“Intuition can lead you astray when not checked by analysis, whether in baseball or on Wall Street. The example on Wall Street is the early 80s, when publicly traded options and futures existed for the first time. When the Japanese bond future was introduced, there were huge arbitrage opportunities because people were trading futures like they weren’t related to anything else. When they liked the market they bought futures, and when they didn’t they sold them. In that environment there were ridiculously fat opportunities because so few people understood the relationship between cash and futures. The same was true in baseball in 2002. On-base-percentage was a huge, fat opportunity that intuition missed for a number of reasons when these analytic tools were first introduced.”  

…And it’s downside…

“[But often people] use statistical arguments as an excuse for not thinking about problems. This is the story of “The Big Short”. You see these people—the Morgan Stanley trading desk is one of the best examples—you see these people who think they know better. It’s not the Long Term Capital Management story because in a lot of ways they did know better. These were smart, thinking people, they just missed how the rest of the world was responding to what they were doing, making similar trades to them, and how they were exposed to other people. In the subprime mortgage market, the people running the [Morgan Stanley] desk weren’t even thinking, they were using the models blindly to take enormous risks without thinking for themselves.”

 To catch the entirety of Michael Lewis’ Interrogation, out in ai5000 Magazine in early April, click here.