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Incorporating Human Behavior Into Wall Street Mathematical Models 300

Posted by Soulskill
from the fear-and-greed dept.
After watching the stock market struggle for the past year, financial experts from Wall Street and academia are putting more effort into bringing behavioral modeling into their complex financial calculations. "The risk models proved myopic, they say, because they were too simple-minded. They focused mainly on figures like the expected returns and the default risk of financial instruments. What they didn't sufficiently take into account was human behavior, specifically the potential for widespread panic." Analysts are looking at research from other fields to supplement the hard mathematics of risk assessment. "Financial markets, like online communities, are social networks. Researchers are looking at whether the mechanisms and models being developed to explore collective behavior on the Web can be applied to financial markets." Another avenue they're exploring is how we react to the spread of disease. Jon M. Kleinberg, a computer scientist at Cornell, said, "The hope is to take this understanding of contagion and use it as a perspective on how rapid changes of behavior can spread through complex networks at work in financial markets."
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Incorporating Human Behavior Into Wall Street Mathematical Models

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  • Such as? (Score:5, Funny)

    by siloko (1133863) on Sunday September 13, 2009 @01:20PM (#29405985)

    Incorporating Human Behavior Into Wall Street Mathematical Models

    What? Like morality?

    • Re:Such as? (Score:4, Insightful)

      by Anonymous Coward on Sunday September 13, 2009 @01:23PM (#29406007)

      What? Like morality?

      Like irrationality. (What was that sound? Oh yeah, it's the collapse of every economic philosophy proposed over the last few centuries as people realize there's no such thing as a rational actor!)

      • Re: (Score:3, Informative)

        by wizardforce (1005805)

        nonsense. what happened was people acted in their own rational [so they thought] interest... few people want to intentionally harm themselves... the system was such that people acting to defend themselves from economic decline caused an avalanche of others doing the same. If someone believes that it is in their best interests to sell their stock it would be irrational of them to just sit there and watch their wealth erode away... but it would also mean that if they did sell their stock under incomplete

        • Re:Such as? (Score:4, Interesting)

          by Helpadingoatemybaby (629248) on Sunday September 13, 2009 @01:55PM (#29406261)
          "nonsense. what happened was people acted in their own rational [so they thought] interest..."

          .

          Whether people think they're rational doesn't make their acts rational. Professors Daniel Kahneman and Vernon Smith challenged the old Libertarian thought that people act in their own self-interest. "human decisions, rather than being based on a full analysis of the situation, often rely on shortcuts or rules of thumb. The studies developed the idea of representativeness, in which people are too quick to see patterns in data that are actually random."

          .

          http://www.independent.co.uk/news/business/news/irrational-studies-lead-to-nobel-prize-for-us-economists-613675.html [independent.co.uk]

          .

          They won a Nobel prize in economics for this.

          If someone believes that it is in their best interests to sell their stock it would be irrational of them to just sit there and watch their wealth erode away... but it would also mean that if they did sell their stock under incomplete information conditions the entire system becomes comparatively irrational... Again, no. Your premise is wrong that they are acting in their own self-interest, your premise is also wrong that they are acting rationally, and your presumption that the entire system becomes irrational because people act on incomplete information is... well, incomplete. This is behavioral finance.

          • Re:Such as? (Score:4, Interesting)

            by ahabswhale (1189519) on Sunday September 13, 2009 @04:39PM (#29407397)
            Just because they are acting on incomplete information, doesn't mean they aren't acting based on their own self interest. They are. It's just that it may turn out that their action ended up working against their best interest. Even when you think you have all possible information to make an informed decision, you don't because it's not possible to see the future. If someone buys stock in an undervalued company with strong financials but then the company's factory experiences a devastating earthquake and ruins the company, he would have failed your "self interest" test based on the way you define it. Sorry but it's a fucking straw man argument.

            What is predictable is that people will do what they "think" is in their own self interest and whether that turns out to be true is pointless for purposes of this discussion.
        • by jonbryce (703250)

          I'm not so sure. We had a real estate bubble, the 2nd most recent in a long sucession of bubbles. Bubbles happen when people are behaving irrationally, and they burst when people start being rational again.

          • Don't forget that the bubbles exist only because the cheap credit allowed them to exist. Take a look at the major bubbles and their collapse. what preceeded them was cheap credit doled out by the federal reserve followed by a constriction.

