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trackstar
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 21st, 2010, 9:47 am

So there is an appetite for content without form. What does that look like? Well, bulllet points are a form and so we will just be performing a substitution.And then you will also have to contend with a second order derivative (at least): my interpretation of Elie's writing. If you read Collector's Blog on Implied Philosophy, you know that the written words from a philosopher are already a derivative of his thought. So we are jumping quickly to third and fourth order derivatives => Elie's Thought > Elie's Words > Trackstar's Thought > Trackstar's Words...But some of you guys like Jump Diffusion models. So this is a nice project on implied philosophy surfaces for the weekend. Will post again later this weekend.***The Continuity of TaoLooked at but cannot be seen - it is beyond form;Listened to but cannot be heard - it is beyond sound;Grasped at but cannot be touched - it is beyond reach;These depthless things evade definition,And blend into a single mystery.In its rising there is no light,In its falling there is no darkness,A continuous thread beyond description,Lining what can not exist,Its form formless,Its image nothing,Its name mystery,Meet it, it has no face,Follow it, it has no back.Understand the past, but attend the present;In this way you know the continuity of Tao,Which is its essence. - Lao Tzu, Tao Te Ching
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Traden4Alpha
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 21st, 2010, 12:35 pm

QuoteOriginally posted by: crmorcomQuoteOriginally posted by: Traden4AlphaPart of me agrees with you, farmer, that the density of Ayache's writings does a disservice to his presumed goal of reaching (and teaching) a broader audience who should listen to his ideas in the context of quantitative finance, market regulation, and economics. Yet I don't think we should confuse style with substance and would hope that we could discuss content, rather than form.Though one cannot separate them reliably, the form does matter for the content - certainly at the extremes. Reading the blurb or the 8 pages that Amazon reproduces, it is virtually impossible to understand what the point of the book is. It has a level of form obscuring function that I have almost never seen before. That is a problem - particularly if Ayache expects me to pay $29.16 and spend hours of my time reading 496 pages.So, a question for you: in one or two paragraphs, what do you understand the content to be? And what, in intelligibly concrete terms, does Ayache add to the debate about economics?That's a very very good question, crmorcom, that I doubt I can answer because I have yet to read the book. From other writings by Ayache (which seem to paraphrase or introduce ideas from the book), I would say that some of his main points (muddled by my explanations) include:1) contingency (real uncertainty about the world) takes primacy over the current model of enumerating states and weighting those states by probability. We can never directly observe probability at the unit-event level (e.g., a AAA bond can default and yet still be properly AAA). Probability only has meaning at a population level and then only by making the dangerous assumption that the unit belongs to some unchanging invariant class of entities or events (e.g., all AAA bonds are alike in the past, present, and future)2) the notion of price (as a source of new information) contradicts the notion of replication of derivatives. If a derivative can be replicated (or even hedged) from other instruments, then its price is redundant and has no meaning. If the price has meaning (i.e., a discrepancy between the derivative price and the price computed form the underlyings), then the replication must be flawed.3) Current methods contain the false notion that if the difference between today and yesterday displays certain properties, then the transition between today and tomorrow will have those same (or very similar) properties. I suspect Ayache sees contingency operating over time -- tomorrow is simply different from today and the many people, banks, funds, and sovereigns have lost lots of money not understanding that the trend is not your friend and that the non-occurrence of certain events in all our yesterdays does not imply the impossibility of the event in our futures (e.g. housing pricing can only go up).In general, I get the sense that Ayache wishes to replace the use of probability theory in our understanding of prices and markets with a much more general theory of contingent claims in markets. This theory would avoid many of the problematic (and empirically false) assumptions and dodgy metaphysics of associating the abstract notion of a probability with a concrete event or instrument. But Ayache would not discard all we know. He'd still use non-arbitrage, for example, but probability theory would be out.I too have trouble with Ayache's style. At some level, he wrote a graduate-level work of philosophy with much discussion of the nature of existence, being, necessity, etc. and with reference to other philosophers as if the reader knew those philosophers intimately. His work may be focused on quant-financial matters, but his methods and style draw on the philosopher's toolbox of intricate arguments, deep excursions into meaning, extremely intentional (sometimes idiosyncratic) definitions of terms, complex counterfactuals, and the presumption that the reader knows the literature. Just as a master-philosopher might find a graduate-level quant finance book to be inscrutable, so, too, a master-quant might find a graduate-level philosophy book to be inscrutable. I think Ayache's choice of style is most unfortunate because the people that really need to read Ayache are master-quants, not master-philosophers
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frenchX
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 21st, 2010, 3:26 pm

