Back To Bedlam  -

This books falls under a specific category of books which includes titles like " In Praise of Slow", Zen books which focus on simplicity, Productivity books etc. As the title hints, there is one simple theme running through out the book - “Declutter your life, in all aspects of your life.” Cutting down variables and living with fewer and lesser variables in life is a far richer experience than dealing with a lot of variables and trying to do justice to all the variables.

Brazilian Straddle :

When traders know that they are technically bankrupt, there is a tendency to take a huge speculative position. If price changes favorably they are saved. Otherwise, the outcome was same as before-“doomed”

A trader who uses this strategy is said to hold a “Brazilian Straddle”. It consists of a large market position held against a one way airline ticket to Brazil in the breast pocket. If the market position proves profitable, the trader sells the ticket and comes back to trade tomorrow. If the trader continues to lose, he runs off to Brazil and leaves his clearing member to clean up the resulting mess.

Stumbling on Happiness, is one of those books which I decided to read, mainly to take a break from the usual type of books that I read.

Last weekend I went to Boston to meet my friend Anoop as I was leaving US for good. As always, the 4.5 hr journey from NY to Boston gives any one a wonderful time to read. Generally, I tend to always remember distinctly some specific facts about books. About this book, I came across this book for the first time in 2006 while working at Fidelity. I remember it browsing through at South Station, Boston. My first impression was that it was some sort of a self-help book. After glancing through the contents a few pages, it did not smell of a self-help book. However I was too busy with my project and work at Fidelity that I did not find time to read this book. Anways , One fine day, I found myself strolling at Borders (near Penn Station, NY)when this book was screaming “Pick me up” from one of the aisles. So, made an impulse purchase knowing that the same book from amazon would cost me 40% cheaper.

Via Bloomberg

Taleb says:

• We have had worst form of banking structure.. Capitalism when banks made profits, Socialism when banks showed losses!
• 2 Tiered structure is the way to go , where the First tier comprises banks that are completely nationalized and are operated as utility companies. Second tier comprises companies that are free to take any risk they want to take,but with the rider that they will never ever be bailed out!!
• I don’t understand Options , being a option trader for 10 years. How will the regulators understand ? Nothing complicated than vanilla options should be traded.

Via Bloomberg

The IMF report released yesterday , Jan 27, signaled that write downs and losses at banks totaling $1.1 TRILLION so far are only half of what’s to come. Losses on that scale would leave banks needing at least $500 billion in fresh capital to restore confidence in their balance sheets.

Here is how fast things are changing…A couple of months back, I read a book called “The Trillion Dollar Meltdown” by Charles R Morris. My review for the book is here . Now there is a new book by the same author titled " The Two Trillion Dollar Meltdown"

You cannot expect to read mathematics the way you read a novel. If you zip through a page in less than an hour, you are probably going too fast. When you encounter the phrase “as you should verify”, you should indeed do the verification, which will usually require some writing on your part. When steps are left out, you need to supply the missing pieces. You should ponder and internalize each definition. For each theorem, you should seek examples to show why each hypothesis is necessary.

This is a book which I have been planning to read for quite some time, may be since an an year . Finally found sometime to spend on this book.
However the book turned out be just about OK, not engaging, considering the amount of hype around it .Having said that, this book has to be read by anyone who is in to back testing trading rules / strategies and has only a vague idea of stats!

This is a classic case of my Irrational behavior. I had been wanting to buy a few books before I left NY. However the price tag for the list of books that I wanted to buy was daunting. I just did not feel like investing that much money, though under normal circumstances (steady pay check), I would have just ordered them with no second thoughts!!

However the last time I checked my amazon order list, I seem to have actually ordered pretty much the entire list of books, by splicing it over a period of time.. Meaning, the cash outflow is the same $ but the decision making has been much easier after splitting the order and having a time lag between orders!! This happened unconsciously….It definitely beats rationality :)

This post is purely for my own recollection purpose and does not make sense to anybody reading this blog.

Then why am I posting it ?

I just want to remember this date forever in my life, and always look back and check the realization of the path I am taking. This date will serve as a reminder that I have deliberately chosen a particular path in life, reason being, I strongly believe that _Life is a non-stationary stochastic process (Markov, may be).

