StreetEYE Blog

100 traders, 100 boxes

A math/probability problem I think is awesome and counterintuitive, and may be instructive about financial markets:

A hedge fund manager puts 100 traders in a room and instructs them:

“On the trading desk, there are 100 boxes. Each box has one of your names. You can go onto the trading desk and open any 50 boxes you choose, to try to find your name. If every one of the 100 traders in this room finds his or her name, you will each get a $1,000,000 bonus. If anyone fails, I will crush all your $100,000 BMWs to create my modern art masterpiece. You can devise a strategy before anyone leaves the room, but once a trader has opened the boxes, they must leave the trading desk exactly as it was before you entered and cannot communicate with anyone else.”

Questions: Should they take the bet? Is there a correct strategy? What is the probability all 100 will each find their name?

A hint, if you want one, by copy and pasting the lines below.

Hint: the answer to the first question is yes. Try to work out the same problem with two traders and two boxes. What is the strategy and approximate probability of success?

Answer tomorrow.

We make our tools, and then our tools make us

Combat in Grand Theft Auto IV has been reworke...

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You didn’t change the game, the game changed you. – Niko Bellic, Grand Theft Auto IV

Everything that’s already in the world when you’re born is just normal; Anything that gets invented between then and before you turn thirty is incredibly exciting and creative and with any luck you can make a career out of it; Anything that gets invented after you’re thirty is against the natural order of things and the beginning of the end of civilisation as we know it until it’s been around for about ten years when it gradually turns out to be alright really. – Douglas Adams

So here is my rant about CDS, a topic I know very little about.

Christine Lagarde has said that a Greek restructuring that would create a credit event is ‘off the table’. Now, inevitably, politicians talk out of both sides of their mouths to avoid roiling markets. But I have seen three different pundits talk about a Greek restructuring that would be done in such a way as to avoid triggering CDS default provisions. This makes no sense.


The bottom is always at least 10% below your worst case expectation

Black Swan, Lake Monger, 2010.

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‘Black swan’ is a term which is overused and under-understood.

1) Evolutionary psychology: Humans aren’t very good at math, but especially intuitions about probability, and improbable things happen more often than we expect.

2) Behavioral economics (or evolutionary psychology part deux) – we feel worse about negative outcomes – a small negative surprise is felt disproportionately sharply relative to a small positive surprise. When humans were evolving on the brink of survival, a small negative weather surprise was the difference between life and death.

So we are risk-averse, and more sensitive to downside risk. But 3) The universe is perverse. Edifices take years to build up. When someone screws up, they collapse or burn down in seconds. The character and probability distribution of downside risk is different from upside risk. When things go bad, they don’t break gracefully, but with chain reactions and unintended consequences. Then they get worse, when people panic and do precisely the wrong thing at the wrong time.

Call it Murphy’s law, or vol skew, the ‘black swan’ event is just another name for entropy in action.

What is money?


Cover of Plato

As far as the laws of mathematics refer to reality, they are not certain, as far as they are certain, they do not refer to reality. – Albert Einstein

This is all Plato’s fault – he founded Western philosophy on a theory of absolute reality, which humans vainly attempt to discern, like cave-dwellers pondering the source of shadows dancing on a wall. 

A good metaphor, but modern science has given the existence of absolute reality a few hard knocks. Heisenberg showed that you can never perfectly know the location and velocity of an object. The more accurately you measure where it is, the less accurately you know where it’s going. It doesn’t even make sense to speak of particles as having absolute attributes, they are better understood as clouds of probability distributions. Space, time, mass stretch depending on the motion of the observer.

Interactions between particles seem more tangible than the particles themselves; you either observe an interaction, or you don’t. And what is a particle except how it interacts with other particles? Suppose there were only a single electron in the universe, would it still be meaningful to say that it has a charge of -1.602 x 1019 coulombs, if there were no other particles and fields for it to interact with? What is the sound of one hand clapping?

Is there a ‘form’ of a chair? Or is it a chair if it’s something you can sit on?

Which brings us to money.


6 Reasons Why There Will Be No Chinese Jasmine Revolution

Ai Weiwei during documenta 12 (2007)

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The Chinese government has taken insecurity and paranoia up a notch in the wake of the Jasmine uprisings in the Arab world. They have ‘disappeared’ dissident artist Ai Weiwei and cracked down hard on human rights activists, meddlesome lawyers, and dissidents.

That is reason number one there will be no revolution in the near future: the government is perpetually on guard against any threats. China is not a police state like East Germany was. Individualism thrives. But the government sets down bright lines. You can do or say anything you wish, as long as you do not threaten the legitimacy of the Chinese Communist Party’s hold on power. If you do, the full force of the state will be brought to bear.


Questions for Gentle Ben

Official portrait of Federal Reserve Chairman ...

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A question for Ben Bernanke at today’s press conference:

• In 2005 at your confirmation hearings, you said there was no housing bubble.

• In 2007, you said the subprime fallout was likely to be contained.

• In 2008, you said you didn’t expect a recession.

• In 2009, you said the Fed would not monetize US government debt.

• In 2010, you said inflation was too low.

Question: Are we supposed to laugh or cry?

Can the US default on its debt?

The S&P rating downgrade was deservedly greeted as a big joke.

Can the US default? Technically, the US defaulted twice in the 20th century, when it devalued the dollar against gold in 1933 and when it went off the gold standard completely and officially in 1971.

But can a sovereign nation default on domestic fiat currency debt? In theory, it can always print money to honor the obligations. In practice though, it has happened, in two scenarios. One is a change in government, like Vietnam, Burma, and Russia (1993). Another is as part of radical shock measures against hyperinflation or similar turmoil, as in Argentina, Brazil, Russia (1998).

Hard to argue that fiscal deficits > 10% of GDP are sustainable. Getting on a sustainable path needs a combination of growth, spending cuts, tax hikes, and inflation. Also hard not to notice the people making the biggest noise about it just held up the President to get tax cuts for the rich extended, and the overall tax burden in terms of receipts as a percentage of GDP is at a historical low.

Logically, default seems like an impossibility. But economic models, by definition, don’t take account of human idiocy.

From the unthinkable to the inevitable: why the Euro is doomed

American economist Tyler Cowen

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The brilliant, provocative, and slightly mad GMU economist and blogger Tyler Cowen wrote his New York Times column about why the Euro zone is headed for breakup. I get the sense an editor read the column, spit out his coffee, and smacked a headline on it that buried the sensational implications, which may be prompting calls from Euro-mandarins to Sulzbergers as we speak.

Here is why the Euro is ultimately doomed:


Why I am not a libertarian

Atlas Shrugged

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I have been reading the poor reviews of Atlas Shrugged. I feel almost disappointed that it is by collective consensus a steaming turd. I would welcome a thoughtful movie about an interesting thought experiment, and I think the country could use a rare substantive debate about the size and role of government.

I like the libertarian ideal of as much economic and personal freedom as possible, consistent with the equal liberty of others.

Nevertheless, people who believe in Libertarianism or Objectivism as a practical political ideology are a bit wacko.

Communists made the unfortunate claim that the individual doesn’t matter, everything is the collective. Individual property is illegitimate, every speech or action is good or bad depending on its impact on the collective. It was a terrible, harmful corruption of an ideal of equality to say individuals don’t matter, only the group matters.

Libertarians make the opposite claim, that individual rights and liberty are all that matters. This reaction to a profound error leads to another profound error.


‘Bretton Woods 2’

A lot of cool videos from INET’s Bretton Woods conference last week. Kind of like TED talks for econ supergeeks.

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