I just read a book about DSL(Domain Specific Language), a summary are written to get a general idea about DSL.
1. interpreter
write grammar using BNF or other grammar notations;
build or generate a parser of grammar(using tools like yacc, javacc, antlr)
script languages can be built in this way(template language like jsp,asp,freemarker,..)
2. embeded
build domain model by general purpose programming language
in a form of API specific to a domain
can be designed for considerable expression power within that domain(jMock)
3. XML
represent grammar by XML schema
processing XML is made easy by many API and tools
very popular in many domains:
definition of state transition in a state machine;
description of object relation mapping in OR Mapping tools
description of web page navigation flow
definition of business process(BPEL)
4. graphical DSL
represent domain model by constructing graph elements and their connections
more intuitive and impressive
graphical model can be transformed into software artifacts
XML is used for well integration with tools(XMI)
Tuesday, December 23, 2008
Thursday, December 11, 2008
the dilemma of obedience
From the very beginning, human is a highly socialized species. From tribes to cities and states, socialized organization become increasingly sophisticated. Like any socialized life like bees or wolves, human get an edge to survive on earth from this feature of highly socialization that is still driving the development of human civilization.
Human live by customs as socialized animals live by rules. A society always shows some kind of division of labor which is considered as the driving force of human evolution and also the foundation of classic economics. Apparently human benefit a lot from society by playing a role in it. However, sometimes human do enormous harm to others by doing the same thing. Numerous notorious genocides in human history are the most noticeable evidences for this case.
A few decades ago the famous Milgram experiment was conducted as an attempt to shed light on this sort of humanity disasters. It shows that a majority of people tend to inflict distress to any extent on others when they are forced to by an authority. It seems that the blind obedience of the majority to the authority is the culprit, because when people do something against his conscience, the blame can be shifted from the individual to the authority so that the individual feels less guilt than he should. And when the number of people getting involved reaches a threshold, herding mentality comes into play, which reinforce the power of authority. And finally a catastrophe is inevitable. This is a psychological explanation of why moral individuals constitute immoral society.
As long as the society exists, the authority, more or less exists. If the authority is doing the right thing, it is a fortune. Otherwise, the harm is beyond anyone's imagination. So what we can do to prevent it? Social psychology give us a special lens to peer into the human nature and give us some clue to figure out a preemptive solution. The key is to limit any forms of authority to develop rampantly. This is where check and balance comes in.
It seems ridiculous that we are battling against our innate nature. But it is the truth. We must employ our reason to won this battle. And there is no way to escape.
Human live by customs as socialized animals live by rules. A society always shows some kind of division of labor which is considered as the driving force of human evolution and also the foundation of classic economics. Apparently human benefit a lot from society by playing a role in it. However, sometimes human do enormous harm to others by doing the same thing. Numerous notorious genocides in human history are the most noticeable evidences for this case.
A few decades ago the famous Milgram experiment was conducted as an attempt to shed light on this sort of humanity disasters. It shows that a majority of people tend to inflict distress to any extent on others when they are forced to by an authority. It seems that the blind obedience of the majority to the authority is the culprit, because when people do something against his conscience, the blame can be shifted from the individual to the authority so that the individual feels less guilt than he should. And when the number of people getting involved reaches a threshold, herding mentality comes into play, which reinforce the power of authority. And finally a catastrophe is inevitable. This is a psychological explanation of why moral individuals constitute immoral society.
As long as the society exists, the authority, more or less exists. If the authority is doing the right thing, it is a fortune. Otherwise, the harm is beyond anyone's imagination. So what we can do to prevent it? Social psychology give us a special lens to peer into the human nature and give us some clue to figure out a preemptive solution. The key is to limit any forms of authority to develop rampantly. This is where check and balance comes in.
It seems ridiculous that we are battling against our innate nature. But it is the truth. We must employ our reason to won this battle. And there is no way to escape.
Wednesday, December 10, 2008
silver bullet for vocabulary building
Vocabulary building is one of the greatest obstacle for all English learners, especially for those who have a very different native language such as Chinese, Japanese. It is claimed that a vocabulary of 2,000 is enough for normal English communication. However, English, as one of the most popular languages, have accumulated a large vocabulary bank in its history. And now it is still inflating when our society is undergoing dramatic changes. One reason why English has developed a so big vocabulary is that when there is a need to express a new meaning, a totally new word is created, even sometimes the new word has only a subtle difference with similar words. Therefore, it is necessary to grasp as much words as possible to communicate more precisely.