            • by jonbryce (703250)

              The Federal Reserve played a part, but it only has about $2tn in Assets. The Royal Bank of Scotland is about double that.

              The problem was, Americans send some green bits of paper with pictures of former presidents to China, Saudi Arabia etc. In return they send their oil and manufactured goods. Having no particular use for the green bits of paper, they lend them back to America, and they use them to buy yet more oil and manufactured goods, and so the cycle continues.

              Federal Reserve credit is much cheaper

      • by digitig (1056110)

        Like irrationality.

        Well, that's what they are going to try to model it seems. Which misses the point, as an AC below points out. The models are already good enough to account for irrationality, what they missed, and which caused the crash, is that the models can be wrong, and that isn't something that can usefully be modelled, it's an attitude that the execs need to have.

    • Re: (Score:3, Insightful)

      by wizardforce (1005805)

      if conditions exist that favor making money through "immoral behavior" then that is what will happen. people didn't magically become depraved sociopaths who inevitably caused the recession- the conditions which favored that behavior did. The models were not sophisticated enough to model human behavior rational or not under these conditions.

    • by jo42 (227475)

      The Greed Factor.

    • by bhima (46039) *

      No. Remember they're talking about Wall Street.

      On a more serious note, Nature Magazine has had several very interesting articles on economic & climatic modeling in the past few months... but I'm sure all of them are behind the Nature.com pay wall.

    • Re:Such as? (Score:5, Insightful)

      by MrKaos (858439) on Sunday September 13, 2009 @11:14PM (#29409889) Journal

      What? Like morality?

      I would have modded insightful because siloko's statement illustrates the tip of a very large and flawed model by which our world economic system is run, a model that is, as a whole, completely unsustainable.

      Is there anybody out there that actually believes that we can keep going this way indefinitely, or even a few more decades? Is there anything in our economic system that is actually related to reality? Most of the world, that doesn't have our level of privilege, have no choice but to face that reality.

      When you consider a countries GDP doesn't measure income but actually economic activity you realise it's a ludicrous measure that doesn't subtract the depreciation of assets like roads and factories or depletion of natural resources. So how is it valid when the resource base it draws from isn't included in the calculation?

      So what is the true cost of the economy when the real actualities are taken into account, cause they don't seem to be in any economists 'equations'. True cost is what give economist's nightmares so (as I mentioned in a response elsewhere) it's not a science, or engineering it's a branch of psychology. None of the factors that should be included, like production of waste and depletion of natural resources are included in the economist's "equations". It's a fucking joke that the world is run this way, as if someone, who suddenly found themselves skydiving and realising that they didn't have a parachute, was told 'worry about that when you get closer to the ground'.

      I want to know where the economist's have been for the past year of this meltdown *they* caused. They're happy to take credit in the good time, but when the shit hits the fans they just disappear. Where is the accountability? Where is the humility? Greenspan once remarked 'we can never have a perfect model of risk', ok, but what about an 'awareness of risk'?. These guys, now rebranding themselves from a science to an engineering profession could not even pick the sub prime collapse and have let people around the world with the mess to clean up while they vanish with their pockets stuffed full of cash.

      To highlight the absurdity if we look back the template for neoclassical economics was based on Hermann von Helmholtz [wikipedia.org] conservation of energy principle substituting physical variables for economic ones. Despite being told by physicists and mathematicians that there was no basis for these substitutions economists claimed that this had transformed their field into a rigorous mathematical science. Today the basis of economics in mid 19th century physics has been forgotten and the theory is accepted as scientific. Assumptions include;

      • Natural resources are inexhaustible
      • Costs of environmental damage lay outside of the system
      • Natural resources exist in a separate domain
      • the market system is a circular flow between production and consumption
      • There are no biophysical limits to the growth of market systems

      This is how the world economy is run, completely divorced from reality. Economics does not even acknowledge the cost of environmental problems or limits to economic growth and unless they start to take these realities into account all the crashes we have experienced in the past are going to be like the kisses in foreplay before we are well and truly fucked and in a worldwide economic tailspin from which there is no return.

  • ....somehow this isn't going to end well.

