Taleb’s Recipe

No, unlike the previous post, this has nothing to do about food. It is about Nassim Nicholas Taleb’s recent op-ed in the Financial Times where he gives his “recipe” for saving the global financial system. Two of my favourite bloggers Arnold Kling and Felix Salmon have responded to it, but I didn’t like either so I thought I should post my response as well.

I borrowed The Black Swan from Aadisht sometime in late 2007. I tried starting to read it several times but never got past Taleb’s childhood stories of his hometown Amioun. I took a couple of months to get past the first 50 pages, I think. And then it was easy reading. I loved the sub-plots. I broadly bought into the main plot. By the time I had finished reading the book, I wanted to ask Taleb to accept me as his sisya. I  bought and read Fooled By Randomness, and liked that too. And then decided to read The Black Swan yet again. It was only a couple of months back that I finally returned the latter book to Aadisht (in the meantime he had bought two other copies of it, and read it).

Till very recently, I would read up any article of Taleb’s that I could find. I wrote to him a couple of times with my CP, and he even responded. I infact wrote to him about “Positive Black Swans and the World of Romance” and he responded with a “Thanks Karthik, Ciao, Nassim”. I had become a worshipper.

However, now I think he’s kinda lost it. I don’t think he intends to write another book and so he has nicely settled down to peddling his last theory (black swan). In response to a recent post on studs and fighters, Kunal had said, “He that is good with a hammer tends to think everything is a nail.”. The same disease affects Taleb I think, as he goes around the world trying to force-fit his black swan model to every conceivable problem.

And then I have a problem with people like Taleb and Satyajit Das, and actually with all those ibankers who are asking for bailouts. These guys made full use of capitalism, and made heaps of money, when things were good. And now that their money has been made, they call for government intervention, and socialism. Taleb and Das are different from the other wall streeters because they are calling for full-scale government intervention, unless the other bankers who are only calling for a bailout!

Now that the elaborate intro is done, let us get to the point. Taleb’s essay consists of ten points. The headings are italicized and there’s a detailed explanation. For purpose of brevity I’m putting only the headings here, and writing my comments after each of them. Go to the FT site to read the full points that Taleb has written.

1. What is fragile should break early while it is still small.

I agree with this. And my take is that competitors need to keep each other in check. For example, if this round of bailouts were not to happen and the biggies were let to fall, no one would grow so big in the future, and even if they did, they would make sure that they were insulated enough from one another. This round of bailouts will make the next crisis (whenever it will happen) worse.

2. No socialisation of losses and privatisation of gains.

Agree with this.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.

Taleb has clearly not learnt his own lessons (fooled by randomness). I might have crashed the school bus once, but it may not be my mistake. the one data point of one bus crash should not be used to decide my career as a driver. One should look at how the driver drove before the crash to determine whether he gets a second chance. Blanket banning of people involved will not help.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.

It’s all about structuring. Taleb was a trader and he forgets about structuring. As long as incentives of the employee and the employer are reasonably well aligned, there is no problem with an incentive bonus. The problem in ibanking was that too much emphasis was placed on short-term performance of employees. It’s tragic that the fall of the financial system has brought to an end what was an excellent compensation system (in principle, mind you; not the way it was practised) – where each person was paid fairly based on his/her contribution.

5. Counter-balance complexity with simplicity.

I think the simplest way would be to leave things to the market. Government intervention would lead to a new form of complexity, and in the overall scheme of things increase complexity rather than decrease it. None of the stuff that Taleb has mentioned is easily implementable.

6. Do not give children sticks of dynamite, even if they come with a warning .

Again Taleb prescribes mai-baap sarkaar. Does he realize that if governments had always had tight control over the markets, the markets wouldn’t have crashed on October 19 1987, and he wouldn’t have made any money? (Taleb has reportedly made 97% of his life’s earnings out of this one event). What is “complex derivatives”? And how can you ban it? If you ban it, it’ll go to the black market. You are better off collecting hefty security transaction tax.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.

