specific remit to control inflation

TO BE NOTED:

Paul Wilmott's Blog

Tax, Cut, Sell, Or...

Posted At : April 23, 2009 12:30 PM | Posted By : Paul Wilmott
Related Categories: General

First my standard disclaimer, Economics Makes My Brain Hurt. I am but a mathematician, and businessman, I suppose. And although I cannot and do not claim to know anything about running a country (which is at least an honest position, one I wish were shared by those temporarily in power), I can draw on my own experiences and on simple logic.

It seems to me that the choices facing the UK government now are not dissimilar to those that might be faced by anyone running a household or a business, e.g. me.

When in debt you have limited choices:

a) Make more money. For the individual this means getting another job. For the government it means increasing tax revenues, which may be the same as increasing taxes (or it may not, depending on disincentives so introduced). Keeping the numbers simple, the goverment/IMF is talking about £200billion debt. Divided across the UK population not such a big number, but still enormous for the man in the street, divided across the rather smaller 200,000 high earners that the government has in its sights, hmmm, not such a small number. However you divide it up though it's all quite frankly impossible (unless you believe Darling's forecasts for growth in 2010, which I don't think even he can believe).

b) Cut spending. Painful for a Labour government (or New Nasty, as I now call them after the scandal of the attempted email slurs), but at least there is lots of waste they've introduced and which they could cut out. But no, cutting waste and public spending is not what Labour do, it's a vote loser.

c) Sell off the silver. Any foreigners want to buy a piece of the UK right now? Going cheap. But wait a while, the country will be even cheaper.

But there's one thing that the public cannot do, and which only governments can, and that is make the debt disappear like a David Copperfield trick. No mirrors, no distracting bright lights, no body doubles or revolving stages (sorry if I'm giving away his secrets!), just simple inflation.

d) Inflate, reduce the value of the pound. Debt disappears (compound interest acts remarkably quickly). And a vote winner among all the borrowers who started this mess. Of course there is the slight problem that the 'independent' Bank of England (made so by Gordon Brown in 1997 remember) has a specific remit to control inflation. So watch out for subtle changes in the BoE rules.

P"

Are you a numbers person or a symbols person? You should instinctively know the answer

TO BE NOTED:

Paul Wilmott's Blog

Numbers People And Symbols People

Posted At : April 21, 2009 8:09 AM | Posted By : Paul Wilmott
Related Categories: General

Are you a numbers person or a symbols person? You should instinctively know the answer. Let’s step back a bit, are you a cat person or a dog person? A cat person? Like me then. You can’t be both. Again, numbers or symbols? Do you like your mathematics done with examples involving numbers or more abstractly with symbols? If you have a maths degree then you are definitely a symbols person, also probably if you have a hard-science background. But accountants prefer numbers.

Numbers are great for illustrating how things work. Add, subtract, multiply, divide, raise to a power, etc., you can’t fool anyone with numbers. If it can be done with numbers then it must be easy. On the other hand with numbers you can’t see structure. If the number 7 appears in some calculation you won’t necessarily know what it means. And is it the same “7” each time it appears? Maybe one is an interest rate and another is a maturity. To get to a deeper level of understanding you need symbols.

Symbols are great for showing structure, abstraction is always necessary if you are to go beyond mere arithmetic. The problem with symbols is that some people are frightened by them. And if you and I are used to using different types of symbols it may take some time before we fully understand each other. One could even be accidentally or deliberately confusing, throw in a symbol without a proper explanation and before you know it everyone is lost.

This is relevant to the teaching of mathematics in schools. People can become terrified of the subject at an early age if taught badly, with the result that they are probably forever lost. (Unless it’s possible to get therapy?) How often at dinner parties have we mathematicians heard the ever-so-original response to what we do for a living “I was terrible at maths at school, me!”? I read recently that the part of the brain that does maths is right next to the part that registers fear. I don’t know whether it’s true but it certainly makes sense.

I am forever hearing politicians wittering on about how maths education in schools needs to be made more fun, and more, what’s the word? Practical! Misguided fools! Not a single GCSE maths above grade D among them. The point of mathematics is that it is supposed to be abstract. If all your maths comes from counting apples then you are going to be stymied by the real thing. Mathematics is abstract, that is the beauty of it. And that’s what actually makes it fun. Teach mathematics properly, don’t terrify children by asking them how long it takes ten politicians to dig themselves into ten holes, explain to the young the beauty of the abstract."

