financial collapse – a historic boom and bust. The jury is still out on the second. The inflationists believe their policy prescriptions strengthen system underpinnings. I believe another bout of global Credit and speculative excess increases the likelihood of eventual financial meltdown. And I believe a dollar crash significantly increases the risk of a very problematic U.S. financial crisis. Worse than benign neglect won’t suffice. Dr. Krugman doesn’t think it makes any sense to consider raising rates. I don’t think it makes any sense to disregard the reality that fiscal and monetary policy went to dangerous extremes.”
Oh dear. We’re done for.
http://prudentbear.com/index.php/creditbubblebulletinview?art_id=10297
22 October, 2009 at 11:02
ABOM
“Once oil prices spike, food prices will spike or actual, sudden food shortages willl appear – either way it will be ugly for poor countries (or those “rich” countries with no arable land – like Japan and Korea). There will be a veritable holocaust when food shortages really become chronic.
Am I mad?”
Not if the NYTimes is to be believed (I don’t take that stupid, slow, East Coast Establishment shill rag seriously myself, but some do)…
http://www.nytimes.com/2009/10/22/world/22food.html?hp
27 October, 2009 at 18:15
ABOM
Uh oh.
I need a syndicate to get into farming.
NOW!
Even the idiot mainstream press are starting to cotton on…
http://www.lewrockwell.com/orig10/evans-pritchard10.html
28 October, 2009 at 12:15
Alice
Im betting inflation ABOM – If they can print that much money in the US with no inflation then Friedman is discredited.
Ahhh but ABOM you forgot the fraud that goes on with stats these days. If the government doesnt want an economic problem they just dont measure it. They will take everything else out of the CPI basket and put poo in it if necessary.
28 October, 2009 at 13:10
Andrew
Or they simply misread the title of the relevant table, huh, Alice.
28 October, 2009 at 14:37
Alice
Andy dont be snarky……you didnt say what table it was. There were so many tables in that doc – you have to be precise. Like “table 3 , row 5″, p.22”
How could I know what table you were talking about???
28 October, 2009 at 14:37
Alice
It would have taken me all day to find the table.
28 October, 2009 at 19:04
ABOM
Gary North, getting it right, yet again.
This is what I believe will happen – the destruction of the supply chain for food, caused by Keynsian-Leninist central banking inevitably failing (as any form of central planning always does), just at the time when the division of labor has made us most vulnerable to starvation.
http://www.lewrockwell.com/north/north777.html
I no longer consider myself mad. Just early.
30 October, 2009 at 10:10
ABOM
“Nonsense, say Malthus’s heirs. All this misses the point: there are too many people for the Earth’s fragile ecosystems. It is time to stop—and ideally reverse—the population increase. To celebrate falling fertility is like congratulating the captain of the Titanic on heading towards the iceberg more slowly.”
Precisely. Either population and production slow sufficiently to save the planet, but bust the finance sector due to aging demographics and reduced GDP, or the finance sector is saved and the environment collapses later due to overfishing, overfarming, overconsuming generally.
The “solution” is monetary reform, you idiots. Even that’s too late to solve this problem now.
Iceberg dead ahead. Either financial market collapse or environmental collapse. Which one will it be? I bet environmental because the Andie’s of the world have too much power to allow monetary reform to take hold.
We’re one of the dumbest species ever to grace the planet. Aware enough to know our own destructive potential, but too enslaved by the money powers to escape killing ourselves on our own overconsumption.
How stupid, how pointless, how suicidal is that?
I used to say “got gold?”. Now I say “got a farm?”
30 October, 2009 at 10:10
ABOM
Reference:
http://www.economist.com/opinion/displayStory.cfm?story_id=14744915&source=hptextfeature
30 October, 2009 at 11:31
Alice
ABOM – exactly “All this misses the point: there are too many people for the Earth’s fragile ecosystems. ”
and we still have idiots in govt making abortion criminal and banning the morning after pill.
30 October, 2009 at 11:59
ABOM
Yeah, I don’t know why the govt wants to ban consensual decisions that private individuals want to make about their own bodies and their own futures.
The role of govt in such sensitive matters is to stay out of it. But in most cases they barge right in.
I don’t know why there are drug laws, legal tender laws, laws regulating alternative medicines (conventinal medicine kills many more people), laws regulating adult prostitution, laws regulating the provision of labour (voluntary exchange), laws regulating trade and commerce (the ACCC is a large intrusion in the market for no reason other than to protect big business and law firm interests and banking and govt), laws regulating speeding (no accident has occurred, no victim exists in a speeding offence – it’s like castrating the son of a pedophile in anticipation of him committing the same crime!).
The State exists (I thought) to protect individuals from unlawful aggression, protect people’s property against theft, and protect the country against foreign invasion. That’s it. Now I find it’s doing everything BUT these things. They have turned plunderer. They have turned thief. They have turned swindler. They have turned counterfeiter. They have turned criminal. They have been made into slaves of those who wish to control and exploit us.
Time for anarchy anyone?
7 November, 2009 at 13:34
Why waste your time? « Karmaisking's Blog
[…] http://ozrisk.net/2009/06/08/normal-curves-and-the-levy-distribution/ […]
1 March, 2010 at 08:57
Volker
I’m a total idiot in these distribution things, but I just read the summary of http://pre.aps.org/abstract/PRE/v60/i5/p5305_1.
“For time scales longer than (Δt)×≈4 d, our results are consistent with a slow convergence to Gaussian behavior.”
So, can I assume then, that for an investment horizon of more than 10 years (S&P500), the difference is irrelevant?