How Did Economists Get It So Wrong? - NYTimes.com

How Did Economists Get It So Wrong? - NYTimes.com

This piece is well written and offers a plausible explanation within the framework of mainstream accepted knowledge. But it's explanations merely reflect what has emerged as conventional wisdom and the intellectual strengths and weaknesses of its author, namely strength in economic history understanding and relative weakness in mathematical fluency.

As a result the piece trashes mathematical skill and look to economic history in Keynesian analysis to seek prescriptions for the current predicament.

What Mr. Krugman may not be able to grasp is not that there are good maths and there are bad maths. The maths used in economic theory and neoclassical economic theory since the end of WWII is transposed from Physics and seems a priori impressive. But we seek to address economic issues. "It ain't Physics" . It is only suitable and built for a world with no constraints on resources, continuity of time and space, unrestricted trade i.e. no frictions, perfect rationality of operators, etc.

There have been recent attempts to correct those assumptions, but all withing the edifice of the traditional mathematical architecture.

Indeed behavioral economics and finance are descriptive theories and provide a well deserved criticism of rational agents theories, but these have not been translated in efficient prescriptive formulations.

BICs are built from the ground up to provide a more resilient framework for more effective formulations that reflect actual human economic reality and behavior. They provide the math to efficiently accommodate evolving economic realities

My biggest concern is with prescriptions that are derived from Mr. Krugman's analysis. They are backward looking and fail to integrate the economic transformations that have taken place since the 1930s, notably the advent of the Internet, the rise of the service and network economies, the relative decline of manufacturing as a source of economic wealth, globalization, the environment...


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PS: The following section made me scratch my head:"The theoretical model that finance economists developed by assuming that every investor rationally balances risk against reward — the so-called Capital Asset Pricing Model, or CAPM (pronounced cap-em) — is wonderfully elegant. And if you accept its premises it’s also extremely useful. CAPM not only tells you how to choose your portfolio — even more important from the financial industry’s point of view, it tells you how to put a price on financial derivatives, claims on claims."

Although the original vanilla call option was originally priced by Fischer Black using a CAPM based argument, derivatives pricing theory in all subsequent textbooks more the arbitrage arguments along Merton's Rational Pricing Theory. It is true that Merton makes a CAPM style argument to value derivatives in incomplete settings such as underlyings driven by jumps, but a robust and replicative pricing argument can still be made without reference to the CAPM and its outrageous assumptions, as I do with BICss.

OK, here let's just say the proposition on CAPM as the modern tool used to value derivatives is debatable. As far as I know, the CAPM is more commonly used in corporate finance for corporate valuation purposes where one uses the CAPM to obtain the required rate of return that is used to discount expected future earnings to deduce present value.

But what's really is a bit startling to me is the characterization of derivatives as "claims on claims"... Derivatives are contracts whose payout is is derived from(i.e. is a function of )the value of other observables(stocks, credit indices, temperature,...) at payout payment time(i.e. maturity).

Introduction to Basis Instruments Contracts (BICs) for Mathematics, Finance, and Economics - a knol by Phil Kongtcheu

Introduction to Basis Instruments Contracts (BICs) for Mathematics, Finance, and Economics - a knol by Phil Kongtcheu

I have just received a notice from Ms. Carole Dobson conference manager that this knol "Introduction to Basis Instruments Contracts (BICs) for Mathematics, Finance, and Economics" has been selected for presentation at the "Quantitative Methods in Finance Conference (QMF) 2009" to be held 16-19 December 2009 in Sydney, Australia.

The conference site is at http://www.business.uts.edu.au/qfrc/qmf/index.html

This conference is a leading annual financial mathematics conference and I am pleased to be given this opportunity and really hope to be able to participate.

The wider scope of BICs

I released this knol on The wider scope of BICs that reaches out to strategic partners.

Mathematical Model and the Mortgage Mess - NYTimes.com

Mathematical Model and the Mortgage Mess - NYTimes.com

Yes, BICs 4 Derivatives Volume I : Theory chapter IX pp 203-232, showed that this was faulty and proposed the coherent alternative. When will you wake up people? when?
I cry a river over this. I cry a river over this....

As I have described at length in other writings(See this or this ), this crisis was a failure of the existing mathematical modeling framework at describing the real world dynamics of underlyings. Therefore the corresponding hedging and risk management strategies failed to represent reality and this fact becomes most obvious at times of crisis. One of the reasons for this development is the over-representation of former physicist at the highest levels of "quantdom" who have forced the adoption of a framework coming from another world. But "It ain't physics". It just ain't.
And I cry a river over this. I just cry a river over this....

They Tried to Outsmart Wall Street - NYTimes.com

They Tried to Outsmart Wall Street - NYTimes.com
The newsy or useful point the article is trying to make kind of eludes me. From the front page snapshot, I thought there would be some statistic showing demand for quants has shot up with the crisis other than the discrete opinion of a quant professor who has a conflicted interest in selling his academic curriculum to prospective students. The reporter apparently just opened his quant rolodex and got a number of known quants say something that would make them look good and prop their books. Unlike what the title "They Tried to Outsmart Wall Street" would suggest, it does not try to hold any of those accountable.

How about BICs Sir, how about BICs, it actually would help...
I cry a river over this...

As I have described at length in other writings(See this or this ), and keep on saying, this crisis was a failure of the existing mathematical modeling framework at describing the real world dynamics of underlyings. Therefore the corresponding hedging and risk management strategies failed to represent reality and this fact becomes most obvious at times of crisis. One of the reasons for this development is the over-representation of former physicist at the highest levels of "quantdom" who have forced the adoption of a framework coming from another world. But "It ain't physics". It just ain't.
And I cry a river over this. I just cry a river over this....

Introduction to BICs Exchange Systems

In this post, I just added a presentation that hopefully more clearly stresses the relevance and applicability of BICs as a sorely needed risk management tool

Introduction to BICs

I am making my first post with an introduction to BICs that I have posted on my knol at:http://knol.google.com/k/phil-kongtcheu/introduction-to-basis-instruments/

This article provides a definition for the concept of Basis Instrument Contracts (BICs) and explains why such a concept is needed and useful in Finance, Economics and Mathematics. It explains how BICs are practical and represent both a prophylactic and a therapeutic structural tool for a crisis such as the 2008 crisis. BICs help mitigate market volatility and facilitate more robust risk management.

More about me also at: http://knol.google.com/k/phil-kongtcheu/-/24v2kgtuvzk2v/0#