THE FOURTH QUADRANT: A MAP OF THE LIMITS OF STATISTICS - Nassim Nicholas Taleb

THE FOURTH QUADRANT: A MAP OF THE LIMITS OF STATISTICS [9.15.08]
By Nassim Nicholas Taleb

http://www.edge.org/3rd_culture/taleb08/taleb08_index.html

A great article on how the use of conventional statistical tools have made us very very susceptible to the impact of rare events.

The article starts with reference to the ongoing Global Financial Crisis and talks about in general people quantifying risks in a financial system almost dumbed it down to – “It has not happened in the last 30 years and hence its probably not likely to happen anytime soon” while almost the reverse was true.

The gist of the article though is how the current state of Financial Statistics dumbs down the improbable but highly dangerous event while modelling and deciding the future mainly because the probability based on past data fools them. A classic case is the Turkey Story.

“A Turkey is fed for a 1000 days—every day confirms to its statistical department that the human race cares about its welfare "with increased statistical significance". On the 1001^st day, the turkey has a surprise.- ITS THANKSGIVING”

He goes on to create a Mapping this based on two distinct types of decisions - true- false binary type and yes-no but how much - and two distinct types of randomness – mediocristan (the measurable randomness) & the extremistan (the event that hits you out of the blue).

He goes on to explain how because of our fragile theories, a game breaking event can throw everything up in the air. And that’s what seems to have happened in general with the current Financial Crisis. Wise men bet so heavily on the a set of probabilities that were self reinforcing that at the first instance of an anomaly, the whole system collapsed like a house of cards caught in a tornado.

The last section deals with what to do with such extremistan items.

Budgeting Time - A few points

While driving back home yesterday, a thought hit me. I think it was around the time I was hearing somebody talking on the radio about the business of selling money. The whole idea that for banks money was only a commodity that had to be sold to get more of the same back was pretty interesting. In many ways that puts me in the role of a person trying to budget time as a resource. Now this concept is a bit vague in my mind and probably I would expand on this as we go along but its interesting nonetheless. For any project, budgeting time works on many levels similar to budgeting money. You have to identify the activities that would consume time and then allocate time to it. So alongwith money and manpower and equipments etc, time acts as a resource. You need a certain minimum amount of time to do a job. This is expandable to a certain extent without affecting the other activity. However the one aspect that is different here is that time can be overlapped with activities working in parallel and still the total time spent would remain the same. This is a unique aspect that makes it more flexible than other resouces. If money were to behave like this then we would have situations wherein the cost of the project would be the cost of the longest activity and nothing more. So in effect time does not work in the strictly cumulative sense that money does.

The other aspect of time is how the projects work on an external calendar and how that affects the way time is distributed across an activity. This has a slightly lesser impact on the other resources. For example – a set of unforeseen holidays in a project would directly stretch the affected activity’s budgeted time but would have no direct effect on the cost, manpower and other resources. Its when we start quantifying time in cost terms that we start seeing a knockon effect on cost.

The other thing that skews the nature of our dealings with time is that even though we budget time, we are not remunerated back in time. We are remunerated in cost. This is the primary driver of the concept of the cash flow. If for a hypothetical case, remuneration were to be allowed in time too, we would have had a scenario of having time surplus and cash profit at the same time. Again this is a vague concept, but it is not totally new. We get salaries for our work but we also get holidays for every day of our work. The issue with time is that there is always a saving on time but never a time profit. So currently there is no system by which I can claim time or ask for a time credit for a task done early. Interestingly, sometime back I was reading about the concept of time debt wherein I would owe somebody the time that I promised and then wasted.