I must say in the first place that there is no silver bullet to memorize words. But there are some methods you can have a try to build your vocabulary more efficiently. Actually some of them are well written in many places. I just list some of them I used and I felt effective.
1. word roots
Almost each English dictionary has an appendix of word roots. By word roots, new words can be created more easily and also more understandable. Many English word roots have a Greek or Latin origin. So, if you can grasp the meaning of these words root upon which a lot of words are built, you somehow grasp the key of the gigantic vocabulary bank.
some useful links:
Common Word Roots
Root Words and Word Origins
English roots chart
2. prefix and suffix
Like word roots, many words are built from prefix or suffix.
Please reference to the links in the first section "word roots".
3. association
It is always hard to remember many single words. But if you can find out some kind of relationship between these single words, you can piece them together like a jigsaw and eventually get a web of words instead of shining stars scattered in the dark sky. Relationship can help you remember words.
(1) synonym, antonym, homonym
Actually when we learn Chinese words we also did a lot of these kinds of exercises. Obviously it also applies well in learning English.
(2) analogy
If some words share a similar part in their structure, you can group them together. If some words share a similar meaning, you can group them together. If some words represent concepts of the same subject, you can group them together. For example, many words describe goodness or kindness, many words describe dislike, and so on. And also you can find out your own analogy as long as it make sense for you.
Common Word Relationships
4. use words as hard as possible to write something
If you manage to get a vague memory about some word but you still can't use it correctly, you can strengthen your memory of the word by using it. Otherwise, the vague meaning will vanish some day.
5. make a summary(in any form: oral or written) about what your heard or read and try to use different words
Sometimes, you can manage to understand something, but if you can't digest the content in your own way, your initial understanding is shaky and easy to fade away.
Some general links:
How to build a better vocabulary
Vocabulary book recommendation:
Webster Vocabulary Builder
I must say in the first place that there is no silver bullet to memorize words. But there are some methods you can have a try to build your vocabulary more efficiently. Actually some of them are well written in many places. I just list some of them I used and I felt effective.
1. word roots
Almost each English dictionary has an appendix of word roots. By word roots, new words can be created more easily and also more understandable. Many English word roots have a Greek or Latin origin. So, if you can grasp the meaning of these words root upon which a lot of words are built, you somehow grasp the key of the gigantic vocabulary bank.
some useful links:
Common Word Roots
Root Words and Word Origins
English roots chart
2. prefix and suffix
Like word roots, many words are built from prefix or suffix.
Please reference to the links in the first section "word roots".
3. association
It is always hard to remember many single words. But if you can find out some kind of relationship between these single words, you can piece them together like a jigsaw and eventually get a web of words instead of shining stars scattered in the dark sky. Relationship can help you remember words.
(1) synonym, antonym, homonym
Actually when we learn Chinese words we also did a lot of these kinds of exercises. Obviously it also applies well in learning English.
(2) analogy
If some words share a similar part in their structure, you can group them together. If some words share a similar meaning, you can group them together. If some words represent concepts of the same subject, you can group them together. For example, many words describe goodness or kindness, many words describe dislike, and so on. And also you can find out your own analogy as long as it make sense for you.
Common Word Relationships
4. use words as hard as possible to write something
If you manage to get a vague memory about some word but you still can't use it correctly, you can strengthen your memory of the word by using it. Otherwise, the vague meaning will vanish some day.
5. make a summary(in any form: oral or written) about what your heard or read and try to use different words
Sometimes, you can manage to understand something, but if you can't digest the content in your own way, your initial understanding is shaky and easy to fade away.
Some general links:
How to build a better vocabulary
Vocabulary book recommendation:
Webster Vocabulary Builder
Thursday, December 4, 2008
list of courtroom drama
Out of enormous curiosity about the legal and judicial system in the west, I find and see some courtroom drama movies and TV shows to try to get insights about how the legal and judicial system works in the west. Some of them are classic ones. I'd like to list their names.
movie
1. To Kill a Mocking Bird
an attorney fight for the accused black person's justice which was badly biased by the white majority, not only with his powerful words but also with his persevering acts
2. 12 Angry Men
12 ordinary persons of different social status, different education level, different occupation, acting as jurors, debating in a meeting room, showed how the jury system works.
