His answer to the second question is even more ridiculous. If I measure risk for a highly leveraged bank (and almost all of them are in that position right now), how can I NOT factor in the possibility that the bank won’t be able to “liquidate [its] risk” ? The absolute, undoubted, #1 danger of leverage is having to de-lever, to ‘liquidate my risk.’ Or, to use the vernacular, to ‘be forced to sell stuff to raise cash.’ You don’t have to have a Nobel prize to realize that there might not be a lot of takers for the assets of a bank in trouble. A model that fails to consider that problem is worthless.
Scholes should know better. After all, he was at the center of a firm that came very close to nuking the world banking system because they were so confident in their risk models that they took leverage to such a staggering degree.
When you hear such nonsense from insiders like Scholes, you have to wonder: are these guys lying through their teeth or just deluded? In general, I’d say the lower-level guys usually believe the nonsense. I know from personal experience that most of that most of these Scholes-number-crunching types believe in their risk models in much the same way Christian Scientists believe God will cure their syphilis. The proof is that they put their own funds on their crazy models. When Scholes’s LTCM firm collapsed, nearly all of the principals lost their entire net worth because it was 100% invested in their own fund. But these are just the disciples. The high priests, like Scholes, are playing a much more cynical game. Scholes knows, can’t help but know, that the model has failed. He’s stonewalling for a very simple, sleazy reason: his whole life depends on it. It’s his whole schtick, the foundation ot just of his wealth but his whole idea of himself. For quasi-celebrities like Scholes, even sexual success is bound up with the model. The model made him rich, famous and adored. He can’t afford to entertain any doubts about it. So he insists, in the face of total disaster, that the model is perfect. It can’t be the model’s fault, so it must be the world’s fault for messing up the model.
Read more: con man, derivatives, finance, Myron Scholes, pulitzer, Mr. Walker, Banking Porn
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16 Comments
Add your own1. John | May 20th, 2009 at 8:58 pm
It certainly is the world’s fault for continuing to be suckers for this kind of crap. Fool me once, shame on me, etc.
What I don’t understand is how is it possible for these people to borrow so much money to invest it back into the financial markets? Who is stupid enough to lend them unsecured money? If your bank isn’t making loans to a corporation, why are you lending money to some black box hedge fun to buy that corporation’s stock?
2. JimDate | May 21st, 2009 at 12:15 am
Shouldn’t it be “Nobel Prize winner”?
3. KKK | May 21st, 2009 at 12:23 am
I wonder what is thats lacking in a really good article like this?
May be it’s like… too late?
Where were you in 2004 Mr. Walker?
4. OldSkeptic | May 21st, 2009 at 1:32 am
The joke is, in 2004 I did a paper which, in passing, proved the Scholes-Black model was wrong. Want to know how long it took me to disprove it? 1 hour tops.
I also built another model which was much harder and far less precise, but had that great feature you normally want .. it actually worked.
Response to my (I think great) piece of work … absolutely nothing. Over a few beers I talked to some people that actually accepted what I said but, responded … “everyone uses it so we have to”.
5. Tam | May 21st, 2009 at 4:48 am
‘He’s stonewalling for a very simple, sleazy reason: his whole life depends on it.’
He sounds an asshole but, I have to admit, in his position I’d probably do the same. No one would exactly thank him for admitting he was wrong, would they?
6. Realist | May 21st, 2009 at 2:36 pm
Yeah, the quantitative economics of our day…
The model may be complete shit and always off target, but at least I use STATA. Also masks the fact that a good part of the derivative instruments market is faith-based.
But then again, our economics profession bursts with totally discredited people claiming the mike. Think Krugmann.
7. Anonymous Coward | May 21st, 2009 at 4:00 pm
Oooooooooohh, the sound of rolling dice to me is music in the air
‘Cause I’m a gamblin’ boogeyman, although I don’t play fair.
It’s much more fun, I must confess, when lives are on the line;
Not mine of course, but yours old boy, well that’d be just fine.
8. Feckeroller | May 21st, 2009 at 4:40 pm
Why if international and American elite is so scheming and evil it gave us the plebs Viagra and first fuckable artificial vaginas in history. I mean realistically, our revolutionery representatives and independent thinkers what else are you asking for? Top models? Frankenstein 3d epoch knowledge them being Hep B, C infested adipose agglomerates of ‘brush tool’ bytery. Gorgeous Slavic sex women? Ames tried them and returned to NY.
13 yo boy-lovers? But who told you the elite are the bad guys in the ‘can I can I not’ have a 13 yo boy-lover’ practical disposition?
9. captain ameirca | May 21st, 2009 at 6:53 pm
this article needs some proofreading. unless acadenuc is a real word. and it may well be. evil nationalists such as myself and http://www.dictionary.com are ot known for our extensive vocabularies.
10. Echelon | May 22nd, 2009 at 12:33 am
capt. america, what is your secret? You’re a nigger (black person)?
11. aleke | May 22nd, 2009 at 11:07 am
What the fuck is 8 and 9 saying
12. Rob | May 29th, 2009 at 8:57 am
Sad there are still malevolent weirdos in the world that make the world worse and shabbier for the rest of us – i.e., you need to monitor and remove some of these comments – 8,9, 10.
Other than that, the explanation for Scholes and his cohorts came apparent to me when I saw them interviewed on a PBS special a few years ago — the guys are very, very arrogant, full of hubris, and self-centered.
13. Tyr | June 2nd, 2009 at 4:04 pm
Shouldn’t that be FAKE nobel winner ? The economics prize isn’t awarded by the Nobel committee.
14. paul cripps | August 22nd, 2009 at 11:50 am
your right these walking dead cunts have no shame
15. Jeff Miller | August 1st, 2010 at 10:27 am
As I understand the Black-Scholes model, if a 747 is flying East to West from Chicago to Los Angles at 30,000 ft cruising at 450 mph, and at the precise moment that the jet crosses the Continental Divide, the engines quit, the probability that it will come down 50 mi East of the Divide is precisely the same as the probability that it will come down 50 mi West of the Divide. It does not take momentum, trends, or trading ranges into account.
An astutue trader can capitalize on this by selling calls at or near the top of a trading range and selling puts at or near the bottom of the range. In both cases, the options are over-priced.
16. diego bergen | January 10th, 2012 at 12:27 pm
what frightens me more than the curious case of doc scholes…….
is what is going to happen when peeps start believing this website…..
with the understanding this website is not some NSA vulture net for nonzombies…ha ha
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