In practical terms, modern mathematical finance's modeling of market with the Gaussian distribution has the implication that it is possible to add together a number of risky items to get a product which is less risky.
Nonsense. Any Finance 101 textbook will tell you this is only true if the securities are uncorrelated. It will also tell you that assuming the EMH holds, people will buy into the lower risk index until returns are reduced to 1%.
As for LTCM, the thing that killed them is that they didn't have an unlimited supply of credit and they got hit by margin calls.
The entire stable of CDO etc product sold on the same basis, the basis of providing risks no greater than the highest rated corporate bond but with significantly higher return.
No, the entire stable of mortgage-backed products was backed by the assumption that housing won't go down crash, a factor exogenous to Black Scholes. Also, you seem to not understand how CDOs are priced - the Black Scholes style models are used for interest rates, which have not exhibited infinite variance. Default rates, which are included separately, also have not exhibited infinite variance (in fact, since they are bounded between 0 and 1 they cannot exhibit infinite variance).
No model works if you plug in the wrong parameters. To quote Babbage: ...I have been asked, – "...if you put into the machine wrong figures, will the right answers come out?"... I am not able rightly to apprehend the kind of confusion of ideas that could provoke such a question.
Nonsense. Any Finance 101 textbook will tell you this is only true if the securities are uncorrelated. It will also tell you that assuming the EMH holds, people will buy into the lower risk index until returns are reduced to 1%.
As for LTCM, the thing that killed them is that they didn't have an unlimited supply of credit and they got hit by margin calls.
The entire stable of CDO etc product sold on the same basis, the basis of providing risks no greater than the highest rated corporate bond but with significantly higher return.
No, the entire stable of mortgage-backed products was backed by the assumption that housing won't go down crash, a factor exogenous to Black Scholes. Also, you seem to not understand how CDOs are priced - the Black Scholes style models are used for interest rates, which have not exhibited infinite variance. Default rates, which are included separately, also have not exhibited infinite variance (in fact, since they are bounded between 0 and 1 they cannot exhibit infinite variance).
No model works if you plug in the wrong parameters. To quote Babbage: ...I have been asked, – "...if you put into the machine wrong figures, will the right answers come out?"... I am not able rightly to apprehend the kind of confusion of ideas that could provoke such a question.