3. Kramer vs. Kramer
a common civil case about the custody right of a boy. a happy ending with a bit suspense. the point is not how the father or mother has more legitimacy to live with child, but what is the best environment for the child to grow up in a single parent family.
4. Witness for The Prosecution
an murder case of much suspense in the ending. great playwriting
5. Judgment at Nuremberg
a famous international trial on Nazi German top officials. thought-provoking
6. Runaway Jury
Out of disappointment on the US judicial system to do justice for those impaired by guns, which proliferated through strong sales channel supported by gun manufacturers, a man managed to become a juror and influence other jurors to reach a verdict favorable to the striving prosecution and also striking to the defendant, and at the same time, extorting a large sum of money from the defendant, gun manufacturers. The weakness of the jury system is also unfolded.
7. JFK
Even now the truth of assassination of JFK is not yet known, so how could a film unravel what really happened at that time? The point is not reveal the truth, but enlighten the people not to be cheated by the misrepresented truth distorted by government for hidden purpose and never give up the rights to pursue the truth. The closing of the prosecutor is very powerful.
8. The Devil's Advocate
It is about the ethical conducts of lawyers? Maybe.
TV show
Out of many courtroom shows such as Law and Order, Shark, Boston Legal is my favorite one in the same class. Boston Legal perfectly blend humor, flirting and exciting court trial.
movie
1. To Kill a Mocking Bird
an attorney fight for the accused black person's justice which was badly biased by the white majority, not only with his powerful words but also with his persevering acts
2. 12 Angry Men
12 ordinary persons of different social status, different education level, different occupation, acting as jurors, debating in a meeting room, showed how the jury system works.
3. Kramer vs. Kramer
a common civil case about the custody right of a boy. a happy ending with a bit suspense. the point is not how the father or mother has more legitimacy to live with child, but what is the best environment for the child to grow up in a single parent family.
4. Witness for The Prosecution
an murder case of much suspense in the ending. great playwriting
5. Judgment at Nuremberg
a famous international trial on Nazi German top officials. thought-provoking
6. Runaway Jury
Out of disappointment on the US judicial system to do justice for those impaired by guns, which proliferated through strong sales channel supported by gun manufacturers, a man managed to become a juror and influence other jurors to reach a verdict favorable to the striving prosecution and also striking to the defendant, and at the same time, extorting a large sum of money from the defendant, gun manufacturers. The weakness of the jury system is also unfolded.
7. JFK
Even now the truth of assassination of JFK is not yet known, so how could a film unravel what really happened at that time? The point is not reveal the truth, but enlighten the people not to be cheated by the misrepresented truth distorted by government for hidden purpose and never give up the rights to pursue the truth. The closing of the prosecutor is very powerful.
8. The Devil's Advocate
It is about the ethical conducts of lawyers? Maybe.
TV show
Out of many courtroom shows such as Law and Order, Shark, Boston Legal is my favorite one in the same class. Boston Legal perfectly blend humor, flirting and exciting court trial.
Wednesday, December 3, 2008
notes on judicial system
The distinctions of law in different countries are very conspicuous. So are the distinctions of judicial system. One of the most conspicuous distinction is the jury which is widely used in countries ruled by common law. The jury system is initially devised by the Greeks and ever adopted by Roman. And later most European countries adopted jury system. But for a variety of reasons some of them abolished jury system. The failure of jury system in these countries may be attributable to social customs, culture characteristics and political system.
Nowadays the most successful case of the jury system is in the United States. In fact, many Hollywood movies and courtroom dramas produced in the United States show some aspects of jury system. I'd like to list some timeless works I've ever seen in another blog. Now I just wanna jolt down my understanding about jury system.
