Highs and lows of a jolly fool's game

A Mathematician Plays the Market
April 30, 2004

Falling in love with the WorldCom stock, one of the early fallen angels of the new equity millennium... This sounds like the plot of another off-beat but fashionable, low-cost, high-pay-off Hollywood movie, tangentially related once more to Wall Street . But it is, in fact, the pretext for the umpteenth book by John Allen Paulos.

My enthusiasm for mathematics, coupled with my pathetically superficial knowledge of the subject (despite so much effort), makes me the ideal reader of Paulos' book, attentive to every well-aimed anecdote and every logical game.

But, in the same way that I can immediately spot a cigar rolled on a bad day, I could see Paulos feeling his way uneasily into not only a new subject, but three of them at once: investment, quantitative finance and behavioural finance.

The book - supposedly the author's way of recouping his financial losses from the WorldCom affair - charts a winding path through logic gems and convoluted scams, pauses for breath with a "rough idea" for a film script, and finally picks up momentum with a popular rendition of quantitative finance's cornerstone theories.

Paulos' fleeting attention moves from probability theory to game theory, statistics and, albeit instantaneously, stochastic calculus. Everyone gets a passing mention, mathematicians, economists and finance theorists alike: Fibonacci, Keynes, Scholes and so on. A real almanac, but a well-structured one.

The Elliott wave, Benford's law and Hill's distribution of distributions, standard textbook option valuation, the capital asset pricing model, portfolio diversification, the efficient frontier, beta, standard deviation, covariance and volatility are well explained without patronising the reader.

The result is an amusing read for the financially competent and a good introduction for most mathematicians, but not an easy read for those unversed in mathematics and finance.

The only sub-chapter that I found bizarre was "Diversification and politically incorrect funds", in which the author suggests that one should "invest heavily in funds holding shares in companies that you find distasteful", using the proceeds to champion one's moral causes, or bearing the losses with a smile, knowing that they also negatively affect the supposedly immoral causes. This is tantamount to scratching one's right ear with one's left hand.

At least Paulos is not attempting to stretch the novelty boundaries. He is content to broaden the understanding of his readers while keeping them entertained - no mean feat given the topics he has chosen. This is a book meant to sell widely, so it is well stuffed with all sorts of relevant actualities. The chief executive officers of recently failed companies get their fair share of critical attention but without cheap contempt.

What I like about Paulos is that he never attempts to diminish his own responsibility for playing a fool's game, and he never mounts the high horse of moral superiority or gets too serious about corporate governance, a field relatively distant from his own expertise.

There is a lesson to be learnt here for those law-makers who, for example, feel that a girl of 14 is competent enough to take the pill unsupervised by her parents, but that a man of 50 is incapable of making unaided investment decisions.

Rudi Bogni is a former investment and private banker.

A Mathematician Plays the Market

Author - John Allen Paulos
Publisher - Allen Lane The Penguin Press
Pages - 216
Price - £12.99
ISBN - 0 7139 9685 4

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