The Calculated Unlikliness of Big Investment Banks

A new study shows the spectacular nature of the fairly-recent calamity that befell big banks — and of a corresponding assessment made by an Ig Nobel Prize winner. The study is:

How Unlucky is 25-Sigma?” Kevin Dowd, John Cotter, Chris Humphrey and Margaret Woods, arXiv:1103.5672v1 [q-fin.GN], March 24 2008. The authors, at Centre for Risk and Insurance Studies, Nottingham University Business School, UK and at University College Dublin, Ireland, explain:

“One of the more memorable moments of last summer’s credit crunch came when the CFO of Goldman Sachs, David Viniar, [pictured here] announced in August that Goldman’s flagship GEO hedge fund had lost 27% of its value since the start of the year. As Mr. Viniar explained, ‘We were seeing things that were 25-standard deviation moves, several days in a row.’

But exactly how unlikely is a 25-sigma shock? … These numbers are on truly cosmological scales, and a natural comparison is with the number of particles in the Universe, which is believed to be between 1.0e+73 and 1.0e+85. Thus, a 20-event corresponds to an expected occurrence period measured in years that is 10 times larger than the higher of the estimates of the number of particles in the Universe. For its part, a 25-sigma event corresponds to an expected occurrence period that is equal to the higher of these estimates but with the decimal point moved 52 places to the left!”

Mr. Viniar, as an executive of Goldman Sachs, shared the 2010 Ig Nobel Prize in economics, which was awarded to the executives and directors of Goldman Sachs, AIG, Lehman Brothers, Bear Stearns, Merrill Lynch, and Magnetar for creating and promoting new ways to invest money — ways that maximize financial gain and minimize financial risk for the world economy, or for a portion thereof.

(Thanks to investigator Andy Roeberg for bringing this to our attention.)

Improbable Research