Customer Reviews

Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets?

5 star:		(4)
4 star:		(3)
3 star:		(4)
2 star:		(1)
1 star:		(14)

 

 

I was attracted to this book partly by the intriguing title, but mostly by the fact that the foreword was written by Nassim Nicholas Taleb, the author of 2 fascinating books on roughly the same material, "Fooled by Randomness" and "The Black Swan".

I was expecting more of the same from Triana, but with perhaps a slightly different viewpoint and possibly more details. What I got was a 350 page polemic from a confirmed math phobe and a slavish paen to Taleb. OK, Black-Scholes is not a great idea and VAR greatly underestimates market risk, but to repeat this theme again and again borders on the lunatic.

But that's not all, here's a quote from p. 203 that sums up the style of writing; he's referring (endlessly) to Black-Scholes-Merton and, in this case, to the S&P 500 volatility surface: "...Obviously, horizontal is not the same as curved. A curved line is a complete violation of BSM. Horizontal is not the same as curved. The end results are not BSM-compliant any more. It's not BSM. Curved is not horizontal. It's something else. BSM endorses horizontality. BSM negates curvedness. It can't be BSM. Curved is not horizontal". I kid you not.

The message of the book, delivered amply in Taleb's foreword and elsewhere, is that too often in the past econometric models put foward by the likes of Merton, Scholes and others have been blindly followed by market makers and regulators, with resultant disastrous effects. Unfortunately, Triana adds little additional insight and commits the greatest of all faults an author can make--to bore the reader.

I read Nassim Nicholas Taleb books, "Fooled by Randomness" and "...Black Swan"; so I figured (regrettable, on hindsight) given that Taleb wrote the foreword then the book would be on par with his books! I was wrong.


Negatives:

The book is way too repetitive!
-Imagine going for >74 pages (that's the longest chapter, #7) of repetition. Not only is he repeating lines from other chapters, no.... at times from the the same paragraph!

The writing style is rather weird.
- At some point he mentions Victor Niederhoffer by name and then at another chapter, he talks about the same story but this time it's no longer Victor but rather a "famous speculator"
- Again, he mentions Emanuel Derman by name and then in another chapter, he talks about the same story but this time, it's not longer Emanuel but it's now a "...famous quant/academic..."!
- I coud go on....


Positive(s):

His understanding of the subject is not in question, at least not by me!
His opinions on VaR, BSM.
His opinions on the need for change, especially the financial economics professors' influence in the real world of finance
The relating of his work experience is another positive

All in all, I'd rather pass on the book, for I can assure anyone that the repetitiveness will be found very annoying.

I agree with the complaints about repetitiveness and poor writing, but it is possible to understand this book. Most poor writing springs from unclear thinking, it is usually not worth deciphering. In this case I blame passion and unfamiliarity with English. If you eliminate all adverbs, ignore everything splitting infinitives, assume prepositions were chosen randomly, recast all sentences into present tense, active voice, indicative mood (the author is very fond of the inverted pluperfect subjunctive, perhaps from reading a lot of 19th century English poetry or conversing with Yoda) and eliminate irrelevant words borrowed from clichés, the book makes sense. For example:

"It is not fanatically expected that those pros who bring advanced analytics into the fold of practice would believe that the adopted models have a high chance of igniting trouble down the road. Rather, they would be assumed to be hopeful about the possible gains to be obtained by pledging allegiance to the math, whether in the shape of better prices, improved hedges, or more accurate risk measurements (the exception here would be those situations where financiers are forced by regulators to embrace a particular quantitative construct, the foundations of which they agitatedly distrust and which side effects they massively fear)."

Means simply:

"Quants do not build models to cause trouble. They hope models improve pricing, hedging and risk management. Sometimes bad models are imposed by regulators."

I understand most readers will not go through the trouble of decoding the prose. If they do, however, they will find there are some original points here, different from Taleb and Derman. They will also find junk. Triana constructs several straw man arguments, then loses to them ungraciously, heaping sarcasm rather than admitting defeat. I disagree with those reviewers who praised his views on Black-Scholes-Merton and Value-at-Risk, those views are deeply misinformed. One of his basic errors, repeated frequently, is to claim the goal of risk management is to predict and prevent disasters. People who guess the future and people who fear failure are the enemies of risk managers. Risk management means trying to prepare for anything that might happen, not guessing the future nor insuring no bad things ever happen. Institutions with good risk management fail often and fail fast, institutions with bad risk management fail only once.

