Saturday, October 11, 2008

Derivatives, and Math

The New York Times reports that
George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.”
(Read More...)

Nor do I.

The world may be more curious in future to learn the true properties of derivatives, so that the knowledge can be applied to:
1. how they should be valued
2. what they evolve into over time, system wide
For a starter (non-mathematical), I liked Financial Derivatives and the Globalization of Risk (2004, by Edward LiPuma). The basic ideas were that world markets are more linked now, since derivatives got popular, and that we don't understand well how or how much.

Basically, Wall Street needs more mathematics.

The most important article I've read in ages is on the International Mathematics Olympiad. (Read the article.) The author decries that Math has is not embraced more by Americans.

Nigeria finally started running National Olympiads. The level of mathematics required to pass this exam is NOT AT ALL COMPARABLE to that required to tackle the International Competitions. Still, getting the channels/infrastructure for math competition in the country is a start.

It is very important for us to develop *excellent* engineers, technicians, and scientists. This, along with: 1. Power Supply and 2. Ensuring Wealth from Agriculture would be my priorities if I ran this part of the world ;)


DonCasiragi said...

Tosin, I think it is too much maths that is killing wall street..and not so honest mathematics too. All these counter party, derivatives and other complex instruments create a situation where a bunch of neophytes are chasing what they hardly understand- and understand at the end, it is 99% of the population that have no clue that is actually putting their money on the line.

The other day I was watching CNBC and one goon was suggesting people sell volatility..I turned to my friend and asked - which company is that? What does volatility make? LOL..apparently, volatility is the VIX index that measures volatility in market, but pray tell- how does that relate to the manufacture of hard goods, creation of wealth and the great capitalist complex Adam smith once dreamed of? A friend commented recently and said- America manufacutures nothing but debt. So true.

t said...

Dear Busayo, yes, I hear you...America manufactures debt :) making huge money in the process. The kids running the financial labs didn't understand derivatives well enough to avoid the recent bankruptcies and all...but they had discovered a way to make wealth out of nothing. My belief is that the experiment will continue, it will be repeated with greater understanding yielding better results (both in good times and bad times) ...
Yep, people buy and sell all sorts, including Volatility hehehe.

So the argument is, all this new finance caused the problem but... who'll put the lid back on Pandora's box? Better to get busy making antidotes since we have to live with it now.

Question: Or do you see a movement back to modest savings accounts and manufacturing plants for America?

DonCasiragi said...

Lady T- answer is I really don't know. We saw a semblance of return to basics for the Japanese economy after the 1988 bust, that turned to a long deflation. My sense is something will have to give: and never underestimate the power of human innovation. I prefer the term New Manufacturing.

t said...

New Manufacturing? You need to teach me what that is...

Hey, hi :)

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