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I mean, that sounds like maybe a bad or overconfident analyst, but it's a bit extreme to declare it ALL BS because of one guy's bad models.

lisper 7y ago
Financial analysts use one of three approaches. There's the "whatever my gut tells me" approach, which is surprisingly common. There is modern portfolio theory. And nowadays there's machine learning. And it's all bullshit. MPT is bullshit because it uses volatility as its model of risk, which is IMHO the wrong model. They use it because it's something they can measure and so write academic papers about without sounding like they're just making shit up, but volatility does not actually correspond with what most people consider the word "risk" to mean. It also relies on the assumption that past volatility is a reliable predictor of future volatility for a particular security, which is often not true. And ML is bullshit because if you throw enough data at a regression algorithm it will find something that looks like a signal but will in fact almost certainly just be a coincidence if you actually do the statistical analysis properly. So yes, I'm probably being a bit harsh. There are probably analysts who actually know something, and MPF is actually not totally worthless. But "it's all BS" is a pretty good first-order approximation.
- asaph 7y ago
  What about the guy played by Christian Bale in The Big Short[0]? Surely his models were not BS. [0] https://en.m.wikipedia.org/wiki/The_Big_Short_(film) https://en.m.wikipedia.org/wiki/The_Big_Short_(film)
  - nradov 7y ago
    The thing is, it's impossible to tell the difference between clever and lucky even in retrospect. It's entirely possible that his models were BS. Even a broken clock is right twice per day.
    - foldingmoney 7y ago
      It's not impossible to tell the difference between a lucky guess and a well-designed model, although in finance you can often be right for the wrong reasons or wrong for the right reasons. The issue is that the things you're trying to model are usually extremely complex and dynamic, in a way that's fundamentally unlike most sciences where the objects of analysis obey more or less immutable laws. So it's less like trying to model where a kicked ball will land in a football game, and more like trying to model where the ball will be after 30 seconds of passing and running. But Michael Burry wasn't doing that, and his models weren't wrong. He correctly saw that the characteristics of the mortgage contracts that were being put into MBSs invalidated the assumption of uncorrelated defaults that were being used in the banks' and ratings agencies' models.
    - sjg007 7y ago
      They uncovered the large systemic threat with credit default swaps and made a bet.
- foldingmoney 7y ago
  What was the unit of analysis? Stock, sector, index, market, world?
  - lisper 7y ago
    Bonds.
    - foldingmoney 7y ago
      Well, bonds are incredibly macro-sensitive, so when the course of the world economy can be upturned by one Trump tweet (or whatever) then yeah, a super complicated model that you throw away and replace with a fudge factor sounds like about the right way to model it.

lisper 7y ago

Financial analysts use one of three approaches. There's the "whatever my gut tells me" approach, which is surprisingly common. There is modern portfolio theory. And nowadays there's machine learning. And it's all bullshit. MPT is bullshit because it uses volatility as its model of risk, which is IMHO the wrong model. They use it because it's something they can measure and so write academic papers about without sounding like they're just making shit up, but volatility does not actually correspond with what most people consider the word "risk" to mean. It also relies on the assumption that past volatility is a reliable predictor of future volatility for a particular security, which is often not true. And ML is bullshit because if you throw enough data at a regression algorithm it will find something that looks like a signal but will in fact almost certainly just be a coincidence if you actually do the statistical analysis properly. So yes, I'm probably being a bit harsh. There are probably analysts who actually know something, and MPF is actually not totally worthless. But "it's all BS" is a pretty good first-order approximation.

asaph 7y ago
What about the guy played by Christian Bale in The Big Short[0]? Surely his models were not BS. [0] https://en.m.wikipedia.org/wiki/The_Big_Short_(film) https://en.m.wikipedia.org/wiki/The_Big_Short_(film)
- nradov 7y ago
  The thing is, it's impossible to tell the difference between clever and lucky even in retrospect. It's entirely possible that his models were BS. Even a broken clock is right twice per day.
  - foldingmoney 7y ago
    It's not impossible to tell the difference between a lucky guess and a well-designed model, although in finance you can often be right for the wrong reasons or wrong for the right reasons. The issue is that the things you're trying to model are usually extremely complex and dynamic, in a way that's fundamentally unlike most sciences where the objects of analysis obey more or less immutable laws. So it's less like trying to model where a kicked ball will land in a football game, and more like trying to model where the ball will be after 30 seconds of passing and running. But Michael Burry wasn't doing that, and his models weren't wrong. He correctly saw that the characteristics of the mortgage contracts that were being put into MBSs invalidated the assumption of uncorrelated defaults that were being used in the banks' and ratings agencies' models.
  - sjg007 7y ago
    They uncovered the large systemic threat with credit default swaps and made a bet.
foldingmoney 7y ago
What was the unit of analysis? Stock, sector, index, market, world?
- lisper 7y ago
  Bonds.
  - foldingmoney 7y ago
    Well, bonds are incredibly macro-sensitive, so when the course of the world economy can be upturned by one Trump tweet (or whatever) then yeah, a super complicated model that you throw away and replace with a fudge factor sounds like about the right way to model it.