I agree

8. Do not give an addict more drugs if he has withdrawal pains.

Agree once again. We need to structurally change things to get to saner leverage than what was practised 1-2 years back. Regulations should be simple and principles-based, minimizing chance for regulatory arbitrage. Remember that the purpose of creation of most “complex derivatives” in the last 25 years is regulatory arbitrage.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.

Bullshit. The point on markets not containing information, that is.

10. Make an omelette with the broken eggs.

None of this makes any kind of practical sense. It’s just an old man ranting. Thanks, guru (pun intended).

Work

Work is not just something you do for money. Yes, what you do working from seven (in the morning) to eleven in the night counts as work. But that is not the only thing that counts as work.

Broadly defined, work is anything that you need to do at a particular given time. It doesn’t need to necessarily be unpleasant. It doesn’t need to reward you financially or otherwise. It is just something that needs to be done. It is a responsibility. It is something that you have taken ownership of. And by definition, it is unpleasant.

For example, if I have promised my mother that I’ll go out an buy vegetables this evening, that is work. If I have promised a friend that I’ll meet her for tea this evening between six and seven, that is ALSO work. Because now you know what you are going to do between six and seven in the evening today, and you can’t do anything else at that time. That part of your schedule is effectively fixed, and everything else needs to work around that.

The importance of uncertainty in life, I think, is grossly underestimated. When uncertainty is in the hands of others, it is uncertainty for you. It is inherently unpleasant. Suppose you have committted that you will do something “immediately after someone does something else”, then absolute jai. You not only have “work” to do, you are also uncertain as to when you’ll have to do that work. You will need to block a large part of your time for that, and that is inherently NED-causing.

On the other hand, when the uncertainty is in your hands, it results in “flexibility”. Suddenly, when you have a set of things to do that only need to be “collectively done” before a certain time, and the time window in question is large enough, it is not so much of work anymore. Some of the tasks maybe unpleasant, but given that you now have the choice of WHEN to do it, it is so much more pleasant.

A few takeaways from this theory:

  • Occasionally, when I crib to people that life has become boring and predictable, their immediate response is to ask me to take up a new hobby. Typically this is something where I’ll need to interact wit h other people – such as music classes, or dramatics, or whatever. And when you take up something where you need to coordinate with others, it becomes work.

    If you make a mental decision to play cricket between six and seven in the evening every day, soon it’ll become work, irrespective of how exciting it might be. Because it gets entrenched into your (already tight) schedule. If you have the option of playing cricket every evening between six and seven, then it is fine, since it doesn’t impose a schedule

  • The more important thing is about work at work. All management gurus you talk to talk about team dynamics, and team play, and coordination, and focus. What they dont’ realize is that all these increases the quantum of work at work. When the interaction between team members is large, and frequent, then you have several, and frequent, “deliverables”. Which creates more “work” on top of the work that you need to do.

    On the other hand, if it is a loosely held team, that interacts infrequently, and which is structured such that each person has a clearly defined piece of work and inputs and outputs, then each member of the team has so much more flexibility. It is so much less “work”.

  • Coming to focus, when people say you need to show focus and you need to concentrate on the one thing that you are doing, they are once again increasing your “work”. Since you need to focus on that one thing, you have zero flexibility. And that is again more “work”. A better situation is where you are balancing several things at the same time, and that gives you so much more flexibility. And when you have several things on your plate, you can put structured procrastination.
  • So the important thing to remember while designing a team project is to keep things flexible, and reduce frequency of interaction. Give uncerrtainty into the hands of the workers; I’m sure they’ll enjoy it. The amount of work that is there to be done cannot be reduced, but the amount of “work” that needs to be done can, and should be.

Uncertainty, flexibility, option value are all things that are in general underestimated. People assume that we live in a deterministic world. They assume that everyone else needs to do things in a deterministic fashion. And this assumption has a serious negative impact on all our lives. Yes, you might recall that the ongoing financial crisis has been caused to to understimation of uncertainty. That is just the tip of the iceberg.

