STREET DOGS

From Benoit Mandelbrot’s The Misbehaviour of Markets: A Fractal View of Financial Turbulence:

Every so often, not so rarely, prices change dramatically, and today prices move much more quickly and these changes are much more important. But it has always been like that. There are stories in the Merchant of Venice by Shakespeare, and even much older books than that, which talked about the existence of a category of people, bankers, who knew very well from experience that ships sometimes went safely on a long trip and sometimes didn’t. And when they didn’t return, it was a big loss to their business. A single loss could sink a big company.

Wild randomness is like the gaseous phase of matter … [there’s] no telling what it can do, where it will go. The fluctuation from one value to the next is limitless and frightening.

Real markets are wild. Their price fluctuations can be hairraising — far greater and more damaging than the mild variations of orthodox finance … individual stocks are riskier than normally assumed.

It means that stock portfolios are being put together incorrectly; far from managing risk, they may be magnifying it. It means that some trading strategies are misguided, and options mispriced … the conventional models and their more recent “fixes” violate the Hippocratic Oath to “do no harm”. They are not merely wrong; they are dangerously wrong.

People think risk means if you invest $10, you may get back $11 if you’re lucky, but somewhere close to $10. In fact, if you look at the actual data … large price changes are observed often enough to matter a lot. If one does not take account of the possibility of a price going up suddenly, or going down suddenly, one takes a risk that is higher than anyone wants.