Nassim Taleb: clown of quantitative finance

One of my fundamental realizations in life is that popular media in the 20th and 21st century is no better at conveying information than the “yellow journalism” of the Robber Baron era. A corollary to this is that most popular science “experts” are clowns. I realized this almost immediately in physics, as I had the good fortune to meet a couple of the charlatans I admired as a youth. It would be incredibly solipsistic of me to assume that this was only true in physics, but that is in fact what I assumed. Until I gained enough expertise in other fields to see through the impostures.

The most popular pop-writer in quantitative finance at present is Nassim Taleb. His latest screed in the Financial Times is what spurred me to write this post. The article wasn’t entirely written by Taleb -though I guess the other guy is his fund partner, so it is no surprise that it suffers from all the mush headed absurdity of Taleb’s other articles and books. I won’t pick on the other guy; or even mention his name: he’s got a job to do, and he has the good manners to not make himself a public figure.Taleb, on the other hand, is sort of the Paul Feyerabend of quantitative finance. Like Feyerabend, he is well read, a good writer and quite charming. Like Feyerabend, Taleb seems to earn his daily bread by showing up and being kind of witty. Finally, both Feyerabend and Taleb are very much Against Method. This means, effectively, they’re both intellectual nihilists. Feyerabend thought we couldn’t know anything for various reasons too silly to get into right now. Taleb thinks all of quantitative finance is nonsense and we should do away with quants. I am guessing the former’s delusions had something to do with drinking the same Berkeley tapwater in the 1960s which made everyone else believe in crazy things, but Taleb was a trader, and it’s a common prejudice of traders to dislike quants for cutting into their P/L.

A lot of what Taleb says is kind of sensible, and even obvious. Many models used in quantitative finance are bad models. Virtually all models used in quantitative finance are nowhere near as statistically sound as, say, models in physics, or even models in a subject as squishy as psychometry. That is no reason to discard the idea of models, yet it seems to be something Taleb repeatedly suggests. If you can’t be bothered to register for Taleb’s FT diatribe, I will regale you with a few choice quotes. It’s a disjointed and bizarre screed, though at least he nails “excessive debt” as the root of the present crisis -this is correct and has plenty of historical precedent. But then, as Taleb generally does, he takes a fairly reasonable statement and uses it as an excuse to careen off into cloud cuckoo land:

Taleb: “…homeowners and others have been recklessly amassing debt. Such non-linearity makes the mathematics used by economists rather useless. Our research shows that economic papers that rely on mathematics are not scientifically valid. Not only do they underestimate the possibility of “black swans” but they are unaware that we do not have any ability to deal with the mathematics of extreme events..”

Um, where did the nonlinearity come from? I’m assuming from a bad editing job. The larger issue is rather more alarming: one rather wonders if he used mathematics in his research on the scientific validity of these “economics papers that rely on mathematics.” I agree that many economics papers are silly. Since economic papers often involve math, his reasoning seems to be something along the lines of “we must do away with mathematics and instead base economic policy on chicken entrails and pixie dust.” It seems to me, sticking some well motivated error bars on economic models is going to get you farther than the chicken entrails approach. Sure, a lot of it will end up as chicken entrails anyway, but it seems utile to use models as a sort of starting point for understanding the world rather than, you know, actual chicken entrails. You can argue about the validity of a mathematical model -if you’re just using chicken guts, there is little hope. Perhaps a more reasonable approach to doing away with bad economics papers would be to insist all economics papers be written in High Church Latin, since most of the bad ones are presently written in English. Restricting economics papers to people who are familiar with the classics would filter out a lot of shallow thinkers. While I can’t prove this is a more “scientific” approach by Taleb’s lights, I’m pretty sure “write economics papers in Latin” is going have a lot more win than “no more math for economists.” If nothing else, latin means less people will read them, which ought to cure some of Taleb’s dyspepsia.

Later, Taleb, presumably unencumbered with any troublesome mathematical thought, informs us he has come up with a solution to the economic crisis:

Taleb: “The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity.”

By jingo, that’s it! We’ll just transform the debt to equity! Hey, wait a minute … what exactly is this “equity” of which Taleb speaks? In return for lowering interest rates on insolvent home owners … the banks get “equity…” in the form of what? A warrant on the front porch? So in 30 years, when the loan is payed off, Bank of America can open a branch office on your porch? Or do you have to go pay off the warrant too? In the latter case -dude, you’re just making the loan term longer: why not just make the term longer? In that case, why not let t->infinity on everyone’s loans and just pay rent to the bank? We’ll all be rich! Or serfs, depending on how you look at things. Since Taleb and friend never tell us what kind of equity they’re talking about, it is rather difficult to assess this proposal. I guess since they never bothered doing so, we can just assume they are merely waving words around. I fear for America should anyone attempt to implement a solution which is based on waving words around. Oh, wait a minute… too late!

Mountebanks like Taleb sell their wares by making the regular jamoke reading his books and essays feel fiendishly intelligent for understanding the concept of fat tails at the expense of all those pointy headed Ph.D.’s in the back room with their slide rules and white laboratory jackets. I think there would be a lot of social equity in doing this, except, the dudes in the white laboratory jackets are well aware of those fat tails. As such, Taleb is merely setting himself up as some sort of heretical alpha monkey of the quants for stating the obvious, the misleading, and occasionally the gratuitously wrong-headed and untrue. One of the annoying things about all this, is his fame has given him access to vast amounts of capital … capital which would be better off invested in T-bills. His strategy of betting on the fat tails has a miniscule Sharpe ratio, though it is hard to tell how bad, as his returns don’t get published in the IASG. Sure, his strat looks like genius during the occasional downturn, but the rest of the time (which is most of the time!) he looks like a plain old bear in a bull market. There are far more successful and long lived funds, as I have already pointed out which trade the inverse of the Taleb “swan strategy” at very high Sharpe ratios. They even win in “black swan” events if they manage their money correctly. Taleb’s strat will only strike paydirt when the poop hits the prop. The poop doesn’t hit the prop very often, almost by definition, no matter what kind of fat tail your black duck has.

So why do people listen to this guy? Part of it is doubtless the “famous for being famous” effect. Taleb is witty and clever, and ruthlessly promoted himself as a public figure after his trading days were over. Not a bad strat for success in the modern media culture: grab the megaphone and declare yourself a genius. Everyone wants to think they’re more of a mental bigshot than the eggheads who run things. Plus, it’s not like Jim Simons has time to write Financial Times articles. He’s too busy making money more or less proving people like Taleb wrong.