QuoteOriginally posted by: FermionQuoteOriginally posted by: mathematalef0But let's come back to the original point of this discussion. Shouldn't we have also a counter-proposal instead of only blaming certain practices or models?An understanding of the basic function of markets, which has hitherto been consistently ignored by stochastic models is a vital element to any counter-proposal. I have such a model, but can't publish it (yet).Another eseential element is regulation. Society accepts regulation as necessary in almost every other area of life except markets. Not to accept it in markets is crazy. We have traffic lights to regulate crossings. Without them people would build bigger, heavier vehicles in order to knock other vehicles out of the way. That is how markets currently operate. Markets need traffic lights urgently!Have you ever come across a red traffic light at 3am when nobody else is on the road? Traffic lights are inefficient, which is why they should be replaced by roundabouts. Regulation increases inefficiency and competiton is vital to eliminate dead wood. The problem is when governments bail out the dead wood. In the long run letting the poor institutions die would have been better, instead we as taxpayers now have a vested interest in these poor institutions who will only make the same mistakes next time. Death is the ultimate punishment in business, now that we have allowed these banks to survive it is sending exactly the opposite message to what we wanted!

QuoteOriginally posted by: barnyQuoteOriginally posted by: FermionQuoteOriginally posted by: mathematalef0But let's come back to the original point of this discussion. Shouldn't we have also a counter-proposal instead of only blaming certain practices or models?An understanding of the basic function of markets, which has hitherto been consistently ignored by stochastic models is a vital element to any counter-proposal. I have such a model, but can't publish it (yet).Another eseential element is regulation. Society accepts regulation as necessary in almost every other area of life except markets. Not to accept it in markets is crazy. We have traffic lights to regulate crossings. Without them people would build bigger, heavier vehicles in order to knock other vehicles out of the way. That is how markets currently operate. Markets need traffic lights urgently!Have you ever come across a red traffic light at 3am when nobody else is on the road?Yes, and in some countries, Italy for instance, people have the good sense to ignore them in those circumstances. Since no one ever gets a ticket in those circumstances, that seems like rational regulation to me.QuoteTraffic lights are inefficient, which is why they should be replaced by roundabouts.I'm definitely in favour of improving the efficiency of regulation.QuoteRegulation increases inefficiencyOnly if it is poor regulation (by definition).Quote and competiton is vital to eliminate dead wood.I agree. That is why we need regulation to prevent the tactics that destroy competition and maintain the dead wood in an artificial bubble of suspended animation for so longQuoteThe problem is when governments bail out the dead wood. In the long run letting the poor institutions die would have been better, instead we as taxpayers now have a vested interest in these poor institutions who will only make the same mistakes next time. Death is the ultimate punishment in business, now that we have allowed these banks to survive it is sending exactly the opposite message to what we wanted!Again I agree. Rational government regulation has nothing to do with bailing out failed capitalists, but everything to do with creating a level playing field and facilitating creative production. It is capitalism that loves government intervention to bail them out.Capitalism has nothing to do with free markets or competition. Capitalism is a system for the accummulation of capital. Period.

Ok we agree that there should regulation that is up to date, in order to protect competition and free markets. However this should be flexible enough. Moreover regulation alone cannot prevent everything. Mentality of people along with regulation can improve things.

Does Taleb think that VaR was the main cause of the current crisis? He sounds like it.I wonder if the whole world was using VaR just at 95%, and just as a proxy of leverage, then nobody would be talking about extreme events, non-normality of returns, black swans, etc.I think Taleb´s critiques should be aimed more on Basel II, that transformed the concept of VaR into a forecaster of crisis, rather than on VaR, or at the Quants as a whole.

