Complex math fails in investing

August 23rd, 2007

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Today, we saw this article in the Washington Post: For Wall Street’s Math Brains, Miscalculations. In that article, it reported that

… Goldman Sachs’ Global Alpha quant fund lost 27% of its value had lost 27 percent of its value this year because its computers failed to anticipate what the firm called “25 percent standard deviation moves” or events so rare Goldman had seen them only twice before in the firm’s history.

For those who do not know what a quant fund is: it is basically a fund in which computers and mathematical models take over the decision-making process.

For those of us who had already read Nassim Nicholas Taleb’s provocative book, The Black Swan: The Impact of the Highly Improbable, this is hardly surprising. As we said before in How the folks in the finance/economics industry became turkeys?Part 2: The Bell curve, that great intellectual fraud, using complex mathematics to make automatic investment decisions is not ?scientific? at all?in fact, it is pseudo-scientific. In this example, using pseudo-science can have devastating consequences to your financial well-being.

So, beware of salesman touting funds that utilises mathematics so complex that only a genius can understand. Chances are, it is another case of obscurity through complexity.