May 29, 2011

I JUST KNOW THE UNDESERVING POOR ARE BEHIND IT SOMEHOW:

Bankers Can’t Avoid Risk by Hiding It (Paul Wilmott , 5/28/11, Bloomberg)

One of the supposed silver linings of our recent economic disaster was the idea that we finally understood how hazardous our exotic financial instruments are and that bankers were finding a better way to "manage"’ that risk. But if at least one of the common practices in banking is anything to go by, risk-management procedures in many cases continue to hide the very dangers they are trying to measure.

This may result in banks taking bigger positions, and end up taking more real risk than they should. And it gets worse. The practice in question goes by the name of "calibration," which is best described using a non-financial example. [...]

I visited a regulator (who shall remain nameless) in Washington recently. People say that regulators don’t have enough bite, so I went there to offer a set of teeth. My goal was to arm them with one simple, surefire way to frighten the pants off any bank. My advice was to ask the banks one simple question: "So, how stable are your calibrated parameters?" They would then find some respect for the regulators. Instead, I found myself surrounded by quants praising calibration, not even appreciating the negating effect of recalibration.

It doesn’t take a rocket scientist to figure out the fallacy in calibration, but it does take someone who can look beyond the math.


Posted by at May 29, 2011 9:47 AM
  

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