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View Diary: The Evening Blues - 4-17-13 (61 comments)

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  •  The Black-Scholes model (6+ / 0-)

    was considered to be some kind of gift from a higher power. It was worshipped back in the 90s when I first heard of it as we were deploying new services and tools for brokers and traders.  We had books on it, needing to understand it well enough to test the software.   There was a reverence around it.

    They won a Nobel prize in Economics for it.

    And guess what?  It was flawed.  Black-Scholes didn't get along with Black Swan.

    Black-Scholes: The maths formula linked to the financial crash

    It's not every day that someone writes down an equation that ends up changing the world. But it does happen sometimes, and the world doesn't always change for the better. It has been argued that one formula known as Black-Scholes, along with its descendants, helped to blow up the financial world.
    "The equation is based on the idea that big movements are actually very, very rare. The problem is that real markets have these big changes much more often that this model predicts," says Stewart. "And the other problem is that everyone's following the same mathematical principles, so they're all going to get the same answer."
    Ten years after the Long-Term Capital Management bail-out, Lehman Brothers collapsed. And the debate over Black-Scholes and LTCM is now a broader debate over the role of mathematical equations in finance.
    Black-Scholes changed the culture of Wall Street, from a place where people traded based on common sense, experience and intuition, to a place where the computer said yes or no.

    "Justice is a commodity"

    by joanneleon on Wed Apr 17, 2013 at 06:59:59 PM PDT

    [ Parent ]

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