Power of maths

principled
God

Posts: 975

Power of maths Apr 28, 2012 18:55:22 GMT 1

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Post by principled on Apr 28, 2012 18:55:22 GMT 1

I came across this interesting BBC article on the history of the Black-Scholes formula. I should point out that I had never heard of this formula or its role in finance before reading the article.
www.bbc.co.uk/news/magazine-17866646
(detail of the formula for those interested at: en.wikipedia.org/wiki/Black%E2%80%93Scholes#Black.E2.80.93Scholes_formula )

From the article I get the impression that those who used the formula and its derivatives appeared to have blind faith in them and didn't seem to take into account the "human factor".
I wonder whether the unbridled use of "quantitative technologies" on the one hand and our rush into the introduction of "artificial intelligence" on the other will result in a better world or one more prone to the economic collapses we've seen in the past few years.

Can any of these technologies comprehend that "there's nowt as queer as folk"?

P

marchesarosa
God

Posts: 5,426

Power of maths Apr 28, 2012 19:24:05 GMT 1

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Post by marchesarosa on Apr 28, 2012 19:24:05 GMT 1

I got the impression that the formula proved advantageous when only a handful of people knew about it because it was a step up from "intuition". However, when EVERYONE was using the same formula and forgot their "intuition" entirely, sticking to the formula proved to have no competitive advantage in the Stock Market at all. The reverse, in fact.

Weird, isn't it, what people get the Nobel Prize for, principled?

Last Edit: Apr 28, 2012 19:32:38 GMT 1 by marchesarosa

mak2
Member

Posts: 241

Power of maths May 2, 2012 15:46:23 GMT 1

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Post by mak2 on May 2, 2012 15:46:23 GMT 1

The Black-Scholes formula is very useful because it enables market makers to quote prices for derivatives. Without the formula, it would be very difficult to trade things like options. Scholes and Merton deserved their prize.
The point is that there are many options, with a large number of different strike prices and expiry dates. Some of them are infrequently traded. So there is no current market price.
An option pricing formula is used to calculate a price by interpolating between prices that have been recently traded.

What happened was that some people used the formula without really understanding its limitations and got their fingers burned.

striker16
Senior Member

Posts: 478

Power of maths May 30, 2012 9:31:10 GMT 1

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Post by striker16 on May 30, 2012 9:31:10 GMT 1

Apr 28, 2012 18:55:22 GMT 1 principled said:

Can any of these technologies comprehend that "there's nowt as queer as folk"?

P

People are unpredictable but even so, maths seems to have the ability to recognize patterns of behaviour over many cases. The advertising industry and public polls attest to this.