Via Nagender :):)

One of my favorite graphic designers is Scott Mccloud. Both his books on comics are gems. If you happen to read those books, I am certain that the next time you will read a comic , you will see it in a completely different way. Ted made his talk public, so had a chance to see him talking.

According to Scott, Vision is about

• Learn from Others
• Follow No One
• Watch Patterns
• Work Like Hell

I think these basic principles apply to trading too !! ..Anyways, Here is Scott talking at Ted – Scott-Ted

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This post is going to serve as a good visual narrative of the development of frequentist world. If you love stats and have worked on identifying patterns in data, it is but obvious that you would have met a host of tests, with different names from different fields. Statistics is one field where the contribution has been made from all kinds of fields ranging from agriculture, clinical psychology, math, finance etc.

“Never put off happiness for the sake of achievement. Never put off the things that are important for your well-being and satisfaction to a later time. Today is the day to live fully, not when you win the lottery or when you retire. Never put off living!”

Learning about probability distribution is pretty boring unless one knows how to relate these to at least some real life application. Well, that can be said about almost anything learnt in life .However in the case of probability distributions, it is strikingly more true.

There is a fair chance that a lot of people know about normal,log normal, student t,weibull,poisson,Cauchy, exponential, chi-square ,brownian, gbm, levy, etc etc.. Somehow I have never found merely learning about these distributions interesting. There are all sorts of distributions which have various parameters. Sometimes I feel I should least know half a dozen real life apps for each of these distributions.

I came across so many references to this book that I finally decided to take a peek in to it. At the heart of it, the book is about Kelly’s criterion.A simple example made me motivate to read this book.

If you know that you gain 50% with prob = 0.6 and lose 50% with prob = 0.4…AND…if you have X dollars, how much do you bet ?A naive strategy of using expectation over one step is dangerous. Expected gain over 1 step = 0.6*0.5-0.4*0.5=0.1 Expected profit >0 . Should you bet your entire $X ? Common sense tells us that it cannot be the answer as there is a high probability that you would be out of the game before law of large numbers kicks in. Kelly was interested in knowing what fraction of the wealth should one bet, given the odds of gains. Well, the answer for the riddle is f=2p-1 where f is the fraction and p is probability of a gain. This is all the matters if you want to have a 10,000 ft view. However if you want to know the STORY behind the criterion, this book is a wonderful way to spend time and understand the story which William Poundstone has thoroughly documented. This book is pretty readable..It just tells the story behind the criterion and it tells it in a fantastic way.

While hacking some trading techniques, I came across an author trying to link Factor analysis and Arbitrage Pricing Theory(Ross). I was wondering the use for it . My thinking was a classic case of an empiricist. Today I came across a reference to a old paper which says the link provided has some meaning to it. It is always better to have some theoretical model before pca/factor analysis/ eigen value decomposition.

On Utility functions , which some people in academia live and breathe by :

“It is difficult to identify the underlying utilities and to tell exactly when the utilities are being maximized , in the case of a mutual fund or a pension fund. The fund manager is cooking for an army. It’s impractical to gauge everyone’s taste for salt-or risk”

-- Henry Latane

Prof, Niall Ferguson says, one doesn’t have to worry too much. Some of his arguments are very convincing.

http://fora.tv/embedded_player

There is nothing noble about being superior to some other person. True nobility lies in being superior to your former self

- Anonymous

One of my friend jokingly remarks that some things in life need to be accepted whether they make sense or not. One of those things he mentions is the dependency between Nifty and S&P500 . One often sees that S&P500 movements and Nifty movements are correlated for no reason. Let me to put some numbers to the angrezi,

Cor(NIFTY, S&P Returns)

I wonder how these numbers will look in the coming 5 years, now that US is getting in to a never seen before kind of recession.

I guess this illustration serves as one of the best ways of explaining pascal’s triangle to a kid.
If you at A, each intersections of street and avenue has a number which tells you the # of ways to reach that intersection.

By the way, the above model is exactly what is taught in binomial tree option pricing in most of MBA courses around the world!

The story about R Madhavan on rediff reminds me of a few friends of mine who were passionate about agriculture, farming, tools etc. One of them was very close to doing something on those lines , purchased some land area, invested in some technology based on improving productivity..However it ended there…Somehow , None of them are pursuing what they said,they were passionate about.

I am optimistic though. I hope , at least one of them decides to give vent to their passion and be truthful to their calling.

