On a freezing day in March 2007, Nassim Taleb walked into a conference room at Morgan Stanley's Manhattan offices on 47th Street and Broadway to address a group of the firm's risk managers. His message: Your models don't work.
Using a whiteboard to scribble out his calculations, Taleb, now 48, began one of his rants, this time against stress tests -- Wall Street lingo for examining how a market rout will play out. Stress tests are inherently risky because they ignore rare but potentially devastating events, Taleb said.
``Past shortfall doesn't predict future shortfall,'' the options trader turned best-selling author recalls telling the assembled group of about 40. The risk managers, part of a tribe of mathematical model makers known in the finance world as quants, stared back at him blankly, and a debate ensued, according to people who were there....
...Taleb has made enemies, too. In August, The American Statistician, the quarterly journal of the American Statistical Association, came out with a special Black Swan issue that published a series of critical reviews alongside an article by Taleb.
``He characterizes statisticians as people who blindly assume things, and nothing could be further from the truth,'' says Peter Westfall, the journal's editor and a professor of information systems and quantitative sciences at Texas Tech University in Lubbock.
Even his one-time colleagues disagree with him. Robert Engle, a Nobel laureate in economics who teaches at New York University's Stern School of Business in Manhattan, says Taleb's book ignores a mass of literature on rare events called extreme value theory, which is often used to assess risks in insurance as well as finance.
``He's reflecting an opinion that financial markets are sort of out of control,'' Engle says. ``I think a lot of mistakes are made, but I don't think he helps us understand the mistakes.'' >>>MUCH MORE
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