Mantras: Songs Fooled By Randomness?

A couple of weeks back, I happened to read Frits Staal’s Discovering the Vedas. I was initially skeptical of the book since it has been blurbed by Romila Thapar, thinking it might be some commie propaganda, but those fears were laid to rest after I read Staal’s interpretation of the so-called “Aryan Invasion Theory” and found it quite logical. I enjoyed the first half of the book, and then lost him. I couldn’t understand anything at all in the second half of the book.

The precise moment where I lost interest in the book was when Staal gave his theory as to why mantras and rituals have no meaning. I found his reasoning of the same quite weak, and since he kept referring back to that later in the book, it became tough to follow. Staal states the following three reasons to claim that mantras precede language, and they are more like bird calls.

  • Mantras are language independent: Anything in language can be translated whereas mantras remain the same in all languages.
  • Mantras, even though they seem to be in a language like Sanskrit, are not used for their meaning.
  • Mantras follow patterns, like refrain, which is not seen in language.

While I find the hypothesis interesting, the proof that Staal gives is hopelessly inadequate. The Beatles might have translated their songs into German, but songs are normally not translated, right? You don’t translate songs, and sing  them into the same tune, unless you are doing some MTV Fully Faltoo or some such thing. On the other hand, what if the songs are in a language that is completely alien to you? There is no way you can translate them, but since you like them you sing them anyway. Without bothering to know their meaning. And songs can definitely have refrain, right? It clearly seems like Staal is trying to force-fit something here. Hopefully he is force-fitting this here so as to prove some other theory of his. But you can never say.

As I had expected, Staal’s theory has caught the attention of the right-wing blogosphere. JK at Varnam writes

This athirathram, which was extensively covered in Malayalam newspapers, was highly respectful and the words I heard were not “playful” or “pleasurable.” I can understand singing for pleasure, but am yet to meet a priest who said, “it’s a weekend and raining outside, let’s do a ganapati homam for pleasure.”

Sandeep at sandeepweb goes one step further, and says:

Even a Hindu not well-versed with the nuances of Mantra intuitively senses that something “divine” or “other-worldly” is associated with every Mantra. In a very crude sense, a Mantra is to some people, a cost-benefit equation: you chant the Gayatri Mantra for spiritual upliftment, the Maha Mrityunajaya to ward off the fear of death, the Surya Mantras for health, and so on. Why, you chant just the “primordial sound(sic),” “OM” to get yet another benefit. Whether these benefits really accrue or or not is not the point. What is immediately discernible is that every mantra is associated with some God or principle. In other words, it has a very specific meaning.

I think mantras are simply songs, in an ancient language, fooled by randomness. As I had explained before I quoted JK and Sandeep, going by Staal’s hypothesis, and the precise reasons that he gives, it is not inconceivable that mantras were composed as songs, in a language that hasn’t survived. In fact, Staal’s “proof” can better explain the song hypothesis rather than a no-language hypothesis. I don’t know why those songs were composed, and I definitely won’t rule out the possibility that they were meant to be devotional (after all, a large amount of later Indian music (including all of Carnatic music) is fundamentally devotional). Anyways the exact reasons for composition may not matter.

So what might have happened is this. I suppose chanting of mantras and conducting rituals was a fairly common event in the Vedic age. I believe that we started off with a much larger repository of mantras and rituals compared to what survive today. And the ones that survive are the ones that were lucky enough to have been associated with certain good events. A chieftan happened to do a certain ritual before going to battle, which he happened to win. And this ritual came to become the “pre-war” ritual. Of course it wouldn’t have been one single event that would have established this as “the” pre-war ritual, but after a couple of “successive trials”, this would have become the definitive pre-war ritual.

Once a particular ritual or mantra got associated with a particular event, then reinforcement bias kicked in. Since it was now “established”, any adverse results were seen as being “in spite of”. Suppose a king dutifully did the pre-war ritual before he got thrashed in battle, people would say “poor guy. in spite of religiously doing his rituals he has lost”. The establishment meant that no one would question the supposed effectiveness of the ritual. And so forth for other mantras and rituals.

