The Poker Face of Wall Street E-Book

Aaron Brown

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2011

Seitenzahl: 627

Beschreibung

Wall Street is where poker and modern finance?and the theory behind these "games"?clash head on. In both worlds, real risk means real money is made or lost in a heart beat, and neither camp is always rational with the risk it takes. As a result, business and financial professionals who want to use poker insights to improve their job performance will find this entertaining book a "must read." So will poker players searching for an edge in applying the insights of risk-takers on Wall Street.

Leseprobe

Copyright © 2006 by Aaron Brown. All rights reserved

Published by John Wiley & Sons, Inc., Hoboken, New Jersey

Published simultaneously in Canada

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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

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Library of Congress Cataloging-in-Publication Data

Brown, Aaron, 1956-

The poker face of Wall Street / Aaron Brown.

p. cm.

Includes bibliographical references.

ISBN-13: 978-0-471-77057-2 (cloth)

ISBN-10: 0-471-77057-4 (cloth)

1. Stocks. 2. Finance. 3. Risk. 4. Poker. I. Title.

HG4661.B766 2006

332.63′22—dc22

2005031902

Contents

Foreword

Preface

Chapter 1: The Art of Uncalculated Risk

Risk

Risk Rules

Finance and Gambling

An Example of the Trading Game

Gambling and Finance

Opponents

Hold ’Em Aces

Truth

Chapter 2: Poker Basics

Poker Hands

Betting

Limits

Mechanics

You Gotta Know When to . . .

And He Answers: “Omaha”

Stud

Draw

Basic Strategies

Calling

Taxes

Chapter 3: Finance Basics

Econospeak

Commercial Banks

Investment Banks

Exchanges

Theory

Financial Challenges

Chapter 4: A Brief History of Risk Denial

I’m Shocked—Shocked—to Find that Gambling is Going on in Here!

Hedging Bets

A Random Walk Down Wall Street

Foreign Interest

Futures and Options

The Crash of ’87

Chapter 5: Pokernomics

Law and Money

Dutch Treat

The Trouble in Scotland . . . and New Orleans

Savage Money

Networks

Adventurers and Planters

Pokerbank

Chapter 6: Son of a Soft Money Bank

The Stormy, Husky, Brawling Laughter of Youth

Triage

A Tall, Bold Slugger Set Vivid against the Little, Soft Cities

Chapter 7: The Once-Bold Mates of Morgan

The Crash of ’79

Bridge Bums, Chicago School, and the Pit

Withered these Latter-Days to Leaf-Size from Lack of Action . . .

History’s Beaten the Hazard

And He Burned Them as Wastepaper

Chapter 8: The Games People Play

When Luck has Something to do with It

God Gave You Guts: Don’t Let Him Down

Guessing Games

Masters of the Bluff

Bluffing Mathematics

Game Fact

Small-Mindedness

Chapter 9: Who Got Game

This Guy Says the Horse Needs Race

Rocket Scientist

Chairman of the Board

Learn by Experiment What Argument Taught

Those Who have Knowledge Don’t Predict—Those Who Predict Don’t have Knowledge

If I have to Fall, May it be from a High Place

Ivory Tower Risk

Do not Limp before the Lame

Fierce as Bluff King Hal

Next Time Stop at the Ethyl Pump

My Way is Multiway

Do Traders Care?

Learning about Learning

Hammurabi’s Rules of Poker

Chapter 10: Utility Belt

I Ponder the Psychology that Roots them in their Place

Safer than Suicide

Five Out of Ten to Pass

Aplomb in the Midst of Irrational Things

Let’s Make a Deal

More Patient than Crags, Tides, and Stars; Innumerable, Patient as the Darkness of Night

Annotated Bibliography

History and Meaning of Poker

History and Meaning of Gambling

Finance and Gambling

Specific Sources

Index

Foreword

Nassim Nicholas Taleb1

I

One would tend to think that gambling is a sterile activity that is meant to occupy those who have not much else to do and others when they have not much else to do. You would also think that there is a distinction between “economic risk taking” and “gambling,” one of them invested with respectability, the other treated as a vice and a product of a parasitic activity.