  • or we burnt the wrong animal at the sacrifice. But let us take this setback as a call to redouble our faith: Soon the saucer will land.
  • Wrong Direction (Score:2, Interesting)

    by benjamindees (441808)

    Personally I think this is a terrible sign. Irrational investors should be discouraged from gambling in the markets instead of coddled and encouraged through tax breaks and an extensive regime of inconsistent regulation. Governments and the fraudulent investment advisors they subsidize and fail to regulate have done us all a disservice by suckering the average person into investing in derivatives markets like the stock exchanges. And now instead of letting the market correct the problem all sides are dra

    • by edremy (36408)
      Hate to tell you this, but *all* investors are irrational at some point. It's human nature. We're in this mess in large part because a bunch of economists convinced themselves that the market is always perfectly rational and prices things correctly. They continued to think this despite the endless strings of bubbles and panics in the markets for centuries. Huge events like the bankruptcy of LTCM and the NASDAQ tech crash didn't seem to bother them in the least. They needed no regulation at all- after a
  • Voodoo (Score:3, Insightful)

    by Weedhopper (168515) on Sunday September 13, 2009 @01:33PM (#29406075)

    Why is it that these people insist on trying to apply a veneer of respectability to this shit?

    Financial engineering is not engineering.
    Economics is not a real science.
    Finance is not real math.

    • Because there is a grain of respectability and truth to the pure quantitative analysis. So engineers/smart people pursue it. And the people with money who want to make more will leverage whatever small advantage the quants can generate.
      • So engineers/smart people pursue it.

        Really? Engineers are the easiest people to dupe with financial numbers. Why, you ask?

        Engineers come from a background where the numbers are based upon physical laws - the numbers mean something tangible in the end. Whereas in accounting and in business in general, the can be and usually are several correct answers, and in some cases, the incorrect numbers look more reasonable. Many times, the numbers are assumptions. Numbers that are assumptions are pulled from one's as

        • by NonSequor (230139) on Sunday September 13, 2009 @04:50PM (#29407477) Journal

          Assumptions are okay so long as you only treat them as elements of long-term planning that will need to be revised periodically. I think that's the only safe way to view financial models.

          But the financial engineers have committed the unforgivable sin of truly believing in their assumptions because they create a pleasant reality where you can bound risk into a little box. Reality is far less forgiving.

      • by hedwards (940851)
        Only in the sense that there's a grain of truth in a Ponzi scheme or in insurance fraud. What happened was they got caught gaming the system and didn't have sufficient capital to back up their leveraged positions as they unwound.

        The best advice I've ever seen is to stay further back the more "innovative" the wall street "geniuses" get, it's almost certainly either a confidence scam or horribly risky. Remember, they make most of their money gaming the system and trading with information that isn't yet ava
    • But *boy* was there money to be made.

      Human behavior again!

    • Human behavior is the core of all economic thinking. It either directly or indirectly is the basis of every model and every theory. The problem might be that the behavior assumed is over simplified to 'greed and fear of risk' when it should include something more, but that's nothing new.

      This doesn't mean the right thing to do is give up on modeling risk and simply give up and go back to simply letting the king (or the five year plan) decide what is worth funding. Venture capital and stock markets are cap

    • by ceoyoyo (59147)

      Because nobody would buy it otherwise. Duh. What they really need is the Sham WOW guy.

    • by 1s44c (552956)

      Why is it that these people insist on trying to apply a veneer of respectability to this shit?

      Maybe the same reason people believe in horoscopes?

      Maybe just because everyone else believes in them and they don't want to stand out?

      Maybe just because most people are dumb.

    • Re: (Score:3, Interesting)

      by martas (1439879)
      what is this "real math" you speak of? it's an application of mathematics, simple as that. is computational biology "real" biology? is it real computer science? who cares! i don't mean to use a buzzword, but we see more and more interdisciplinary applications of different theories emerging as autonomous fields. this applies to computational biology, pretty much every kind of modern (>1980) AI research, and, of course, economics and finance. it's not a bad thing that people are learning that applying know
  • Another avenue they're exploring is how we react to the spread of disease

    Prevention is better than cure! It can be averted by less risky behaviour!

