Monday, May 21, 2007

The Challenges of Forcasting In Finance

Mises writes in Profit And Loss "If all people were to anticipate correctly the future state of the market, the entrepreneurs would neither earn any profits nor suffer any losses. They would have to buy the complementary factors of production at prices which would, already at the instant of the purchase, fully reflect the future prices of the products".

At the recent Derivatives 2007 conference at the NYU Stern School of Business, Emanuel Derman critisized the use of models in the practice of derivatives trading. He stated, "If models can predict prices, there would be no markets!"

Indeed, consistent with von Mises, is that uncertainty is what truly drives market activity. The market for derivaties and securities is driven by the uncertainty of market players. While the original Black Scholes model was able to calculate the price of an option independent of supply/demand factors of the underlying asset, in practice true market activity is driven by the uncertainty.

1 comment:

JHS said...

This is possibly the most fascinating thing I have ever read - at least today, anyway.

Great writing.