This book shows that the distinction between what is called purely gambling and “productive economic activity” is one of those socially constructed ones that remain sticky in our minds. While many may disagree with the point (our economics culture is vitiated by these mental boundaries between activities), it remains that gambling injects currency into economic life in the form of the expectation of future cash transfers and that, and not just narrowly defined “productive” activities, may make the world advance. We may not accept it because economics is a narrative discipline and this appears to be the wrong narrative. It is not that gambling imitates economic life, but that economic life is largely modeled after gambling. That was the idea of the original thinker John Law, made infamous with his bankruptcy; Aaron Brown, another original thinker, revives it and takes it further.

II

Until the day when I opened the manuscript for this book, I was not interested in gambling, any form of gambling. I had taken the aggressive view that, contrary to what we were taught in all these probability volumes, and in the misguided books on the history of probability and “risk,” gambling could not offer us lessons about real randomness, nor that it could be a laboratory where you could get actual training for the messy, aPlatonic real life. Just as we tend to underestimate the role of chance in life in general, we tend to overestimate it in these games, by the mechanism of the availability heuristic that makes things the more salient when they easily come to mind.

Indeed, I found it infuriating to listen to people who, upon being informed that I specialize in problems of Chance, immediately jump to references to dice. Two illustrators for a paperback edition of one of my books spontaneously and independently added dice on the cover (the cover illustrator) and below every chapter (by the typesetter), putting me in a state of rage. The editor warned them to “avoid the ludic fallacy” as if it were a well-known intellectual violation—amusingly, they both reacted with “ah, sorry, we didn’t know.” What I call ludic fallacy (after the Latin ludus, play) is the misuse of games as the wrong epistemological ground.

How does randomness end up disappearing in these games? Just consider that you know the probability, and that the payoff does not change throughout. The casino never surprises you by announcing that it will be paying you 100 times more, or a tenth of your take. Furthermore, the dice average out so quickly that I can say with certainty that the casino will beat me in the very near long run at, say, roulette, as the noise will cancel out, though not the skills (here, the casino’s advantage). The more you extend the period (or reduce the size of the bets), the more randomness, by virtue of averaging, drops out of these gambling constructs.

The ludic fallacy is present in the following chance setups: random walk, dice throwing, coin tosses, the infamous digital “heads or tails” expressed into 0 or 1, the “Brownian motion” corresponding to the movement of pollen particles in water, and similar examples. These generate a quality of randomness that cannot be even qualified as randomness—protorandomness, or Mandelbrot’s “mild randomness” is a more appropriate designation. At the core, all these theories ignore a layer of uncertainty. Worse, they do not know it!

The revelation was that poker differs greatly from the random walk—hence, one could learn from it; furthermore, it may be the sole venue for us to learn about randomness. How? Simply, it has other hidden higher layers of uncertainty—many of them. It has suckers, people who invite you to take advantage of them. It also has people for whom you are the sucker (of course, without your being aware of it). You are not flipping a coin and moving left or right. You are not betting against a large machine like a roulette wheel. You are not engaging in a blind draw. You are playing against other humans. You cannot easily control their maximum bet. Your betting policy matters far more than the probability of getting a given card. You can bluff your way, confuse other players, win in spite of a bad hand, or lose in spite of an unlikely good one. Not least, bets can escalate.

In short, there is autistic probability and social probability, one that is made complicated (and interesting) thanks to the messes and convolutions of human relations. Poker and this book bring us to the latter.

So poker resembles real life, owing to uncertainty about the cards, uncertainty about others’ betting policy, and uncertainty about the perception by others of your own betting policy. But it is even more similar to real life, as we saw, in quite unsuspected ways.

III

In spite of having known Aaron B. for several years, mostly as an empirical-minded intellectual of probability, I did not really know what he was about until I read this book. I knew that he has the unusual and valuable background of someone who engaged in the intellectual activity of risk management, but had experience in trading and gambling, therefore got to know uncertainty with more depth and an open mind—which is what uncertainty requires. In other words, a finance professor practitioners could talk to without getting angry.

But here is a person with a single, but large, idea, and who spent his life exploring it vertically and horizontally, maturing it, getting into its interesting wrinkles. This is far rarer than the already rare category of open-minded probability intellectuals. Pokernomics or just generalized gambling is what Aaron B. is about. He views the world from a prism, that of play.

