[perkoff]

Why is Taleb getting all this mainstream attention? The finance guys have been aware of fail tail distributions all along.

As Eugene Fama points out on his website... http://www.dimensional.com/famafrench/2009/03/qa-confidence-...

"Half of my 1964 Ph.D. thesis is tests of market efficiency, and the other half is a detailed examination of the distribution of stock returns. Mandelbrot is right. The distribution is fat-tailed relative to the normal distribution. In other words, extreme returns occur much more often than would be expected if returns were normal. There was lots of interest in this issue for about ten years. Then academics lost interest. The reason is that most of what we do in terms of portfolio theory and models of risk and expected return works for Mandelbrot's stable distribution class, as well as for the normal distribution (which is in fact a member of the stable class)."

[oakmac]

The finance guys may have been aware of it, but their actions were clearly not in line with this knowledge as evidence by the year 2008.

From the article you linked: "None of this implies, however, that the existence of outliers undermines modern portfolio theory or asset pricing theory."

In fact, that's exactly what it does. This is what happens when you build houses on top of sand.

[perkoff]

Big crashes will always occur, but I would not blame the recent crash on the gaussian models. I'd rather say that (almost) everyone underappreciated the risks connected to the real estate prices.

Taleb pushes for a strategy that consists of buying a lot of very safe assets and blending them with bets on "extreme events" (like buying far out-of-the-money put options). Is that a viable long-term strategy? I have my doubts, since there are no evidence suggesting that 'uncertain' strategies have greater returns that more quantified ones.

[jwecker]

Since Taleb started thinking through this stuff he's been able to cash out on two big crashes- just in the last 10 years. The second (current) one came after the black swan was published. It's almost erie reading it now. In any case, he's not advocating that everyone use that as a trading strategy. What he's advocating is that people be aware of the nature of the underlying system and stop fooling ourselves into thinking that it's "gaussian + weird things that are obvious in retrospect."

[ewjordan]

Big crashes will always occur, but I would not blame the recent crash on the gaussian models. I'd rather say that (almost) everyone underappreciated the risks connected to the real estate prices.

Part of the reason they underestimated those risks is that they paid attention only to the middle of the distribution, where things are approximately normal. I wouldn't say the explicit Gaussian-ness of the models was the reason for the trouble, but it's hard to imagine a Gaussian model providing any sort of reasonable risk estimate for the type of thing that we saw happen. It was so far outside the "business as usual" range that no risk estimate based on what was happening on most days would have been legitimate.

Taleb pushes for a strategy that consists of buying a lot of very safe assets and blending them with bets on "extreme events" (like buying far out-of-the-money put options). Is that a viable long-term strategy? I have my doubts, since there are no evidence suggesting that 'uncertain' strategies have greater returns that more quantified ones.

I don't know about this; it's all a question of price. If far out of the money puts are really underpriced compared to how often they "hit", then he could be right. My immediate impression is that the crappy prices you tend to get due to low liquidity in the extreme tails might make a profitable strategy tough to come by.

One could certainly look at the historical data over the past several decades and see whether such a strategy might have been profitable (which wouldn't necessarily tell you whether it will be profitable in the future, but might shed at least some light on the matter), but I don't have options data going back very far, so I'm not the man for the job...

[ewjordan]

Why is Taleb getting all this mainstream attention?

He's telling people that "common knowledge" in a particularly despised sector of our economy is not only wrong, but downright idiotic.

And he's presenting it in a way such that Joe the Plumber can feel like he groks it, even if he doesn't stand a snowball's chance in hell of really understanding what's been happening here.

Not that Taleb's altogether wrong - Eugene Fama may be very aware of the limitations and caveats implicit in risk measurements, but it wasn't Fama that got caught pants down screwing around for billions with an asset class that he didn't understand, was it?

What academics understand about the market often has very little to do with what real traders and banks will do in it. Taleb has valid criticisms against the real players, who were freaking idiots in a lot of ways, but he's presenting them as if they're criticisms against the establishment as a whole, which is a bit unfair, but makes for a good publicity play.

Smart move, if you ask me. Nobody would know or care who the hell he is if he hadn't made such a fuss over this stuff.

[wmorein]

My recollection of a mathematical finance course I took was that early on we spent about 30 minutes going through the caveats you mention and that were covered in the article, and then they were promptly forgotten or ignored for the entire rest of the semester. I always found that very odd, particularly considering that the course was the start of what was considered (I think) a pretty good MA in Mathematical Finance, with a lot of alumni ending up at well known places on Wall Street: http://www.math.columbia.edu/department/mafn/page5.html

[zby]

Why is Taleb getting all this mainstream attention? - my (partial) answer is that he is ambiguous enough so that everyone can write his own interpretation and the conversation is going on. This is very much alike the web 2.0 thing. And it is what Henry Jenkins calls 'spreadable media'.