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There are two types of theories: those that are wrong (because they
have been falsified, that is, shown to be wrong) and those that are
exposed to be falsified. In other words, theories are only innocent
because they have not been proven guilty. Past data has a lot of
good in it, but it is the bad side that is bad. A theory, say like
Astrology, that does not present a set of conditions under which it
would be wrong would be termed charlatanism --they would be
impossible to reject otherwise.
We should not treat theories as if they were plain wrong, merely
that we should not put ourselves in a position that could lead to
harm (bankruptcy)if these theories were ever falsified.
I refused to blindly accept the notion that knowledge can increase
with incremental information – which is the foundation of
statistical inference. It may in some instances, but we do not know
which ones. Many of the insightful people, such as John Maynard
Keynes, reached the same conclusions. Many of Sir Karl Popper's
detractors can be loosely termed Bayesian probabilists; they believe
that favorably repeating the same experiment again and again should
lead to an increased comfort with the notion that "it works". Sir
Karl feared that some type of knowledge did not increase –but which
one we could not ascertain. He is important for us traders because
to him the matter of knowledge and discovery is not so much in
dealing with what we know, as in dealing with what we do not know.
I speculate on theories that represent some vision of the world, but
with the following stipulation: no rare event should harm me. In
fact, I would like all conceivable rare events to help me.
In finance, more than any other discipline, we face the problem of
dependence on a single unwanted observation: a single black swan can
bankrupt you, or worse, bring down the entire financial system (LTCM
for eg.) In other disciplines, say, zoology, a single black swan
will be a mere oddity of small consequence. It will be called an
outlier and merit an entry in some book of records –but it will
cause no serious financial penalty to the financial research
institute. In finance, more than the sciences, we cannot merely
look at frequencies, we have to consider the outcome, namely, the
loss, which can be very negative...
rgds, pal
--- In amibroker@xxxxxxxxxxxxxxx, "T Virgil" <truvirgil@xxxx> wrote:
> Your characterization of "financial engineering" practitioners,
and your
> understanding of their practise is far off the mark.
>
> I've worked in a financial engineering firm that has served many
of the big
> investment banks, pension funds and insurers. Many client-facing
financial
> engineers are MBA's, and wouldn't consider themselves to be
scientists. The
> more research oriented financial engineers are often physics
Phd's, or
> similar disciplines. There were actually no statisticians on the
staff. The
> people in the field aren't the idiots you might think they are.
>
> Managing a multi-billion dollar book spread over trading floors in
different
> time zones, with thousands of positions (many of them synthetic)
and many
> dependencies is the big headache. Many models are simplified, e.g.
VaR,
> RiskMetrics because it takes enormous computational power to deal
with
> stress testing and MCS. Daily reports using an elaborate model are
no good
> if they take a week to compute. Something like computational
weather
> forecasting.
>
> ----- Original Message -----
> From: "palsanand" <palsanand@xxxx>
> To: <amibroker@xxxxxxxxxxxxxxx>
> Sent: Saturday, December 13, 2003 12:04 AM
> Subject: [amibroker] Re: MaxRisk (was Optimizing Max Open
Positions)
>
>
> > Practitioners of "financial engineering" methods measure risks,
using
> > the tool of past history as an indication of the future. They
call
> > themselves scientists but do not show an inch of critical
thinking,
> > or self-doubt, which is the hallmark of science. The mere
> > possibility of the distributions not being stationary makes the
> > entire concept seem like a costly (perhaps very costly) mistake.
> > This demarcation between science and charlatanism is apparent
when we
> > examine financial engineering and the applications of modern
> > financial theory to risk management.
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