Here is a prediction saying we are in a frightening bear market! As all predictions are, it is a prediction after all. If only the author bets money on the bearish trend, will I take the prediction , seriously.

Alas! neither can the author confirm on that, nor I can verify his action! This is the perennial problem of all predictions. Is it cheap talk! or a serious prediction! ? God knows!

Currently, US National Debt stands at $10.59 Trillion.

Now look at this metric : The National Debt has continued to increase an average of $3.49 billion per day since September 28, 2007!

Link : Debt Clock

There are a couple of books which I think , every risk manager should read. After reading them I hypothesize that there will be 4 outcomes

• Risk manager ignores the view as just another view and moves along ( and moves the firm too , in a downward direction)
• Risk manager starts introspecting his/her methods and starts becoming skeptical about them and will probably do something about it
• Risk manager starts introspecting his/her methods and becomes extremely skeptical about them and will do something about it, hopefully
• Risk manager quits his job and does something else, far removed from the field of risk management. Who knows, he might just embrace risk with out giving any consideration to the frame of thinking at his/her previous job

“Plight of the Fortune Tellers” is one such book which should be on the must-read list for any risk management professional. It is a book which was written years ago , before this subprime mess hit the economy. Its insightful view of the risk management world from the world of frequentist and bayesian worlds is bound to shatter a lot of myths for an open-minded reader. I always intuitively knew that bayesian is the way to go. But this book reinforced my thoughts as the author brings a lot of facets and goes very deep in to the subject to show that Risk management’s current practices are completely flawed. BTW, there is not a single equation in the book . It is a remarkable achievement for any author on risk management to avoid equations and explain his ideas in simple english!!. **This book rocks!
**

Here is a brilliant intro to Precompiled Headers . Overall, the site “Games from Within” is superb and should be del.icio.us for any C++ hacker.

Link : The Care and Feeding of Pre-Compiled Headers

As for the quants, they love nothing more than having to tackle technically difficult problems.the more difficult,the better. Not only will the pleasure in solving the puzzle be greater, but, at least as importantly, the quants’ indispensability to the firm will be further confirmed. So, it is not so surprising after all that the quant suggesting that a simpler, less quantitative approach should be used to solve a problem is only slightly less rare than a turkey voting for Christmas. This has had unexpected consequences

Here is a similar idea that TP and I tried during 2004-05 in India . Couldn’t scale it then.

http://unyk.com/

Will it work now in India ? May be someone will go for it again

“VC - Founders” link explored by Paul Graham, in the light of recession.

Link : Could VC be a casualty?

Where do we use conventional stats in the real world ? Taleb says there is an edge beyond which it does not make sense. Here is an illustration from his recent article

Link : An Edge
Appendix is worth going over too - Technical Commentary

The following figures are as of Dec 07. Any guesses about the % increase in the following figures as of Dec 08 ?

Why is NSE equity derivatives turnover 68 times BSE equity derivatives turn over?

Accept whatever comes to you woven in the pattern of your destiny, for what could more aptly fit your needs ?

-- Marcus Aurelius

It’s close to 2 years since I read “Black Swan” for the first time. It had a definite effect on me for most of the arguments the author puts forth are very strong. One thing that propelled me in rereading this book was an article by one of my Prof’s who said that the teaching system for MFE courses should radically transform itself for it to have any use in the times to come . I was immediately reminded of Ludic Fallacy which Taleb mentions in his book. So, managed to reread the book.

Via Calling in Life (advice to a young banker) :

What Wall Street did so well, for so long, was to give people jobs that they could pass off to themselves as well as others as callings. Such was their exalted social and financial status: Wall Street jobs made people feel special without actually having to be special. You never really had to explain why you were doing it – even if you should have. But really, the same rule that applies to properly functioning financial markets applies to other markets: There’s a direct relationship between risk and reward. A fantastically rewarding career usually requires you to take fantastic risks. To get your seat at the table on Wall Street you may have passed through a fine filter, but you took no real risk. You were just being paid, briefly, as if you had. So which is it: job or calling? You can answer the question directly, or allow time to answer it for you. Either way, I think you’d be happier if you stopped thinking of what the world had to offer you, and started thinking a bit more about what you had to offer the world. Real excitement isn’t just in whatever you happen to be doing, but in what you bring to it.