QuoteOriginally posted by: Traden4AlphaQuoteOriginally posted by: crmorcomQuoteOriginally posted by: Traden4AlphaI too have trouble with Ayache's style. At some level, he wrote a graduate-level work of philosophy with much discussion of the nature of existence, being, necessity, etc. and with reference to other philosophers as if the reader knew those philosophers intimately. His work may be focused on quant-financial matters, but his methods and style draw on the philosopher's toolbox of intricate arguments, deep excursions into meaning, extremely intentional (sometimes idiosyncratic) definitions of terms, complex counterfactuals, and the presumption that the reader knows the literature. Just as a master-philosopher might find a graduate-level quant finance book to be inscrutable, so, too, a master-quant might find a graduate-level philosophy book to be inscrutable. I think Ayache's choice of style is most unfortunate because the people that really need to read Ayache are master-quants, not master-philosophersyeah the writing style is quite disturbing. it's the same with Michel but as soon as you explain them that you understood nothing they begin to explain you in proper simpler term I fear that the writing of Elie is a bit complex... I agree totally with him on his arguments but I think he should explain them in simpler form to catch a large scale readers. By the way, I'm interested in his book and I really hope that he will be translated in french
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trackstar
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 21st, 2010, 9:33 pm

So some of our little projects will be helpful in this regard.The bullets are coming along - it is very interesting to work with the book in this manner, so watch for something later this month. In the meantime, I have started posting summaries on some of the Philosophers on my blog in the OT. This material has been taken partly from Wiki (to leverage my time), and additional material will come from the original texts and my own commentary. Part 1 went up this afternoon and contains Jacques Derrida, Gilles Deleuze, Felix Guattari, Alain Badiou, and Quentin Meillassoux. Part 2 contains Spinoza, Kant, Hegel, Nietzsche, Bergson and Heidegger. More philosophers, real and implied, with their volatility smiles, to follow. Benedict de SpinozaSmiling like the Mona Lisa.
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trackstar
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 23rd, 2010, 6:29 pm

I found a little extra time today and continued with the philosophers on trackstar's blog. There is a lot of material so I will not cross post those threads, but they are there for the curious and brave of heart and mind. Part 3 - Select PhilosophersRoland BarthesJean BaudrillardMaurice Blanchotand a few names that are not so familiar. These are philosophers and also translators/commentators on some of the works previously cited in Part 1: Deleuze & Guattari, and Badiou.Manuel de LandaPeter HallwardBrian MassumiFrancois Zourabichvili***Now I will take a break and come back with original comments in September. Time for a little vacation.
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crmorcom
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 23rd, 2010, 7:55 pm