To summarize, we started off with a significantly larger number of mantras than we have today. Association of certain mantras with certain “good events” meant two things. One, they got instantly associated with such good events, and two, they got preference in propagation – limited bandwidth of oral tradition meant only a certain number could be passed on sustainably, and these “lucky mantras” (notice the pun – they brought luck, and they survived) became the “chosen ones”.

The sad part in the whole deal is that mantras were taught without explaining the meaning (similarly wiht rituals). Maybe the oral tradition didn’t permit too much bandwidth, and in their quest to learn the maximum number of mantras possible, people gave short shrift to the meanings. And by the time writing was established, the language had changed and the meaning of the mantras lost forever. In fact, this practice of mugging up mantras also gets reflected in the way education happens in India today, with an emphasis on knowledge rather than understanding. I suppose I’ll cover that in a separate blog post.

Lazy Post – Statistical Analysis

I call this a lazy post since I didn’t originally write it as a blog post. I had written this as an email to a mailing list, and now thought it might make sense as a blog post. The reference to context: a prominent and well-respected member of the group had written a fairly lengthy argument, and ended it by saying “Maybe this calls for a good regression analysis….” . My reply is here.

I need to mention here that this mail to the group wasn’t responded to (apart from one tangential remark by  Udupa). I don’t know if it simply got lost in the flood of mails on the list today, or if people on the group (in general, a very intelligent lot) don’t care for this kind of stuff, or if, for some reason, this caused discomfort of some sort. Anyway, I begin:

I think I had raised this point before in a similar context. it is about the use and misuse of statistical analysis. i think one lesson that ought to be learnt from the ongoing financial crisis and the events leading up to this is that statistical analysis, when misused, can have dangerous consequences, and this is not just for the people who are misusing the analyses.

there is this popular view that if there is data, then one ought to do statistical analysis, and draw conclusions from that, and make decisions based on these conclusions. unfortunately, in a large number of cases, the analysis ends up being done by someone who is not very proficient with statistics and who is basically applying formulae rather than using a concept. as long as you are using statistics as concepts, and not as formulae, I think you are fine. but you get into the “ok i see a time series here. let me put regression. never mind the significance levels or stationarity or any other such blah blah but i’ll take decisions based on my regression” then you are likely to get into trouble.

i think this is broadly the kind of point that is made by people like Paul Wilmott. that the problem is not with statistical analysis, but  with the way people use statistical analysis.

ok, now that i’m done with my rant, I’m very sceptical about regression yielding any kind of conclusive results here. i think the number of data points we have here is too small to produce any meaningful results. of course i’m saying this without really looking at all the data that you want to might want to include. and i won’t be surprised if a few tens of papers get published on this topic. all based on statistical analyses. and the results all being orthogonal to one another.

On Alonso and Delta Hedging and Creating Positive Black Swans (and louvvu of course)

Yesterday, on the Twisted Shout blog, I had blogged about Xabi Alonso, and his methods for scoring goals. Complete with videos of a few of his goals, and incomplete because I couldn’t find a few other videos, I explained how he goes about the entire process. He takes long shots, I had explained. From a distance. Hoping to catch the goalkeeper off guard. And accurate enough to get the ball in the net most of the time.

Towards the end of The Black Swan, Nassim Taleb talks about how you can make black swans work for you. He talks about industries such as moviemaking and book publishing, and he says they traditionally thrive on positive black swans. They lose a little money on most projects – books or movies, but make significantly more money when one of them succeeds.

The book industry, Taleb argues, has now lost its traditional revenue model. Nowadays, the norm for publishers is to dole out huge advances to authors who will potentially write blockbusters. This, Taleb says, now exposes the publishers to huge negative black swans. The advances are so huge that if a book sells well they recover their investments. If not, they are prone to losing a huge amount.

