Re:The Big Takeover
by petewarden on Sunday March 22, 2009 @03:07AM
(#527061)
"somewhat independent" is the crux of the problem. In a crash the only things going up are the correlations. The modelling behind mortgage securities assumed that defaults were uncorrelated based on the short time period they based them on. Now we know better.
Misunderstanding correlations among defaults was part of it but the other big surprise was that different asset classes which less independent than thought.
For example, no one expected an increase in mortage defaults to be accomplied by problems in stocks.
In fact, its likely that these two things fed each other, that the unexpected correlation in defaults is at least partly due to the unforseen correlation across asset classes and the unforseen correlation across asset classes is at least partly due to the unexpected correlation in defaults.
You write that like it's wrong or in error.
As Google has demonstrated, you can create something that it is more reliable than its parts.
A bundle of somewhat independent things has less variance than the pieces.