    • Re: (Score:3, Informative)

      by wizardforce (1005805)

      often times it was closer to being fraudulent than risky... the current system allows companies to leverage far more capital than they have in assets [fractional reserve banking] that is very dependant on the stability of the money supply... consequently when there are monetary expansions followed by monetary restrictions by the federal reserve we observe a collapse of the system catalysed by panic.

  • NO! Not again! (Score:3, Insightful)

    by QuoteMstr (55051) <dan.colascione@gmail.com> on Sunday September 13, 2009 @01:34PM (#29406085)

    Between these revived, yet still pernicious models and Wall Street's darling new death bonds [businessweek.com], we look poised to blow another bubble, destroy another decade of growth, and funnel more money into the hands of the obscenely wealthy when the system flies apart.

    We cannot allow that to happen. Finance needs to be returned to a staid utility that forms a relatively minor part of our economy. We need to be deeply skeptical of innovation in the financial sector: it's been around for a long time, and we've already explored most of the beneficial ideas. What remains is deception and fraud.

    • Wrong link (Score:5, Insightful)

      by QuoteMstr (55051) <dan.colascione@gmail.com> on Sunday September 13, 2009 @01:38PM (#29406115)

      Corret one [nytimes.com].

      The bankers plan to buy "life settlements," life insurance policies that ill and elderly people sell for cash -- $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to "securitize" these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

      The earlier the policyholder dies, the bigger the return -- though if people live longer than expected, investors could get poor returns or even lose money.

      Keep in mind that these things will be securitized, tranched, and then the pieces will be securitized and tranched, greatly magnifying the risk. On top of that, there will be a new, brisk trade in various hedges on these instruments, including the infamous credit default swaps. In this way, a tiny diseases market can metastasize throughout the economy.

      • Damn, didn't people learn how stupid this was back when they did it to AIDS patients?

        Investing in life insurance scams is plain gambling. No wealth is created and the insurance company generally is smart enough to set itself up as "the house". And the house always wins.

        So either you lose, or you're taking death benefits from the elderly. Not a position I'd want to be in when somebody decides to do a news piece on it.

        • by hedwards (940851)
          That's what insurance is, you're paying somebody an agreed upon amount for the insurance that you're not going to be out more than that. You pay them typically a bit more than you expect because over the pool it evens out. If you knew ahead of time what the real costs would be there'd be no point, you'd just save your own money.

          Whether you call the losing out or not is a matter of opinion, but you're paying the company in most cases for piece of mind. There are times when that's not the case, such as wit
        • by nomadic (141991) <nomadicworld@@@gmail...com> on Sunday September 13, 2009 @03:59PM (#29407131) Homepage
          Investing in life insurance scams is plain gambling. No wealth is created and the insurance company generally is smart enough to set itself up as "the house". And the house always wins.

          Oh, not at all. The insurance companies HATE this idea, they do NOT want people to be allowed to invest in life insurance policies, because these investors will do anomalous things like PAY THE POLICY PREMIUMS, and not let the policies lapse. As it is now a huge number of life insurance holders let their coverage lapse (either through financial problems, laziness, cost gets too high, etc.) In that case the insurance company gets the benefit of all those payments already made (sometimes DECADES of them), without any of the cost (i.e. having to pay out the policy when the holder dies).
      • Apparently some of these guys pay as little as 20% which is how they can offer the returns they do. The problem is that when a regulator hears that you're ripping off a sick grandma who has trouble even understanding the forms they tend to pass laws. Some of these may invalidate existing agreements or put the companies creating them out of business. When the companies aren't there you run into all sorts of management issues - like the premiums not being paid, paperwork not being filed and payments not fo

    • by jonbryce (703250)

      It mentions Keydata Investments in England, but doesn't mention that they were shut down for tax evasion, and subsequently it has been discovered a lot of investors' money has been lost in fraud as well.

  • I'm yet to hear a decent explanation on how day trading isn't gambling while poker is.

    Both are working on limited information
    Both involve you making money off of other people's mistakes
    Neither creates wealth and merely shifts it around
    Both can cost you fortunes even though you did nothing wrong

    • The market isn't zero sum or negative sum (well, usually). When the economy is good (which used to be most of the time), almost everyone wins. A good investor will make money consistently even when the market is down (if maybe not when its in freefall like the last couple years).

      • Re: (Score:3, Insightful)

        by ClosedSource (238333)

        So you're saying that a good investor will make money consistently except when they don't.

