Welcome!

Web 2.0 Authors: Liz McMillan, Carmen Gonzalez, Pat Romanski, Yeshim Deniz, Rick Delgado

Related Topics: iPhone, Java, XML, Wireless, SOA & WOA, ColdFusion, Websphere, PowerBuilder, Weblogic, .NET, Linux, Adobe Flex, Symbian, Open Source, SYS-CON MEDIA, Eclipse, Search, AJAX & REA, PHP, Web 2.0

iPhone: Article

New Column: A Geek's Bookshelf

Book Review: A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Invocation

Geeks like to read – and not only programming books. Most of us read incessantly. Whether it’s popular science, sci-fi or fantasy, a good thriller or an occasional popular history book or biography, it’s a rare geek who isn’t in love with books. And I am no exception, although I have to confess I am rather an extreme case since my love of books and eclectic tastes borders on the “gentle madness” aka “bibliomania.” 

What I am going to do in this regular column is feed my habit by highlighting some of the books I am reading, and (mostly) enjoying. (I will only rarely write negative reviews; it’s a rare book that I “do not put down gently but throw across the room with great force” after all.)

Finally, since I remain involved with Apress (www.apress.com), the publishing company for IT professionals I helped found, is there any potential for a conflict of interest? I don’t think so nor do the kind people at SYS-CON; the kind of books I will be reviewing are the books I read “non-professionally” –for fun – in my spare time. It is only these books, rather than professional books, that I will review.

Title: A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Invocation
Author: by Richard Bookstaber
Publisher: John Wiley 2007, ISBN 978-0-471-22727-4.
Price: $27.95

Talk about prescience, this amazingly relevant book, 10 years in the making, was actually published in April of 2007 – four months before the market meltdown that was caused by subprime mortgage-backed instruments going very, very south. Yet, in this extremely interesting, extraordinarily well-written book, Bookstaber essentially predicted this, and also (alas) he predicts more crises to come. The first paragraph of the book sets the stage:

“While it is not strictly true that I caused the two great financial crisis of the late 20th century – the 1987 stock market crash and the Long-Term Capital Management (hedge fund debacle)…”

Who is Bookstaber? He was one of the early “quants” on Wall Street. These are the physicists, mathematicians, statisticians, and mathematical who revolutionized trading on Wall Street by trying to search out hidden patterns and values. The foremost among them, the great mathematician James Simon, made a mere $1.7 billion last year by apparently doing exactly this.

The idea, roughly speaking, of most of these strategies is: can you find two (seemingly) equivalent securities that should trade in parallel but are currently not? Buy one and sell short the other, wait (hope) for a regression to the mean and make a bundle. Only you won’t make a bundle unless you use a lot of leverage because the anomalies are small at best. And leverage, as the old Wall Street adage has it, cuts both ways. If something really strange happens (a “black swan event,” in the words of best-selling author Nicolas Taleb whose very interesting book I’ll review soon) that makes the divergence greater than historical norms, your billions upon billions of leveraged investments often leads to catastrophic losses. And they did. What’s worse, there is a Heisenberg quality to this kind of historical/statistical arbitrage. As Bookstaber puts it: “Predicated on their conviction that the relationship had long-term stability, they would take positions based on the assumption that it would return, or converge, back to its historical value. What they did not appreciate was that they had changed history. There had never been someone trading hundreds of billions of dollars in the middle of this relationship before.”

Of course, it isn’t only about statistical arbitrage affected by the size of the investments made by people playing the game. As Bookstaber often points out, there is a certain amount of stupidity, cupidity, and outright deceit at work here. For example, the Enron-related transactions of Citigroup were described by the then head of risk management at CitiBank as: “[our] accounting is aggressive and a franchise risk to us if there is publicity,” which Bookstaber translates beautifully as: “we’re making this up and if anyone finds out, we’re in trouble.” Of course, Enron was found out and billions upon billions were lost and some of the people who went beyond merely aggressive accounting actually went to jail. (He has a wonderful suggestion about how to handle financial reporting by the way – one that will appeal to programmers: replace a lot of the hocus pocus in financial reports by requiring that the raw data be made available in basically XML form, and thus let smart data miners make sense of it without it being filtered through high-priced accounting firms with potential stakes in the matter.)

