Economic slowdown Problem lesson and solution

Einstein: Predicted the Economic slowdown and related problems caused due to over use of mathematics when he said.
Albert Einstein said “Elegance is for tailors warning against mathematics do not believe in it only because its beautiful formulae”.
A monster called Synthetic CDO which was created caused the episode Financial crisis Investment banking fund demonstrated this overindulgence with mathematics..Sentiments are Psychology and sociology, the fundamentals are economics, finance and Mathematics is just calculation…What buddha said everything is in balance who can balance who is equal in all areas..who can do justice to each area and no preference of one. Its easy to make 200 rupees from 100 rupees but its difficult to make 200 crore from hundred crore because it averages out..hedge funds invest in bulk in big ticket investment which has similar effect the Macro and micro Economics conditions from time to time influences the particular sector with high growth trajectory..but the is law of diminishing marginal utility which when applied to market reads more and more market absorb money the return averages out.person increases consumption of a product – while keeping consumption of other products constant – there is a decline in the marginal utility that person derives from consuming each additional unit of that product.

The utility of sector such as now biotech decreases out as more and more its absorbed in market. same way as we consume sweet first time we feel its very sweet as well marginally increase sweet amount of value we drive from it single unit decreses marginally

In buffet-style restaurants operate. They entice you with “all you can eat,” all the while knowing each additional plate of food provides less utility than the one before. And despite their enticement, most people will eat only until the utility they derive from additional food is slightly lower than the original.
Excellent Example: say you go to a buffet and the first plate of food you eat is very good. On a scale of ten you would give it a ten. Now your hunger has been somewhat tamed, but you get another full plate of food. Since you’re not as hungry, your enjoyment rates at a seven at best. Most people would stop before their utility drops even more, but say you go back to eat a third full plate of food and your utility drops even more to a three. If you kept eating, you would eventually reach a point at which your eating makes you sick, providing dissatisfaction, or ‘dis-utility’.

Quant of Investment banking depend on complex mathematics to predict interest rate of future, or how volatile interest rate in future,or prepayment be in future and translate into price depends on your view but mathematics did not cause financial crisis its the greed which caused financial crisis.It  can be corrected to win win for everyone what is needed is middle path which drives equal respect to Economics,Mathematics,Psychology,Sociology are are equally important.Mathematics is just medium if we do not quantise everything we cannot relate and predict it would be worst situation.But problem is actually these models are not predicting they are a views you body can predict in accuracy how many people are going to prepay there mortages or are going to default in future, or how many company are going to default in future.Its put in algorithms and then for sometime its very statisfying to see everything working according to it.CDO were excellent instruments where anyone get to choose from all risk first packaged into one bond then it can be sliced and diced based on risk you want to take you get to choose the slice.To Sell CDO you need to have big profit margin to cover risk or margin for error.When diminishing marginal utility comes into picture..First utility is great so everyone wants to enter in CDO then more people enter the competition increases the profit margin shrinks. the CDO brand then gets commoditized  which leads to fall in profit which investment banking firms it profit decrease but margin for error is more people enter market in CDO the size of investment becomes huge leading to fall in profit..and making it exposed to risk of margin of error which is not covered due to increased competition.Danger of mathematics credit derivatives become evident.

Minimal computation: abstarct manipulation of symbols,ability to see patterns in abstract mathematical symbol.Like probability of  housing loan defaults happening with behaviour of two companies going independently vis correlation the factors of probability of risk is these mortgages interest with each other..but this is not problem then assumptions are made on top of it then its incorporated into model.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s