Antifragile: Things That Gain from Disorder (44 page)

Long before I knew of the results in
Table 5
, of other scholars debunking the lecturing-birds-how-to-fly effect, the problem started screaming at me, as follows, around 1998. I was sitting in a Chicago restaurant with the late Fred A., an economist, though a true, thoughtful gentleman. He was the chief economist of one of the local exchanges and had to advise them on new, complicated financial products and wanted my opinion on these, as I specialized in and had published a textbook of sorts on the so-called very complicated “exotic options.” He recognized that the demand for these products was going to be very large, but he wondered “how traders could handle these complicated exotics if they do not understand the Girsanov theorem.” The Girsanov theorem is something mathematically complicated that at the time was only known by a very small number of persons. And we were talking about pit traders who—as we saw in the last chapter—would most certainly mistake
Girsanov for a vodka brand. Traders, usually uneducated, were considered overeducated if they could spell their street address correctly, while the professor was truly under the epiphenomenal impression that traders studied mathematics to produce an option price. I for myself had figured out by trial and error and picking the brains of experienced people how to play with these complicated payoffs before I heard of these theorems.

Something hit me then. Nobody worries that a child ignorant of the various theorems of aerodynamics and incapable of solving an equation of motion would be unable to ride a bicycle. So why didn’t he transfer the point from one domain to another? Didn’t he realize that these Chicago pit traders respond to supply and demand, little more, in competing to make a buck, with no need for the Girsanov theorem, any more than a trader of pistachios in the Souk of Damascus needs to solve general equilibrium equations to set the price of his product?

For a minute I wondered if I was living on another planet or if the gentleman’s PhD and research career had led to this blindness and his strange loss of common sense—or if people without practical sense usually manage to get the energy and interest to acquire a PhD in the fictional world of equation economics. Is there a selection bias?

I smelled a rat and got extremely excited but realized that for someone to be able to help me, he had to be both a practitioner and a researcher, with practice coming before research. I knew of only one other person, a trader turned researcher, Espen Haug, who had to have observed the same mechanism. Like me, he got his doctorate
after
spending time in trading rooms. So we immediately embarked on an investigation about the source of the option pricing formula that we were using: what did people use before? Is it thanks to the academically derived formula that we are able to operate, or did the formula come through some antifragile evolutionary discovery process based on trial and error, now expropriated by academics? I already had a hint, as I had worked as a pit trader in Chicago and had observed veteran traders who refused to touch mathematical formulas, using simple heuristics and saying “real men don’t use sheets,” the “sheets” being the printouts of output from the complex formulas that came out of computers. Yet these people had survived. Their prices were sophisticated and more efficient than those produced by the formula, and it was obvious what came first. For instance, the prices accounted for Extremistan and “fat tails,” which the standard formulas ignored.

Haug has some interests that diverge from mine: he was into the subject
of finance and eager to collect historical papers by practitioners. He called himself “the collector,” even used it as a signature, as he went to assemble and collect books and articles on option theory written before the Great War, and from there we built a very precise image of what had taken place. To our great excitement, we had proof after proof that traders had vastly, vastly more sophistication than the formula. And their sophistication preceded the formula by at least a century. It was of course picked up through natural selection, survivorship, apprenticeship to experienced practitioners, and one’s own experience.

Our paper sat for close to seven years before publication by an academic economics journal—until then, a strange phenomenon: it became one the most downloaded papers in the history of economics, but was not cited at all during its first few years. Nobody wanted to stir the pot.
²

Practitioners don’t write; they do. Birds fly and those who lecture them are the ones who write their story. So it is easy to see that history is truly written by losers with time on their hands and a protected academic position.

The greatest irony is that we watched firsthand how narratives of thought are made, as we were lucky enough to face another episode of blatant intellectual expropriation. We received an invitation to publish our side of the story—being option practitioners—in the honorable
Wiley Encyclopedia of Quantitative Finance
. So we wrote a version of the previous paper mixed with our own experiences. Shock: we caught the editor of the historical section, one Barnard College professor, red-handed trying to modify our account. A historian of economic thought, he proceeded to rewrite our story to play down, if not reverse, its message and change the arrow of the formation of knowledge. This was scientific history in the making. The fellow sitting in his office in
Barnard College was now dictating to us what we saw as traders—we were supposed to override what we saw with our own eyes with his logic.

I came to notice a few similar inversions of the formation of knowledge. For instance, in his book written in the late 1990s, the Berkeley professor Highly Certified Fragilista Mark Rubinstein attributed to publications by finance professors techniques and heuristics that we practitioners had been extremely familiar with (often in more sophisticated forms) since the 1980s, when I got involved in the business.

No, we don’t put theories into practice. We create theories out of practice. That was our story, and it is easy to infer from it—and from similar stories—that the confusion is generalized. The theory is the child of the cure, not the opposite—
ex cura theoria nascitur
.

It turned out that engineers, too, get sandbagged by historians.

Right after the previous nauseating episode I presented the joint paper I had written with Haug on the idea of lecturing birds on how to fly in finance at the London School of Economics, in their sociology of science seminar. I was, of course, heckled (but was by then very well trained at being heckled by economists). Then, surprise. At the conclusion of the session, the organizers informed me that, exactly a week earlier, Phil Scranton, a professor from Rutgers, had delivered the exact same story. But it was not about the option formula; it was about the jet engine.

Scranton showed that we have been building and using jet engines in a completely trial-and-error experiential manner, without anyone truly understanding the theory. Builders needed the original engineers who knew how to twist things to make the engine work.
Theory came later,
in a lame way, to satisfy the intellectual bean counter. But that’s not what you tend to read in standard histories of technology: my son, who studies aerospace engineering, was not aware of this. Scranton was polite and focused on situations in which innovation is messy, “distinguished from more familiar analytic and synthetic innovation approaches,” as if the latter were the norm, which it is obviously not.

