Posts filed under “Philosophy”
I very much appreciated this perspecitve offered by Dylan Grice of Société Générale:
“All outcomes are caused by an underlying process. In very general terms, all we did by constraining the QI to have a 2% tracking error was impose an outcome on a process. But as soon as we did that we also changed the process. Instead of including stocks that matched the criteria we were looking for, we included stocks that didn’t because doing so helped us hit our tracking error target. But once we change the process we necessarily change other outcomes. Thus, while we achieved the outcome we were targeting, we negatively affected the outcomes we weren’t targeting (returns, volatility and drawdown). The overall effect of targeting one outcome was then detrimental.
It might be tempting to think that tracking error is just the wrong thing to target. But I’d argue that for even mildly complex systems, any outcome is the wrong thing to target. As we just saw, targeting one outcome of such a process changes that process, and changing the process subsequently changes all the other outcomes. In any kind of complex system where the underlying outcome generating processes aren’t well understood – whether a company, or a society – the effects of changing the process won’t be well understood either. Unintended consequences must ensue.
Yet even a cursory glance at the news shows ‘outcome targeting’ to be endemic: in response to the damage caused by Basle II, we’re given the ‘new and improved’ targets of Basle III (now already being traduced); the insurance industry now faces Solvency II targets; investors fret that banks won’t be able to hit their RoE targets; investors wonder if China will be able to hit its 8% GDP growth target; most major central banks target some sort of CPI inflation rate.
This is lunacy. How much damage has already been caused by banks that overreached themselves in trying to meet their RoE targets? How lopsided and capital destructive has China’s insistence on hitting its breakneck GDP growth targets at all costs been? How much of today’s painful credit deflation was caused by the credit inflation central banks pumped up while aiming for their CPI inflation target? In targeting these outcomes, underlying processes were distorted. Unforeseen outcomes resulted. But regulators continue to prescribe capital targets, banks continue to target RoE, China continues to target a growth rate, and central banks continue with ever more experimental methods in defence of their inflation targets. Indeed, today in Europe we’re seeing the unintended consequences of imposing outcomes (i.e. an exchange rate) on the eurozone economies.”
Good stuff . . .
Popular Delusions The tyranny of targets: process, outcome and the complexity of it all
Société Générale, GLOBAL STRATEGY 15 June 2012
“Economics is a faith-based pursuit forever in search of a new deity . . . Each of the gods has been worshipped with the fanatical fervour of the convert. What is curious for those sitting outside the sacred circles is that the apostles show not the slightest hint of self-doubt. The Treasury has become…Read More
Last weekend, I got into — or more like watched — an interesting finance debate related to specific policies, websites, officials and analysts. All the usual suspects were covered. One person went on and on about central-bank planned economies, manipulated currencies, debasing of the dollar, gold, HFT, etc. “Its all a Ponzi scheme” he declared,…Read More
> Over the weekend, Josh Brown directed me to this monthly commentary from the Eclectica fund, which had the very interesting chart, above. (Full Eclectica Fund April 2012 commentary is here). The issue with the graphic above is that we have no real comparative history by which to judge this. It seems to be a…Read More
“Here’s to the Lazy Ones. The halfwits, the bumblers, the square pegs in the round holes. The ones who don’t see things at all. They’re not fond of rules (can’t remember them). They have no respect for the status-quo, which they think its Latin for Fendi. You cannot quote them, as they say little that…Read More
This is the single cleverest thing I expect you will read all weekend: Facts, 360 B.C.-A.D. 2012 In memoriam: After years of health problems, Facts has finally died. A quick review of the long and illustrious career of Facts reveals some of the world’s most cherished absolutes: Gravity makes things fall down; 2 + 2…Read More