First, "regulation" is no solution unless we speak of specific regulations. We've already discussed how some well-meaning regulations (e.g., Basel II and CRA) probably contributed to the crisis.Second, what models should regulators use? Something tells me that regulators would only use the most carefully vetted models from the academic world. And if regulators use fatally flawed igNobel prize-winning models, don't we run the risk that the entire system will be mandated to use the bad models? What prevents us from ending up with a "thou shalt use VaR" set of regulations? Moreover, wouldn't such regulations become the ultimate sanctuary from liability and responsibility -- as long as IB/HF execs followed the letter of the "enhanced" laws on risk management, they would be safe from the consequences of the bad decisions that they make.Third, research shows that the addition of complexity to a body of regulations actually favors the bullies over the small guys. In industries ranging from poultry processing to air conditioning, large companies have favored stricter regulation (even if it increased costs) because they knew it would create relative competitive advantage. Increased regulation inevitably increases fixed costs for a firm which gives big firms the advantage over small firms.Fourth, regulation can become a massive single point of failure in the system by inducing causal correlations in behaviors and portfolios. The greater the depth and breadth of regulation, the more correlation will be induced in the participants. Tight regulation leaves less room to innovate and differentiate oneself. This interacts poorly with mark-to-market accounting because it means that the balance sheets of well-run firms are damaged by forced-liquidations of badly-run firms which have the same portfolio structure or regulation-enforced rules for buy/sell/hold.

QuoteOriginally posted by: Traden4AlphaFirst, "regulation" is no solution unless we speak of specific regulations. We've already discussed how some well-meaning regulations (e.g., Basel II and CRA) probably contributed to the crisis.Second, what models should regulators use? Something tells me that regulators would only use the most carefully vetted models from the academic world. And if regulators use fatally flawed igNobel prize-winning models, don't we run the risk that the entire system will be mandated to use the bad models? What prevents us from ending up with a "thou shalt use VaR" set of regulations? Moreover, wouldn't such regulations become the ultimate sanctuary from liability and responsibility -- as long as IB/HF execs followed the letter of the "enhanced" laws on risk management, they would be safe from the consequences of the bad decisions that they make.Third, research shows that the addition of complexity to a body of regulations actually favors the bullies over the small guys. In industries ranging from poultry processing to air conditioning, large companies have favored stricter regulation (even if it increased costs) because they knew it would create relative competitive advantage. Increased regulation inevitably increases fixed costs for a firm which gives big firms the advantage over small firms.Fourth, regulation can become a massive single point of failure in the system by inducing causal correlations in behaviors and portfolios. The greater the depth and breadth of regulation, the more correlation will be induced in the participants. Tight regulation leaves less room to innovate and differentiate oneself. This interacts poorly with mark-to-market accounting because it means that the balance sheets of well-run firms are damaged by forced-liquidations of badly-run firms which have the same portfolio structure or regulation-enforced rules for buy/sell/hold.Those are all good points. Furtunately, however, I have a solution: appoint me to be the regulator-in-chief . I'll select a bunch of good thinkers to help build a good system. T4A, there's a place for you on the board, if you want it. As regards the specific type of regulation I would like to see, the primary ingredients would be 1. Separation of activity: preventing a single entity from taking part in two or more activities which would create a conflict of interest with implications for the public interest. E.g. (a) Those who control resources (by which I mean both natural resources and other means of production such as finance, energy, transport) are not able to take advantage of that in a productive industry that depends on those resources. (b) Banks can take deposits and make loans, but not speculate in credit derivatives or form a private central bank (effectively a cartel like the fed).2. Transparency in markets: no hidden deals. All bids and offers (and the parties identities) open for all to see and take up if they wish.3. Honest accounting: whatever valuations appear in balance sheets, "mark-to-market" values must appear as well, even if, in illiquid markets, they are only best guesses.4. Intellectual property must be treated as a resource whenever its owner's participation in a productive market becomes dominant. E.g. (a) Microsoft's OS must be published and licensed for public use.(b) If my market model enables me to dominate the options market then I must publish and license it.

