» The Misbehavior of Markets: A Fractal View of Financial Turbulence

The Misbehavior of Markets: A Fractal View of Financial Turbulence Reviews

Customer Rating:
Summary: Limited Value
Comment: Mandelbrot describes some problems with financial models that are designed to provide approximations of things that can't be perfectly modeled. He pretends that pointing out the dangers of relying too much on imperfect approximations shows some brilliant insight. But mostly he's just translating ideas that are understood by many experts into language that can be understood by laymen who are unlikely to get much value out of studying those ideas.
His list of "ten heresies" is arrogantly misnamed. Sure, there are some prestigious people whose overconfidence in financial models leads them to beliefs that are different from his "heresies", but those "heresies" are closer to orthodoxies than they are to heresies.
His denial of the equity premium puzzle is fairly heretical, but his argument there is fairly cryptic, and relies on suspicious and poorly specified claims about risk.
He says market timing works, but the strategy he vaguely hints at requires faster reaction times than are likely to be achieved by the kind of investor this book seems aimed at.
His use of fractals doesn't have any apparent value.
Mandelbrot is primarily a mathematician with limited interest in understanding how markets work. One clear example is his mention of a time when Magellan "was still a small fund, too small for any detractors to argue that its size alone gave it a competitive edge". Any informed person should know that's completely backward - larger funds have a clear disadvantage because they are limited to trading the most liquid investments.
Another example of a careless mistake is when he claims the evidence suggests basketball players have hot streaks, seemingly unaware that Tversky and others have largely debunked that idea.

---

Customer Rating:
Summary: Outstanding explanation of math and markets
Comment: To begin, I am not a mathematician or investor, however, this book opened the world of those topics to me in an understandable way. The author is an out-of-thebox thinker who clearly explained the topic well, causing me to investigate the ideas more.

---

Customer Rating:
Summary: Exposing the Cracks in the Facade - But Not Filling Them In
Comment: First, a warning. This is not a book that's going to teach you how to predict the markets. If you're looking for that kind of book, look elsewhere. In fact, if you're looking to learn about trading or investing in the markets, this is probably not a good book for you. This is not an overly practical book in terms of providing any methods or techniques for use in your day to day trading.

The (Mis)Behavior of Markets is much more along the lines of a scholarly discussion of prices. For those with a desire to understand how prices move, this is a good book. In particular, it's great for understanding why it is that even the supposedly best and brightest (like Long-Term Capital Management - LTCM) could get it so wrong. In short, much of what university economics and finance departments have been teaching for years is at best misleading and at worst dangerous.

I must state for the record that I have long held a less than aggreeable view toward efficient market theory, Black-Scholes, random walk, and all of that stuff. It goes back to my days as an undergraduate finance student when I just intuitively didn't believe what I was being told and often saw the major flaws. When I started working in the markets I saw first hand how ridiculous many of the underlying assumptions behind classic financial theory really are.

In The (Mis)Behavior of Markets Mandebrot takes on classic financial theory in a very straightfoward manner. He is extremely critical of the way economic (and by extension financial) theory has been developed and moved forward. He spends a fair amount of time explaining how the now classic theories of price movements came about, which I found interesting since I'm a bit of a history buff.

From what I understand, many of the things that I used to gripe about with my professors as being major problems with classic finance have finally been recognized in recent years by academia as just that. This from a professor friend of mine. I don't know whether or not things have changed in what's being taught, though. My impression is not so much, which to me seems a major disservice.

The thing I found most interesting in the book was how all these theories have been torn apart, not just recently, but for decades. Mandelbrot and others figured out very early on that price changes do not conform to a normal bell shaped distribution. They also figured out that price changes are not independent (among other things). Those are two major capstones underlying efficient market and random walk theories and the pricing of options using Black-Scholes.

The thing that really irks me is that none of these critiques were ever presented to me in the classroom. We were just taught the same stuff that had been taught for years and years with no perspective on how research was showing major problems.

The biggest thing Mandelbrot focuses on in terms of the implications of all the errorenous assumptions is the implied risk. He points out that things like the Crash in 1987 and other market shocks in recent years were also so improbable as to be beyond any reasonable expectation of classical theory. Given how many securities are priced using models based on that classical foundation, and how the commonly employed Value at Risk (VAR) calculations are similarly based, you can see how this is a major problem. Investors and institutions have been taking much more risk than they thought. This is something which once again became readily apparent last summer as the credit crises exploded.

Mandlebrot, naturally, presents a different way of looking at price movement - one founded in his fractal theories. He readily admits, however, that it is still early in its development. Much more work and research needs to be done. One cannot use anything he presents in the book to help forecast prices, though it can help to understand better how prices move, and thus by extension the risk of financial assets, which is a benefit of potentially enormous value on its own.

To be honest, the discussion of the fractals and such was the least interesting part of the book for me. That could just be my practitioner's perspective, though. Others might be much more facinated. I personally am far from convinced that mathematics is ever going to be suitably useful in price forecasting the way people seem to think it will.

All in all, I would call The (Mis)Behavior of Markets a good read. It's informative and thought provoking, but doesn't bog the reader down in a gread deal of math and complexity (there's an appendix for those inclined in that direction). If you are at all intellectually curious about the financial markets, this is definitely a book worth reading.

---

Customer Rating:
Summary: No doubt about it: Mandelbrot is smarter than you are
Comment: Mandelbrot is quite a character. I admire the guy's independence, his creativity, his chutzpah and all his achievements in the world of mathematics. However, this book is an intellectual rat hole. This is the type of book you could read and immediately feel smarter than those silly practitioners who have to make do with bad models, like the Gaussian and the CAPM. But the fact of the matter is, Gaussians and CAPM are a good way to go. A good fraction of modern life is based on these models. Anyone who has worked with the actual financial data for a few seconds will realize they're baloney (at least compared to models like Maxwells Equations), but they still are quite useful. Mandelbrot makes it sound as if some lone genius might some day come up with a mathematically perfect distribution which works better than a Gaussian and steal all the MBA's money. This is not a useful way of thinking about things, to say the least. Mandelbrot doesn't point us towards the useful ways of thinking about such things.

While Mandelbrot stands at one fat tail of his statistical distribution, this book is somewhere in the opposite tail. Don't waste your time.

---

Customer Rating:
Summary: Lack of substance
Comment: Mandelbrot & Hudson attack some popular thoughts on how financial markets work and try to set up a model to replace them.

There are two main focuses of attacks: that returns follow a normal or Gaussian distribution and that future returns are independent of past returns. The attacks are effective - the authors show that these are false and therefore any existing model based on them is doomed.

Next, the authors try to argue that returns follow a "multifractal" - a fractal both in value and a fractal in time. Using this model, they can create pictures of financial returns that are difficult for people to differentiate from real financial returns.

If the pictures were easily distinguishable, it would disprove their model. However, the converse is not true. Just because the pictures are indistinguishable, it does not mean that the model is correct. In fact, the authors are hard pressed to tell the reader how to build a model for a particular financial market and show zero results in using the model to predict a financial market (which is the true measure of the value of a model).

To conclude, the book does a good job of dispelling some myths. However, it's argument for multifractals is that they are worthy of consideration of future research. And given that they cannot even show how to build a multifractal to model a particular market, it is doubtful that they are worth considering at all.

---

More Reviews for The Misbehavior of Markets: A Fractal View of Financial Turbulence