I looked for more stories, and the historian of technology David Edgerton presented me with a quite shocking one. We think of cybernetics—
which led to the “cyber” in cyberspace—as invented by Norbert Wiener in 1948. The historian of engineering David Mindell debunked the story; he showed that Wiener was articulating ideas about feedback control and digital computing that had long been in practice in the engineering world. Yet people—even today’s engineers—have the illusion that we owe the field to Wiener’s mathematical thinking.

Then I was hit with the following idea. We all learn geometry from textbooks based on axioms, like, say, Euclid’s
Book of Elements,
and tend to think that it is thanks to such learning that we today have these beautiful geometric shapes in buildings, from houses to cathedrals; to think the opposite would be anathema. So I speculated immediately that the ancients developed an interest in Euclid’s geometry and other mathematics because they were already using these methods, derived by tinkering and experiential knowledge, otherwise they would not have bothered at all. This is similar to the story of the wheel: recall that the steam engine had been discovered and developed by the Greeks some two millennia before the Industrial Revolution. It is just that things that are implemented tend to want to be born from practice, not theory.

Now take a look at architectural objects around us: they appear so geometrically sophisticated, from the pyramids to the beautiful cathedrals of Europe. So a sucker problem would make us tend to believe that mathematics led to these beautiful objects, with exceptions here and there such as the pyramids, as these preceded the more formal mathematics we had after Euclid and other Greek theorists. Some facts: architects (or what were then called Masters of Works) relied on heuristics, empirical methods, and tools, and almost nobody knew any mathematics—according to the medieval science historian Guy Beaujouan, before the thirteenth century no more than five persons in the whole of Europe knew how to perform a division. No theorem, shmeorem. But builders could figure out the resistance of materials without the equations we have today—buildings that are, for the most part, still standing. The thirteenth-century French architect Villard de Honnecourt documents with his series of drawings and notebooks in Picard (the language of the Picardie region in France) how cathedrals were built: experimental heuristics, small tricks and rules, later tabulated by Philibert de l’Orme in his architectural treatises. For instance, a triangle was visualized as the head of a horse. Experimentation can make people much more careful than theories.

Further, we are quite certain that the Romans, admirable engineers, built aqueducts without mathematics (Roman numerals did not make quantitative analysis very easy). Otherwise, I believe, these would not be here, as a patent side effect of mathematics is making people over-optimize and cut corners, causing fragility. Just look how the new is increasingly more perishable than the old.

And take a look at Vitruvius’ manual,
De architectura,
the bible of architects, written about three hundred years after Euclid’s
Elements
. There is little formal geometry in it, and, of course, no mention of Euclid, mostly heuristics, the kind of knowledge that comes out of a master guiding his apprentices. (Tellingly, the main mathematical result he mentions is Pythagoras’s theorem, amazed that the right angle could be formed “without the contrivances of the artisan.”) Mathematics had to have been limited to mental puzzles until the Renaissance.

Now I am not saying that theories or academic science are not behind some practical technologies at all, directly derived from science for their final use (not for some tangential use)—what the researcher Joel Mokyr calls an “epistemic base,” or propositional knowledge, a sort of repository of formal “knowledge” that embeds the theoretical and empirical discoveries and becomes a rulebook of sorts, used to generate more knowledge and (he thinks) more applications. In other words, a body of theories from which further theories can be directly derived.

But let’s not be suckers: following Mr. Mokyr would make one want to study economic geography to predict foreign exchange prices (I would have loved to introduce him to the expert in green lumber). While I accept the notion of epistemic base, what I question is the role it has really played in the history of technology. The evidence of a strong effect is not there, and I am waiting for someone to show it to me. Mokyr and the advocates of such view provide no evidence that it is not epiphenomenal—nor do they appear to understand the implications of asymmetric effects. Where is the role of optionality in this?

There is a body of know-how that was transmitted from master to apprentice, and transmitted
only
in such a manner—with degrees necessary as a selection process or to make the profession more respectable, or to help here and there, but not systematically. And the role of such formal knowledge will be overappreciated precisely because it is highly visible.

Cooking seems to be the perfect business that depends on optionality. You add an ingredient and have the option of keeping the result if it is in agreement with Fat Tony’s taste buds, or fuhgetaboudit if it’s not. We also have wiki-style collaborative experimentation leading to a certain body of recipes. These recipes are derived entirely without conjectures about the chemistry of taste buds, with no role for any “epistemic base” to generate theories out of theories. Nobody is fooled so far by the process. As Dan Ariely once observed, we cannot reverse engineer the taste of food from looking at the nutritional label. And we can observe ancestral heuristics at work: generations of collective tinkering resulting in the evolution of recipes. These food recipes are embedded in cultures. Cooking schools are entirely apprenticeship based.

On the other side, we have pure physics, with theories used to generate theories with some empirical validation. There the “epistemic base” can play a role. The discovery of the Higgs Boson is a modern case of a particle entirely expected from theoretical derivations. So was Einstein’s relativity. (Prior to the Higgs Boson, one spectacular case of a discovery with a small number of existing external data is that of the French astronomer Le Verrier’s derivation of the existence of the planet Neptune. He did that on the basis of solitary computation, from the behavior of the surrounding planets. When the planet was actually sighted he refused to look at it, so comfortable was he with his result. These are exceptions, and tend to take place in physics and other places I call “linear,” where errors are from Mediocristan, not from Extremistan.)