Linda, a writer, ever write a book about American judicial system. In the book, Simpson's case is elaborated in very detail. And the author made a metaphor I think is very appropriate. He said, the judicial system in the US is like a football match. The defense attorney represents the accused person to cast reasonable doubts or overturn the evidence against the defendant. The district attorney represents the prosecution to provide as much evidence as possible to prove the defendant guilty. Cross examination is used by two sides of attorneys to clarify the scenario of the case. The judge controls the trial process. If any side asked irrelevant question or made irrelevant request, the judge can overrule or sustain the question or request. During the trial period, the jury is isolated from the outside and is supposed to make an objective verdict according to the evidence presented on the court. In most criminal cases all the jurors should reach an unanimous judgment to make a verdict. In some civil cases the rule of majority is used.
The democratic characteristic of the jury system is very evident. The essence is that the accused should and can be judged by those have the same social status with him in a just procedure. All jurors are randomly chosen from local registered electors and two sides of attorneys should reach a consensus about the list of the jury. It is no wonder that in some cases even when the defendant lost the case he still insisted that he was judged with justice.
Such a democratic system is not without problem. Actually we can clearly see the problem from Simpson's case. Until today most Americans believed that Simpson was guilty. However, the jury announced that Simpson was not guilty in the final verdict because the dream defendant attorneys brought forward some reasonable doubts which were partly caused by the prosecution side. So we can say, a notorious murder escaped justice under protection of the judicial system which most Americans are proud of. Maybe this system is too democratic. If there is no jury or the jury is not responsible for the final verdict, Simpson would definitely be announced guilty. The democratic system make it harder for the jury to reach consensus. This is the cost of democracy. But on the other hand, the democratic system make it harder for any force of authority to abuse power and lead to injustice. The founders of such system must have thought of this problem but they finally insisted on this system because they thought that preventing good men from injustice outweighed letting criminals at large.
Besides the problem of the democratic process of the jury, each juror, as key roles in the judicial system, is vulnerable to the influence of public opinion. Although each juror is supposed to make objective judgment according to what he saw and what he heard on the court, the infiltration of mass media, the argumentation of attorneys and the opinions of other jurors all may have an impact on one's judgment. The herding mentality inevitably takes effect in the jury. The movie Runaway Jury showed that how the jury is manipulative although the process may be a bit fictional but it is probable in reality.
In china, the reform of judicial system is on the agenda. And the civil juror is installed on court to participate in trial process. Most of them are selected from the middle class or the so-called elites. But the role of civil juror is more like assistants of the judge. They don't make the verdict independently. It is too early to say how these civil juror will influence the practice of justice in China and what's the next step to go. The same devise may appear in different way in different places. So let's just wait and see.
Nowadays the most successful case of the jury system is in the United States. In fact, many Hollywood movies and courtroom dramas produced in the United States show some aspects of jury system. I'd like to list some timeless works I've ever seen in another blog. Now I just wanna jolt down my understanding about jury system.
Linda, a writer, ever write a book about American judicial system. In the book, Simpson's case is elaborated in very detail. And the author made a metaphor I think is very appropriate. He said, the judicial system in the US is like a football match. The defense attorney represents the accused person to cast reasonable doubts or overturn the evidence against the defendant. The district attorney represents the prosecution to provide as much evidence as possible to prove the defendant guilty. Cross examination is used by two sides of attorneys to clarify the scenario of the case. The judge controls the trial process. If any side asked irrelevant question or made irrelevant request, the judge can overrule or sustain the question or request. During the trial period, the jury is isolated from the outside and is supposed to make an objective verdict according to the evidence presented on the court. In most criminal cases all the jurors should reach an unanimous judgment to make a verdict. In some civil cases the rule of majority is used.
The democratic characteristic of the jury system is very evident. The essence is that the accused should and can be judged by those have the same social status with him in a just procedure. All jurors are randomly chosen from local registered electors and two sides of attorneys should reach a consensus about the list of the jury. It is no wonder that in some cases even when the defendant lost the case he still insisted that he was judged with justice.
Such a democratic system is not without problem. Actually we can clearly see the problem from Simpson's case. Until today most Americans believed that Simpson was guilty. However, the jury announced that Simpson was not guilty in the final verdict because the dream defendant attorneys brought forward some reasonable doubts which were partly caused by the prosecution side. So we can say, a notorious murder escaped justice under protection of the judicial system which most Americans are proud of. Maybe this system is too democratic. If there is no jury or the jury is not responsible for the final verdict, Simpson would definitely be announced guilty. The democratic system make it harder for the jury to reach consensus. This is the cost of democracy. But on the other hand, the democratic system make it harder for any force of authority to abuse power and lead to injustice. The founders of such system must have thought of this problem but they finally insisted on this system because they thought that preventing good men from injustice outweighed letting criminals at large.