In opposition to the ludic fallacy, there is the ludic virtue, the model of man as an agent of play, presented by Jan Huizinga’s Homo Ludens, generalized by Roger Caillois’s Les Jeux et les Hommes (Man, Play and Games), or, more recently, in Mihai Spariosu’s Dyonisus Reborn2—though it remained difficult to make the leap between these literary and philosophical ideas and a modern explanation of economic life. What makes this a landmark book is that it does not just mix Homo economicus with Homo ludens. It tells us, quite convincingly, that Homo economicus is Homo ludens. Economic life is gambling.

I hope the reader will start viewing the world in a different manner, as I did.

1. Author, Fooled by Randomness: The Hidden Role of Chance in Life and Markets.

2. Johan Huizinga, Homo Ludens: A Study of the Play Element in Culture. New York: Roy Publishers, 1950; Roger Caillois, Le Jeu et les Hommes (Paris: Gallimard, 1958); Mihai Spariosu, Dionysus Reborn: Play and the Aesthetic Dimension in Modern Philosophical and Scientific Discourse (Cornell University Press: Ithaca, NY, 1989). See also Spariosu’s God of Many Names: Play, Poetry, and Power in Hellenic Thought from Homer to Aristotle (Duke University Press: Durham, NC, 1991).

Preface

One January night in New York City, I was playing Texas Hold ’Em with some financial people who were attending the Global Association of Risk Professionals annual conference. I had spent the day teaching a course called “Using Credit Derivatives,” then rounded up some new and old friends for a poker game. One of them happened to be Bill Falloon, senior editor for finance and investment at John Wiley & Sons. Before long, we got to talking about some of the poker articles I had written. It took a few months, but Bill came up with a contract to write The Poker Face of Wall Street. Bill, his assistant Laura Walsh, marketing managers Kim Craven and Nancy Rothschild, and everyone else at Wiley have been incredibly helpful and supportive.

The best part about writing this book is the extraordinary amount of help volunteered by friends and strangers. Everyone loved the topic and dropped important work to explain things to me, give helpful advice, and introduce me to others. Rather than put in a long list here, I’ve mentioned them at the appropriate points in the text, to encourage them to read the book. A few people did not make it into the text, but their ideas did, and they were extremely generous and encouraging: poker guy-of-all-trades, player, writer, and pundit Dave Scharf; superstar financial risk journalist Rachael Horsewood and her equally talented colleague Nina Mehta, who specializes in quantitative finance writing; and noted poker columnist Amy Calistri. David Parlett, the world’s expert on indoor games, provided helpful answers. Tom MacFarland, a physicist turned hedge fund guy at Parallax Fund, provided helpful information and referrals, although he confessed to avoiding the high-stakes games encouraged by fund manager Roger Low. Michael Heneberry got tired of making suggestions and just rewrote, and vastly improved, three of the most important paragraphs in the book. In the process, he gave me the nine-word tagline that crystallized my thinking. I received more essential support from people posting in the online forums at www.Wilmott.com, the best site for quantitative finance, and www.twoplustwo.com, the best site for poker. I’d thank the people who run these sites here, but they’re mentioned in the text.

I’ve had some wonderful teachers in finance and related fields. I learned a lot from social network theorist Harrison White (my advisor at Harvard); accountant Katherine Shipper; statisticians Fredrick Mosteller, Craig Ainsley, Miriam Green, Harry Roberts, Robert Engle, John Tukey, Arnold Zellner, Charles Stein, and his student Ed George (my advisor at Chicago); economists Kenneth Arrow, Graciela Chichilnisky, George Stigler, Gary Becker, and Milton Friedman; finance professors Eugene Fama, Jon Ingersoll, Merton Miller, Robert Jarrow, and Fischer Black (who was particularly inspirational for this book, although he strongly disagreed with about a third of the core idea). In more than one case, I returned the favor with some lessons at the poker table. If someone ever offers an award for lifetime net poker winnings from Nobel Prize winners, I would immodestly place my own name in nomination (I have no way of knowing whether I would win). I learned as much from my fellow students and students I taught as a professor, some of whom appear in this book. I met Marco Avellaneda, Peter Carr, and Emanuel Derman after my course-taking days were over, but I benefited enormously from the wonderful mathematical finance seminars they run in New York.

