Maybe Thunderdog is right, maybe he ain't... However, assuming that human behavior cannot ever be understood and/or predicted is not gonna get us anywhere, so I prefer to think that it's not the case. I might add that people at one point thought that radioactivity and stomach ulcers couldn't be understood, but look at us now.
Assumptions of CAPM All Investors: Aim to maximize economic utility. Are rational and risk-averse. Are price takers, i.e., they cannot influence prices. Can lend and borrow unlimited under the risk free rate of interest. Trade without transaction or taxation costs. Deal with securities that are all highly divisible into small parcels. Assume all information is at the same time available to all investors. Answer yourself the question which of the assumptions might be manipulated...
I am saying predicted in (time). Not human behavior can never be predicted. So to make a model that make the most profit,and calculate risk, you will miss some profit if you add human behavior (risk) to that model over (all time) because you do not know (when) in time. This is a general opinion because I do not know the detail of Taleb thinking or the price model of CAPM that the poster is asking. So will people take a less profit because something (is possible) to happen but not likely, or will people go with probability?
Again - the prescriptives are there - clear as a bell. That many don't like his approach is a separate issue. Regards.
We know the answer to this - it's an emphatic NO for most people. Right now there is a guy in another thread trumpeting his profits in what he KNOWS is a ponzi scheme. This is knowingly investing with a "I'll smoke until I'm one cigarette away from lung cancer" approach, and the markets are absolutely rife with this sort of behavior. And the compensation schemes accentuate it. It's how we're built as people, I honestly don't see any regulatory approach to end it. Whatever rules are implemented, it will take no time at all to find ways to circumvent them.
No, I'm not suggesting human behavior should not be studied. However, I don't think that sophisticated math has been a very good predictor of behavior thus far. Perhaps it has something to to with the fact that math is a pure science whereas the study of human behavior is a social "science." Maybe I'm mistaken, but the more complex a model is, the deeper in trouble its adherents are likely to run into in the fullness of time. Too may moving parts relying on too much numeric specificity, if you ask me. (Think of a calculator, where you take two seat-of-the-pants estimates, multiply them, and get accuracy to the eighth decimal place. Then keep going.) Perhaps they should begin by acknowledging that the sophisticated models' reach exceeds their grasp. It is for this reason that, for my own limited purposes, I have a very basic trading method that is downright laughable in its simplicity and its modest principal objective by academic standards. But it works. Getting back to CAPM, and if I may just get in a last dig, there is the small matter of timing, which, as a pricing model, it does not address. This reminds me of the old saw about the market's ability to be irrational longer than you or I can remain solvent. In my eyes, its value is dubious on a number of levels.
The fundamental problem with math is that electrons don't solve differential equations to figure out where they go next.
Taleb doesn't use or offer any alternative analyical frameworks, because he knows they are all bullshit when extreme events happen. He keeps it simple by taking no risk, yet at the time taking enormous risk. He buys t-bills, and uses the interest income to buy optons. It's a strategy most people can't stomach, because one will lose most days using it, before it pays off big.
You're simplfying things a bit here. What exactly do you refer to as "sophisticated math"? For example, a basic understanding of neural networks + stochastic calc. + cauchy distributions will get one very far in adequetely modeling the magnitude component of many time series events - such as the extent of market shocks etc. The temporal components are exponentially more difficult to model due to computational limitations, but, not theoretically impossible. Your brain can be modeled almost perfectly with *enough* computing power... and more importantly, any organic (read human) dynamic can also be modeled. The limitations exist in figuring out the proper rule set and implementing that rule set. AFAIK, the rule sets for forecasting most any non-linear behavior already exist, the problem lies in resource constraints; its the limitations of silicon combined with the NP-complete problem. http://en.wikipedia.org/wiki/NP-complete http://www.britannica.com/EBchecked/topic/603575/traveling-salesman-problem Just my 2 cents. Mike P.S. RAPM, CAPM, BS are all flawed. What astonishes me is that business schools still teach these models like they are gospel...
Absolutely. As for the rest of your post, it is well and truly over my head, so perhaps I should just stick to my knitting.