Wednesday, 21 January 2009

Tarring Taleb

I have always been a little suspicious of Nassim Taleb. He seems to take too much pleasure in discussion of crises. And his first book -- a very conventional account of hedging -- isn't actually very useful for actually running portfolios of options. Now a post on Models and Agents (an excellent blog I have only found recently) gives a more focussed critique:
the current crisis is not a black swan. Alas, the world’s economic history has offered a slew of (very consequential) credit and banking crises ... So not only aren’t credit crises highly remote; they can be a no-brainer, particularly if they involve extending huge loans to people with no income, no jobs and no assets.

Taleb also recommends that we buy insurance against good black swans—that is, investments with a tremendous (though still highly remote) upside but limited downside. For example, you could buy insurance against the (unlikely?) disappearance of Botox due to the discovery of the nectar of eternal youth. And make tons of money if it happens.
And that surely is the point. Yes, the unexpected happens with considerable frequency. But knowing which black swan is more likely than the market is charging for is the hard part. Buying protection in the wings on everything is far too expensive to be a good trading strategy. If all Taleb's observations amount to is the claim that being long gamma can sometimes be profitable, then they are hardly prophetic. What would be much more useful would be his analysis of when, exactly, black swan insurance is worth buying.

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