The Bankwatch

Tracking the consumer evolution of financial services

How bankers took mathematics and misused it

Within the world that we (most readers of this blog)  live in, the words "’financial innovation’ means new online banking services or adding pfm capability to banking services online.  Its all about online.

The major lesson for me from the credit/banking crisis is what financial innovation actually means to the financial community.  Gillian deals with it in this excellent piece.  Financial innovation to the rest of the world means creation of derivatives.

Mathematicians must get out of their ivory towers | Gillian Tett

No longer. In the three years since the financial crisis exploded, financial mathematics has come in the line of fire, with “quants” and models blamed for fuelling the banking woes. Hence Dr Johnson now has his work cut out, as he tries to defend the world of maths. Or as he told a conference this week: “There [is] a sense of bewilderment amongst mathematicians [about] the view that mathematics was responsible for the crisis.”

While it is a narrow view there is not doubt it is a significant view in terms of the impact on the banking industry.  She goes on to point out the philosophical differences that are arising as the debate evolves amongst the mathematicians, economists and sociologists.

The good news is that if these types of endeavours swell, it could potentially change how financial economics and mathematics is done. The bad news, however, is that it is still unclear whether this will occur. The level of debate between the mathematicians, economists and sociologists remains pretty low. And while many intellectuals and regulators in Europe now seem open to a radical new debate, the intellectual climate in America appears far more constrained. So much so, in fact, that when Mr Soros held the inaugural conference for his institute, he deliberately did this in the UK – and not the US, where (he claims) the sense of intellectual conformity remains too strong.

Then the clincher.  The admission that math is not a perfect science and in fact is used by mathematicians as something to explore.  Yet bankers used it based on assumption of precision and perfection.

Moreover, rewriting the rules of financial mathematics – or economics – risks challenging many vested interests. After all, it is far easier for a Wall Street bank to make profits by plugging numbers into a crude model, than to admit that money could be a cultural or relativist construct.

Nevertheless, now, at least, there is a chance to reshape the debate. What really damaged the financial system in recent years was not so much “maths” or “economics”; instead the crucial problem was bad maths (and economics) that was used and abused. Now, more than ever, mathematicians need to get out of their ivory towers or back offices and state that loudly, not just for their sake, but for economists. And, of course, those bankers.

Written by Colin Henderson

April 15, 2010 at 22:39

Posted in Uncategorized

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