New Taleb Book

[psztorc]

https://docs.google.com/file/d/0B8nhAlfIk3QISHRiY1VLTkRiS1k/edit

Its off to a great start, as usual.

This author is currently teaching a course with the absurd title "risk management and decision-making in the real world"...this is a total absurdity...In "real" disciplines, titles like "Safety in the Real World", "Biology and Medicine in the Real World" would be lunacies. But in social science all is possible as there is no exit from the gene pool for blunders, nothing to check the system, no skin in the game for researchers.

Hopefully some of those things can change!

[BldSwtTrs]

Last time I checked he was not a proponent of prediction markets, to say the least.

[psztorc]

Hypocrisy and laziness are part of the human condition, unfortunately. They're in us all, myself included.

My reading of The Tabeb-Hanson Twitter Incident was that Taleb had concerns about individuals using PMs to hedge against certain risky events happening. PMs indeed are more-than-a-little-awkward when used this way, as you are sensitive to basis risk ("a war" vs "a world war") and limited by the $ the counterparty has put down. PMs are not really for hedging, but for information-aggregation. In fact, elsewhere Hanson has even said something like "[PMs] use the market mechanism, but are otherwise not markets at all", claiming that PMs don't do a single thing unless subsidized (with $ or with entertainment-value), unlike markets which exist for efficiency reasons (and only aggregate information as a side-product). In his papers Hanson refers to the trades as "reports" or "updates" to the current forecast.

PMs make cheap talk expensive, provide 'skin in the game' for forecasters (which improves accuracy), favors forecasts which employ human reasoning over those that "fit the past data", and, most Taleb-like, are part of the ancestral wisdom. I think that Taleb just has some resentment toward academic economics that he just projected onto Hanson before he understood his point of view.

PMs are a major improvement in bias-reducing forecasting technology. Forecasts will still be limited by imperfect human understanding, and individuals would do better to be robust to forecast errors. Taleb himself might be a great PM-trader, being skeptical of the whole enterprise (but, assume for the moment, convinced that the software is stable [quite a Grey Swan]), might trade contrarian in all markets, moving the price back to uniform-distribution to capture cheap Black Swan exposure (as he sometimes does today in traditional options markets). This would improve forecast accuracy and allow him to profit from proving PM-deficiencies. He can also make his own carefully-worded PMs. Of course, unlike in previous debates, all of this would require some of Taleb's skin to be in the game; how fashionable it can be to demand accountability in others, from the safety of theoretical academic papers!

[BldSwtTrs]

What allows me to instantly get the concept and the utility of prediction markets is my knowledge of Hayek's work in economics. What strikes me is that Taleb also knows Hayek's work but nonetheless doesn't get it.

Honestly, Taleb disappointed me a lot with Antifragile (where he argues against individualism and technology). I think he is a very good mathematician and trader, a sophisticated person, but yet a poor thinker.

[martinBrown]

PMs are not really for hedging, but for information-aggregation. In fact, elsewhere Hanson has even said something like "[PMs] use the market mechanism, but are otherwise not markets at all", claiming that PMs don't do a single thing unless subsidized (with $ or with entertainment-value), unlike markets which exist for efficiency reasons (and only aggregate information as a side-product).

I've been thinking more lately about the potential for using TruthCoin to hedge the price of bitcoin (effectively creating a way to hold decentralized dollars). So I'm particularly interested in this right now.

More generally, the applications pdf proposes hedging as an application of PMs:

Through creative use of the tradable shares, one can provide an entire marketplace of financial services, including risk-management, insurance

Further down there's a section for "Event derivatives" and insurance (as in, decentralized insurance). Isn't this hedging?

edit: Maybe instead I should ask, how is a PM different from or less efficient (and to what degree) than say, a futures market.

[psztorc]

I meant to communicate that PMs do not necessarily imply hedging (they way they do necessarily imply info-aggregation). However, PMs can be used for hedging under certain circumstances, namely when the market is clearly defined and liquid enough. Those conditions would be met in a USD "decentralized dollar" market, which would probably have wide appeal, be redundantly defined several times and for many dates, both near at hand and in the distant future, allow for clearly defined arbitrage, etc.

Contrast that with a Taleb example: You can't short "A war to break out between US and China" to 'hedge' your risk, because [basis risk] the "war" is not carefully defined (the risk you're trying to hedge could be small or catastrophic) and [counterparty interest] the counterparty is ambiguous (who is putting money down on either side of the bet? how much? and why?). Moreover, an event like this is "fourth quadrant" not easily predictable (if at all), not obvious from past data, high-impact, so the percentage-likelihood revealed by the PM [even if optimally-correct] is not as meaningful. ( What does a 0.3% likelihood of war mean to us as decision-makers? What if the error on that likelihood [optimal != perfect] is 100 basis points, or 200? Is "a more accurate forecast" the right way to approach this question? )


Another interesting thing to keep in mind is that Taleb's critique is only on "binaries" (and not 'vanillas' [unbounded bets] or 'bounded exposures' [the scaled claims that I implemented in version 1.2 and the .xls]). It would be interesting to hear his views on the extension to Scaled Claims ("bounded exposures"). I know that we agree that, as the exposure approaches the bound, the bound behaves more and more like a binary (which, quite obviously, favors wide bounds).