The book's original contribution is to defend traditional corporate finance, as practiced in the United States from about 1910 to 1970. Triana is deeply reactionary. His only similarity to the revolutionaries and technocrats he quotes is dislike of current practice. Taleb wants to throw away prediction and measurement and face the unpredictable future with elegance. Derman wants us to understand the limits of models, to continue on our present course but with more humility and broader vision. Triana wants to go back to a simpler time when hands-on managers used simple math and no theory. There is a strong religious streak in this book, on the "may the force be with you" level.

Few people have less sympathy for this view than I do, but I still found it a useful and thought-provoking argument. I cannot recommend this book for general readers, but if you are very interested in this stuff and have the patience to wade through the style and repetition, you will learn things from it.

I came on Amazon with the intention of spelling out why this book is so disappointing. I see a few people have already written my criticism. If you like reading criticisms that are repetitious you will 1) Like this review and 2) Like this book.

Just to reiterate, the writing is unbelievably bad. Whether it be the repetition, the rambling, or the awful humor (most of it stolen from others...e.g. the "Good Will Hunting" line about library fees), the author makes reading this book as painful as possible. He spends pages and pages bemoaning those in academia, specifically what he calls "B schools" (yes, he's one of the guys that says "B school"), but if he'd lower himself to some instruction he might find the practice of outlining before writing leads to a better product (and a more terse one). He clearly sat down at the computer and started churning words. I doubt he has read this book himself.

What is unfortunate is, when he gets into his specific points on the credit crisis, he does a better job than any others I've read of explaining what all the products were and how the progressive collapse occurred. However, what would have been an excellent couple of magazine articles was wrapped in an endless (and unnecessary for the book) rant against a few MBA classes, repeating himself, uncomfortable sexual jokes, and his incessant crusade against Black, Scholes et. al. Skip this book.

The blame game for the current "financial crisis" is ongoing, with an intensity and volatility that is going way beyond the pale of any acceptable standards of human discourse. As this book is an excellent example of, the level of vituperation and ridicule is reaching the stratosphere, and shows no sign of abatement. At least for this reviewer, this book was tough to read, not because its technical content is difficult, which it is not, but rather because of the steady and irritating commentary on part of the author. In addition, he seems to switch from one position to its opposite, as if he flipped a coin while writing the book, with his stance depending on which side of the coin came up. In one part of the book he is excoriating the practitioners of "pure mathematical finance" for the bringing down of the markets. Just a few pages later he is revealing to the reader that such an approach was not even used at all, or at least minimally.

Between these Markov transitions from one position to the next, the author is busy indulging himself in distasteful and unprofessional ridicule of the "arrogant" and "self-serving" financial theorists who never spent a minute on the trading floor, and who were responsible for "terrible, theory-ignited mischief." Risk management he asserts should be handed back to "freethinking, gumption-honoring, innumerate chums". In other words, the financial decision-making should return to the use of "old-fashioned commonsense." Throughout the book he lifts up the quasi-mythical "Black Swan" symbolism in order to justify his belief in the power of "rare events" and the inability of VAR models to account for them.

One can certainly commend the author's rejection of social and intellectual hierarchies, and his encouragement of this rejection to the reader. Degrees, accolades, and exaggerated recommendations mean nothing when it comes to describing and understanding real systems. The only thing that matters is evidence, and this comes at a high cost, both in dollars and in time. The obtaining of true knowledge is difficult, and frequently must be done without worrying about recognition or monetary compensation. A high degree of mental discipline is required, along with large blocks of time.

But rebellion against authority and word arrows fired against stuffy, arrogant mathematicians does not prove a thesis. The author has failed to prove his in this book, in spite of the title and the page count. Indeed the writing and logic is confused and leaves the reader wanting as to what the author is really asserting:

- Quantitative finance is derided for its potential to "sow the seeds of market chaos" but the author does not define what "market chaos" is nor entertain the possibility that chaotic dynamics in a financial market may indeed be an efficient way of allocating capital and labor. There are several systems of interest, such as data networks and the human neural system, which depend on chaotic dynamics for their proper functioning.

- Financial engineers are scolded about their attempts to predict future market movements by sole reference to the past, but the author then praises the financial savvy of "commonsense" traders who acquired their knowledge and expertise by years of trading.

- In attempting to explain the (in his opinion, unjustified and reckless) adoption of techniques from quantitative finance, he author claims that it was also due to regulatory agencies or public relations but does not give one example, even anecdotal, to support this. Which regulatory and advertising agencies were involved?