I notice a similar problem in the romance industry. Suppose you have been hitting on, or even seeing, a girl for a long time, and it’s now time for measurement. By conducting the measurement experiment now, you are exposing yourself to a huge negative black swan. You have already made considerable investment in the relationship, mostly emotional but also monetary and temporal. And what if the measurement doesn’t go the way you want it to go? You are already in the D (desire) of Kotler’s AIDA. It will take a long time for you to recover from it, and this could even be career threatening, as I had discovered the hard way a couple of days years back.

Now, my theory with relationships (I don’t know how much you want to trust this – since I’ve never been in a relationship) is that in order to succeed, both parties should be at least in the I (interest) zone. And one of the parties has to be in D zone. This is a necessary but not sufficient condition for the relationship to go thorugh.

So, how about testing whether the other person is in the I zone when you are also in I zone? If she is, then well and good – you can start the process of figuring out if you want to get into D, etc. If she isn’t you can quickly cut your losses and move on. If she does admit to being interested in you, it’s great. It’s a positive black swan. And if she tells K, you haven’t really invested much in the relationship so it shouldn’t be hard. Right? So that’s how my mind ran when I thought about this problem yesterday.

I sent her a mail asking her for permission to put blade on her. I explained to her in the mail (i’ll probably blog the mail at a later date – I’m quite proud of my efforts on second thoughts I won’t blog the mail. I think she deserves exclusivity to that masterpiece) that I ever since I met her a few days back I have gotten really interested in her, and am considering the possibility of blading her. That if she is not interested in getting bladed by me, then there is no point in my continuing and wasting both our times and energies, and so she should tell me that right now. I sent this mail to her earlier this evening and I’m still awaiting her reply.

So where does delta hedging fit into this?  It is like the road to Ithaca as this poem mentions. It is about the journey being more enjoyable than the destination. It is about the process of doing something being more enjoyable than the results. It is from the excitement you get just by doing something for the heck of it. These are all what I call as second order effects. They are, in effect, derivatives. First order derivatives of something you are doing, which is effectively the underlying.

As I had mentioned in my previous post, by going ahead with the blading, the only thing I had to lose was my confidence. My form. And if I had gone about blading the conventional way, poking and probing, and making small inroads, the process too would’ve been excruciating, and would’ve added to the pain of the blade not succeeding. So was there a way in which I could hedge out the loss of form and confidence?

I think I’ve been fairly ingenious in going for my long shot. I’m doing something unusual by going about it the unconventional way. Add to this the joy of sitting and drafting that letter to her (yes, it’s a masterpiece). And the possibility of the insights I might gain from this process. And of blogging it, as I am doing now. As soon as I had hit upon this method, i realized that the second order advantages from this were huge. And would easily hedge away any blues that failure in my attempt would bring. It was like getting a put option along with a stock. You knew that your losses were capped.

On the other hand – if she accepted – the returns would be huge. It would be a positive black swan. Capped losses and uncapped gains! Once I had figured this out it was a no brainer that I should go for it. And I have gone for it. A long shot a la Alonso. And I’m waiting for the result. Wish me luck.

The difference between Taleb and McKenzie

A few minutes back I finished reading Richard McKenzie’s Why popcorn costs so much at the movies and other pricing puzzles. Since the book is not available in India, I managed to procure an online pirated version through a friend. And since the book isn’t released in India, I didn’t feel guilty about reading the pirated version.

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the hybrid pen

Back when I was in school, my father brought me two “Hero” pens. One brown and one green. Soon enough, the barrel of the brown pen was broken, and the nib of the green pen followed presently. I put made use of what was later to be called as ‘Genetic Algorithms’ and continued working. I don’t know what I did with the spare cap though. The cap was once shiny gold in colour, but through constant biting and chewing, it’s become quite dull now.

Two years later, I decided to classify this pen as my “lucky pen”, based on one data point. I had used it to write my IIT JEE. Everything I did that day became lucky. The navy blue shirt. MES College. The breakfast (onion upma). The car in which I traveled to the venue. The Sankey tank route to Malleswaram. All based on just one data point. It was some eight years before I read Taleb.

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