I’m not worried about evil, it’s stupidity that is soon going to be victorious.

TO BE NOTED: From Paul Wilmott's Blog:

"Society Has Finally Risen To The Level Of Its Own Incompetence

Posted At : April 8, 2009 1:05 PM | Posted By : Paul Wilmott
Related Categories: General

The Peter Principle (named after Dr Lawrence Peter) is the idea that people “rise to the level of their own incompetence.” Originally it was proposed in a humorous book published in 1968 but has since become accepted as giving genuine insight into how humans interact. According to Wikipedia “It holds that in a hierarchy, members are promoted so long as they work competently. Sooner or later they are promoted to a position at which they are no longer competent (their ‘level of incompetence’), and there they remain. Peter’s Corollary states that ‘in time, every post tends to be occupied by an employee who is incompetent to carry out his duties’ and adds that ‘work is accomplished by those employees who have not yet reached their level of incompetence.’” This is related to the concept that everything interesting happens at the margins.

The same is now clearly true of larger organisms, and I am obviously thinking of western society as a whole. The evidence is unambiguous: Bonus-bewitched bankers destroy institutions that had been around for centuries, politicians rescue their rich friends and ensure they get handsomely rewarded for their catastrophic failures, then people protest peacefully at the G20 summit where the police are the aggressors.

This has been made possible by ‘progress’ thanks to technology, the Ponzi scheme that is the world economy, the lawyer-led victim culture, the abandonment of common sense because of political correctness, the advance of globalization so that we are all tied together in one giant global-village/shopping-mall and the ubiquitous career politicians having no productive real-world experience but who know how to crawl their way to the top, lining their pockets all the way, over the bodies of the hard working and what are now called the ‘coping class.’

Senior management being paid in inverse proportion to their achievements; Personal Identification Numbers everywhere so that we are forced to use the same one every time therefore increasing the security risks they were meant to reduce; Health and safety rules that mean we are not permitted to experience the small pains that stop us from suffering from the deadly; There being so much new legislation that most people commit a petty, trivial crime each day, while real criminals go unpunished; No one being allowed to fail, all students must be given an A grade so it is impossible to tell who is fit for a job, while simultaneously lying on CVs is encouraged; The BBC being unable to spell its news announcements correctly, they happen so quickly; Over-paid professors proposing that spelling be relaxed because children find it too hard; Children unable to play in the streets because of hysteria over paedophilia; Children unable to learn contact sports properly because teachers are not allowed to touch them; People allowed to drown because ‘rescuers’ didn’t have the right ‘certificates’; People vying to be in minorities so as to get special treatment; Bins too heavy for binmen; Fines for not sorting rubbish; Homeopathy; Creationism;…

On my street recently a man was deliberately run into by a car and carried around the neighbourhood on the bonnet. The man suffers from MS. The police did nothing, even though they have a CCTV camera in the spot and it recorded the whole incident including the car’s number plate. But they manage to use the same CCTV on the same road to record parking violations and issue tickets without any problem. The reason is obvious, fining people for parking is profitable, solving crimes is not. And according to en vogue theories every part of society must be a self-sufficient, profit center, mustn’t it? Utter madness.

Society has risen to the level of its own incompetence and at the same time the means to return to a more sensible world has been legislated out of existence. The above we all know. But only some of us really care. If you are one of us, you will already know the solution, but you are perhaps understandably afraid to carry it out. The solution is this…I ask please do your best to bring back freedom of speech and expression; Please be politically incorrect at every opportunity; Tell jokes that are in bad taste; Travel on trains without a ticket, and then for your court appearance hire Cherie Blair as your barrister. Laugh in the faces of health and safety personnel! Edmund Burke, the political philosopher, is attributed with the saying “All it takes for evil to triumph is for good men to do nothing.” I’m not worried about evil, it’s stupidity that is soon going to be victorious. But the world can only continue its descent into madness if you let it."

I just wish that banks had been nationalized first so that the taxpayer would have benefitted from this.

TO BE NOTED: From Paul Wilmott:

"G20 End Of Term Report: B Minus, Could Do Better - See The Teacher

Posted At : April 2, 2009 8:54 PM | Posted By : Paul Wilmott
Related Categories: General

As I write this I have not seen details of the G20's agreement and related events. So I'm going by soundbites and rumours that I've heard in the last few hours. Nevertheless, I can't resist a few quick comments.

