“Physics Envy…” presentation by Prof Andrew Lo: Risk & Uncertainty (in financial systems)


In this entertaining presentation, Andrew Lo poses some very interesting questions and adds further fuel to the argument that a rigorous scientific approach may yet help us undo some of the ills created by man’s feeble attempts to cheat nature – dare I say, man-made complexity!?

Andrew Smithers (Smithers & Co) has drawn his conclusion – below – It wasn’t rotten maths, it was rotten epistemology. But, I’m sure he won’t be offended if I draw and justify my own conclusions as well as adding some further thoughts from Andrew Lo which would appear to support my own position. In fairness to Mr Smithers his commentary is upon the presentation. My own thoughts are more focused on the robustness [RESILIENCE] of the SYSTEM rather than that of individual companies, portfolios or strategies. I am no expert. More of an enthusiastic amateur whose personal pursuit of a means to develop financial products that delivered TRANSPARENCY, SUSTAINABILITY and CUSTOMER VALUE led me to the realisation I would be better equipped for “the journey” armed with an understanding of COMPLEXITY…something that Einstein spoke so passionately about (below). Hence my involvement with Ontonix.

I have also included, below, a link to a superb article from Fund Strategy magazine, “Back to Nature”. In it Andy Haldane (Director of Bank of England), Lo and others recognise that there is much more for economists…all of us…to learn from the study of biological systems.

If you are involved at all in investment, insurance, credit or risk management and have aspirations that you may continue to be so, then you had better make sure you get your head round this message and ensure that your boss (and their boss) understand it…or, at least, give it some thought!

If an eminent Economist and a Physicist, both with in depth knowledge of the financial markets, are warning of the dangers of making key business decisions without a thorough and inter-disciplinary (see below) approach, business leaders need to listen if some businesses – industries – are to have a future.

Will anyone be so bold as to model that!!?

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Goldman Sachs: God’s work ain’t easy on anyone!


World Youth Day is a popular Catholic faith th...

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Link: ‘Sophistication’ debate heats up

By Gillian Tett, FT

Last year the author wrote a column “that argued it was time to start a debate about the definition of “sophisticated” investor. That was sparked by a saga bubbling in Italy, where investment banks have flogged numerous derivatives trades to local governments, and other entities (including convents) – and some of the deals are now turning sour, sparking law suits”.

So, Goldman Sachs’ [self cast as God’s financial emissaries] crimes could be retribution for on a Church guilty of committing, covering up and denying heinous sins [not my words!] perpetrated against its own people.

Individual convents may not be deemed to be “sophisticated investors” but that does assume that they make such decisions independent of the central authority of the oldest and most wealthy non-profit in history! Not, by the stretch of anyone’s imagination, anything other than a sophisticated investor.

Victims set to be denied thrice

No matter the outcome of any institution v institution actions, the victims can never be fully compensated for a string of the worst institutional crimes. Abuse of Office, trust and individuals.

Institutions are under pressure like never before and it will only get worse because they are more intent upon defending the indefensible and to fight to retain power and wealth…worryingly reminiscent of the words of Dr Joseph Tainter referring to The Collapse of Complex Societies:

Complex societies collapse because, when some stress comes, those societies have become too inflexible to respond. In retrospect, this can seem mystifying. Why didn’t these societies just re-tool in less complex ways? The answer Tainter gives is the simplest one: When societies fail to respond to reduced circumstances through orderly downsizing, it isn’t because they don’t want to, it’s because they can’t.

buiding-collapse In such systems, there is no way to make things a little bit simpler – the whole edifice becomes a huge, interlocking system not readily amenable to change. Tainter doesn’t regard the sudden de-coherence of these societies as either a tragedy or a mistake—”[U]nder a situation of declining marginal returns collapse may be the most appropriate response”, to use his pitiless phrase. Furthermore, even when moderate adjustments could be made, they tend to be resisted, because any simplification discomfits elites.

When the value of complexity turns negative, a society plagued by an inability to react remains as complex as ever, right up to the moment where it becomes suddenly and dramatically simpler, which is to say right up to the moment of collapse. Collapse is simply the last remaining method of simplification.

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Complexity: Clay Shirky draws attention to this major threat…


Clay Shirky

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I have lifted this text directly from Clay Shirky’s blog and, if your interest is in TV and media I would urge you to read it. On the other hand UNLESS the lessons about the impact of COMPLEXITY upon society itself are learnt your focus may be upon more practical issues like…survival!

In 1988, Joseph Tainter wrote a chilling book called The Collapse of Complex Societies. Tainter looked at several societies that gradually arrived at a level of remarkable sophistication then suddenly collapsed: the Romans, the Lowlands Maya, the inhabitants of Chaco canyon. Every one of those groups had rich traditions, complex social structures, advanced technology, but despite their sophistication, they collapsed, impoverishing and scattering their citizens and leaving little but future archaeological sites as evidence of previous greatness. Tainter asked himself whether there was some explanation common to these sudden dissolutions.

