Black
boxes, Artificial Intelligence and FinTech - likely a deadly combination that
is going to destroy a lot of wealth. We have seen this before - fresh graduates
from business schools coupled with mathematicians and physicists, descending on
Wall Street to make the world go around in the opposite direction. As they
appear on TV after hours - mad and fast - to confuse and pillage small money,
ascertaining where every stock is going and even the market, there are 20
million fat fingers across the world chasing the illusion.
The theory underlying financial
markets has been robust in spite of the recent confusion about "behavioral
economics." New information moves markets and unless one has insider
information, it is impossible to create alpha from fundamental or technical
analyses. A lot of careers are made and destroyed on this false idea.
For some of us, theory still matters and it can be shown without any empirical
uncertainty that alpha is a white elephant. If an adviser is demonstrating
consistent alpha, one has to wonder where the information is coming from. The
SEC has gotten a lot more sophisticated lately but a simple heuristic of alpha
consistency will tell you that there is something wrong.
Business schools need to
rethink their focus. Some even have classes in "trading," and that
idea is utterly inconsistent with everything we know. In the presence of uncertainty,
it is easy to make returns and lose them quickly. In spite of all the academic
literature behind this, not many involved in "money management,"
really talk about alpha (only returns). Granted, a single factor model is
woefully inadequate to measure risk but not considering risk in your returns,
like the TV moguls do, is a prescription for disaster. The fact that conventional
finance education and even the high-end certifications do not prepare the
professionals adequately is symptomatic of education chasing trends and not
sticking with what is known.
The financial industry
appears to be dominated by engineers and accountants, the former unaware of
economics and the later unaware of the fact that we have computers now to count
money. Adding mathematicians and physicists on top of this already deadly
combination can only result in tears.
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