I think that content without form is a beautiful idea, and something that we should all aspire to!Quote1) contingency (real uncertainty about the world) takes primacy over the current model of enumerating states and weighting those states by probability. We can never directly observe probability at the unit-event level (e.g., a AAA bond can default and yet still be properly AAA). Probability only has meaning at a population level and then only by making the dangerous assumption that the unit belongs to some unchanging invariant class of entities or events (e.g., all AAA bonds are alike in the past, present, and future)Agreed. But this is not a new issue. A strictly frequentist view of probability has not been intellectually defensible for a long time. To reject the interpretation you suggest above is rather a straw man, I think.Quote2) the notion of price (as a source of new information) contradicts the notion of replication of derivatives. If a derivative can be replicated (or even hedged) from other instruments, then its price is redundant and has no meaning. If the price has meaning (i.e., a discrepancy between the derivative price and the price computed form the underlyings), then the replication must be flawed.Again, this is entirely true as far as it goes. But to acknowledge that the replication is flawed is not to say that it's completely useless. One just needs to be rather clear-headed about how it's flawed.QuoteIn general, I get the sense that Ayache wishes to replace the use of probability theory in our understanding of prices and markets with a much more general theory of contingent claims in markets. This theory would avoid many of the problematic (and empirically false) assumptions and dodgy metaphysics of associating the abstract notion of a probability with a concrete event or instrument. But Ayache would not discard all we know. He'd still use non-arbitrage, for example, but probability theory would be out.The basis of much of classical economics is not probability at all but, indeed, already prices and contingent claims. All the core ideas in general equilibrium theory - Arrow and his buddies - are based on agent preferences and beliefs and prices. There is no mention of probability at all. Many of the other assumptions are hugely flawed (convex production functions, agent preferences only depending on own consumption, etc, etc), but there's no probability. It's all about people bargaining with each other to exchange goods and services based on their possibly wildly heterogeneous and a-probabilistic beliefs. Probability sneaks in when you try to restrict your agent utility functions (expected utility) or when you try to pretend that your Arrow-Debreu prices are meaningful as discounted probabilities (pricing measures; Girsanov). As above, people have been worrying about this for generations. Of course, traders may trample the theoretical niceties if they get between them and their next dollar, but no amount of book-publishing is going to change that.None of this is an attack on you at all, T4A, by the way. I agree with your points. It's just that, as they stand, they don't justify a 496 page book and the time that would take to read it. I'm not saying the emperor has no clothes for sure but, if he does, I find it rather unsatisfying that he should refuse to wear them or even flash a bit of petticoat.
 
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Traden4Alpha
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 23rd, 2010, 9:33 pm

Excellent points, crmorcom. I feel edified, not attacked. Your comments on my comments suggest two hypotheses. Either I have failed to understand the depth of Ayache's ideas or the depth is lacking because Ayache's critiques of current probability-based thought have already been addressed. In the current context, I dare not assign probabilities to these hypotheses. What is clear is that Ayache has constructed a 496-page island of densely-forested thought but has not provided sufficient motivation or sufficiently commodious bridges and footpaths to ensure that people inhabit the island.
 
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 1:24 pm

Nicely put. Trackstar may be building some infrastructure already. I hope he includes some nice cabanas on the beach and a decent supply of Mai Tais. I will bring sunscreen and a good, sharp, machete.
 
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 2:00 pm

QuoteOriginally posted by: crmorcomNicely put. Trackstar may be building some infrastructure already. I hope he includes some nice cabanas on the beach and a decent supply of Mai Tais. I will bring sunscreen and a good, sharp, machete.Our attractive and attentive waitstaff will stop by regularly to take your drink orders, so you will not even need to rouse yourself from your chair in the cabana. For crmorcom: a little reading and a little snoozing in the sun.
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Alan
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 2:53 pm

QuoteOriginally posted by: crmorcomProbability sneaks in when you try to pretend that your Arrow-Debreu prices are meaningful as discounted probabilities While I don't believe objective probabilities for finance-type outcomes truly exist, I do believe inthe existence of the subjective ones that we get from derivatives. For example, although there are practical problems of interpolation, extrapolation, bid-ask spreads, etc.,what is wrong with saying C''(K) dK is a (discounted) probability, where C is a euro-style call option price with strike K?Or, if we have a binary betting market, betting on outcome O with market price P(O), (againignoring bid-ask issues), what is wrong with treating P(O) as a probability? Serious question. p.s. BTW, just did a search of Ayache's book for some mention of the Breeden-Litzenberger formula andfind it quite puzzling that there are no matches, given the title.
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 3:31 pm

that's because it's a philosophy book as opposed to a book on derivatives
 
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Alan
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 3:37 pm

Searching for 'derivatives' in the book shows 241 matches.
 