Besides the problem of the democratic process of the jury, each juror, as key roles in the judicial system, is vulnerable to the influence of public opinion. Although each juror is supposed to make objective judgment according to what he saw and what he heard on the court, the infiltration of mass media, the argumentation of attorneys and the opinions of other jurors all may have an impact on one's judgment. The herding mentality inevitably takes effect in the jury. The movie Runaway Jury showed that how the jury is manipulative although the process may be a bit fictional but it is probable in reality.
In china, the reform of judicial system is on the agenda. And the civil juror is installed on court to participate in trial process. Most of them are selected from the middle class or the so-called elites. But the role of civil juror is more like assistants of the judge. They don't make the verdict independently. It is too early to say how these civil juror will influence the practice of justice in China and what's the next step to go. The same devise may appear in different way in different places. So let's just wait and see.
notes of legal system
From the very beginning of human civilization, people lived under the order of rules. Among them are social customs, moral codes and laws. Almost every modern state was ruled by law to some extent. Some countries have more complete and thorough judicial system than others. There are two most used legal system today, common law and civil law. Common law originated in England and thrived throughout all Britain common-wealth countries, some colonial countries of Britain and also the United States. Most of the rest countries adopted a kind of civil law system.
Common law is also called case law, because the main criteria of judgment is the cases which have been decided and can be used to determine similar cases happened later. Given the cases accumulated along the time is so enormous, it must be very difficult for the lawyers or judges to reference these cases. Therefore, there is no country completely ruled by common law. Many common rules have been generalized from these cases and written in separate codes as judging criteria. The most noticeable feature of common law is that the judges can largely participate in the process of legislation by making precedent cases. Maybe this feature partly accounts for the meaning of "common". The power comes from common people, not the elite legislation.
Civil law is probably the most used legal system in the world. One of the reasons is that continental law is enacted and enforced in a top-down manner. The legislation of a country passed laws and the judicial system ensured the obedience of law of the subjects. Obviously civil law system gives the judges less control or participation in the process of legislation, which make those countries which are not governed by an elected government tend to adopt civil law system in order to keep power in the control of the few.
The legal system plays a very crucial part in modern state governance. It even determines whether a country will prosper or perish. In short, the law system provides a rule of game in which each parties, government,individual or corporation, can make best of their capabilities to get as much benefits as possible.
Common law is also called case law, because the main criteria of judgment is the cases which have been decided and can be used to determine similar cases happened later. Given the cases accumulated along the time is so enormous, it must be very difficult for the lawyers or judges to reference these cases. Therefore, there is no country completely ruled by common law. Many common rules have been generalized from these cases and written in separate codes as judging criteria. The most noticeable feature of common law is that the judges can largely participate in the process of legislation by making precedent cases. Maybe this feature partly accounts for the meaning of "common". The power comes from common people, not the elite legislation.
Civil law is probably the most used legal system in the world. One of the reasons is that continental law is enacted and enforced in a top-down manner. The legislation of a country passed laws and the judicial system ensured the obedience of law of the subjects. Obviously civil law system gives the judges less control or participation in the process of legislation, which make those countries which are not governed by an elected government tend to adopt civil law system in order to keep power in the control of the few.
The legal system plays a very crucial part in modern state governance. It even determines whether a country will prosper or perish. In short, the law system provides a rule of game in which each parties, government,individual or corporation, can make best of their capabilities to get as much benefits as possible.
Thursday, November 6, 2008
complexity of risk modeling
An article in nytimes "In Modeling Risk, the Human Factor Was Left Out" draw my attention because it attempted to peer into the current financial turmoil from risk modeling perspective. Maybe this kind of microeconomics thinking would refresh my mindset about the crisis.
"But the larger failure, they say, was human — in how the risk models were applied, understood and managed. Some respected quantitative finance analysts, or quants, as financial engineers are known, had begun pointing to warning signs years ago. But while markets were booming, the incentives on Wall Street were to keep chasing profits by trading more and more sophisticated securities, piling on more debt and making larger and larger bets."