    • by moon3 (1530265)
      Most of business is kind of gambling only with variable risk factors. Even if you create something of a real value -- like when GM produces a car, that doesn't mean cost of production and other factors will not drive them into red numbers.
    • you act like both have the same amount of randomness... if you make a bet at a poker table it is likely to be significantly more risky than investing in say mcdonalds. one is mostly random and the other is a company unlikely to collapse any time soon. one involves risk and concealment, the other involves risk and possible wealth creation. big difference.

  • by dark_requiem (806308) on Sunday September 13, 2009 @01:37PM (#29406105)
    Human behavior is the basis for the Austrian school of economic thought. Has been from its roots. Ludwig von Mises, one of the founders of Austrian economics, titled his magnum open "Human Action". The basic idea of Austrian economics is that the study of economics is an a priori discipline. In other words, you can't implement, from both a practical and ethical standpoint, experiments to study economics on a useful scale. Instead, economics must be viewed as a study of human behavior. Humans are the principle actors in an economic system, so their behavior and drives must be the primary focus of economic study. The study of economics can therefore be viewed as a study of groups of self-interested participants working for their own betterment.

    Incidentally, Austrian economics also posits that interference with the operations of markets produces a boom-bust business cycle, by promoting misallocation of scarce resources. It's worth noting that many Austrian economists were predicting our current economic crisis well before it occurred, when the more mainstream Keynesians were still calling it a golden age of economic development.

    What is being proposed here is to continue to view markets as purely mathematically modelable phenomena. Economic decisions occur on the most local of levels, the individual level. No model accounts for the variability of the individual. For a Keynesian-style planned economy to function requires omniscience.
    • by xs650 (741277)
      "The study of economics can therefore be viewed as a study of groups of self-interested participants working for their own betterment."

      That could also describe a study of crime families and drug gangs.
      • Re: (Score:3, Informative)

        by benjamindees (441808)

        Crime families and drug gangs are economic phenomena.

        Both usually comprise an underground economy of immigrants (people outside the normal purview of government) working to avoid government regulation of business activity.

    • by Trepidity (597) <delirium-slashdo ... g ['ish' in gap]> on Sunday September 13, 2009 @02:33PM (#29406495)

      It's true that the Austrian school of economics correctly realizes that human behavior is the central component of economics. But they base their entire subsequent theory on an absurd model of human behavior with no scientific support:

      The study of economics can therefore be viewed as a study of groups of self-interested participants working for their own betterment.

      This is making a pretty huge assumption about human behavior that most scientific studies of human behavior, in any field, don't bear out.

      • by Tablizer (95088)

        Indeed. Psychology is often called a "soft science" because it's hard to isolate specific factors for experiments, let alone repeat them; and so educated guesses are the main mode. Software engineering (beyond machine performance) may also fall into this type of problem.

    • by osu-neko (2604) on Sunday September 13, 2009 @03:41PM (#29406989)

      The basic idea of Austrian economics is that the study of economics is an a priori discipline.

      Which is to say, it's an attempt to reason from assumptions instead of draw conclusions from evidence. An a priori discipline is an arcane way of saying a philosophy, mathematical system, or religion. It's the opposite of science, which is a posterioi.

    • Re: (Score:3, Insightful)

      by Cally (10873)

      Firstly, may I be the first to link to the Gaussian Copula [wikipedia.org]. If you'd like to point to one equation that did more than any other bit of modelling to bring about the collapse in the credit derivatives market and the ensuring banking finance, David Li's horribly misused [wikipedia.org] work is what you're looking for. Google is your friend for far more than you want to know.

      Secondly, your assertion that "Human behavior is the basis for the Austrian school of economic thought" is, frankly, nonsense. I'm a great believer in mar

    • Re: (Score:2, Insightful)

      by Abcd1234 (188840)

      Uh, you're contradicting yourself. If this statement is true:

      The study of economics can therefore be viewed as a study of groups of self-interested participants working for their own betterment.

      Then this statement is false;

      What is being proposed here is to continue to view markets as purely mathematically modelable phenomena. Economic decisions occur on the most local of levels, the individual level. No model accounts for the variability of the individual.