Econometric theory is like an exquisitely balanced French recipe, spelling out precisely with how many turns to mix the sauce, how many carats of spice to add, and for how many milliseconds to bake the mixture at exactly 474 degrees of temperature. But when the statistical cook turns to raw materials, he finds that hearts of cactus fruit are unavailable, so he substitutes chunks of cantaloupe; where the recipe calls for vermicelli he uses shredded wheat; and he substitutes green garment dye for curry, ping-pong balls for turtle’s eggs and, for Chalifougnac vintage 1883, a can of turpentine.

Via Niall Ferguson

What are the geopolitical implications of all this(credit crunch)?

One possibility is that the “great reconvergence” between East and West is speeding up. If you go back to the very first report that Goldman Sachs produced about the “BRICs economies” (Brazil, Russia, India and China), China was projected to overtake the United States in gross domestic product in 2040. But in more recent reports, that has been brought forward to 2027. Maybe it will be even sooner. For one inevitable consequence of the credit crunch is that the United States will grow more slowly for the foreseeable future – at closer to 1 or 2 percent per year, rather than the 3 or 4 percent it has grown used to. By contrast, China’s semi-planned economy can comfortably maintain growth of 8 percent or more per year, propelled forward by state-led investment in infrastructure and growing consumer demand. Because net exports are no longer the key driver of China’s growth, an American sneeze need not necessarily cause an Asian cold.

Taleb on Banks : Banks will just become utility companies

http://video.google.com/googleplayer.swf?docid=6253625706730831653&hl=en&fs=true

MFE is one of the wildly popular masters program. But what is behind these MFE programs ? Is it worth your time and effort ?

Here’s my Prof’s take on it. I concur with him . Link

When I came across this statement ," Bootstrap method has now been hailed by an official American Statistical Association volume as the only “great breakthrough” in statistics since 1970 “ , I was humbled by the fact that I had never come across this method earlier.

The only kinds of bootstrapping I am aware of is

1. Bootstrap a venture :)
2. Bootstrap method to build yield curve using a set of fixed income instruments.

I came across bootstrapping as a method to find out the holding period of arb trading strategy . Apparently it is used widely in calculating the holding period of a stock/stock pair using one single realization. Naturally I was curious to know more about it and stumbled on to this beautiful online resource Resampling - Julian L Simon

“Uncertainty, in the presence of vivid hopes and fears, is painful, but must be endured if we wish to live without the support of comforting fairy tales.” —Bertrand Russell

Sometimes there are so many random variables that one needs to deal with all at once. It kind of gets on to your nerves.

Most of the variables are stochastic in nature. The distribution for each of these variables X(t) changes for each day. It looks as though X(t) follows a known distribution for a given t. However as t increases, one starts seeing the distributions are no longer stable. There are jumps / non random behavior beyond comprehension.And worst of all, completely independent variables(at least which I assume) start showing extremely positive correlation / extremely negative correlation.

Media is touting that Mumbaikers are back to their normal activities . Media is using the word “Resilient”.

Well, it is more a “Resigned Mumbai” than a “Resilient Mumbai” where the common man has to just go on with his activities, come what may.

What else can he do if the elected government / administrative machinery fails to put in adequate safety measures?

Movies like “A Wednesday” are a fantasy in common man’s imagination. It is finally up to the administrative machinery to do something to prevent a repeat of 26/11.

For plain vanilla interest rate derivatives option seller/buyer, it is very important that his position is delta hedged.
Reason : He can make money on gamma .Or he can enter in to an exotic derivative(similar to forward start option) where he need not delta / gamma hedge . Make money trading vega.

However that was not the case with Indian Banks as RBI has strict regulations where banks were forced only to take short positions!!.
Basically , Interest Rate derivatives market NEVER took off because of these restrictions…

Pic says it all!

A resident takes cover for possible return fire as National Security Guard commandoes fire at suspected militants holed up at Nariman House in Colaba

Its a scary sight in mumbai. It has been more than 20 hours since the first explosion happened and the hostage crisis, the fight between police and terrorists continues. Disgusting day in the life of any Indian.

One can only hope the situation comes back to normalcy(if that word “normalcy” makes any sense, any longer, for the victims) soon.

Link : Hours of Chaos

The future , will belong not only to the educated man, but to the man who is educated to use his leisure wisely
- C.K.Brightbill