Can you imagine any reader of Human Action being fooled by this?
It was a brilliant simplification of an intractable problem. And Li didn’t just radically dumb down the difficulty of working out correlations; he decided not to even bother trying to map and calculate all the nearly infinite relationships between the various loans that made up a pool. What happens when the number of pool members increases or when you mix negative correlations with positive ones? Never mind all that, he said. The only thing that matters is the final correlation number — one clean, simple, all-sufficient figure that sums up everything …
Read the whole thing. This has got to be the most powerful illustration yet of the fallacy of mistaking a math function for real phenomena in the market.