25 Sigma Charlatanism

By Fred Bethune on Friday October 1, 2010 11:46 AM

I had almost forgotten about Nassim Taleb when I came across his interview regarding this year's Pseudo-Swedish Dynamite Prize in Economics.

"I want to remove the harm from these economic models. And the Nobel is not helping. They should be held partly responsible, if not largely responsible, for the crisis," Taleb told Reuters by telephone.

The Nobel prize, really?

Taleb is a former trader who took advantage of the mispricing of derivatives to make his fortune in the years before the crisis. He published "The Black Swan" in 2007 and went on to make millions more during the upheaval.

No, Taleb actually lost money and ran his first hedge fund, Empirica, into the ground until it finally collapsed in in 2006. His second fund, Universa -- which no one in New York would touch following the Empirica disaster -- was funded by promoting to rubes in California, run by an Austrian Mises.org-reading fool, and lost money until achieving a return of 100% at some point in the crisis of 2008.

One hundred percent -- that's pretty good though, isn't it? Well, no, it's not really. A fund that was set up specifically to take advantage of that once-in-a-lifetime event and steadily drains money at all other times should have had returns of 500% to 5,000% when that event occurs, like those run by Andrew Lahde, and many other people who actually foresaw the crisis and understood its nature. If he did, he would have bought some CDS instead of equity puts, like everyone else who got in on the big short. Maybe that's what motivated Nassim to tell embarrassing lies about his fund's performance.

Federal Reserve Governor Ben Bernanke he calls "a true charlatan," arguing his idea of a "Great Moderation" made the world more dangerous because it masked underlying risks. "He got us here. He crashed the plane," Taleb said. "I say it literally, he doesn't know what's going on."

A true charlatan! That's a laugh, coming from Taleb. Bernanke may be many unsavoury things, but a charlatan he is not. I suspect that Taleb has never bothered to read any of Bernanke's work with Gertler. Bernanke understands what is going on fairly well, and that is what makes him so culpable.

For now, Taleb is content to write books and try to advance his ideas. He says he has given up trading, but has a clear purpose for all the profits he made. "I'm using the money now to finance the destruction of the economic establishment."

Hmm, so he's "given up" trading now. I take that to mean that his deeply philosophical strategy of buying OTM puts has run down the gains from 2008, and is now sinking Universa in the same way that Empirica was sunk. It seems to be following the same pattern: get lucky in one year (2000 in Empirica's case, 2008 in Universa's) go on a promotional fundraising blitz, and then lose all of the money over the next few years. And as if his marquee strategy were not stupid enough, last year Universa started another fund dedicated solely to betting on hyperinflation. I'm sure that has worked out swimmingly.

It would have been helpful if the interviewer had asked Taleb exactly how his mountain of money is being used to finance the destruction of the economic establishment. And, since he is, we are told, spectacularly rich, and only concerned with attacking the economic establishment, it might also be worthwhile to ask if he still charges a speaking fee.

Anyways, on to the money quote:

Asked if he would accept a Nobel prize himself if selected, Taleb is uncharacteristically hesitant. People might think he had sold out, he worries. But he concludes: "If it would help society that I got something like that, I probably would."

Yes, for the good of society, of course.

Comments (10)

Bernanke understands what is going on fairly well, and that is what makes him so culpable.

That's a roger, Roger!

Mr Black Swan can kiss my un-black Ass. He's the Eckhart Tolle of "economics."

op:

not hip to any of this street guru crowd

its a parallel universe
as far as
econ con macro policy goes

at least he's a nassim
not a nigel or a nathan

ts:

My googling sent me to a Janet Tavakoli article that mentions empirica kurtosis voluntarily returned $375 million to investors in 2004/2005. He only outperformed the hedge fund average for one year of six, but his only losing year was 2001. Underwhelming, but hardly "running it into the ground".

FB:

ts,

I think they also had losses in 2002, but it's hard to say when Taleb won't publish audited returns. I guess that I was being overly harsh there, but something does not smell right about his story at all.

- why would a fund with a long-term strategy just shut down like that voluntarily?
- how many involuntary redemptions did they have before voluntarily returning the rest?
- why does Taleb evade questions about Empirica and only give vague answers about performance ("losses", "single-digit gains")?
- he's made false claims in public that are inconsistent with what little we do know

The other problem is that he has explained his strategy, and there doesn't seem to be any way for it to perform very well over the long term. It's basically the same as with Bernie Madoff. He said he was generating his profits by using a split-strike conversion strategy, but there's no way that strategy would yield 12% returns.

With Taleb's strategy, he's either going to erode his capital quickly by buying lots of put options in the hope of a big payoff, or buys only small amounts of put options to limit quarterly losses, but with a reduced payoff. In neither case do I see Taleb's strategy having favourable risk reward ratio over the long term. There's no obligation to publish this type of information, but I would also like to see his P&L split between his treasury holding and his options strategies.

The other problem with his strategy is the assertion that deeply out of the money puts are systematically underpriced. He argues that Black-Scholes underprices tail risk, which is fine, but hardly news. The more important question is whether or not the market underprices OTM puts. The answer is almost certainly no. The market hasn't obeyed B-S since the crash of 1987 (when it learned not to underestimate tail risk), and the prices themselves now consistently exhibit fat tails, even though the standard pricing theory does not. It's called the volatility smile. Taleb's critique has been priced into the options (probably overpriced, if Warren Buffett's trades are anything to go by) that he buys since 1987, so how does he make money from underpriced options?

From what I've read, his story just doesn't add up.

FB:

op

The investment gurus are all pretty much frauds (with the exception of Benjamin Graham and a few others), but when it comes to the hedge fund game itself and high finance, I find the sport of it fascinating

If only for pleasure, you should check out the Big Short by Michael Lewis.

You can download it here:
http://gigapedia.com/

Al Schumann:

Here's an excerpt from the book FB recommends. It's a fascinating read.

Compare Taleb to Burry for maximum enjoyment of FB's post.

Well said. He's possibly found a better use of his talents as a writer / philosopher / flaneur than as a trader. Although the egotism on paper turns many readers off.

It doesn't make much sense to identify 100+ recipients of the dynamite prize with certain applied practice of BSM formalism, does it?

I don't really agree with his "antifragility" idea either. Robustness = NON-fragility. Antifragility would be like betting on hyperfragility. I wrote a short critique on the blog linked in my comment name, more directly isomorphimes.tumblr.com/tagged/Nassim+Taleb

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