Presentation to Data Scientists of Stamford

1. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Information, Knowledge, Wisdom
The Case for Modesty
February 22nd, 2017

2. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
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Agenda
• Conceptual Models
• Gaps in Understanding
• Informational – statistics
• Structural – over-determined equations
• Behavioral – rational irrationality
• Opportunities – case study

3. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Conceptual Models
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4. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Conceptual Models
Model: One mps Fast
One meter Newton Einstein
Small Quantum Umm…
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5. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Ways of Knowing
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Statistical
Recency, fit vs. Credibility, smoothness
Structural
Wisdom of crowds vs. Validate, curate
Behavioral
Think fast vs. Think slow

6. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Gaps in Understanding
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7. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Statistical
• Jeff Wu: data science is statistics
• data collection / data modeling & analysis / decision making
• Brawlers, drunkards and gamblers
• “The candle’s not worth the game” but how to divide the pot?
• “What do we know, and how do we know it?”
• Classic statistics
• When life is binomial, the Normal is…convenient
• Fat tails and the real reason for Black Swans
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8. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Statistical
• Metaphors from biology
• Blind trial and error
• AI and emergent behavior
• Genetic algorithms in particular
• Ants / irregular vessel / chemists
• But is there a signal in trading history?
• Appropriate applications
• engineering, pharma, industrial, logistics…
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9. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Structural
• Free markets
• Wisdom of crowds is better than top-down, and
• Not perfectly efficient, but
• Always the direction of the restoring force
– Continuous, infinitesimal, instantaneous adjustment
• Principle of over-determined equations
• More constraints than variables (¥/$ forwards)
• Now regulators are players (“iatrogenic disease”)
– Regulatory capture goes both ways
• Unavoidable, unintended consequences guarantee arbs
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10. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Structural
implied forward…
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$ interest rate: 4.0%
¥ interest rate: 0.5%
¥/$ exchange: 120.0
$100,000
¥12,000,000 ¥12,060,000
¥/$ 120 ¥/$ 116
$104,000

11. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Structural
...except not
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80
90
100
110
120
130
140
150
¥/$ Exchange Rate

12. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Behavioral
• Retail
• Adaptive “arms race”
– Inventory risk, timing of sales, promotions
– Example - visit site without action, wait for follow-up coupon
• Psychological segments require multiple channels
• Financial markets
• Euphoria & panic
• Misaligned incentives
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13. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Summary
• Statistical
• Data quality, quantity, recency, credibility
• Unrecognized correlations
• Mechanical
• Over-determined equations
• Model structure, relationships
• Behavioral
• Rational irrationality
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14. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Case Study
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15. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Case Study
• Microinsurance
• Coffee growers at risk for “rust”
• Find a way to price that risk, and then hedge it
• Challenges
• Incomplete understanding of infection and its life cycle
• Scarce history of outbreaks
• Lack of data on conditions favorable
• Perspective
• “if you were the rust…”
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16. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Case Study
• “What do we know, and how do we know it?”
• Bayesian prior
• All life is in an arms-race
• Hosts and parasites co-evolve
• Epidemiological patterns; the comparables offer information
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17. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Case Study
• Crypto-sexuality
• Evidence of non-clonal evolution
• Adaptation to coffee’s defenses
• Interrupt. Identify and target the secondary host
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18. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Case Study
• Big Data to identify proxies
• Guided search for operational factors
• Environment, genetics, unanticipated relationships
• Wisdom of Crowd
• Sell forward part of the crop, “at-risk,” for a discount
• That sets a maximum hedge cost
• Fill the behavioral need
• Optimize pre-sales
• Social preferences, political priorities
• Subsidized financing at a fraction of policy limits
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19. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Discussion
• Challenging questions
• Thoughtful replies delivered with quiet confidence and
dry humor, demonstrating sophisticated understanding.
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20. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Supplementary Material
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21. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
The Real Paradigm Shift
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versus
Remember, at one time ‘auto mechanic’ was high-tech

22. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Correlation ↔ Causation
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http://datarep.tumblr.com/archive

23. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
Best Discipline
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24. Risk Finance Advisors
©1999-2017 Risk Finance Advisors
With great abstraction come great responsibility
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