First, Gordon Brown has talked vaguely about only rewarding bankers for positive performance. Well, believe it or not, apart from packages paid to the likes of Fred Goodwin, that is exactly the current situation! And it is this that encourages risk. Compensation needs to be tied to maturity of contracts. And diversification within institutions needs to be encouraged. We have to align the interests of bank employees with the interests of depositors. I'm still not convinced that those in power get this yet.

I understand that mark-to-market is being relaxed in parts. I approve. I just wish that banks had been nationalized first so that the taxpayer would have benefitted from this. Again banks have "upside exposure with no downside risk" as they say in the prospectuses. For the taxpayer it is the opposite, so no change there.

And finally, they are going to be publishing a list of bad tax havens in order to shame them. Isn't that rather like telling teenagers where to buy the cheap alcohol? At the moment we have no idea where to put our money, since once-respectable banks are no longer safe. But this time tomorrow we'll all know exactly where to go!

I'm being harsh, you say. They mean well. Oh, yes, I'm sure they do!"

"I like to boil things down to the very basics whenever I am trying to learn something new"

Another marvelous post from Paul Wilmott:

"A friend of mine, you may know him, you certainly know ‘of’ him, has called for the return of a couple of economics Nobel Prizes. It’s Nassim Nicholas Taleb, in case you didn’t know. (I mention his name because it may increase the number of times this blog is read thanks to Google!) I’m not fussed one way or the other whether or not they get to keep their prizes, I don’t really see much difference between their work and that of many of the others awarded the economics Nobel. (Yes, I know, it’s not a proper Nobel, blah, blah, blah, Bank of Sweden, blah, blah, we can take that much as read!) Or even those awarded the prize in other fields. The Nobel Prize for Literature seems to be political (political meaning either greasy pole, or as in politically correct), the Peace Prize is downright perverse, so the Economics Prize is no different for being pointless. In contrast, we probably all respect laureates in medicine, chemistry and physics for mostly decent work that has stood the test of time.( WE ALSO HAVE FEWER OPINIONS ABOUT THESE AWARDS. SCIENTISTS IN THESE FIELDS MIGHT FIND THEM MORE DISTRESSING. )

Economics is a queer subject. I like to boil things down to the very basics( THE CORRECT METHOD ) whenever I am trying to learn something new, doing research or teaching, as the students on the CQF can attest—think of some of my stranger analogies, guys! But this doesn’t work with economics. Starting with a couple of blokes in a cave, one of whom has just invented the wheel, try to imagine the exchanges that take place and how that turns into General Motors. No, it makes my brain hurt. No matter how much red wine I’ve drunk it doesn’t seem to work.

And I’m supposed to be clever. Why am I incapable of understanding economics, a straightforward enough subject that it’s even taught in schools?

My failure led me to think about economists, as opposed to economics, and they’re much easier to figure out. This is how it works. An economist starts with a few axioms, ones that bear a vague similarity to a small part of the human condition under restricted situations and in an idealized world. (You get my drift here?)( I AGREE COMPLETELY ) From those axioms follows a theorem. More often than not this will be a theorem based upon rational behaviour. That theorem gets a name. And that’s the point I identify as being the problem: The jargonizing of complex ideas based upon irrelevant assumptions into an easily used and abused building block on which to build the edifice of nonsense that is modern economics( ECONOMICS HAS ITS USES. BUT POLITICAL ECONOMY IS WHERE THE ACTION REALLY IS ).

Small assumption by small assumption, the economist builds up his theories into useless gibberish. By acceptance of each step he is able to kid himself he is making progress. And that’s why I struggle with economics. It is not mathematics where, barring mistakes, each step is true and indisputable and therefore you can accept it, even forget it, and move on. And others can do the same, using everyone else’s results without question. This you cannot do in a soft science( EVER ). I’ve mentioned this in another blog, beware of anyone talking about ‘results’ in finance or economics, it says more about them and their perception of the world than it does about the subject( I AGREE ).

Not so long ago Alan Greenspan famously said he had found a flaw in the “critical functioning structure that defines how the world works.” “I don't know how significant or permanent it is but I have been very distressed by that fact.” Ohmigod! His naivety and lack of self knowledge is staggering( TRUE ). He has fallen into the same trap as other economists. By believing the theories he has believed the axioms on which they are based. The edifice of nonsense has collapsed on top of one of its builders.

You beautiful, complex, irrational people! Please, promise me that you will continue to violate every axiom and assumption of economics, maybe not all the time, that would be too predictable, but now and then, just so as to keep those pesky economists on their toes!