- The 1987 "crash" is blamed on Black-Scholes-inspired trading strategies, but no convincing evidence is given anywhere in the book. And along these same lines the author refers to this as a "cataclysm", as do a few others in the financial press. But it would be just as easy to refer to it as merely a market correction, considering the behavior of the market a few days after "Black Monday." And just because a collection of wealthy people lose a lot of money does not mean that it is a "cataclysm."

- The claim that no mathematical model can capture the intricacies of human psychology. This is not true, as research into cognitive neuroscience will reveal. Although much work remains to be done in this area, it is progressing with all deliberate speed.

- The author asserts that humans are so unpredictable in their financial dealings that not even a "Prophet" could sort it all out. Humans "change the rules constantly". But on the other hand many times in the book he is proclaiming the wisdom of Leo-Malamed-type "commonsense" traders to do just that. Apparently folk wisdom and "commonsense" can "untangle" the "conundrums" of the financial markets. How many commonsense "chums" were actively involved in the 1929 Crash, the Latin American banking crisis in the 1980's, Black Monday in 1987, the bond market meltdown in 1994, the Asian 1997 crisis, the 1998 Russian default, the 2000 NasDaq crisis, the 2001 Enron Bankruptcy, and the 2002 WorldCom bankruptcy? None at all? Predominantly?

- What evidence is there that "outliers" are "created by people who don't believe in outliers"? Has the author studied this real-time, or can he give some sort of historical evidence supporting this claim? Can a collection of people doing trading on a "assumption of normality" actually give results that are "non-normal"? How would one study this phenomenon? It seems the author is making a prediction here. But from dialog throughout the book, he ridicules the attempts to make predictions on human financial behavior.


There are many more outrageous claims that would add to this list, but space restricts this reviewer from going any further. To substantiate the claims that the author is making in this book would swell its pages to number in the thousands. It is a tiresome collection of ranting and ridicule, and adds nothing to the debate on the efficacy of quantitative finance. From working in financial modeling, this reviewer has always encountered extreme skepticism regarding mathematical modeling on the part of senior management. But these examples are purely anecdotal, and it would take many years to show that this is widespread, or that the converse is true.

If one humble lesson could be taken from reading this book it is that the financial markets of the twenty-first century rattle and intimidate some people, even seasoned traders and financial professionals. Yes, there are complicated mathematical constructions that are employed to describe financial markets and that are used to trade securities. But this reviewer looks forward to more mathematics in finance, not less, in the years ahead. Even better, and this is certainly on the horizon, is a situation where the commonsense of human financial dealings is completed automated into the technology used to implement financial transactions.

I fully agree with other reviewers about the bad writing and poor style of the book. The message of the book could have been presented in less than 40 pages. It has been said that the worst thing for a good idea is a bad fan. This is exactly what this book is doing to the ideas of Nassim Taleb. Taleb should have not given his endorsement to this book: It does more harm than good to his reputation.

"Can Mathematical Theories Destroy the Financial Markets?"

The question is certainly a very good one. Unfortunatelly, the answer offered by Pablo Triana in this book is far from satisfactory.

The problem is not with the selection of topics. To be fair, the author covers in good detail the usual suspects (Black-Scholes, CDO, Copulas, VAR), identified by most commentators to have a played a significant role in the credit crisis. He also re-states some interesting ideas from Derman, Taleb and Haug.

The problem is with the style of writing, which is convoluted and repetitive to the point of making it unbearable. I wholeheartedly agree with previous reviewers here in Amazon.com, Amazon.co.uk, internet blogs (e.g. Satyajit Das's Blog [...]) and elsewhere (e.g. The Economist, 25th Jun 2009). Take this passage from page 318 for example:

"Deliciously paradoxically, the Nobel could end up diminishing, not fortifying, the qualifications-blindness and self-enslavement to equations-led dictums that, fifth-columnist style, pave the path for our sacrifice at the altar of misplaced concreteness."

Do you see what I mean? And it is like that for 400+ pages...

I feel uncomfortable to write a negative review of the book given that the author had such high expectations. He himself says that "I think the book came out neat, could even perhaps become a classic of sorts" (Pablo Triana's Blog [...]). Well, sorry Mr Triana, but I seriously doubt it. I am in fact expecting him to burst in this webpage any moment now to give himself a five star review, as he did for his other book "Corporate Derivatives". In that review [Amazon.com] he wrote:

"I have given myself five stars for three main reasons: 1) Amazon requires some rating, 2) Giving less (say, three, as I originally and modestly planned) could send the wrongful message that the author is less than proud of his work, 3) I honestly do believe the book deserves five stars."

