QUESTION TO THE READERS: Could anyone guess what Nassim Nicholas Taleb would think of the prediction markets?

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The idea that catastrophe can strike without warning does not seem particularly hard to understand. Why doesn&#8217-t Wall Street ever seem to allow for that possibility? And why doesn&#8217-t it learn from past catastrophes?

Let me blame business schools and the financial economics establishment – they have a vested interest in promoting models and devaluing common sense.

I worked on Wall Street for close to two decades in trading and risk management of derivatives. I noticed that while portfolio models got worse and worse in tracking reality, their use kept increasing as if nothing was happening. Why? Because in the past 15 years business schools accelerated their teaching of portfolio theory as a replacement for our experiences. It looks like science, and they have been brainwashing more than 100,000 students a year. There is no way my experiences can be transmitted to the next generation because of these schools. We&#8217-ve had fiascoes in finance that they need to neglect because they contradict their models. The problem may also be the Nobel in economics that gave a stamp to these junky theories. Someone needs to make the Nobel committee account for this, for the damage to society – and I hope to do so.

Strongly anti-establishment guy. (More here, last year, with Felix Salmon.)

Could anyone guess what Nassim Nicholas Taleb would think of the prediction markets? Would he think that our prediction market researchers (Robin Hanson, Justin Wolfers, and company) are &#8220-giving stamp to junky theories&#8221-, hence &#8220-damaging society&#8221-?

Anyone (who knows NNT) willing to guess???&#8230-

UPDATE: Jason Ruspini&#8230-

The basic answer is obvious – Taleb considers predicting as such to be nonsense, although the papers in this area by Wolfers et al only need appeal to information aggregation.

I do think Taleb would be very skeptical of the model-based papers on manipulation. While he and Robin Hanson seem to have some similar interests, this might be a difference. Consider Taleb&#8217-s &#8220-Fat Tony&#8221- and &#8220-Dr John&#8221- characters from The Black Swan. Fat Tony is more intuitive and &#8220-street-smart&#8221-. Dr John is more &#8220-platonic&#8221-, nerdy, and more apt to make mistakes because of a bad model or assumptions. The characters are each posed the following question: &#8220-Say I flip a fair coin ten times and it comes up heads all ten times. What are the chances of it coming up heads on the next flip?&#8221- Dr John replies, &#8220-Elementary. They are independent events, so 50%.&#8221-  Fat Tony says, &#8220-Less than 10% because the coin is probably loaded. Your assumptions are wrong or you are lying!&#8221-

The model-based papers on manipulation assume equal trading budgets and no feedback trading. These assumptions rarely hold.

Previous blog posts by Chris F. Masse:

  • “I’m very concerned with the international situation and what’s happening in Tibet.”
  • How to win $100 in play money at HubDub, regardless of any political outcome
  • Problem 17: Prediction Markets — USMA D/Math Problem of the Week — Submission Deadline: April 3, 2008 at 1600
  • Midas Oracle is now powered by WordPress 2.5 —and you should be too.
  • Would be fun to have the equivalent for event derivatives.

Nassim Nicholas Taleb likens modern-day financial markets to medicine in the 1800s, when going to a hospital in London or Paris multiplied your risk of death by four times, he says. Similarly, quants increase risk by deploying flawed financial tools designed to reduce it, he argues.

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Via Stan Jonas, Nassim Nicholas Taleb cited in a Bloomberg article (Taleb Outsells Greenspan as Black Swan Gives Worst Turbulence):

Stress tests are inherently risky because they ignore rare but potentially devastating events. […] .. [“stress test” = Wall Street lingo for examining how a market rout will play out]

Past shortfall doesn&#8217-t predict future shortfall. […]

Bayesian is necessary but not sufficient. […]

If you are in banking and lending, surprise outcomes are likely to be negative for you. Put yourself in situations where favorable consequences are much larger than unfavorable ones. […]

Go to parties! If you&#8217-re a scientist, you will chance upon a remark that might spark new research. […]

Also, see Stan Jonas&#8217- 2 takes on FOMC.