      Anyone who knows anything about game theory can tel

    • Name one! (Score:3, Interesting)

      by fishexe (168879)

      I challenge you to name one Austrian economist who predicted our current economic crisis. In fact, the free-marketeers who worship Friedman (I know that's Chicago school, not Austrian, but bear with me) ignored the potential for the current crisis while Keynesians like Krugman, in point of fact, predicted it. And Keynesianism hasn't been mainstream (in the US) for decades, so I don't know where you're getting the idea to say "the more mainstream Keynesians". The trend has been to trust markets more and m

  • Please don't. (Score:5, Insightful)

    by Shihar (153932) on Sunday September 13, 2009 @01:38PM (#29406111)

    I really wish wall street would get off their 'risk models' fetish. The financial systems of the world are wildly complex beyond all comprehension. "Risk models" make three, very shitty assumptions and, as a rule, eventually always fail. As we saw with the latest blow up, some times they fail with epic spectaularity. The three shitty assumptions are:

    1) That the model has enough information to make predictions in this infinitely complex system
    2) The system doesn't change.
    3) We will see nothing in the future we have not seen in the past.

    It is like watching someone try and figure out a way to predict the winner of a game where the rule book takes a library to hold AND the rule books are constantly being swapped out for new rule books. Everyone likes to blame the current recession on greed, evil bankers, and corporate corruption. While all of those things exists, they are not what caused the melt down. What cause the melt down was that a bunch of morons were using a 'risk' model that basically predicted that what happenend could NEVER possibly happen, so don't worry about it. Based upon this bad information, people made some very awesomely bad 'safe' bets. When the "impossible" (as the risk "models called them) happened, those very bad but "safe" bets imploded and you saw the wide spread destruction that happened as a result.

    • by oldhack (1037484)
      Can't you cut the Wall St. Assholes a break? You don't think they bleed black pus when cut like the rest of us?
      • by 1s44c (552956)

        Can't you cut the Wall St. Assholes a break? You don't think they bleed black pus when cut like the rest of us?

        That is one theory that someone should test. A sample size of a few hundred should be used for a scientifically valid test.

    • by hibiki_r (649814)

      It's harder than that. What a speculator does is try to guess what other people think the majority will find popular. Read about the Keynesian beauty contest: It shows why the market, while somewhat based in fundamentals, is inherently unstable.

    • by Abcd1234 (188840)

      I really wish wall street would get off their 'risk models' fetish.

      I think you're slightly off base, here. Risk models and the like aren't fundamentally a bad thing if they're used as a *tool* for guiding investment strategies. The problem, I think, was that too many looked at the output of any given model, and then proceeded to internalize the results wholesale with doing even a basic gut check. I mean, come on, does it really take a genius to realize that handing out huge mortgages to people who can't

    • Re:Please don't. (Score:4, Insightful)

      by Cally (10873) on Sunday September 13, 2009 @03:46PM (#29407027) Homepage
      > I really wish wall street would get off their 'risk models' fetish.The financial systems of the world are wildly
      > complex beyond all comprehension. "Risk models" [...] as a rule, eventually always fail.
      >
      [emphasis mine.]

      I'd be interested to hear your proposal for alternative ways for banks should manage risk without mathematical models. Wet finger in the air? Lottery numbers? Astrology?
  • it wont work (Score:4, Insightful)

    by Iamthecheese (1264298) on Sunday September 13, 2009 @01:39PM (#29406123)
    to steal a quote, markets can remain irrational long after a rational trader becomes insolivant. This includes rational predictions about human behavior.
    • by Shikaku (1129753)

      So you are trying to rationalize irrational rationalization of rational human behavior?

  • Sign me up... (Score:4, Interesting)

    by Paul Fernhout (109597) on Sunday September 13, 2009 @01:40PM (#29406135) Homepage

    High math and analytical GRE scores, a degree in psychology, previous work in the speech group at IBM Research, lots of programming and simulation knowledge... :-)

    Might as well make a little money out of the market before post-scarcity issues obsolete it. :-)
        http://www.pdfernhout.net/post-scarcity-princeton.html [pdfernhout.net]

  • What about widespread greed?

  • The biggest problem with some economic models is that they don't consider the irrationality of a consumer. This is fine when an economy is based on manufacturing or processing/export of natural resources since that follows more rational processes.

