The Probability That Kiyoshi Ito Will Design Anymore Equations That Robert Merton Will Use To Blow Up A Hedge Fund Has Dropped Significantly

From NYT (my emphasis):

Kiyoshi Ito, a mathematician whose innovative models of random motion are used today in fields as diverse as finance and biology, died Nov. 10 at a hospital in Kyoto, Japan. He was 93.

His death was confirmed by his daughter, Junko Ito.

Mr. Ito is known for his contributions to probability theory, the study of randomness. His work, starting in the 1940s, built on the earlier breakthroughs of Albert Einstein and Norbert Wiener. Mr. Ito’s mathematical framework for describing the evolution of random phenomena came to be known as the Ito Calculus.

“People all over realized that what Ito had done explained things that were unexplainable before,” said Daniel Stroock, a professor of mathematics at the Massachusetts Institute of Technology.

Mr. Ito’s research was theoretical, but his models served as a tool kit for others, notably in finance. Robert C. Merton, a winner of the Nobel in economic science, said he found Mr. Ito’s model “a very useful tool” in his research on the evolution of stock prices in a portfolio and, later, in helping develop a theory for pricing stock options that is used on Wall Street today. Mr. Ito, he said, was “a very eminent mathematician.”

Actually, Ito appears to have used his theoretical equations properly in the world of theory and not incorrectly in the field of finance. Robert Merton and Myron Scholes have given Ito a black name by using the equations he designed, inappropriately. They blew up Long Term Management Capital together, and Scholes is on his way to blowing up another hedge fund.

There are no constants, zero, in the field of human action, thus no equilibrium equations can be designed. What the likes of Merton and Scholes do is assume some variable is a constant, attempting to defy Wenzel's Observation #1.

(ViaNick)

Nobel Prize Winner Scholes Freezes His Hedge Fund After Losses

Platinum Grove Asset Management LP, the hedge-fund firm co-founded by Nobel laureate Myron Scholes, temporarily stopped investor withdrawals from its biggest fund after it lost 29 percent in the first half of October.

The decline left Platinum Grove Contingent Master fund with a 38 percent loss this year through Oct. 15, according to investors. Funds employing a similar approach of exploiting differences in the value of related securities fell 14 percent last month and 30 percent this year, according to data compiled by Hedge Fund Research Inc.

Somebody really ought to take Scholes' equations away from him. Scholes was also a partner in Long Term Capital Management that blew up in spectacular fashion in the late 1990's by losing $4 billion.

According to Platinum Grove's web site, they:

...rely upon sophisticated and proprietary quantitative modeling augmented by
qualitative research, on a global basis... Risk control is central to asset management and PGAM relies on an innovative risk-control framework and on sophisticated processes to add to returns while preserving capital.

The LTCM Meeting Versus The Lehman Meeting

When Long Term Capital Management was collapsing the New York Fed held an emergency meeting similar to the meeting held yesterday evening regarding Lehman Bros.

The LTCM meeting was held on September 22, 1998. It is instructive to review who was at that meeting, almost 10 years to the day of the emergency Lehman meeting:

Bankers Trust, Barclays, Bear Stearns, Chase, Credit Suisse First Boston, Deutsche Bank, Lehman Brothers, Morgan Stanley, Credit Agricole, Banque Paribas, Salomon Smith Barney, Societe Generale, Merrill Lynch, Goldman Sachs, UBS and JPMorgan

Of this group, Bear Stearns is gone, Lehman will be buried on Sunday and Merrill Lynch is on the edge. The only other independent investment banks still standing are Goldman Sacks and Morgan Stanley.

This needs to be re-stated. If Merrill goes down, the only remaining significant(that the NY Fed calls to emergency meetings) independent investment banks will be Goldman Sachs and Morgan Stanley.

Maybe its time to re-read my Does Goldman Sachs Run The World? column.

-Robert Wenzel