SERVING THE QUANTITATIVE FINANCE COMMUNITY

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Kurtosis
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### Paper for comments by Nassim N Taleb

Hello,There is a new paper. Technical comments are welcome. Thank you in advance.New PaperNassim
Last edited by Kurtosis on October 28th, 2013, 11:00 pm, edited 1 time in total.

Alan
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### Paper for comments by Nassim N Taleb

I looked briefly. The Jan 21, 2008 market event is interesting and there are various similarities/differenceswith the Oct, '87 crash, which you might discuss. In both cases there was a 'forced selling' triggered by abouta $80 bil position. The '87 crash was triggered primarily by the front-running of the known intentionsof the Leland, O'Brien, Rubinstein firm (LOR), and it turned out that LOR didn't sell that much.Since your point is that ten$8 bil sales would not be so disruptive, it suggests that large institutions in the marketneed to be forced to think through their order management practices prior to a panic event.
Last edited by Alan on October 29th, 2013, 11:00 pm, edited 1 time in total.

Kurtosis
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### Paper for comments by Nassim N Taleb

Stable distributions make no difference. Solved for ALL unimodal distributions.

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### Paper for comments by Nassim N Taleb

Interesting work! There's a key example of a large centralized system that you might want to add to your list.Systems in which the components are coupled by global markets and correlated asset holdings show the same diseconomies that speak about. For example, even if all banks are small, to the extent that they share identical price data on the same pool of assets (e.g., mortgages), then the system is a large fragile one in which the failure of one small bank increases the probability of failure of other small banks due to the impact of one bank failure on asset prices which, in turn, impact the balance sheets of all other banks holding the similar assets. The problem may be further exacerbated if all banks, are subject to similar time-varying reserve requirements.
Last edited by Traden4Alpha on November 14th, 2013, 11:00 pm, edited 1 time in total.

Cuchulainn
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### Paper for comments by Nassim N Taleb

QuoteSystems in which the components are coupled by global markets and correlated asset holdings show the same diseconomies that speak about. That's just about everything then? We then have one 'chain of faulure'.Can't see an alternative. Maybe I've missed something.

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### Paper for comments by Nassim N Taleb

QuoteOriginally posted by: CuchulainnQuoteSystems in which the components are coupled by global markets and correlated asset holdings show the same diseconomies that speak about. That's just about everything then? We then have one 'chain of failure'.Can't see an alternative. Maybe I've missed something.At some level, you are right that there is no easy alternative. The world has inexorably moved from the small (largely independent economies and independent financial systems in respective countries) to the large (a global economy with a global financial system). This problem is well known to epidemiologists and ecologists who fear that the rise of global travel and commerce mean that contagion can race unchecked around the world. By that analogy, the only solution is a series of quarantine zones that isolate chunks of the financial system from each other. I doubt that can happen.But that doesn't mean we can't create incentives for some beneficial logical separations within the globe's portfolio of financial institutions. If we make each financial institution's tax rate proportional to that institution's correlation to other institutions, we create a direct disincentive for herd-like investment in bubbles. A tax on correlation would encourage each institution to find uncorrelated or anticorrelated investments rather than join the bandwagon investment du jour. A correlation tax is a strong incentive for genetic diversity in financial institutions and reduces the chance of some particular investment strategy becoming too big to fail.

farmer
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### Paper for comments by Nassim N Taleb

Any time there are speculators - any time an asset's sale can be postponed - it creates problems for a price signal. Because you cannot separate the demand of end users, and the supply of producers, from the demand of speculators in the price. And obviously speculators can change their plans much more quickly than producers or users.A price may not be an "equilibrium" price, but simply a popular and temporary guess. It can help if you know that, for example, 50% of homes are owned by owners, and 50% of homes are owned or being built by speculators, whose intention is to sell them in the near future, rather than live in them. But this sort of information is impractical, and most economic activity evolves around the price ticker.There is a simple solution: price instability. In currencies, for example, trend traders push the prices as far as they dare one way and the other, so that immediate and long-term volatility generally match. So more specifically, the solution is immediate price instability that is indicative of long-term instability.The immediate price instability tends to regulate the balance of speculators. It is not random that housing, which is very illiquid and hard to change the location of, is where we have seen the most problems lately. Rather than in oil, or something, where people think of there being a lot of speculators. Because trend traders can run the price of oil up and down until they shake off speculators and run their stops, and at the same time find the bids and offers of end producers and consumers.So price instability in a liquid market tends to weaken the signal of speculators, which can lead to redundant inventories. And it reveals the signal of actual supply and demand levels of end users. The most useful piece of information would be like actual curves and elasticities for supply and demand. Running the price up and down the chart - such that speculators cannot hold prices at a single level long enough to completely hide actual demand levels - reveals such curves sort of like a sweeping radar image reveals 360 degrees of airspace.If you wanted to perform an economic experiment to determine actual demand for any good, what would you do? You would try offering it at different prices for periods of time, and see the quantities demanded at each price. Running it up and down extremely fast would allow you to detect a trend, like a really fast spinning radar gives you enough sample points to plot motion in a single craft.One implication of this, is that a "flash crash" is an extremely useful tool, like a fire drill. The more flash crashes there are, the healthier a market will be so far as planning patterns of production. We didn't have any flash crashes in housing for many years, and it certainly was no help to planning optimal leverage and patterns of production and speculation. A speculator must plan for a range of outcomes, and his plans are better informed by observing a range of outcomes while making his plans.
Last edited by farmer on November 15th, 2013, 11:00 pm, edited 1 time in total.

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### Paper for comments by Nassim N Taleb

ppauper
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### Paper for comments by Nassim N Taleb

purbani
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### Paper for comments by Nassim N Taleb

One of the issues that has been exercising my mind with regard to the markets current love affair with risk parity is the degree to which there may already be be crowding into the same risk factor trades due to all of the necessary dimensional reduction via PCA etc. This may have the effect of increasing the overall systemic risk along the lines of the following paper

alexw
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### Paper for comments by Nassim N Taleb

Doesn't PCA fall into the family of tools based on L2 norm, and thus according to the book that is the subject of this thread (p60): "fundamentally wrong...and not dependable enough to be of use in anything remotely related to risky decisions" ?Do we know when the final version of the book will be published?

Kurtosis
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### Paper for comments by Nassim N Taleb

Indeed PCAs will be necessarily unstable ?anything related to variance.So are correlations of course.

farmer
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