As this book is just filled with interesting information and great anecdotes, I could go on for a long time describing its virtues. For example, there’s a wonderful discussion of what portfolio insurance is and how it (inevitably with hindsight) led to the crash of 1987, for example. In the end, however, the whole point of this book can be summed up by the following passage:

“The danger to the system is the system…despite all the risks we can control, the greatest ones remain beyond our control. Those are the risks we do not see, things beyond the veil…”

Combine this inescapable fact with the amazing leverage that modern hedge funds can use, throw in the usual amounts of human stupidty and cupidity, the speed with which things happen in our modern era, the interconnections of everything with everything and Bookstaber has convinced me at least that more and more disasters await the financial system.

Before I leave this review though I do want to point out some parts of the book that will be especially interesting to programmers. Here is an amusingly scary one that occurred in the past and perhaps is not so relevant anymore; however, it remains of vital importance to everything we do. He describes how one early crisis (1995) was caused by the use of a now exotic programming language called APL (“A Programming Language”) created by Turing award-winner Ken Iverson. APL was an amazingly fun language for math types. You could invert a matrix with a single key stroke and write the most amazing one-liners. But let’s forget about the maintenance problems of a language that makes PERL seem like COBOL in it lucidity; the real problem was that APL was interpreted in an era when JITs were still a decade away and computers were hundreds of times slower. But many financial calculations require zillions of iterative calculations to compute prospective values, and APL, since it was not compiled in those days, simply couldn’t do them. So oddball situations weren’t well modeled in the financial models built with APL, and, once upon a time, this failure to use a compiled language led to a loss of between 100 and 250 million dollars to UBS – and this was back when a quarter of a billion dollars was real money.  

But more important is his stressing that the worst nightmare of financial machinations is our worse nightmare as well: the effects of tight coupling on systems. OOP was designed to solve this problem but it hasn’t proven the panacea its early proponents had hoped for. And, as anyone who was on the Vista team can testify (for example), tight coupling remains the biggest problem we face for large software projects.

In sum, get this book. Read it and learn. It’s beautifully written and full of insights that apply not only to financial management but to “life, the universe, and everything.”

More Stories By Gary Cornell

Gary Cornell has a PHD in mathematics from Brown University. At various times and among other things he has been a professor, a program director at the National Science Foundation, and a visiting scientist at IBM's Watson Labs. He has written or co-written numerous best-selling and award-winning computer books. Most recently he co-founded Apress (www.apress.com), which under his leadership became one of the largest publishers of books for IT professionals in the world. And he did all this while simultaneously having a truly serious case of the 'gentle madness,' AKA bibliomania.

Comments (4) View Comments

Share your thoughts on this story.

Add your comment
You must be signed in to add a comment. Sign-in | Register

In accordance with our Comment Policy, we encourage comments that are on topic, relevant and to-the-point. We will remove comments that include profanity, personal attacks, racial slurs, threats of violence, or other inappropriate material that violates our Terms and Conditions, and will block users who make repeated violations. We ask all readers to expect diversity of opinion and to treat one another with dignity and respect.


Most Recent Comments
Debbie Moynihan 10/15/07 01:52:26 PM EDT

Interesting review, I love the idea of a geek book review column. The suggestion to make raw financial data available in XML would be interesting. It would be cool to be able to grab data from various companies and do interesting things with it, but that might be a bit scary to some people...

Jane 10/11/07 04:39:13 PM EDT

Nice start to your new column, Gary. Great review of an interesting sounding book.

Paul E. Hanson 10/11/07 04:48:04 AM EDT

I did get a laugh (on a morbid level) that the blame for LTCM debacle does not lay where popularly thought. I will not give away the source for future readers.

Rajat Bhatia 10/11/07 04:28:17 AM EDT

Derivatives, trading and hedge funds are here to stay. They perform a valuable service to the financial markets, though Warren Buffet will disagree with me.

Nevertheless, it is the mis-use of derivatives and the excessive use of leverage that leads to financial disasters. This book provides an excellent insight into why we witness financial turmoil in some of the most liquid markets.

