Re-engineering Wall Street

Modern financial theories (Random Walk, Efficient Market Hypothesis, Capital Asset Pricing Model, Modern Portfolio Theory, and the Black-Scholes formulae) were built on the “coin-tossing” concept: namely, price changes are serially (time) independent and their distributions fit a bell-shaped curve.

Such notions defy reality. First, financial markets often exhibit dependencies such as mean reversion, persistent trends, seasonality factors and business/credit/equity-market cycles. These memory-like attributes confirm that stock prices are serially dependent. Second, according to Gaussian (bell-curve) statistics, a Black Monday event (October 19, 1987 where the Dow Jones Industrial Average plunged -22.6%) should have occurred only once in 4 x 10⁷⁵ days (or 1 x 10⁷² years). To put this in perspective, the age of our universe is 13.8 billion years (1.38 x 10¹⁰ years). According to the bell-curve statistics, the Black Monday type of crash should have occurred only once in a billion billion billion billion billion billion times the age of our universe. In reality, we had one Black Monday event in only 400 years – the oldest stock exchange was the Amsterdam Stock Exchange established in 1602. Hence, the bell curve statistics grossly underestimate actual market risks by an astronomical factor.

The unrealistic assumptions and oversimplified statistics behind modern financial theories are being challenged by a new generation of advanced research in fractal geometry (Pareto distributions vs. Gaussian), chaos theory (interdependency), and behavioral finance (irrational investor psychology).

If the random walk math cannot explain statistical outliers (fat tails and black swans), risk control tools derived from modern financial doctrines (i.e. efficient frontier, systematic risk, diversified portfolios) are destined to fail. Furthermore, if the market is inefficient and prices have memories, there is alpha to be gained.

Our goal is to usher in a new age of financial market analysis utilizing well-established scientific and engineering tools to overcome the herd mentality prevalent on Wall Street. By starting with experiences and perspectives outside of Wall Street, we are free from the biases and outdated paradigm afflicting the Wall Street establishments for decades. 

Ted designed satellite and military sensors for almost forty years. Many of the engineering design tools and applied statistics used in optoelectronics can be adapted to model the financial markets. These models do not predict the future. They enable us to quantify the present investment climate and to reduce the probability of outlier risks. They help us take advantage of latent market memories and dependencies. More importantly, systematic approaches and quantitative models give us clarity and discipline in executing investment decisions without the distortions from our emotions and the non-value-adding noise from the 24/7 media.