QuoteOriginally posted by: FermionThose are all good points. Furtunately, however, I have a solution: appoint me to be the regulator-in-chief . I'll select a bunch of good thinkers to help build a good system. T4A, there's a place for you on the board, if you want it.I'm flattered! Perhaps you'd like to join the Need help with World Domination Plan A thread.QuoteOriginally posted by: Fermion1. Separation of activity: preventing a single entity from taking part in two or more activities which would create a conflict of interest with implications for the public interest. E.g. (a) Those who control resources (by which I mean both natural resources and other means of production such as finance, energy, transport) are not able to take advantage of that in a productive industry that depends on those resources. (b) Banks can take deposits and make loans, but not speculate in credit derivatives or form a private central bank (effectively a cartel like the fed).We've had this debate. I don't see how someone can be said to "control" an asset but yet not take actions employing that asset for their own profit. What is the basis for generating a financial return in finance, energy, transport except in the differential deployment of resources controlled by the organization? Moreover, what is this "public interest" and how does it amalgamate the conflicting interests of different segments of the public (e.g., shareholders vs. employees vs. suppliers vs. customers vs. lenders vs. other community bystanders).QuoteOriginally posted by: Fermion2. Transparency in markets: no hidden deals. Transparency will lead to deleterious gaming of participant's actions for any non-trivial financial transaction (e.g., multi-leg options trades, portfolio rebalancing, asset rotation activities, etc.) Moreover, it will destabilize the market to the extent that some participants attempt to replicate the portfolios of other participants (which they will be able to do if they see who is bidding/offering what for what). What would you do if you knew all of Jim Simon's trades?QuoteOriginally posted by: FermionAll bids and offers (and the parties identities) open for all to see and take up if they wish.Open bidding has problems at both the large and small ends of the spectrum. On the large-end, many transactions (e.g., taking a significant interest in a company) come with non-financial effects. The deal can't be reduced to just highest-bidder/lowest-offer. On the small-end, we have a host of privacy, information asymmetry, and transaction cost burden issues.QuoteOriginally posted by: Fermion3. Honest accounting: whatever valuations appear in balance sheets, "mark-to-market" values must appear as well, even if, in illiquid markets, they are only best guesses.Mark-to-market accounting is destabilizing in the passive and active senses. It both increases the propagation of volatility in the system and provides outsiders with a mechanism for manipulating prices. (Of course, mark-to-model accounting is destabilizing in the passive and active senses.) The larger issue is that no scalar number can suffice as the "value" of an asset. The true value resides in a contingent range.

QuoteOriginally posted by: Traden4AlphaI don't see how someone can be said to "control" an asset but yet not take actions employing that asset for their own profit. They decide what price they want to sell it at. What they can't do is sell it to competitors at a higher price than it's productive value to themselves as that would be anti-competitive. QuoteWhat is the basis for generating a financial return in finance, energy, transport except in the differential deployment of resources controlled by the organization? Moreover, what is this "public interest" and how does it amalgamate the conflicting interests of different segments of the public (e.g., shareholders vs. employees vs. suppliers vs. customers vs. lenders vs. other community bystanders).Deciding what is the public interest is what governments are supposed to do all the time. Are you saying it's not their job? What it is in practice is a separate debate.QuoteQuoteOriginally posted by: Fermion2. Transparency in markets: no hidden deals. Transparency will lead to deleterious gaming of participant's actions for any non-trivial financial transaction (e.g., multi-leg options trades, portfolio rebalancing, asset rotation activities, etc.) Moreover, it will destabilize the market to the extent that some participants attempt to replicate the portfolios of other participants (which they will be able to do if they see who is bidding/offering what for what). What would you do if you knew all of Jan Simon's trades?This argument assumes that people will make the same trades as they do when there is no transparency. But the whole point of transparency is to change that. QuoteQuoteOriginally posted by: FermionAll bids and offers (and the parties identities) open for all to see and take up if they wish.Open bidding has problems at both the large and small ends of the spectrum. On the large-end, many transactions (e.g., taking a significant interest in a company) come with non-financial effects. The deal can't be reduced to just highest-bidder/lowest-offer. On the small-end, we have a host of privacy, information asymmetry, and transaction cost burden issues.If a deal is private, then to my mind that is an "insider" trade since it involves secret information. Are you trying to suggest that issues of "privacy, information asymmetry, and transaction cost burden " will be worse with transparency than they are now????.QuoteQuoteOriginally posted by: Fermion3. Honest accounting: whatever valuations appear in balance sheets, "mark-to-market" values must appear as well, even if, in illiquid markets, they are only best guesses.Mark-to-market accounting is destabilizing in the passive and active senses. It both increases the propagation of volatility in the system and provides outsiders with a mechanism for manipulating prices. (Of course, mark-to-model accounting is destabilizing in the passive and active senses.) The larger issue is that no scalar number can suffice as the "value" of an asset. The true value resides in a contingent range.If people want to mark to model they can. I just want them to show the market value too.

