Bell Curve Blues

Nearly all mainstream financial economists are mad.  Most financial market participants are trained by financial economists and use these models mechanically when trying to anticipate market movements.  Therefore, ipso facto, the whole financial market is blind, and bark raving mad.

Why do I say this?

Well, the definition of madness is doing the same thing again and again and expecting a different result.

Mainstream financial economists almost universally use the normal distribution to model risk in financial markets, when the data clearly prove that the actual distribution of returns in financial markets does not match the normal distribution.  Incredibly, the Basel II Accords mandate its use for modelling capital adequacy – even though the evidence is clearly against the applicability of the bell curve in financial markets, with the historical data consistently displaying “skewed” distributions.

Recently developed, highly complex, agent-based market simulations appear to support the hypothesis that volatility is correlated with leverage and that there is a “freeze-point” in the markets where leverage becomes unsustainable and results in cascading failures, very much like what we saw in Q4, 2008.  The traditional models do not deal with these dynamic aspects of the markets, and did not predict or anticipate anything like Q4, 2008.

Yet there has been minimal attempt by the mainstream to adjust their models to reality.

This is madness, pure and simple.

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  1. December 18, 2009 at 12:40 pm

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