If you want to read a solid and informative book on the role of maths on the financial crisis, I suggest The Failure of Risk Management: Why It's Broken and How to Fix It by Douglas W. Hubbard, Wiley, 2009. In Amazon the book has 21 reviews of which 19 are 5 stars... reviews written by readers, not by the author.

I bought this book because the title and the foreword by Taleb suggest that it contains an original contribution to the critical discussion in the aftermath of the big financial crisis. When reading through the author's lengthy foreword I could not help asking myself again and again: How could Mr. Taleb (who stands for lucid and concise writing, original insights and thorough understanding of his subjects and the respective background) endorse a piece like that? Triana sounds like an undergraduate student who just failed his quantfin 101 class and now he hates the "professors" with their "excessive analyticialization" and their "self-serving theorizing" (quotes).

As for the main point(s) of the author: BSM is wrong. Right. Academic literature is full of empirical and theoretical accounts of the failings and possible extensions of the formula. Triana battles the normal distribution assumption, he does not even make it to the more subtle (and critical) assumptions of the theory: perfect liquidity, frictionless markets, continuous trading and the absence of systemic events as we have seen it during the crisis.

As a remedy for the problems the author seems to suggest something like "practice without theory" (only natural given that he seems to be a third-tier practitioner who has not mastered the theory), lacking the most basic insight that EVERYBODY acts on theory be it formal or not. Interestingly, as a first witness he quotes Jim Simons from Renaissance Technologies who only hires top mathematicians and scientists for his hedge fund saying "that there is no fundamental, set-in-stone truth in the markets". The author (mis-)interprets this as to mean that formal thinking is harmful in financial markets. So, Mr. Triana, what do you imagine top scientist do at Renaissance? I bet, there is some heavy analyticalization going on there...

While many sectors of the economy are collapsing the output of books on the economic crisis is booming. Many are shameless attempts by an author to cash in on their expertise or background and lack the capacity to cover complicated financial and macroeconomic issues well. Quite simply put, the economic crisis has too many causes to be easily addressed in a comprehensive manner no matter how talented the author on the subject. Typically speaking the best books on finance or microeconomics focus more narrowly on a single company or deal, such as "Barbarians at the Gate" about the takeover of RJR Nabisco or "The Smartest Guys in the Room" about the Enron fiasco. Pablo Triana however opts for a thematic approach, focusing on how the infusion of mathematicians and financial economists into the financial industry led to overdependence on their theories and the increase in unwise risk-taking in the markets. Triana rightly points out that economics is not a science as humans adapt and change behavior in ways that can be unpredictable. That's true, but was more capably pointed out in "The Myth of the Rational Market" and countless other books on group psychology. The better argument Triana makes is that the mathematical models not only were unlikely to work but worse still they gave bankers and financial firms a false sense of security that created the willingness to take greater risks. We're right back at Captain Smith ignoring the telegrams about icebergs and relying on the infallibility of watertight compartments. As smart as we think we are, as much as we think we've mastered risk, we are still going to fail from time to time.

For all of his insight and flashes of brilliance there is the problem with Triana's horrifically dense and contorted prose. It not only would be trying for non-specialists to read, it would be difficult for economists, bankers and financial types to wade through. At times it almost seems he's taking stabs at wit or eruditeness but they instead tangle themselves into verbose knots. And in the end Triana is merely pointing out the obvious, our faith in mathematical modeling failed us, so now what? Have we learned our lesson? Thinking of Captain Smith again, I don't honestly think we have nor are we likely ever to.

This book is written by a young derivative salesman. If you are a young derivative salesman your mission in life is twofold:

1. Repeat soundbytes that other people tell you. Over and over again.
2. Rip people off. Get people to pay the wrong price for something, then prance down to the trading desk patting yourself on the back and watch the trader try to keep a straight face.

This book does both in spades.... unoriginal thought verbosely repeated......Triana is annoying throughout, his false self-deprecation and poor attempts at copying Talebesque wit make the book a trudge thinking there is something about to change or emerge from the text.....sadly it does not.

The best book I have read in the genre is Traders Guns and Money by Satyajit Das........Check out it's reviews....A well written tour de force from a smart guy who knows what he's talking about......Traders, Guns and Money: Knowns and unknowns in the dazzling world of derivatives Revised edition (Financial Times Series)