ALBERT HERTER

‘RADIO STORIES, ‘ by James Kwak at baselinescenario .com.

In Uncategorized on February 11, 2010 at 05:13

Radio Stories

Posted: 10 Feb 2010 06:55 AM PST

I spend a lot of time in the car driving to and from school, so I end up listening to a lot of podcasts (mainly This American Life, Radio Lab, Fresh Air, and Planet Money). I was catching up recently and wanted to point out a few highlights.

Last week on Fresh Air, Terry Gross interviewed Scott Patterson, author of The Quants, and Ed Thorp, mathematician,  inventor of blackjack card counting (or, at least, the first person to publish his methods), and, according to the book, also the inventor of the market-neutral hedge fund. These are some of Thorp’s comments (around 24:20):

“As far as you can tell now, how are quants being used on Wall Street? Are these mathematical models being relied on as heavily now after the stock market crash as they were before?”

“My impression is: pretty much. There’s a giant industry now; many thousands of people who otherwise would have gone into engineering and science have gone over to Wall Street to work on these things because the pay is better and it’s fun. They’re still there — they have a vested interested in staying there — and I think a lot of people think that we’re just going to go back to business as usual in this country, that this is all going to blow over and we’re not going to have any significant increase in regulation, we’re not going to have any significant listing of off-the-book derivatives on exchanges like the commodity futures exchanges, and that we’ll set ourselves up for another big fall. That’s what I’m afraid will happen.”

“So, how is that affecting how much you want to have invested in the market?”

“Well, it’s tough. The question is where do you go. We only have one world we live in. If they  had a market on Mars, I might think about going there. But I think it’s going to be very difficult. I personally find it hard to guess exactly when some bad thing will happen and how long it will take and what will trigger it, just like in this last crash. You know something bad’s going to happen; you just don’t know when or how.”

A few weeks back, Planet Money had an interview with MIT finance professor Andrew Lo, where he repeated his call for a financial industry equivalent to the National Transportation Safety Board, which investigates airline crashes and recommends new procedures to protect against crashes in the future. Lo also gave a reasonable explanation and defense of proprietary trading. But the unsatisfying thing was that his main argument for proprietary trading was that it provides liquidity (beginning around 9:30), which Alex Blumberg calls him out on. Even after Lo explains it, though, he doesn’t explain why we need large banks’ proprietary trading desks to provide liquidity. After all, isn’t that what hedge funds do? How much liquidity do we need, and how much of that is supplied by institutions with banking licenses? And at the least, couldn’t the large banks at least spin off their internal hedge funds? Then you would have just as much trading, but less of it would be backed up by government guarantees.

I finally got around to listening to Planet Money’s interview with Russ Roberts from December. Russ Roberts and I are pretty sure to disagree on almost any actual policy question. But what I liked about his interview was that he basically admitted that policy questions cannot be settled by looking at the empirical studies. On whether the minimum wage increases or decreases employment for example, he says that he can poke holes in the studies whose conclusions he doesn’t agree with, but other people can poke holes in the studies he agrees with. In Roberts’s view, people’s policy positions are determined by their prior normative commitments.

I don’t completely agree. I don’t think that these questions, like the one about the minimum wage, are inherently unanswerable in the sense that the answer does not exist. But I agree that empirical studies are unlikely to get to the truth, particularly on a politically charged question, because there are so many ways to fudge an empirical study. As one of my professors said, there are a million ways you can screw up a study, and only one way to do it right. But I agree with the general sentiment. We are living in an age of numbers, where people think that statistics can answer any question. Statistics can answer any question, but they can answer it in multiple ways depending on who is sitting at the keyboard.

By James Kwak

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