A Simple Theory of the Financial Crisis or, Why Fischer Black Still Matters

The key question about the current financial crisis is how so many
investors could have mispriced risk in the same way and at the same
time. This article looks at the work of Fischer Black for insight into
this problem. In particular, Black considered why the “law of large
numbers” does not always apply to expectations in a market setting.
Black’s hypothesis that a financial crisis can arise from extreme bad
luck is more plausible than is usually realized. In this view, such
factors as the real estate market are of secondary importance for
understanding the economic crisis, and the financial side of the crisis
may have roots in the real economy as a whole.

That's the abstract from an article by me, Financial Analysts Journal, Vol. 65, No. 3, 2009. I don't yet know of an on-line copy.


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