Some of the poker players whose talents are indirectly reflected in this book are John Aglialoro, Mike Caro, Bob Feduniak, and David Hayano; I list only the famous ones and omit many of comparable abilities who play mainly private games and might not thank me for the exposure. Stan Jonas and Mike Lipkin took the time to give me long interviews—Stan had some great stories and Mike some great theories, all of which ended up on the cutting-room floor. I apologize, but I don’t throw writing away; I’ll use the material in articles. I never met James McManus, the author of the incomparable nonfiction poker novel Positively Fifth Street, but he provided some answers and encouragement for the book, as well as access to some of his unpublished poker writing. Not least, I thank him for a wonderful line I stole for a subchapter heading, which would have made a good title for this book.

Muhammad Cohen, the founder of Writing Camp, provided editing above and beyond the call of duty, taking random fragments of thought from me and returning what you will see in the following pages, putting in enough hours and changing enough words to almost justify a coauthorship. Inspired by Graham Greene novels to join and then smart-aleck his way out of the Foreign Service, this product of Yale and Stanford hides out from husbands of ex-girlfriends, Christmas music, people who wear suits—or file them—and government gunmen, in a part of Hong Kong that appears on no maps. If you find him, you’d better bring cards, chips, and Krugerrands. Copy editor Ginny Carroll improved the text immensely, one letter or punctuation mark at a time.

Writing a book is stealing from your family. Time, energy, attention, patience, and civilized behavior you owe them get shoveled down the black hole of the book. It doesn’t seem right to thank people for stealing from them. Fortunately, I can thank my wife, Deborah, as a partner. She took time away from her own work as a portfolio manager to track down interviewees (some of whom tried hard not to be found), research facts, and talk people into giving me quotes. I made a deal with my children, Jacob and Aviva, which they both kept better than most grown-ups I know. Now that I’m finished with the book, I can keep my end.

Aaron Brown

August 24, 2005

CHAPTER 1

The Art of Uncalculated Risk

This book is about how to gamble and win.

Gambling lies at the heart of economic ideas and institutions, no matter how uncomfortable many people in the financial industry are with that idea. Not surprisingly, the game most like the financial markets—poker—is hugely popular with financial professionals. Poker has valuable lessons for winning in the markets, and markets have equally valuable lessons for winning at poker.

This book will give you insight into both kinds of gambling. We’ll begin with basic information about poker and finance, then delve into the psychology of finance and the economics of poker. We’ll review elementary and advanced tactics for winning. Along the way, we’ll see how America’s passion for gambling at poker and in the markets has shaped the country’s economic success and national character, and spilled over to make the globalized world we live in today. I’ve stuck bits of my autobiography in the Flashback sections to make the points personal. Finally, we’ll look at some of the cutting-edge work being done in these fields and some of the dangerous nonsense to avoid.

RISK

My first point is obvious but often overlooked. In order to win, you must take risk. Therefore, to someone who wants to win, risk is good. However, I have great respect for risk. It is real. Trying to make a living at poker or trading, or anything else that involves risk, means you might fail. You might end up broke or friendless and miserable or dead. Or worse. If you don’t really believe that, if you think that God or the universe or a Hollywood scriptwriter guarantees a happy ending for a shrewd, good-hearted adventurer—or that nothing really bad ever happens to people like you—this book will do you more harm than good. Of course, since God’s looking out for you, you don’t have to worry about that.

It’s easy to say that there’s no alternative to gambling, that you take risk by getting out of bed in the morning or crossing a street. That’s true enough, but you can try to avoid unnecessary risk. More important, you can avoid uncalculated risks; you can always look before you leap. It’s hard to win much that way, though. Other people snap up the riskless profits pretty fast and bid the price of calculable risk opportunities to near their fair values. Things get a lot less crowded if you go for the incalculable risks, leaps of faith that cannot be inspected carefully before takeoff. So that is where you find extraordinary opportunities.

If you can tolerate what life offers in low- and calculable-risk opportunities, you should take it. That is the defining strategy of the middle class, but it can be adopted by anyone, rich or poor. Choose a career in a low-risk field, and get plenty of good training. Be nice to everyone. Select sound investments; make conventional choices; pay your taxes; obey the law. Do a little better every year than the year before, and raise children who will do a little better than you. For many people, this is the American Dream. For others, it’s the only sensible choice, the only kind of life that allows happiness without achieving it at the expense of someone else.