1/ A short thread about the relationship between academic finance and real $ trading. πππ
2/ First of all, I need to get something off my chest. I loved the Asimov Foundation books as a kid.
Much like Paul Krugman, the idea of doing math to understand complex societies, and to predict their evolution, was transfixing. And still is.
Much like Paul Krugman, the idea of doing math to understand complex societies, and to predict their evolution, was transfixing. And still is.
3/ I used to do mathematical modeling of complex systems before I even knew it was a thing.
When I was working as an engineer (and running a lot), I spent more time that I'll admit trying to build a model of the human lactate response to exercise. For fun.
When I was working as an engineer (and running a lot), I spent more time that I'll admit trying to build a model of the human lactate response to exercise. For fun.
4/ A few years later, I was modeling the statistical distribution of fab yields for IIP2 (go look it up), completely outside of my "real" job of designing radio chips. But it was interesting.
It's what got me to realize that I needed to leave engineering and do trading.
It's what got me to realize that I needed to leave engineering and do trading.
5/ The reason for the autobiography is that I have a pre-existing strong tendency to WANT to believe what academic finance is selling.
That you CAN find the ur-model that explains how markets (or some aspect of them) work.
That you CAN find the ur-model that explains how markets (or some aspect of them) work.
6/ At the same time, I like money.
And I'm a huge believer in the adverse selection of publication: papers which show no effect never get published, so the universe of published (and preprint) papers is biased towards "stuff that seems to work".
And I'm a huge believer in the adverse selection of publication: papers which show no effect never get published, so the universe of published (and preprint) papers is biased towards "stuff that seems to work".
7/ Even worse, in finance there's a second even-stronger adverse selection effect:
If someone had found a pot of money, the last thing they'd do is write a paper about it. They'd go trade it. Or at least, sell it to someone who would go trade it.
If someone had found a pot of money, the last thing they'd do is write a paper about it. They'd go trade it. Or at least, sell it to someone who would go trade it.
8/ The value of a trade or strategy or idea is inversely proportional to the number of people who know about it.
So, why pay attention to finance papers?
So, why pay attention to finance papers?
9/ Because they're interesting. Or at least some of them. Whether they're right or not doesn't *really* matter.
And arguing about the value of academic finance is IMO beside the point.
And arguing about the value of academic finance is IMO beside the point.
10/ They're playing a different game to the one real $ traders are playing. Their incentive structures are different from yours.
So saying "academic finance is worthless" is like a basketball player saying books about soccer are worthless.
Different game.
So saying "academic finance is worthless" is like a basketball player saying books about soccer are worthless.
Different game.
11/ But even soccer books are useful to basketball players, as long as you're reading them the right way.
As a source of ideas.
As jumping off points.
The longer you're in this business, the more everything starts to look the same. You get into a rut whether you want to or not.
As a source of ideas.
As jumping off points.
The longer you're in this business, the more everything starts to look the same. You get into a rut whether you want to or not.
12/ Reading papers (finance or not) is, if you do it right, a jolt out of your rut.
Much like @paulg talks about when evaluating a startup pitch, try to find the good idea in it. Instead of why it's bad.
Rationalists call it steelmanning. What version of this COULD be good?
Much like @paulg talks about when evaluating a startup pitch, try to find the good idea in it. Instead of why it's bad.
Rationalists call it steelmanning. What version of this COULD be good?
13/ It doesn't mean you actually *think* it's good or useful or would make money. It just means you're being truly honest about taking the idea seriously.
About trying to break out of your rut.
About trying to break out of your rut.
14/ "I'm not in a rut" you argue.
Yes you are. We all are. Ruts are priors. We all have them and we'd be useless without them.
But the tendency is for your priors get too strong. Or perhaps more accurately, you should periodically weaken them. Anneal them into a better shape.
Yes you are. We all are. Ruts are priors. We all have them and we'd be useless without them.
But the tendency is for your priors get too strong. Or perhaps more accurately, you should periodically weaken them. Anneal them into a better shape.
15/ Anyway, that's how I try to look at finance papers.
YMMV but it's been useful for me over the years.
/END
YMMV but it's been useful for me over the years.
/END
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