In a sense you are right, because your description of the models and their purpose is spot on (although I would quibble with your assertion that Black-Scholes doesn’t predict volatility. If it didn’t, how could it price assuming that the market is efficient.)

However, I wasn’t referring to their purpose, but the method in which they are structured. They are based on the assumption that volatility in markets is distributed normally according to a Gaussian curve. The predictions I mentioned are based on the same assumption (I actually stole them from Mandelbrot).

So while the models don’t explicitly predict those numbers, implicitly they do. Inherent in this type of model is that events are independent. There is a long lineage dating back to Bachelier at the beginning of the century, rediscovered by Samuelson, taken further by Markowitz, Fama, etc.

The assumption is absurd on its face, but the models explained much better about how markets work than anything before, so they were adopted enthusiastically and probably did their share of good. It wasn’t their fault that Wall St switched from partnerships to shorter term compensation (well, Scholes and Merton deserve some blame).

However, I think the point still stands. The models work well enough as long as you don’t take them too seriously (also, as I understand, there are a variety of “fat tailed” models that do a better job of accounting for extreme events but I’m getting seriously out of my depth here).

Which brings me back to the guys “in the white coats.” Actually, I think most of those guys have a healthy respect for uncertainty. Einstein was greatly influenced by Hume’s assertion that we only expect the sun to come up tomorrow as an expedience. We can recognize the possibility that it won’t and also recognize the impracticality of acting on that possibility.

Most scientists take a similar view to their work (at least they’re supposed to). Darwin could well have been wrong, but if you are trying to design a solution for antibiotic resistant bacteria, Darwin’s theory is extremely useful and yields better results than anything else.

So my point wasn’t to knock Nobel-prizewinning economists or scientists, but overconfident marketers.

Thanks for a very rigorous comment (I need to be kept honest:-)

- Greg

I do agree with the general premise of your article and there is way too much faith in things just because a guy in a lab-coat says it’s right. I do have to take issue with what you said about the financial models.

“The models predict that a stock market move of more than 3% should happen roughly every 2 years (we recently had 3 such moves in a week). A real crash should occur only once every 300,000 years or so. We’ve had two in the last decade.”

The only thing the Black-Scholes model does is establish a price for an option. What made it worthy of a nobel prize is it was the first option pricing model that exclusively used quantifiable inputs. It requires the person using the formula to calculate the current market volatility to establish the price based on current risk.

CAPM does have some larger flaws and the way it is applied under estimates the risk in a traditional portfolio that is almost exclusively highly correlated investments in stocks & bonds. The model works much better on portfolios with real diversification.

Neither model predicts future volatility or price moves. All the models can do is give a snapshot of the current market.
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It really comes down to objectives. I have nothing against direct response, if that’s really the objective (it almost always is in part, but not in whole).

Two examples:

Let’s say a car buying cycle is 3 years. Customers are actively shopping for the last 6 months or so and for that stage direct response is extremely important. Things like test drives, price offers, etc. get people to the dealerships cheaper and faster than anything else.

The problem is that by that point, customers already have a mental “consideration list” (usually 3-5 brands) and rarely will buy anything that they are not considering. So you have to build up some kind of consumer preference (sorry, I know you hate that word) before they actually start shopping.

It’s very obvious for durable goods, because a purchase is a real event. Ask anybody who is shopping for a car or expensive appliance and he’ll be able to rattle of 3-5 brands he’s considering.

But it’s also true with non-durable goods as well. Some years ago I was helping out on a fast food account. The operations people always wanted to do sales promotions, because that delivered an immediate response. However, the problem was that the response kept decaying. When they did a brand campaign, sales would fall, but future sales promotions would improve.

So it really isn’t “brand vs. direct response,” but identifying objectives and finding the proper mix. There’s no real formula except to monitor as best as you can and execute well.

However, I do agree with you that brand marketing often devolves into mindless babble. There’s no point in talking about brand awareness, preference, loyalty, etc. unless you are actually monitoring those things, see a real need for improvement and have a clear objective in mind.

(btw – the real problem I have with all the social media people is that most actually don’t know much about social networking – unfortunately, there’s math involved)

- Greg

That stated, how do you respond to my belief system? Clearly your concerns intersect with mine on a few levels. And that excites me. Summarized here…

http://vimeo.com/12248449

Thanks for considering — and for your earlier thoughtful response that I’ve not had time to react to
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Thanks. That’s very kind of you to say.

- Greg

Good point about agencies. Now that I work for a global agency network, I have adopted the convention of instantly agreeing whenever anybody slags them off (when I was on the supplier side, I was an agency apologist).

I understand your point about confidence, but what I think is even more important is the knowledge that every investment is a crap shoot. If you make judgments, you’re inevitably going to get it wrong sometimes and, most likely, the world will not end.

The real damage is done when people fail to account for mistakes and let them perpetuate until they become real disasters. If you are monitoring your activity, you should be able to get things back on track before any real damage is done.

As David Hume said, we only expect the sun to rise tomorrow out of expediency. It was this view that Einstein said greatly influence him and the development of relativity theory.

Thanks for your comment.

- Greg

- Greg

Love these words “There are no rules that can bestow certainty”… so true.

On the other hand, I think what marketers really seek is “confidence” more than certainty. Confidence to make the “right call” in the face of uncertainty … they rely on the science, math and metrics to guide what they believe will be informed decisions. Considering the commodization of advertising agencies, most marketers don’t believe their advertising agency is the place to expect science or certainty.

Thomson Dawson http://www.pullinc.com
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