White Tiger’s Lair

I recently read an article in the MIT Technology Review called “The Blow-up” about the financial blow-up this summer and it brought up a few interesting points.

Are the linkages in our financial system really unforeseen and unpredictable??? While the article suggests that no one could have predicted that two financial products with no know “correlation” could so strongly affect each other, I think it should have clear it could and would happen.  I am not saying that I knew it was coming or that anyone could have known thing would happen in this way, I am saying that any time you look at something in a vacuum and don’t think about interactions, you are asking for trouble.

We have an intricate financial system and in even simple systems small changes can have major side effects and side effects of those side effects, in diverse and sometimes seemingly unconnected places.  Whenever people try to “game” the market, or depending on your point of view, enhance the efficiency of the markets by a strictly numbers (historical data and algorithms) approach, you should expect unexpected results, and when those same people (algorithms) are large enough to move the markets on their own then the “unpredicted results” are magnified.

Our financial market and not pure markets.  Yes, vast amounts of the capital movement is controlled by fast computers making, assumingly, logical decisions based on facts (number based data), but that is only part of the story.  If the system consisted only of computers executing algorithms based on logical yes/no decisions then the system would be predictable, logical and would continue to function, its not.

This is only the top layer and only part of the top layer at that.  The system is also people, and we know from experience that no matter how “rational” people may be, we are not always rational when it comes to money and our hopes and fears influence out decisions in ways numbers can’t predict.  Secondly, there may be strong correlations (or negative correlations) between financial instruments that you can predict in many cases, but these instruments are based on the success of companies run by, sometimes illogical people, who supply products to people who based their buying decisions on all sorts of irrational factors.

In addition, it cannot take into consideration factors that change the markets.  I would be very curious to know if any of the models had predicted the booming renewable energy/clean tech market 3-4 years ago and can account for the difference between the Chinese, German and American stocks in this industry. 

With statistical analysis provides key information for decision making, I worry where we as humans outsource thinking and decision making responsibility to computers that cannot understand non-quantifiable relationships, and the decisions based on imagination, creativity greed, fear and hope.