Greenspan also said that risk models and econometric models are still too simple( OTHER WAY AROUND ). Lord, help us!

Let me tell you a story.

A decade or so ago I was browsing through the library of Imperial College, London, when I happened upon a book called something like “The Treasury’s Model of the UK Economy.” It was about one inch thick and full of difference equations. Seven hundred and seventy of them, one for each of 770 incredibly important economic variables. There was an equation for the rate of inflation, one for the dollar-sterling exchange rate, others for each of the short-term and long-term interest rates, there was the price of fish, etc. etc. (The last one I made up. I hope.) Could that be a good model with reliable forecasts? Consider how many parameters must be needed, every one impossible to measure accurately, every one unstable. I can’t remember whether these were linear or non-linear difference equations, but every undergrad mathematician knows that you can get chaos with a single non-linear difference equation so think of the output you might get from 770. Putting myself in the mind of the Treasury economists I think “Hmm, maybe the results of the model are so bad that we need an extra variable. Yes, that’s it, if we can find the 771st equation then the model will finally be perfect.” No, gentlemen of the Treasury, that is not right. What you want to do is throw away all but the half dozen most important equations and then accept the inevitable, that the results won’t be perfect( TRUE ).

A short distance away on the same shelf was the model of the Venezuelan economy. This was a much thinner book with a mere 160 equations. Again I can imagine the Venezuelan economists saying to each other, “Amigos, one day we too will have as many equations as those British cabrones, no?” No, what you want to do is strip down the 160 equations you’ve got to the most important. In Venezuela maybe it’s just one equation, for the price of oil.

We don’t need more complex economics models. Nor do we need that fourteenth stochastic variable in finance. We need simplicity and robustness( TRUE ). We need to accept that the models of human behaviour will never be perfect( HUMAN AGENCY EXPLANATION ). We need to accept all that, and then build in a nice safety margin in our forecasts, prices and measures of risk( TRUE ).

Happy New Year!"

And to you as well.

"Unfortunately the training that most quants get seems to actively discourage creativity. "

Paul Wilmott with another interesting post:

"Quantitative finance and risk management are not just about the numbers. Numbers play a part, but so does the human side of the business. When analyzing risk it is important to be able to think creatively about scenarios. Unfortunately the training that most quants get seems to actively discourage creativity."

The human side is what I call the Human Agency side. To be honest, philosophical education can also discourage creativity. Thinking about scenarios is what I call Narrative Thinking. Behind all this is a misunderstanding of the nature of math models and their tenuous, but useful, relationship to the world. By the way, if you want an example of Narrative Thinking, I would recommend Kierkegaard.

"Some of the following appeared on the BBC website in December 2008.

We've learned the hard way how important it is to measure and manage risk. Despite the thousands of mathematics and science PhDs working in risk management nowadays we seem to be at greater financial and economic risk than ever before. To show you one important side of banking I'd like you to follow me in an exercise with parallels in risk management"

It's interesting how this mirrors Skepticism. I believe that as science and rationality have advanced, the argument of the Skeptic has gotten stronger. I call this Paradoxical, and believe that human existence, and Human Agency, and Narrative Thinking, are inherently Paradoxical. The concept of Risk is no exception. The more you can understand and capture risk, the riskier life will seem.

"You are in the audience at a small, intimate theatre, watching a magic show. The magician hands a pack of cards to a random member of the audience, asks him to check that it's an ordinary pack, and would he please give it a shuffle. The magician turns to another member of the audience and asks her to name a card at random. "Ace of Hearts," she says. The magician covers his eyes, reaches out to the pack of cards, and after some fumbling around he pulls out a card. The question to you is what is the probability of the card being the Ace of Hearts?"

It's rigged. That's his job. The Magician, a good one, will always pull out the correct card.

"Think about this question while I talk a bit about risk management. Feel free to interrupt me as soon as you have an answer. Oh, you already have an answer? What is that, one in fifty two, you say? On the grounds that there are 52 cards in an ordinary pack. It certainly is one answer. But aren't you missing something, possibly crucial, in the question? Ponder a bit more.

One aspect of risk management is that of 'scenario analysis.' Risk managers in banks have to consider possible future scenarios and the effects they will have on their bank's portfolio. Assign probabilities to each event and you can estimate the distribution of future profit and loss. Not unlike our exercise with the cards. Of course, this is only as useful as the number of scenarios you can think of.