@ThingsExpo Stories
SYS-CON Events announced today that Aria Systems, the recurring revenue expert, has been named "Bronze Sponsor" of SYS-CON's 15th International Cloud Expo®, which will take place on November 4-6, 2014, at the Santa Clara Convention Center in Santa Clara, CA. Aria Systems helps leading businesses connect their customers with the products and services they love. Industry leaders like Pitney Bowes, Experian, AAA NCNU, VMware, HootSuite and many others choose Aria to power their recurring revenue business and deliver exceptional experiences to their customers.
The Internet of Things (IoT) is going to require a new way of thinking and of developing software for speed, security and innovation. This requires IT leaders to balance business as usual while anticipating for the next market and technology trends. Cloud provides the right IT asset portfolio to help today’s IT leaders manage the old and prepare for the new. Today the cloud conversation is evolving from private and public to hybrid. This session will provide use cases and insights to reinforce the value of the network in helping organizations to maximize their company’s cloud experience.

SUNNYVALE, Calif., Oct. 20, 2014 /PRNewswire/ -- Spansion Inc. (NYSE: CODE), a global leader in embedded systems, today added 96 new products to the Spansion® FM4 Family of flexible microcontrollers (MCUs). Based on the ARM® Cortex®-M4F core, the new MCUs boast a 200 MHz operating frequency and support a diverse set of on-chip peripherals for enhanced human machine interfaces (HMIs) and machine-to-machine (M2M) communications. The rich set of periphera...