The answer he arrived at was that they hadn’t collapsed despite their cultural sophistication, they’d collapsed because of it. Subject to violent compression, Tainter’s story goes like this: a group of people, through a combination of social organization and environmental luck, finds itself with a surplus of resources. Managing this surplus makes society more complex—agriculture rewards mathematical skill, granaries require new forms of construction, and so on.

Early on, the marginal value of this complexity is positive—each additional bit of complexity more than pays for itself in improved output—but over time, the law of diminishing returns reduces the marginal value, until it disappears completely. At this point, any additional complexity is pure cost.

Tainter’s thesis is that when society’s elite members add one layer of bureaucracy or demand one tribute too many, they end up extracting all the value from their environment it is possible to extract and then some.

The ‘and then some’ is what causes the trouble. Complex societies collapse because, when some stress comes, those societies have become too inflexible to respond. In retrospect, this can seem mystifying. Why didn’t these societies just re-tool in less complex ways? The answer Tainter gives is the simplest one: When societies fail to respond to reduced circumstances through orderly downsizing, it isn’t because they don’t want to, it’s because they can’t.

buiding-collapse In such systems, there is no way to make things a little bit simpler – the whole edifice becomes a huge, interlocking system not readily amenable to change. Tainter doesn’t regard the sudden de-coherence of these societies as either a tragedy or a mistake—”[U]nder a situation of declining marginal returns collapse may be the most appropriate response”, to use his pitiless phrase. Furthermore, even when moderate adjustments could be made, they tend to be resisted, because any simplification discomfits elites.

When the value of complexity turns negative, a society plagued by an inability to react remains as complex as ever, right up to the moment where it becomes suddenly and dramatically simpler, which is to say right up to the moment of collapse. Collapse is simply the last remaining method of simplification.

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Fund Strategy Magazine: Complexity lessons from nature for a better economic future…


In case you thought that “complexity management” is just more mumbo jumbo from the financial sector I suggest that you read the following piece and any of my previous blogs on the subject of complexity.

Complexity analysis, mapping and management is available NOW and, if a business leader is intent upon gaining a greater insight into their operations, making more informed decisions, managing more effectively, gaining competitive advantage and “staying ahead of the curve” this is the time to contact me: david@ontonix.com or on +44 (0) 7919 917150.

In the wake of the 2008 crisis, some economists have started to base their financial models on an approach that mirrors biological ecosystems, focusing on how companies interact and markets evolve. Vanessa Drucker reports from New York.

A model is like a little toy. Social and natural sciences use theories, based on assumptions, in an imperfect attempt to make sense of the world outside. While the history of science traces refinements in our understanding, reality may, over time, reveal how painfully inaccurate the models were.

Just as new theories shook the foundation of physics in the early 20th century, financial theory faces its own upheaval. Before the crisis struck in 2008, regulators tended to focus on individual financial firms and banks, rather than on addressing systemic risk across the entire global network. Traditionally, a micro-style financial theory looked individually at how to evaluate a company, a derivative, a swap or even a collateralised debt obligation (CDO), or how to optimise a portfolio or annuity. More recently, a movement has been gaining momentum to model how firms relate and interact dynamically.

To tackle the problem, economists consider an “evolutionary” paradigm, as an adjunct to, or replacement for, the rational expectations framework that has dominated the field for more than 60 years. Both physical and financial activities can be described by parabolic partial differential equations, a tool that could illustrate either heat diffusion or options pricing.

Read the remainder of this enlightening article here.

”Imagine assessing the robustness of the electricity grid with data on power stations but not on the power lines connecting them”

No transparency = no trust


The Head of FSA tells us/them that: Banks Must Restore public trust

He should realise by now that, until such time as regulatory bodies and politicians ACT to force change, this will sound like yet more sabre rattling in an attempt to fool the public…or have grown I too cynical!?

BBC – Peston’s Picks
“It is counter to common sense and social justice that taxpayers should insure investment banks, which are no more socially or economically useful than any other kind of imaginable business”.

Are these the same taxpayers that elect governments and own banks!!?

“The level of debts written off because defaulting borrowers will never repay them shot up in 2009, Bank of England figures have shown”.

Oh no(!), how the hell could that happen??? It’s OK I am only kidding. I do remember.

THE MESSAGE TO BANKERS FROM GOVERNMENT: Don’t worry about it. Don’t fret for your professional reputation, financial penalty, prosecution or the impact of your collective actions upon your relations, neighbours and fellow citizens – we really should be happy to help – For, as long as the routine is to “privatise profits and socialise losses” and tiptoe around regulatory change nought will change.