"The problem is when governments bail out the dead wood."That nails it, right there imo.The problem in my experience is almost never lack of law or regulation, it's lack of enforcement. Or even worse, selective enforcement. (Bullies have the bigger lobbyists)I'm glad a lot of other people noticed these things about Taleb. I read his books and I was always waiting for the punchline, but it never came. I still like him, and at the time I just assumed he didn't want to divulge anything too profitable.It's far easier to point out problems, especially after the fact. We need clever solutions these days...

All these proposals/thoughts have good points, but we should never forget the human factor. Greediness..... will make people find loopholes even in the best set of rules or lobby with lawmakers/politicians in exchange for supporting their political campaign.Fear......if you publish both market value and a "mark-to-model" then you can have a wide range (for example 0 and 30 respectively for illiquid asstes) Who decides which model should be used? This will confuse participants, that are less knowledgeable, which value should they believe. People will start exiting the market.Investors should educate themselves in order to take desicions knowing the risks. Participants should change their mentality. PS. Why shouldn't be able to take advantage of an invention that I made for my profit? I have spent the time, the effort, the money! In my opinion is the extent that you profit. You shouldn't take advantage of the society and the public interest and this is where goverment comes in to enforce laws and protect the public interest.

The fundamental problem can only be solved if people are willing to accept high short-term volatility in exchange for mitigating large deviations (you want thinner tails? then you _have to_ accept fatter shoulders). Since humans have finite lifespans and finite careers, they will always prefer short-term stability in one domain or the other. If quant finance is regulated to prevent this, there will emerge other domains where humans can play this game (and this will attract an influx of wealth and people, just like finance did). Underestimating Black Swans is a fundamental property of the human brain, there is nothing we can really do about it unless we accept high short-term volatility, which, I'm afraid, is not really sustainable over multiple generations. Any new regulations will be susceptible to be slowly drawn back when each successive generation thinks they "know better."Discovering immortality will probably solve the problem though.

QuoteOriginally posted by: FermionQuoteOriginally posted by: Traden4AlphaI don't see how someone can be said to "control" an asset but yet not take actions employing that asset for their own profit. They decide what price they want to sell it at. What they can't do is sell it to competitors at a higher price than it's productive value to themselves as that would be anti-competitive. That's ridiculous! If an asset is worth $20 to a competitor but only $10 to the owner, why can't the owner split the difference and sell it for $15 so that both buyer and seller profit equally? Wouldn't it be anticompetitive if the buyer is the only one that can profit from a transaction?QuoteQuoteOriginally posted by: Fermion2. Transparency in markets: no hidden deals. Transparency will lead to deleterious gaming of participant's actions for any non-trivial financial transaction (e.g., multi-leg options trades, portfolio rebalancing, asset rotation activities, etc.) Moreover, it will destabilize the market to the extent that some participants attempt to replicate the portfolios of other participants (which they will be able to do if they see who is bidding/offering what for what). What would you do if you knew all of Jim Simons' trades?This argument assumes that people will make the same trades as they do when there is no transparency. But the whole point of transparency is to change that.If I run an index fund, I'm fairly locked into the portfolio weights by the index. So if I need to build or liquidate holdings, anyone watching my trades will be able to profit from my need to stay balanced across the portfolio even as some trades take longer to execute. Others can easily front-run me as soon as they spot the first of my trades. Moreover, trading in any large size would become extremely hard and induce greater market impact than under the current partially anonymous system. One key to preserving the fiction of the Efficient Markets Hypothesis is in preserving the appearance of randomness in the pattern of buyer and sellers. But with enough information on each buy and sell, we can construct an exact model of each person and each fund's portfolio and make much stronger predictions of future behavior.QuoteQuoteOriginally posted by: FermionIf a deal is private, then to my mind that is an "insider" trade since it involves secret information.Absolutely and that's as it should be! Should private companies be forced to reveal secret product plans as a prerequisite to raising debt or equity from private sources of capital? If a small compnay seeks private equity or venture capital, shouldn't it retain the right to decide who it approaches and who it reveals it's business plans to?