The Internet of Things (IoT) is making everything it touches smarter – smart devices, smart cars and smart cities. And lucky us, we’re just beginning to reap the benefits as we work toward a networked society. However, this technology-driven innovation is impacting more than just individuals. The IoT has an environmental impact as well, which brings us to the theme of this month’s #IoTuesday Twitter chat. The ability to remove inefficiencies through connected objects is driving change throughout every sector, including waste management. BigBelly Solar, located just outside of Boston, is trans...
SYS-CON Events announced today that Matrix.org has been named “Silver Sponsor” of Internet of @ThingsExpo, which will take place on November 4–6, 2014, at the Santa Clara Convention Center in Santa Clara, CA. Matrix is an ambitious new open standard for open, distributed, real-time communication over IP. It defines a new approach for interoperable Instant Messaging and VoIP based on pragmatic HTTP APIs and WebRTC, and provides open source reference implementations to showcase and bootstrap the new standard. Our focus is on simplicity, security, and supporting the fullest feature set.
Predicted by Gartner to add $1.9 trillion to the global economy by 2020, the Internet of Everything (IoE) is based on the idea that devices, systems and services will connect in simple, transparent ways, enabling seamless interactions among devices across brands and sectors. As this vision unfolds, it is clear that no single company can accomplish the level of interoperability required to support the horizontal aspects of the IoE. The AllSeen Alliance, announced in December 2013, was formed with the goal to advance IoE adoption and innovation in the connected home, healthcare, education, aut...
SYS-CON Events announced today that Red Hat, the world's leading provider of open source solutions, will exhibit at Internet of @ThingsExpo, which will take place on November 4–6, 2014, at the Santa Clara Convention Center in Santa Clara, CA. Red Hat is the world's leading provider of open source software solutions, using a community-powered approach to reliable and high-performing cloud, Linux, middleware, storage and virtualization technologies. Red Hat also offers award-winning support, training, and consulting services. As the connective hub in a global network of enterprises, partners, a...
The only place to be June 9-11 is Cloud Expo & @ThingsExpo 2015 East at the Javits Center in New York City. Join us there as delegates from all over the world come to listen to and engage with speakers & sponsors from the leading Cloud Computing, IoT & Big Data companies. Cloud Expo & @ThingsExpo are the leading events covering the booming market of Cloud Computing, IoT & Big Data for the enterprise. Speakers from all over the world will be hand-picked for their ability to explore the economic strategies that utility/cloud computing provides. Whether public, private, or in a hybrid form, clo...
Software AG helps organizations transform into Digital Enterprises, so they can differentiate from competitors and better engage customers, partners and employees. Using the Software AG Suite, companies can close the gap between business and IT to create digital systems of differentiation that drive front-line agility. We offer four on-ramps to the Digital Enterprise: alignment through collaborative process analysis; transformation through portfolio management; agility through process automation and integration; and visibility through intelligent business operations and big data.
The Transparent Cloud-computing Consortium (abbreviation: T-Cloud Consortium) will conduct research activities into changes in the computing model as a result of collaboration between "device" and "cloud" and the creation of new value and markets through organic data processing High speed and high quality networks, and dramatic improvements in computer processing capabilities, have greatly changed the nature of applications and made the storing and processing of data on the network commonplace.
Be Among the First 100 to Attend & Receive a Smart Beacon. The Physical Web is an open web project within the Chrome team at Google. Scott Jenson leads a team that is working to leverage the scalability and openness of the web to talk to smart devices. The Physical Web uses bluetooth low energy beacons to broadcast an URL wirelessly using an open protocol. Nearby devices can find all URLs in the room, rank them and let the user pick one from a list. Each device is, in effect, a gateway to a web page. This unlocks entirely new use cases so devices can offer tiny bits of information or simple i...
Things are being built upon cloud foundations to transform organizations. This CEO Power Panel at 15th Cloud Expo, moderated by Roger Strukhoff, Cloud Expo and @ThingsExpo conference chair, will address the big issues involving these technologies and, more important, the results they will achieve. How important are public, private, and hybrid cloud to the enterprise? How does one define Big Data? And how is the IoT tying all this together?
The Internet of Things (IoT) is going to require a new way of thinking and of developing software for speed, security and innovation. This requires IT leaders to balance business as usual while anticipating for the next market and technology trends. Cloud provides the right IT asset portfolio to help today’s IT leaders manage the old and prepare for the new. Today the cloud conversation is evolving from private and public to hybrid. This session will provide use cases and insights to reinforce the value of the network in helping organizations to maximize their company’s cloud experience.
TechCrunch reported that "Berlin-based relayr, maker of the WunderBar, an Internet of Things (IoT) hardware dev kit which resembles a chunky chocolate bar, has closed a $2.3 million seed round, from unnamed U.S. and Switzerland-based investors. The startup had previously raised a €250,000 friend and family round, and had been on track to close a €500,000 seed earlier this year — but received a higher funding offer from a different set of investors, which is the $2.3M round it’s reporting."
The Industrial Internet revolution is now underway, enabled by connected machines and billions of devices that communicate and collaborate. The massive amounts of Big Data requiring real-time analysis is flooding legacy IT systems and giving way to cloud environments that can handle the unpredictable workloads. Yet many barriers remain until we can fully realize the opportunities and benefits from the convergence of machines and devices with Big Data and the cloud, including interoperability, data security and privacy.
All major researchers estimate there will be tens of billions devices - computers, smartphones, tablets, and sensors - connected to the Internet by 2020. This number will continue to grow at a rapid pace for the next several decades. Over the summer Gartner released its much anticipated annual Hype Cycle report and the big news is that Internet of Things has now replaced Big Data as the most hyped technology. Indeed, we're hearing more and more about this fascinating new technological paradigm. Every other IT news item seems to be about IoT and its implications on the future of digital busines...
Cultural, regulatory, environmental, political and economic (CREPE) conditions over the past decade are creating cross-industry solution spaces that require processes and technologies from both the Internet of Things (IoT), and Data Management and Analytics (DMA). These solution spaces are evolving into Sensor Analytics Ecosystems (SAE) that represent significant new opportunities for organizations of all types. Public Utilities throughout the world, providing electricity, natural gas and water, are pursuing SmartGrid initiatives that represent one of the more mature examples of SAE. We have s...
The Internet of Things needs an entirely new security model, or does it? Can we save some old and tested controls for the latest emerging and different technology environments? In his session at Internet of @ThingsExpo, Davi Ottenheimer, EMC Senior Director of Trust, will review hands-on lessons with IoT devices and reveal privacy options and a new risk balance you might not expect.
IoT is still a vague buzzword for many people. In his session at Internet of @ThingsExpo, Mike Kavis, Vice President & Principal Cloud Architect at Cloud Technology Partners, will discuss the business value of IoT that goes far beyond the general public's perception that IoT is all about wearables and home consumer services. The presentation will also discuss how IoT is perceived by investors and how venture capitalist access this space. Other topics to discuss are barriers to success, what is new, what is old, and what the future may hold.
Swiss innovators dizmo Inc. launches its ground-breaking software, which turns any digital surface into an immersive platform. The dizmo platform seamlessly connects digital and physical objects in the home and at the workplace. Dizmo breaks down traditional boundaries between device, operating systems, apps and software, transforming the way users work, play and live. It supports orchestration and collaboration in an unparalleled way enabling any data to instantaneously be accessed on any surface, anywhere and made interactive. Dizmo brings fantasies as seen in Sci-fi movies such as Iro...