Book reviews

#Lecturing Birds on Flying: Can Mathematical Theories Destroy the Financial Markets? (Pablo Triana)

http://www.amazon.com/Lecturing-Birds-Flying-Mathematical-Financial/dp/0470406755

Like Nicholas Taleb, who wrote the foreword, Triana is a strong opponent of the mathematicization of finance. Key points include:

1. The over-reliance on financial models that assume that financial data have a lognormal distribution.

2. Business schools do not provide enough of a practical education. Instead, they have sought out professors who do too much theoretical work—leading to a further fetishization (my words) of mathematical models.

3. He claims that financial markets will be better off without mathematical models that give us a false sense of security; they knew how to price products effectively before mathematics came on the scene (hence, “lecturing birds on flying”).

These points are not without validity; it is true that mathematical models, and their spinoff products, like Value at Risk (VaR), the Black Scholes model of option pricing, have led created a false sense of security that contributed to the financial crisis of 2008–2010. This is no doubt due to an ignorance (wilful or not) of the assumptions behind such models.

Triana is in a good position to critique these problems: he has the academic pedigree—an NYU postgraduate degree in finance—as well as the experience in trading to know what worked and what did not.

However, the points that he wishes to make does not warrant the length of the book. There is a lot of repeated material, and after some time the book becomes a tirade, and tiring because there is no new insight.

Second, one might wonder whether the flaws of existing models should lead to a complete denial of the value of academic research in finance. True, the existence of models, developed by academics and researchers, led to their adoption as practitioners sought out better ways to make money. However, I think that their flaws, and their terrible consequences for the economy, still do not mean that they should be banned. There is no way to ban them, anyway, and what is better is greater awareness of their shortcomings, especially on the part of regulators. And research promises us the possibility of better models that capture the behavior of existing data.

Lastly, it is unclear if a world without models is truly desirable; mathematical models did not exist before the late 19th century (when Brownian motion was used to model data), but financial crises predate this date. That said, we can’t say for sure whether early crises are due to other factors, such as the lack of regulation.

Reviews on Amazon also point out other flaws, e.g. the lack of evidence that mathematical models caused the October 1987 crash, as Triana claimed.

The book could be improved if it were made more concise, given more depth, and more data on how mathematical models came to be adopted over time. Triana should have enough mathematical background to deliver a clearer critique of the models, for example.

#The Game Makers: The Story of Parker Brothers, from Tiddledy Winks to Trivial Pursuit (Philip E. Orbanes)

This was a much easier read compared to Lecturing Birds on Flying. Orbanes was a former executive at one of the modern day incarnations of Parker Brothers, and had access to company archives and longtime employees, as sources for his history of the company. However, his position also makes me wonder about the objectivity he brings to the telling of the story (note the choice of word: “story”).

From a “literary” standpoint, it is interesting to see that Orbanes uses George Parker’s (the founder) twelve business principles (see below), and attributes George Parker and his successor’s success/failure according to whether they stuck to these principles or not.

#George S. Parker’s Twelve Business Principles

1. Know your goal, reach for it.
2. Find “winning moves.”
3. Play by the rules but capitalize on them.
4. Learn from failure, build upon success.
5. When faced with a choice, make the move with the most potential benefit versus risk.
6. When luck runs against you, hold emotion in check and set up for your next advance.
7. Never hesitate and give your opponents a second chance.
8. Seek help if the game threatens to overwhelm you.
9. Bet heavily when the odds are long in your favor.
10. If opportunity narrows, protect your strong points.
11. Be a gracious winner or loser. Don’t be petty. Share what you learn.
12. Ignore principles 1 to 11 at your peril!

But overall I found Orbanes a fair historian. Although he did not explicitly name flaws with the first generation’s management of the company, the “problems” are still evident: child labor, haphazard production methods, poor expansion planning (choosing to add on to existing facilities than to expand properly). The measures undertaken by George Parker’s successors also show that these were problems even in their eyes.

It was also interesting to see the applications of corporate finance in the case of Parker Brothers, a labor-intensive firm that is heavily dependent on new products for revenue. Funding was always a problem, not least because successful products sold in the millions, and there would be a need to re-kit. But raising funds was always difficult; loans were expensive and capped profits for the owners, while issuing stock diluted existing ownership and exposed management to the scrutiny of the market. The conservative management of the company, as well as its need to continuously develop new products (the long-term success of Monopoly, as we see, is an exception), meant that investor scrutiny could damage the company. The latter we saw in General Mills takeover: management was placed under pressure to deliver constantly.

The book however tends to treat dips in the company purely as leadership failure, but leaves out the role of rapid changes in consumer habits and technology (e.g. television, video games) that made it difficult for the company to adapt, e.g. because it lacked the funds and expertise. The lack of expertise can be partly attributed to legacy—a burden produced by an institution’s history—cannot be denied.

In the book, Parker Brothers as an entity ended the 20th century as a niche toy-maker (very rightly pointed out by an Amazon reviewer), and not the leading toy-maker as it was in the 1930s and 1940s. Is this a deterioration of its position? Probably. But it was also part of a bigger brand (Hasbro). In my reading, to survive the changes of the mid-century, the company would have to diversify, and maybe consolidate with its rivals, which is indeed what it did, albeit after taking a slightly tortuous route.