    The US economic meltdown was long overdue since the writing was on the wall with housing screaming up in value while any job that could be outsourced overseas was sent regardless of the quality and logistics issues it may create.

    A consumer-based economy with jobs f

  • by Anonymous Coward

    They're just *now* trying this?
    .
    Seriously?

  • bringing behavioral modeling into their complex financial calculations.

    Am I the only one who read that as 'fictional calculations'? It may be more appropriate ...

  • by GTarrant (726871) on Sunday September 13, 2009 @02:08PM (#29406331)
    While I dislike how suddenly the financial markets have gotten back into these windfall risky investments, there's little push to stop it, so I guess taking into account the kind of behavior that, you know, actual people would do, is better than nothing.

    Most 'risk analyses' done by these things almost go as far as to assume everyone involved acts as Economic Man - the theory that everyone will always act in such a way as to best improve their position, in a 100% rational way. This is a pipe dream put up in economic theory and doesn't always work. If you assume everyone involved acts that way, then some possible outcomes - like the ones we saw in the past year - can't be the slightest bit possible, therefore the models that were being run at the time disregarded them. Of course, the models were wrong - because people don't act that way.

    Consider what is sometimes called the Ultimatum Game - everyone's heard of it. Person A has a pile of money to divide between themselves and Person B. They split it, and Person B can either accept the division, in which case each gets their share, or reject it, in which case neither player gets one red cent and the money is lost.

    Economic Man theory would say Person A should give the smallest possible amount (let's say 1%) to Person B, and keep 99%, or whatever the maximum share is, and that Person B should then readily accept, because they're better of taking something rather than nothing. In reality, when this "game" is tested, it doesn't work that way - if Person A doesn't offer enough to B (say, 20%), Person B tends to reject it, whether out of spite, or a sense of fairness. The responses change depending on how much money is involved, and culture (different countries and regions have different thresholds) and everyone seems to have their own threshold of course - but very few Person B's say "OK, I'll take one penny and Person A can have $99.99" even if that's what Economic Man would do.

    Likewise, Economic Man doesn't see that much of a difference between, say, 10% chance of loss, or a 5% chance of losing double that amount and a 2 1/2% chance of losing quadruple - while real people tend to disregard a small chance of large losses, but be quite averse to a reasonable chance of smaller losses - they'd probably go for the last option, even if percentage wise the "odds" are the same.

    Most of these financial models, in essence, assume people are Vulcans, when they're not - they're people, and no amount of economics saying "You should act like Economic Man!" is going to change that.

    If they're going to continue using these models, a push to start getting them better is at least some progress.
  • It didn't work last time, but we know just the tweak to throw in to fix it! Honest! We're gonna get it right this time!

  • by gmuslera (3436) on Sunday September 13, 2009 @02:14PM (#29406369) Homepage Journal
    The human behaviour they should put into those models arent panic or riots, but what humans do when know what those models predict. Thats the biggest problem about predicting what people will do, what if that people know that prediction?

    That was the problem, too much people "knowing" what will happen, acting in a big way, and of course, failing because those predictions didnt included that behaviour.
    • by ceoyoyo (59147)

      Systems with significant feedback are extremely difficult to model usefully. In cases where the model does not converge, it's impossible. THAT's why they don't do it.

      Suppose you're modelling the market. Your model gives you a prediction. You then build that prediction into the model. The model tells you that the prediction is now different, because of the existence of the prediction. So you feed THAT prediction into the model. Which changes the prediction....

      IF the predictions converge (in some reaso

  • We all know that modelling human behaviour in software is anything but a trivial task, and that the results have to be taken with quite a grain of salt, but that's a step in the right direction, because for the last few decades economists have considered the market players to be perfectly reasonable, rational and competent, assuming little to no chaos in what actually goes on. If this crisis did anything good, it's given a much needed reality check to economists, particularly west of the Atlantic. I read a [nytimes.com]

    • by jcr (53032)

      They do very futile and dumb things, but in an extremely sophisticated and brilliant manner.

      Sophisticated and brilliant? More like obfuscated and arrogant. Krugman is a moron.