You have another answer for me already? You'd forgotten that it was a magician pulling out the card. Well, yes, I can see that might make a difference. So your answer is now that it will be almost 100% that the card will be the Ace of Hearts, the magician is hardly going to get this trick wrong. Are you right? Well, think just a while longer while I tell you more about risk and its management. "

The Magician can get it wrong. I call "scenario analysis" understanding the context, presuppositions, and beliefs underlying the situation.

"Sometimes the impact of a scenario is quite easy to estimate. For example, if interest rates rise by 1% then the bank's portfolio will fall in value by so many hundreds of millions. But estimating the probability of that interest rate rise in the first case might be quite tricky. And more complex scenarios might not even be considered. What about the effects of combining rising interest rates, rising mortgage defaults and falling house prices in America? Hmm, it's rather looking like that scenario didn't get the appreciation it deserved."

I'd say that it didn't get the fear and prudence it deserved.

"Back to our magician friend. Are those the only two possible answers? Either one in 52 or 100%? Suppose that you had billions of dollars of hedge fund money riding on the outcome of this magic trick would you feel so confident in your answers? When I ask this question of finance people I usually get either the one in 52 answer or the 100%. Some will completely ignore the word 'magician,' hence the first answer. Some will say "I'm supposed to give the maths answer, aren't I? But because he's a magician he will certainly pick the Ace of Hearts." This is usually accompanied by an aren't-I-clever smile! Rather frighteningly, some people trained in the higher mathematics of risk management still don't see the second answer even after being told."

I'm sorry, but I'm traumatized by the billions of dollars scenario. It's like a joke that can't be understood by some people, especially people with no sense of humor.

"This is really a question about whether modern risk managers are capable of thinking beyond maths and formulas. Do they appreciate the human side of finance, the herding behaviour of people, the unintended consequences, what I think of as all the fun stuff. And this is a nice question because it very quickly sorts out different types of thinkers."

Between people who have a good sense of humor and the humorless?

"There is no correct answer to our magician problem. The exercise is to think of as many possibilities as you can. For example when I first heard this question an obvious answer to me was zero. There is no chance that the card is the Ace of Hearts. This trick is too simple for any professional magician. Maybe the trick is a small part of a larger effect, getting this part 'wrong' is designed to make a later feat more impressive...the Ace of Hearts is later found inside someone's pocket. Or maybe on the card are written the winning lottery numbers that are drawn randomly 15 minutes later on live TV. Or maybe the magician was Tommy Cooper. Or it was all the magician's performance-anxiety dream the night before. When I ask non mathematicians this is the sort of answer I get."

In order for magic to work, you have to work with people's expectations. I think this limits the possible plays the magician has. One of them has to be that he picks the correct card.You see, the human mind will supply a context, so I disagree with him here.

"The answer one in 52 is almost the answer least likely to be correct! Magicians only rarely rely on probability. Clue: How many times did Houdini die during his Water Tiorture trick? (Unless the magician was using an ordinary deck of cards, was aiming to pull out a different card but accidentally pulled out the Ace of Hearts instead! Accidentally not making the intended 'mistake.')"

He can make a mistake. He's not a real "Magician".

"A member of wilmott.com didn't believe me when I said how many people get stuck on the one in 52 answer, and can't see the 100% answer, never mind the more interesting answers. He wrote "I can't believe anyone (who has a masters/phd anyway) would actually say 1/52, and not consider that this is not...a random pick?" So he asked some of his colleagues the question, and his experience was the same as mine. He wrote "Ok I tried this question in the office (a maths postgraduate dept), the first guy took a fair bit of convincing that it wasn't 1/52 !, then the next person (a hardcore pure mathematician) declared it an un-interesting problem, once he realised that there was essentially a human element to the problem! Maybe you have a point!" Does that not send shivers down your spine, it does mine."

The Human Element is uninteresting. What can that mean?

"Once you start thinking outside the box of mathematical theories the possibilities are endless. And although a knowledge of advanced mathematics is important in modern finance I do rather miss the days when banking was populated by managers with degrees in History and who'd been leaders of the school debating team. A lot of mathematics is no substitute for a little bit of commonsense and an open mind."

Throw in Philosophy as well old boy, and we'll call a wrap.

"How can we get quants and risk managers to think beyond the mathematics? I'm afraid I don't think we can, the way the majority of them are currently educated."

One never ceases being educated.