We Need To Stop Worshiping Algorithms
In 1954 the economist Paul Samuelson received a postcard from his friend, the statistician Jimmie Savage asking, “ever hear of this guy?” The ”guy” in question was Louis Bachelier, an obscure mathematician who wrote a dissertation in 1900 that anticipated Einstein’s famous paper on Brownian motion published five years later.
The operative phrase in Bachelier’s paper, “the mathematical expectation of the speculator is zero,” was as powerful as it was unassuming. It implied that markets could be tamed using statistical techniques developed more than a century earlier and would set us down the path that led to the 2008 financial crisis.
For decades we’ve been trying to come up with algorithms to help us engineer our way out of uncertainty and they always fail for the same reason: the world is a messy place. Trusting our destiny to mathematical formulas does not eliminate human error, it merely gives preference to judgements encoded in systems beforehand over choices made by people in real time.
The False Promise Of Financial Engineering
By the 1960s a revolution in mathematical finance, based on Bachelier’s paper and promoted by Samuelson, began to gain momentum. A constellation of new discoveries such as efficient portfolios, the capital asset pricing model (CAPM) and, later…
