Neil Schemenauer's Web Log


October 08, 2008

Riskiness of financial markets

From a story on Iceland's financial problems: I believe it is absolutely wrong to say these banks were reckless. Quite the contrary. They were hugely unlucky. Perhaps "reckless" is too strong but I think it's clear that they underestimated risk. Again I have to recommend Benoit Mandelbrot's book The Misbehavior of Markets. I didn't buy into the whole fractal theory stuff but the observation that price changes do not have a finite variance seems beyond doubt. That means distributions have "fat tails" and that most models underestimate risk. If your dice come up as snake-eyes every few rolls then maybe you should start suspecting that they are loaded.