QuoteOriginally posted by: Traden4AlphaQuoteOriginally posted by: FermionQuoteOriginally posted by: Traden4AlphaI don't see how someone can be said to "control" an asset but yet not take actions employing that asset for their own profit. They decide what price they want to sell it at. What they can't do is sell it to competitors at a higher price than it's productive value to themselves as that would be anti-competitive. That's ridiculous! If an asset is worth $20 to a competitor but only $10 to the owner, why can't the owner split the difference and sell it for $15 so that both buyer and seller profit equally? Wouldn't it be anticompetitive if the buyer is the only one that can profit from a transaction?But they are not the only one. First, the owner of the resource profits by selling it. But they are competing with other resource owners in the price they ofer it at. Second there will likely be numerous competing buyers who can profit from using it. All that is being done here is a separation of activity to enable fair competition in each.QuoteIf I run an index fund, I'm fairly locked into the portfolio weights by the index. So if I need to build or liquidate holdings, anyone watching my trades will be able to profit from my need to stay balanced across the portfolio even as some trades take longer to execute. Others can easily front-run me as soon as they spot the first of my trades.Anyone who knows you are running an index fund can do the same. They don't need to see your trade to front-run you. And if they thought it was a useful thing to do, they wouldn't need to know you were doing it too.QuoteMoreover, trading in any large size would become extremely hard and induce greater market impact than under the current partially anonymous system. One key to preserving the fiction of the Efficient Markets Hypothesis is in preserving the appearance of randomness in the pattern of buyer and sellers. But with enough information on each buy and sell, we can construct an exact model of each person and each fund's portfolio and make much stronger predictions of future behavior.Because we have more information and more efficient markets!QuoteQuoteOriginally posted by: FermionIf a deal is private, then to my mind that is an "insider" trade since it involves secret information.Absolutely and that's as it should be! Should private companies be forced to reveal secret product plans as a prerequisite to raising debt or equity from private sources of capital? If a small compnay seeks private equity or venture capital, shouldn't it retain the right to decide who it approaches and who it reveals it's business plans to?Your approach is stuck in the capitalist concept of accummulating capital through gaming the markets to the detriment of the public interest. My goal here is to re-establish the socially constructive function of markets -- to facilitate efficient production for social benefit. Naturally, there are some areas of a company's activities that need to remain confidential for productive investment to occur. But manipulating financial markets or hiding critical trading information from other financial market participants is not one of them.

QuoteOriginally posted by: mathematalef0PS. Why shouldn't be able to take advantage of an invention that I made for my profit? I have spent the time, the effort, the money! In my opinion is the extent that you profit. You shouldn't take advantage of the society and the public interest and this is where goverment comes in to enforce laws and protect the public interest.Exactly. This is why I proposed a limit to personal ownership of IP. When an IP owner dominates a particular market, then they have profited enough from the secrecy. They can still profit by licensing it, but the monopoly power of secrecy needs to be curbed.

QuoteOriginally posted by: mathematalef0Another eseential element is regulation. Society accepts regulation as necessary in almost every other area of life except markets. Not to accept it in markets is crazy. We have traffic lights to regulate crossings. Without them people would build bigger, heavier vehicles in order to knock other vehicles out of the way. That is how markets currently operate. Markets need traffic lights urgently!Traffic lights are bad example for generally accepted regulations. In Beijing the traffic works "just fine" without them ---> Beijing TrafficBeijing TrafficAnd you can definetely see they did not build any bigger, heavier vehicles either .However, I am not saying they are the ones who respect human rights very much.