Another thing with time and the manner we do stuff and the issue of procrastination is to do with risk. Yesterday while talking to Ashwini, I again had a brainwave ( funny how most of these come when I am talking to her). The assertion that I make here is not new but we never perceive it in the manner I am putting it forward. And my assertion is that procrastination after a point of time exponentially increases the risk sensitivity of your budgeted time in the future. Let me make it clear with an example. If I had 4 days to pack my stuff up for a road trip, then by putting it off to the last moment would surely increase the risk sensitivity of my last moment. Any small impact on that last moment would have huge disproportional impact on my project completion. So while it is very convenient and tempting to procrastinate, it is a very costly strategy

Gloating time

Now that I have had my share of crows to eat on the Satyam saga and question Ive had to ask myself on where we were going with regards to Satyam as a company and as an investible stock, let me announce with some self congratulatory glee that if you had been the ones pumping in money when Satyam was around Rs 25 per share , you would have doubled your money today and that is just in 1 month. The underlying logic has always been one of going against the prevailing trend and not to panic. Going ahead from here, this is what I feel will happen with Satyam:

• price will be news specific and will fluctuate around Rs 55 levels till we get concrete news on ownership change.
• and once that happens, the share will start floating along with the general sensex.

So my recommendations are:

• buy on every fall. Be prudent and dont overdo it, the general trend for this stock seems to be up only

On a different note though:

How many people today believe, that the Zimbabwean dollar is a good investment avenue. I know this will be a conventionally nonsensical idea but I have a feeling that judging by the manner in which the currency has depreciated, anytime in the future the currency starts to appeciate, it will do so in much the same manner. Again, sentiment seems very much against the currency and any minor good news will drastically improve the returns. So do we start buying our 1st billions of Zimbabwean dollars?

http://www.businessweek.com/bwdaily/dnflash/content/jan2009/db20090116_786365.htm

So it appears, not all is gloom and doom in a recession. A very nice article from BusinessWeek about recession unaffected jobs. Some of them are quite logical, trades relating to repair tend to perform better as people resort to more reuse, so does training and education.

Satyam scam: It was there, we refused to look

http://economictimes.indiatimes.com/articleshow/msid-3968559,flstry-1.cms

finally somebody’s putting 2 n 2 together.

What is a 'strong balance sheet'?

http://www.equitymaster.com/detail.asp?date=1/12/2009&story=

The Satyam Saga continues ....

Raju yesterday declared that he was a fraudster. And this melted Satyam’s stock value by 90%. Some people made a lot of money selling short but a lot other have panicked. The questions remain though. And for some reason, the figure don’t seem to add up.

• If Satyam does not have any money now, how does it propose to pay salaries to its employees.
• A collorary to the above, if satyam had gone ahead with the deal to buy Maytas with its fictitious money, then how did Satyam propose to pay its employees and the suppliers?
• How has satyam been giving dividends all this while?
• How come there were talks of a buyback coming from the company when the actual situation was so dicey?
• How did PWC did not manage to check the big hole in the balance sheet?
• What is the value or EPS of the share now?
• What happens with the management now?

The situation is still dicey with a few people now suggesting that raju did manage to siphon off the money and now is lying about it not being there….

Some of the coverage doing rounds…

http://www.dnaindia.com/report.asp?newsid=1219762
http://www.dnaindia.com/report.asp?newsid=1219704&pageid=0

Looking beyond...Should I be hedging against inflation??

http://freakonomics.blogs.nytimes.com/2009/01/05/investment-tips-for-retirees-worried-about-inflation/

Now this is really interesting… Due to this whole business of injecting liquidity and easing credit crisis, one thing we are surely going to launch headlong into is INFLATION. Big and nasty and probably again commodity driven (because of their depleting nature), read mainly OIL. The big question here not IF but WHEN. And WHAT are we doing about it from a personal investment point of view?? All ideas welcome… Here’s to start this…..

· Start buying into commodity stock and companies. (Ensuring at the same time that they would survive this slump)

· Start buying into Gold????

The Traffic Paradox - Do additional lanes contribute to overcrowding?

http://query.nytimes.com/gst/fullpage.html?res=9C0CE7D81530F936A15751C1A966958260&sec=&spon=&pagewanted=all

A very interesting article on how traffic congestion can paradoxically increase on the additional of additional lanes and vice versa. Essentially it implies that by suggesting that an additional option is available to people, the existing system tends to slow itself down as everybody crowds to the same route. Traffic is something I have begun to understand quite well in the past years and this brings a new perspective it all.

Getting Things Done- A review

http://www.thesimpledollar.com/2007/05/06/review-getting-things-done/

A really nice review of this Iconic book on Productivity. Courtesy The Simple Dollar.