Even most people are blind to the risk, some insider can still have sensible insight to point out the risk. But if only few people have different view, they are dissents. They are just ignored by others.
"That out-of-control innovation is reflected in the growth of securities intended to spread risk widely through the use of financial instruments called derivatives. Credit-default swaps, for example, were originally created to insure blue-chip bond investors against the risk of default. In recent years, these swap contracts have been used to insure all manner of instruments, including pools of subprime mortgage securities.
Credit-default swaps, though intended to spread risk, have magnified the financial crisis because the market is unregulated, obscure and brimming with counterparty risk (that is, the risk that one embattled bank or firm will not be able to meet its payment obligations, and that trading with it will seize up)."
Credit default swap has been ever well known to financial professional, but it is so to everybody by exposing devastating catastrophe to the public. This kind of risk management instrument fails to meet their goal. I think the increased complexity brought about by weaving so many institutions together was less investigated that people are less informed upon the accordingly increased risk. So it is no wonder CDS was notoriously blamed as the main cause of this crisis. But is it simple like this?
"Math, statistics and computer modeling, it seems, also fell short in calibrating the lending risk on individual mortgage loans. In recent years, the securitization of the mortgage market, with loans sold off and mixed into large pools of mortgage securities, has prompted lenders to move increasingly to automated underwriting systems, relying mainly on computerized credit-scoring models instead of human judgment.
If the incentives and the systems change, the hard data can mean less than it did or something else than it did,” said Raghuram G. Rajan, a professor at the University of Chicago. “The danger is that the modeling becomes too mechanical.”
Risk management model are mainly based on math and statistics. In the world of this model each party is treated as a robot. That means their behavior are certain or statistically certain. However, it is obvious that this model is not compatible with the real world. It seems that we just can't precisely model the real world because we are all insiders so that we can't thoroughly understand it. We are part of this world but we try to understand the whole. It is mission impossible. The so-called reflectivity theory from a famous insider George Soros also well extrapolate this point. So, attempting to manage the risk by statistic modeling is doomed. So, what can we do to prevent such risk or at lest mitigate the magnitude of the risk?
"The Fed economists concluded that the risk models used by Wall Street analysts correctly predicted that a drop in real estate prices of 10 or 20 percent would imperil the market for subprime mortgage-backed securities. But the analysts themselves assigned a very low probability to that happening."
It seems that the models are less disappointing that it roughly predicted the probable collapse of subprime mortgage securities. However, in the booming times the probability of this kind of dismal event are deliberately minimized.
“The price of an asset, like a house or a stock, reflects not only your beliefs about the future, but you’re also betting on other people’s beliefs,” he observed. “It’s these hierarchies of beliefs — these behavioral factors — that are so hard to model.”"
"To confuse the model with the world is to embrace a future disaster driven by the belief that humans obey mathematical rules.”
This point also coincides with the modeling paradox.
"Among economists and academics, he said, the research was well received. “On the industry side, it was dismissed,” he recalled."
Well, the academia is not to blame because at least some of them have uttered warning according to their work. However, the sound of academia is so small that it is totally overwhelmed by the uproar of the Wall Street.
"Financial regulation, Mr. Lo said, should be seen as similar to fire safety rules in building codes. The chances of any building burning down are slight, but ceiling sprinklers, fire extinguishers and fire escapes are mandated by law.
“We’ve learned the hard way that the consequences can be catastrophic, even if statistically improbable,” he said."
Fire safety rules is a good metaphor to such statistically improbable events as financial turmoil. So, modeling is a daydream, and financial instruments such as CDS are also just mess. What left is rigorous regulation long resisted by the Fed. According to the testimony by the former Fed chairman Greenspan, the belief that the market will self-correct itself to remain healthy is also a daydream. So, it seems that regulation is necessary. But is regulation sufficient? The old question about regulation is "who would be responsible for regulating the regulators?" From the perspective of politics, check and balance strategy is well formed to mitigate the possibility of wrong-doing by government. So is it possible that this strategy is introduced into financial market? If so, how? If you can figure out this problem, please let me know, thanks:-)
"But the larger failure, they say, was human — in how the risk models were applied, understood and managed. Some respected quantitative finance analysts, or quants, as financial engineers are known, had begun pointing to warning signs years ago. But while markets were booming, the incentives on Wall Street were to keep chasing profits by trading more and more sophisticated securities, piling on more debt and making larger and larger bets."
