Le virus brownien en 10 points / The Brownian virus in 10 key points

10 years after the financial crisis: 10 key ideas to understand for avoiding a future crisis

In a series of papers (2008, 2009, 2010, 2011 and 2012), I proposed a cognitive analysis of the financial meltdown, termed « Brownian virus »

Topic

New way of thinking

Consequence

1. Accidental fall ?

It was not a failure of prediction, but a failure of predictability based on the Brownian / Gaussian representation of risk. The classical (econometric) view, which consists in separating “trend” (the phenomenon) and “noise” (the residual chance) has to be re-examined.
2. Securitization The Brownian / Gaussian representation of risk transformed trashy things in pure gold. The magical trick came from the smoothness of random: the continuity assumption. The diversification and the tools of financial engineering techniques, according to the continuity assumption, have to be re-examined.
3. The Brownian virus The subprime crisis is firstly and mainly a crisis of knowledge: the way of thinking – and ill thinking – the uncertainty. Any diagnosis of the crisis is not complete if it doesn’t include this epistemological cornerstone: the representations of uncertainty embedded in the financial theories.
4. The mathematical expectation of the speculator is zero. The virus B enters finance with Jules Regnault (1863) and Louis Bachelier (1900) first for ethical reasons. The classical ethical scheme separating the “normal” market regime and the “irrational exuberance” regime is a cognitive effect of the virus B and has to be re-examined.
5. Majesty and misery of the American school of finance The American choice of the Brownian representation is not technical but ideological. The risk models and risk numbers can be used only when there is no risk. The Black-Scholes world is a risk-free world.
6. Lethal chance The Brownian representation presses banks to take more risk. The whole financial system relied on the rating techniques. The rating techniques relied on the Brownian representation.
7. The formula that killed Wall Street The non Brownian nature of randomness flawed the techniques of diversification The classical statistical notion of correlation has to be re-examined.
8. Pandemic diffusion The Brownian representation was a strong incitation to increase risk. The rating agencies have to replace the Brownian representation inside their rating techniques.
9. Dr Greenspan and Mr Hyde Incestuous relationship between the invisible hand and the Brownian representation. It is of an absolute necessity to renew the conceptual framework of the financial regulation.
10. Morituri Other types of probabilistic models existed yesterday and exist yet today. The risk management tools have to take account of the shape of the risk, and not only the magnitude of the risk (volatility).


Christian Walter

Actuaire agrégé, chercheur en philosophie et sciences sociales, spécialiste de la finance / Fully qualified actuary, my research activities relate to financial modelling, history of financial thought, epistemology of finance and ethics of finance.

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