Black Swans vs Financial Engineering

[Andy Nguyen]

Khashanah, the director of Stevens Institute of Technology’s Financial Engineering program, has a problem with Black Swans.

Black Swans are those seemingly impossible, game-changing events popularized by Nassim Nicholas Taleb in his 2007 book, The Black Swan. Taleb picked the name because Europeans thought all swans must be white, until they discovered black swans in Australia during the Eighteenth Century.

According to Taleb, a Black Swan has three characteristics: First, it is so rare, “nothing in the past can point convincingly to its possibility.” Second, it has very high impact. Third, people “concoct explanations for its occurrence after the fact, making it explainable and predictable.”

To Khashanah, Taleb’s focus on the unpredictable nature of Black Swans seems to fly in the face of everything he knows about the ability of mathematics to find patterns in the world around him.

“Taleb does not identify the current financial meltdown as a Black Swan, even though it appears to meet his own definition of a Black Swan,” Khashanah said. Banks were shocked by how badly risk models underestimated their vulnerability. The result upended the global economy. In retrospect, everyone says we should have seen the signs.

“Still, you cannot tell me that whole financial system had no information that could have warned us about subprime mortgages and derivatives, that the crisis was just random. I don’t buy that,” said Khashanah, who is also a Distinguished Service Professor at Stevens.

“As a field, Financial Engineering is presented with two choices. We can either stop producing risk models because the phenomenon is too complex, or face up to that complexity and try to incorporate it within a new modeling paradigm. I choose the latter.”

See the whole article at Black Swans vs. Financial Engineering Office of University Communications: Stevens Institute of Technology, Hoboken, New Jersey, USA

 

[bigbadwolf]

Khashanah seems to have a profound misunderstanding of "black swans." A black swan is something for which there is no prior intimation. It's not some pattern that can be discerned in prior experience but for some reason -- sloth, lack of imagination -- was not. It's something that has never occurred in the past. If memory serves, black swans were first discovered in Australia. There was no prior experience to suggest that there might be such a phenomenon. This is what Taleb is talking about. What Taleb argues is that such "black swans" -- shocks to our empirical conceptions -- come more frequently that we expect, partly becuase we think our conceptions are more accurate, complete, and robust than they really are.

 

[mattown]

I think Khashanah is over stretching himself here. History has always shown that excessive money lending leads to crashes, its just that simple.

Timing wise I think you could argue it was a black swan, as its very difficult to predict exactly when a crash will precisely occur, but the reasons for it were pretty clear well before it happened, at least to me they were. When you look at the job numbers, coupled with average wages and generational shifts + skyrocketing mortgages what else did you think was going to happen? I had a feeling the whole time a crash was going to come, I mean its just seasme street, "one of these things is not like the other *whistles*"

I believe financial engineering as a discipline needs to be dynamic enough to adjust itself according to technology, but I see its shining point as a means for tinkering and finding 'tricks' in the market, you can't expect to predict things 100%, but use the technology and the tools to develop interesting strategies.

---------- Post added at 11:49 AM ---------- Previous post was at 11:46 AM ----------

A true black swan you can't predict it doesn't exist...excessive money lending has existed for 100s of years...

If someone were to invent cheap fusion power tomorrow or if a political leader was murdered or large scale terrorist attack..etc now that is black swan terrority