      -jcr

  • by PPH (736903) on Sunday September 13, 2009 @02:31PM (#29406485)

    Lets say the people who have the Federal Reserve Board of Governors on speed dial decide that the dollar needs to move in a different direction. So they call up Alan Greenspan and have him dump a few billion in foreign reserves. Exchange rates change, followed by interest rates. Pretty soon, people with marginal mortgages get caught short. Investment banks figure this out and pull the rug out from under mortgage backed securities. Commercial banks' capital ratios collapse. Wall Street sees this and responds. Panic ensues.

    But its too late. Understanding the market by analyzing panic is like trying to diagnose diarrhea by looking in the public sewers. The people who initiated the problem have taken their profits and run long ago. Their lackeys have moved on and retired. If you want to know what the market is up to, you're going to have to collect data a lot earlier in the investment cycle.

  • Of COURSE Wall Street's math models fail to take human behavior into account. We as a species don't even know what human behavior *is*, let alone what kind of mathematical equations might describe it. Attempting to model any behavior is doomed to failure as long as the model is incomplete. All humans have their own perceptions, interpretations of events, and people will make money decisions based on information that you can't possibly predict algorithmically.
  • We know they're frauds. We know that we're buying a ponzi scheme. They're the only ones who seem to believe their "models" have a basis in reality. Sort of like how facebook "models" my friends.

    • by 1s44c (552956)

      We know they're frauds. We know that we're buying a ponzi scheme. They're the only ones who seem to believe their "models" have a basis in reality. Sort of like how facebook "models" my friends.

      Doubleplus true.

      However I suspect the majority of the general public will be fooled, even after getting burnt by these money-grabbing parasites.

  • Yeah thats it (Score:2, Insightful)

    by shaitand (626655)

    This is the same bullshit they have been spouting among stock traders all along. Its all just because people are panicing and afraid. Sure the stock market works that way but the real world does not.

    It couldn't possibly be that we trade debt and have changed our production system to solely attempting to maximize profit rather than total production. Never that.

    A highly liquid economy is NOT a substitute for a solvent one backed by actual tangible assets of innate and functional value. Encouraging people to b

  • Oh hell just gimmie a penny for my thoughts.

    Informed, rational investors can likely use game theory and an auction model to structure functional investment strategies in efficient markets. Irrational investors likely need to be viewed as lepers and those fleeing lepers. Irrational investors might even be more effectively treated as what they are. They're hunter-gathers with a built in reward system that fuels their investments as something akin to a huge rack of a recent kill nailed to the rec room wall,

    • by Renraku (518261)

      This is certainly true.

      By our very nature, humans are investors. We don't till fields for 6 months to get nothing out of it. We expect food or flowers or something that will increase our chances for survival. That's a risk. A gamble. Sometimes the crops die in a sudden snap frost. Sometimes a flood. Whatever the cause, sometimes the food or flowers or what not that have come up from the ground for ten years suddenly don't. Then there's famine. People die. People are miserable.

      Faced with starvation

  • by macraig (621737) <mark DOT a DOT craig AT gmail DOT com> on Sunday September 13, 2009 @03:15PM (#29406773)

    Mark my words, there's some guy named Hari Seldon to blame for this....

  • financial experts

    You mean snake oil merchants.

  • http://www.foxbusiness.com/story/markets/industries/finance/lazy-portfolios-floor-behavioral-finance-funds/ [foxbusiness.com]

    Ignore the writer talking about his own strategy, and the boxing metaphors, the Nobel prize winning father or Behavioral Investing has had his own Investment funds rated Below Average by Morningstar, and a 2006 study of Behavioral Investing funds found

    ...in a 2006 research study by three finance professors from Florida State and Central Michigan universities. They analyzed "16 mutual funds that are self-proclaimed or media-identified disciples of behavioral finance," including the two Fuller-Thaler funds. Conclusion: "Behavioral mutual funds are essentially value funds [and] exhibit no ability to time risk-return opportunities" because "investing based on the principles of behavioral finance is indistinguishable from value investing."

    In addition to being about the same or worse as a Value Investing strategy, they have high stock turnover, bad for you at tax time and fees tend to be hi

  • Did the previous risk models fail? Well then OBVIOUSLY the previous model was were wrong risk model and not complex enough.

  • We've been manipulating and modeling human behavior for decades. We chuckle when economists suddenly realize that humans act in so-called "irrational" (but theoretically and statistically predictable) ways. It's only irrational insofar as economists don't understand it.

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