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The Midas Formula: Trillion Dollar Bet
The account behind maybe the best recipe ever created in finance: the Black-Scholes-Merton alternatives pricing model. Two of its creators were granted the Nobel Prize in Economic science in 1997. A yr. later their hedge fund Long Term capital Management (LTCM) had fallen in with stupefying losses of $ $ 100 billion dollars a result of substantial leveraging of a typical scheme.
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The Black-Scholes Recipe was deduced by noting that an investor can just double the payoff suitable call option by purchasing the underlying stock certificate and funding piece of the stock certificate purchase by borrowing. Only five variables were needed: the cost of the stock certificate; the usage toll of each pick; the riskless interest rate; and how much time to due date of a typical option. The only unobservable is the unpredictability of a typical underlying stock certificate cost.
The problem with a theoretical account (which presumes the drive to use riskless arbitrage and active hedge in uninterrupted clip) is that it doesn’t consider how an alteration in marketplace dynamics (noticeably fluidity risk of exposure and default option) can impact overall marketplace opinion.
This means the tolls of properties and assets can in some abrupt instances vary from what the rule says should keep. LTCM was brave and took a contrarian perspective. It took over still further from the face of a typical comprehended profitable effect. Instead the opposite materialized (things just kept getting worse day in day out).
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The Wise One
"He who would do some great thing in this short life, must apply himself to the work with such a concentration of his forces as to the idle spectators, who live only to amuse themselves, looks like insanity." – John Foster
I get other information that they don’t get! i.e I break the law!
when did this first air?
0:10
@ouroboro747 that’s Hilarious man ! hahahhahah
One formula to rule them all, one formula to find them, one formula to bring them all and in the darkness bind them… this doc is a bit over dramatic. haha
@Weng321, his name is Leo Melamed. He’s a legendary futures trader. He’s the one that introduced currency futures. He now sits at the board of the CME group.
What is the name of the “legendary trader” about 5 mins into this video?
I resisted the urge to be the first downvo—i mean dislike
In the history side, it’s a interesting documentary. But if you want the real formula you have to wait until the end of the doct., lol… starting at minute 7 of part five. It’s all there, literally.
Must read: “the superinvestor of Graham-and-Doddsville”.by Warren Buffett, an article of 1984, where he refute the argument of pure chance.
@jaymz699 it’s always wise to understand the limitations of any theoretical model. Kudos to you for understanding this already. It’s a humbling experience to realize that you are limited in scope in trying to understand any phenomenon-whether physical or economics based. In addition, never stop learning math. I think you’re already beginning to realize the scope and breathe that mathematics entails in developing theory. Good luck.
@1czelaya Entirely correct and I couldn’t agree more. There is a tendancy for far too much faith in models among many of my peers (and argubly economics as a discipline). It’s good to hear from someone who does a natural science that eventually things become just as erratic and unpredictable! Ofcourse in economics we don’t have the ability to experiment as such, which means we can’t confirm much of what we know beyond having various degrees of plausability.
@jaymz699 In addition, when attempting to solve global properties of the equations (in this case thermodynamics), I get values, again, that don’t agree experimentally. The possible solutions from the mathematics are too extensive. There all normalized probable solutions but which ones are correct? That’s very difficult to understand when dealing with 1000 variables that are not linear, complex(z), & are functions of other variables(functionals)… alas, chaos in its purest mathematical form.
@jaymz699 For instance, I attempt to model organic crystalline structures at low temperatures & simplify all theoretical and experimental conditions. The quantum mechanical equations I use to model are incredible difficult (The Schrodinger Equation- a complex partial differential equation in Hilbert Space-the solutions aren’t pretty). Even with solvable complex solutions & rather large assumptions (to simplify), my models don’t agree with experiments (the litmus test). Why? Chaos.
@jaymz699 It’s not so much a cause of “misunderstanding”, it’s the case of putting too much faith in the mathematics or models. Stochastic systems are chaotic because because they deal with an extensive number of variables that are functions of other variables-unbelievable dynamical. This is purely a problem dealing with mathematics. Our math is just not powerful enough and it may never be. In addition, the initial boundary values, at times, aren’t really known because of the above.
@1czelaya I’m an Economics/Finance Econometrics graduate. What you say is correct, learning binomial lattices/BS, the first thing my lecturer told us was that it was borrowed from thermodynamics. We do NOT however use BS for prediction. Also, I think you’ll find systematic tendancies such as those in economics or arbitrage arguments like those used in BS and a lot of finance in fact do warrant fairly extensive use of mathematics. Why do you believe we ‘misunderstand’ stochastic systems?
@oligiscool1 Introductory quants (for instance: Introduction to Quanative Finance by Robert R. Reitano- the mathematics needed for that were taught at the undergraduate level in physics-see Mathematical Methods for Physicist by Arfken) book are not that challenging, and believe me any graduate student in theoretical chemistry or physics has no problem understanding the mathematics. Remember, the physical science can predict with incredible accuracy and its litmus test in experimentation.
@oligiscool1 Actually, I have Masters in Theoretical Chemistry and finishing my Ph.D in Chemical Physics. I’m assuming you really don’t know the education required for the physical & theoretical sciences but I can assure it’s highly extensive. Courses that I’ve taken: 4 semesters calculus, partial & differential equations, group theory, abstract algebra, real & complex analysis, differential geometry, mathematical methods for physicist (4 semesters), methods of approximations, & tensor analysis.
Forex Trading 1985 ——-> /watch?v=KACDo519ccY
It’s about the game…
I found it humorous when they pondered the question “How does one participate in the upside while eliminating the down side?”. Wall Street’s had the solution to that for years: Trade with other people’s money.
that guy on the floor got tossed, he should start slammin some weights after work
Love the hand signals. Corporate gangsters. Amazing.
@1czelaya this is not quite precise. black-scholes-merton model belongs to the realm of finance, not economics. finance rarely deals with prediction, and so your point about predicting chaos, although perhaps valid in sentiment, is unwaranted. rather, finance usually deals with consistent pricing of structured products via calibration of underlying distributions against current market conditions. unless you are a math Ph.D, you likely have less of an education than the average entry-level quant.
a suitable supplement to watching and teaching the recent release of the motion picture Inside Job.