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crmorcom
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 4:40 pm

QuoteOriginally posted by: AlanQuoteOriginally posted by: crmorcomProbability sneaks in when you try to pretend that your Arrow-Debreu prices are meaningful as discounted probabilities While I don't believe objective probabilities for finance-type outcomes truly exist, I do believe inthe existence of the subjective ones that we get from derivatives. For example, although there are practical problems of interpolation, extrapolation, bid-ask spreads, etc.,what is wrong with saying C''(K) dK is a (discounted) probability, where C is a euro-style call option price with strike K?Or, if we have a binary betting market, betting on outcome O with market price P(O), (againignoring bid-ask issues), what is wrong with treating P(O) as a probability? Serious question. Because they are not probabilities - no matter which (attempted) definition of probabilities you take. Clearly they aren't frequentist probabilities by any stretch of the imagination. But they aren't Bayesian probabilities or beliefs, either, unless you construct some kind of "representative" agent designed purely and tautologically to have such beliefs that would justify the prices that you see. The "probabilities" you construct are an abstraction which works well only under a very strong set of assumptions - efficient, complete, frictionless, arbitrage-free markets where you can ignore externalities, strategic behaviour and general-equilibrium effects. None of this would necessarily matter very much except that calling them probabilities leads often to a sense of false mathematical overconfidence that takes you away from thinking hard enough about the real world. If any of the canonical assumptions fail (and we all know that they all do almost all the time), you can very easily get negative "probabilities". I have had some quite senior quants and traders tell me that negative probabilities are "impossible". We do not get to tell the world what is possible or not; we only get to observe what happens. Suppose I see the market selling very, very cheap index option puts before 1987. I say "the implied probability of a crash is very low". That tends to lead to me believing that the puts are not cheap - they are fairly priced because the market says so. Calling them "probabilities" increases their aura of mathematical inevitability and increases pressure for herd-mentality and group think.Of course, the opposite can happen too: it is easy to construct straw-man arguments against use of mathematics and probability in economics and quite a number of quite well-known people have sold quite a few books based on this with very little real thought added. I would rather people followed neither the sandal nor the gourd, but thought for themselves.
 
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 5:06 pm

AlanI don't understand what you are sayingQuoteWhile I don't believe objective probabilities for finance-type outcomes truly exist, I do believe in the existence of the subjective ones that we get from derivatives.You're not saying forward rates are "someone's" subjective expectation of future spot rates? The whole point of carry trades is/was precisely that people didn't believe that the future spot was going to follow the forward.I am looking forward to Trackstar's bulletpoints. I think Ayache's central point is that with the "advent" of stochastic vol models, quants seem to believe that there is some fundamental model of underlying asset prices movements- if only we could identify that then derivative pricing would be solved. Whereas the market in vanilla options is effectively determined only by supply and demand (in those options, rather than the underlying) [market incompleteness]. Previously when one just had lognormal timedependent models, no one would have suggested that there was a fundamental reason 1 year volatilities were higher/lower than 2 years ie that volatility was going to increase/ decrease in a years time - it was just a way of getting consistent pricing. This was highlighted by the fact that each day you recalibrated your vol surface ( basically the term vols stayed roughly the same rather than sliding along the forward volatility)! I personally think this is a very important issue, and if someone knows of another author who has addressed what a model is for I would be interested to hear of them.sean
 
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frenchX
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New Book - The Blank Swan: The End of Probability by Elie Ayache

August 24th, 2010, 5:15 pm

I know that it's quite a debate here but I have a very naive point of view. The "pseudo randomness" of the markets is only the lack of information. If at each time t you 'd know all the transactions in the world then you could find a deterministic price. Moreover even if it's very low, there is a feedback effect. When you act in the market you modify it (even subtely). Probability is just a view of modelling our lack of information by saying that our incertitude is probabilistic but even if the models work, the basic assumption is wrong. Gods of the market don't play with dices