There is another factor that Adam Smith noted a few years ago: The over-weening conceit which the greater part of men have of their own abilities, is an antient evil remarked by the philosophers and moralists of all ages. Their absurd presumption in their own good fortune, has been less taken notice of it. It is, however, if possible, still more universal .... The chance of gain is by every man more or less over-valued, and the chance of loss is by most men under-valued. [Smith 1776, I.x.b.26, pp. 124-5]
I have been visting my daughter, so I have not been active on the web for a while, especially because the school servers have been down. Skimming recent activity on the list looks like you do better in my absence. On Tue, Aug 21, 2007 at 08:01:09AM -0400, Julio Huato wrote: > > Since long, people in finance *know* in their minds that the > distribution of returns is nonstationary, that it has "memory." On > the analytical side, the fundamental intractability of nonstationarity > forces them to frame the problem in terms of heavy-tail distributions. > But that's like an arms' race: the quants keep fattening the tails of > their respective distributions only to realize that even the fattest > tails are unable to deal with the next extreme event. Clearly, the > root of this silly practice is not lack of mathematical > sophistication, behavioral quirks (in spite of Taleb), or sheer > stupidity. It is moral hazard! > > Simply put, there's a strong incentive to disregard unlikely (extreme) > events. Most of the time, disregarding extreme events works to your > advantage. You'll do fine most of the time. And, when an extreme > event hits you (if you haven't retired yet), many others along with > you will be hurt. Nobody will fault you personally. You (like all > others) can credibly claim that the event was truly unpredictable and > demand that the Fed bail you out, as it's done before. You and all > others are too big to fail. You and all others can bring the whole > economy down. Etc. > > Ultimately, this will continue until those below pull the plug. -- Michael Perelman Economics Department California State University Chico, CA 95929 Tel. 530-898-5321 E-Mail michael at ecst.csuchico.edu michaelperelman.wordpress.com
