People cause crises (incentive structure edition) April 30, 2012 at 2:19 pm
Lisa Pollack has an interesting, if rather too fair minded post on Alphaville about the dubious claim that the Black-Scholes formula somehow caused the crisis.
Let’s be clear. Black-Scholes is about options pricing, and hedging in particular. It has nothing to do with securitization, and little with tranching. So the claim that Black-Scholes caused the crisis is BS.
There is a boarder claim that somehow mathematical finance in general – and risk models in particular – were to blame. Certainly many VAR models under-estimated risk before the crisis, while some models of tranches were response for assigning great ratings to assets that didn’t perform well. But no model went out on a wet Wednesday about bought fifty billion of sub-prime ABS. A trader did that. Blame them, and the incentive structure in their firm that encouraged them.