Comment by russell | Hacker News Reader

Comment by russell | Hacker News Reader

Yes we should. Vermeulen says the idea of Darwinian economic competition is wrong. Even Darwin wouldnt buy it. He gives examples of why the flu doesnt kill everyone and why ISO9000 in the long run saps the vitality out of a company. Hey, look at Motorola.

I think the whole idea of market efficiency came about because economics wanted to be a science, and everyone simplified their models to the the point that they were understandable, except that they were all wrong. First perfect efficiency requires perfect information. With the internet we are getting the first hints of perfect information, and we are being overwhelmed. Adam Smith certainly didnt have it. Second all decisions are to some degree irrational, based on taste, beliefs, friendships, bribes, etc. Kahneman got a Nobel prize in 2002 for that insight. (This is the same group the gave Merton and Scholes a prize for the derivatives pricing model that brought down the universe.) If all decisions were completely rational, we would all be programming Python. ;-)

> Vermeulen says the idea of Darwinian economic competition is wrong. Even Darwin wouldnt buy it.

Actually, V doesn't. Instead, he shows that what's wrong is the notion that economic survival/success is simple. Instead, it's complicated - fitness functions are unknown, context sensitive, and variable, just like life. And, whenever organisms interact, so do their fitness functions.

The only people who don't understand that are the ones thinking that they can buy silver bullets.

There was nothing wrong with using Black-Scholes to price stock options. The problems started when people started using it to price their own Grandmothers.

It didn't work so well at Long-Term Capital Management where they were among the resident geniuses.

What? Long-Term Capital Management didn't use Black-Scholes. It hired Merton and Scholes, but used a completely different trading strategy.

They tried fixed income arbitrage with very high leverage. Black-Scholes ONLY applies to options.

The work that won the Nobel Prize had nothing to do with the downfall of Long Term Capital Management. Get your facts straight.

Variations of Black-Scholes are still used successfully in the trading world. The only difference is that no one thinks that returns follow a normal distribution anymore (but the Black-Scholes formula allows you to choose any probability distribution you want).

What did LTCM in was Russian government bonds - they strayed out of their area of expertise.

Black-Scholes assumes the change in stock prices follows a normal distribution. It is quite easy to show, by pulling data from any online stock site and creating a histogram, that stock prices do not follow a normal distribution (instead they are power laws). If stock options followed a normal distribution, 'crashes' such as last year should basically never occur.

Simple models also assume independent variables, because dealing with cross-correlations for thousands of stocks is hard. This is a mathematical statement of the 'common sense' expectation that you loose a little, win a little. However, in reality the market is highly correlated, for example in the last year virtually everything has gone down.

This is pretty common knowledge in the research branch called 'econophysics', google it. It's an interesting field, one of their major 'result' is that classical economic theories are fairly flawed, and only seem to work because they are like self-fulfilling prophecies (traders implement their beliefs, but only up to a point!).

I once took a course in statistical physics. As an aside, the prof. neatly showed that the Black-Scholes equation is actually a simple diffusion equation. It requires a few variable substitutions and the like, but then it has the exact same form. And of course that makes sense.

Reply on news.ycombinator.com