Archive for February, 2008

Michael Lewis has an article about how the markets have begun to realize that the Black-Scholes model for risk doesn’t really work:

“No one believes the original assumptions anymore,” says John Seo, who co-manages Fermat Capital, a $2 billion-plus hedge fund that invests in catastrophe bonds—essentially bonds with put options that are triggered by such natural catastrophes as hurricanes and earthquakes. “It’s hard to believe that anyone—yes, including me—ever believed it. It’s like trying to replicate a fire-insurance policy by dynamically increasing or decreasing your coverage as fire conditions wax and wane. One day, bam, your house is on fire, and you call for more coverage?”

Does this mean they have to give back the Nobel prize? I would have thought Black-Scholes was pretty universally questioned after the whole LTCM fiasco


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