Did a lot of reading this weekend on papers detail with incomplete markets and utility based pricing.
I didn’t realize how the concept of “incomplete markets” was so tightly mixed in with neo-classical economics. The basic problem with neo-classical economics when applied to derivatives pricing is that neo-classical economics assumes equilibrium states and in an equilibrium state there is no need for a market. I think I can “go Austrian” and assume that you have a lot of actors with different utility functions. One immediate consequence of this is that the trading volume of Shanghai warrants should be a function of the price volatility. If the price is constant then everything moves to equilibrium, but if the price starts changing, then people will start trading derivatives back and forth.
All this connects with my earlier posts about passion and emotion. Neoclassical economics assumes rationality on the part of people participating in a market, whereas Austrian economics by focusing on the individual allows for passion and emotion. Passion can be almost defined as an irrational willingness to decrease individual utility, which breaks the assumptions of neoclassical economics.
This creates a duality which I think is apt
neo-classical economics <-> Austrian economics
Plato <-> Aristole
Song Learning Neo-Confucianism <-> Han Learning / Evidential school
Chu Xi <-> Dai Zhen
Part of the reason I distrust neoclassical economics is that I’ve worked in a corporation. You just are not going to be able to convince me that corporations are rational profit maximizers.
I need to read more about Veblen. I think I can describe my economic views about the Chinese economy as Austrian institutionalism. You begin with the Austrian view of individual choice as the basis for an economy. You then look at how these choices influence and are influenced by economic institutions. Then and only then, you see how these economic institutions behave give certain economic inputs. The problem with applying neo-classical economics to China is that they assume that a certain institutional structure already exists, and it doesn’t.
Anyway, I now have a testable prediction which is that the volume of warrant trades on Shanghai is a function of the daily shift in prices. This will be one of the things that I want to graph once my system comes back up. Right now things are broken because python 2.5 is out and not all of the packages have been upgraded. I looks like to integrate vtk, quantlib, and python will take a lot of thinking.
The other thing I want to do is to review some of the papers on the Malliavin calculus. The problem with the Malliavin calculus is that it should be a calculus. There should be a canned set of rules that will let you apply it to a derivatives pricing situation. Something like Feymann rules.
OK now that I seem rational, do I have permission to go a little nuts?
Maybe not now…. But….. There is a “craziness quotient” that I have to keep aware of. If I start looking to crazy people tend to get scared and turn off. So before I go crazy, I have to wear the nice suit, and look “normal.” See I can talk about economics and program C++, so I must not be too insane, and then once I “fake normal” *then* I can take off the mask and let people know how cracked I really am.
The problem is that I’m getting a little tired of the mask. Businesses just want the C++ programmer and the nice quantitative models. What they don’t realize is that programming and model building is a creative, artistic process, and you just have to put up with a bit of insanity to get the good stuff.
Writing good code is a lot like writing poetry. In fact it *is* writing poetry. When you code something, you are trying to strip the process to its creative essence, you are using odd rules of meter and rhyming (each open brace in C++ must be followed by a close brace), and making interesting allusions in the form of library calls.
The problem with the code at work that I’ve written in the last two or three weeks is that my heart just isn’t in it. Yes the code works, but it is not particularly elegant or graceful or beautiful. I’m just too upset about my work environment to write poetry about it.