Even most people are blind to the risk, some insider can still have sensible insight to point out the risk. But if only few people have different view, they are dissents. They are just ignored by others.
"That out-of-control innovation is reflected in the growth of securities intended to spread risk widely through the use of financial instruments called derivatives. Credit-default swaps, for example, were originally created to insure blue-chip bond investors against the risk of default. In recent years, these swap contracts have been used to insure all manner of instruments, including pools of subprime mortgage securities.
Credit-default swaps, though intended to spread risk, have magnified the financial crisis because the market is unregulated, obscure and brimming with counterparty risk (that is, the risk that one embattled bank or firm will not be able to meet its payment obligations, and that trading with it will seize up)."
Credit default swap has been ever well known to financial professional, but it is so to everybody by exposing devastating catastrophe to the public. This kind of risk management instrument fails to meet their goal. I think the increased complexity brought about by weaving so many institutions together was less investigated that people are less informed upon the accordingly increased risk. So it is no wonder CDS was notoriously blamed as the main cause of this crisis. But is it simple like this?
"Math, statistics and computer modeling, it seems, also fell short in calibrating the lending risk on individual mortgage loans. In recent years, the securitization of the mortgage market, with loans sold off and mixed into large pools of mortgage securities, has prompted lenders to move increasingly to automated underwriting systems, relying mainly on computerized credit-scoring models instead of human judgment.
If the incentives and the systems change, the hard data can mean less than it did or something else than it did,” said Raghuram G. Rajan, a professor at the University of Chicago. “The danger is that the modeling becomes too mechanical.”
Risk management model are mainly based on math and statistics. In the world of this model each party is treated as a robot. That means their behavior are certain or statistically certain. However, it is obvious that this model is not compatible with the real world. It seems that we just can't precisely model the real world because we are all insiders so that we can't thoroughly understand it. We are part of this world but we try to understand the whole. It is mission impossible. The so-called reflectivity theory from a famous insider George Soros also well extrapolate this point. So, attempting to manage the risk by statistic modeling is doomed. So, what can we do to prevent such risk or at lest mitigate the magnitude of the risk?
"The Fed economists concluded that the risk models used by Wall Street analysts correctly predicted that a drop in real estate prices of 10 or 20 percent would imperil the market for subprime mortgage-backed securities. But the analysts themselves assigned a very low probability to that happening."
It seems that the models are less disappointing that it roughly predicted the probable collapse of subprime mortgage securities. However, in the booming times the probability of this kind of dismal event are deliberately minimized.
“The price of an asset, like a house or a stock, reflects not only your beliefs about the future, but you’re also betting on other people’s beliefs,” he observed. “It’s these hierarchies of beliefs — these behavioral factors — that are so hard to model.”"
"To confuse the model with the world is to embrace a future disaster driven by the belief that humans obey mathematical rules.”
This point also coincides with the modeling paradox.
"Among economists and academics, he said, the research was well received. “On the industry side, it was dismissed,” he recalled."
Well, the academia is not to blame because at least some of them have uttered warning according to their work. However, the sound of academia is so small that it is totally overwhelmed by the uproar of the Wall Street.
"Financial regulation, Mr. Lo said, should be seen as similar to fire safety rules in building codes. The chances of any building burning down are slight, but ceiling sprinklers, fire extinguishers and fire escapes are mandated by law.
“We’ve learned the hard way that the consequences can be catastrophic, even if statistically improbable,” he said."
Fire safety rules is a good metaphor to such statistically improbable events as financial turmoil. So, modeling is a daydream, and financial instruments such as CDS are also just mess. What left is rigorous regulation long resisted by the Fed. According to the testimony by the former Fed chairman Greenspan, the belief that the market will self-correct itself to remain healthy is also a daydream. So, it seems that regulation is necessary. But is regulation sufficient? The old question about regulation is "who would be responsible for regulating the regulators?" From the perspective of politics, check and balance strategy is well formed to mitigate the possibility of wrong-doing by government. So is it possible that this strategy is introduced into financial market? If so, how? If you can figure out this problem, please let me know, thanks:-)
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