Wednesday, October 24, 2007

A swipe at risk management techniques

Naseem Talib, a former trader, is something of a maverick when it comes to risk management. He has produced articles and books that question the value of many modern tools of risk management. In FT, he takes another swipe at these:

MPT (Modern Portfolio Theory) produces measures such as “sigmas”, “betas”, “Sharpe ratios”, “correlation”, “value at risk”, “optimal portfolios” and “capital asset pricing model” that are incompatible with the possibility of those consequential rare events I call “black swans” (owing to their rarity, as most swans are white). So my problem is that the prize is not just an insult to science; it has been putting the financial system at risk of blow-ups.

I was a trader and risk manager for almost 20 years (before experiencing battle fatigue). There is no way my and my colleagues’ accumulated knowledge of market risks can be passed on to the next generation. Business schools block the transmission of our practical know-how and empirical tricks and the knowledge dies with us. We learn from crisis to crisis that MPT has the empirical and scientific validity of astrology (without the aesthetics), yet the lessons are ignored in what is taught to 150,000 business school students worldwide.

.......The environment in financial economics is reminiscent of medieval medicine, which refused to incorporate the observations and experiences of the plebeian barbers and surgeons. Medicine used to kill more patients than it saved – just as financial economics endangers the system by creating, not reducing, risk


Anonymous said...

So what do you think about it? You yourself being a professor at one of the esteemed 'B- Schools'. Do you subscribe to doing away with all the Fin terms and theory? Is it ok to rely just on experience knowledge? I guess your answer would be sitting on the fence : We need both of them! - Nothing wrong I would say.

suzan said...

Nice article about risk management techniques