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More from Taleb on the Flight to Simplicity
The Simplicity Rule

A major rule should be taken into account: The market always tends to flow to simplicity. Complexity is generally costlier to both monitor and produce, and somehow in the long run, demand moves away from the complex in favour of the simple. New, elaborate contracts certainly attract people, but typically the novelty wanes. Operators will then try to satisfy their needs for protection by seeking the cheapest possible way.

Complex products cost more to replicate. An optimal operator becomes cost conscious and avoids enriching the financial institutions when he can satisfy his interests more economically. This becomes noticeable with the life or death of listed financial instruments. It is the recipe for the survival of exchange contracts. This rule will be discussed in the study of exotic options.

While he's writing about complex options contracts, the reasoning clearly applies to any financial instruments. Is it any wonder that the asset-backed commercial paper binge was going to end in indigestion as the more complex paper became illiquid?

We have met the enemy, and he is us — Pogo
by Migeru (migeru at eurotrib dot com) on Sat Jan 26th, 2008 at 11:39:03 AM EST
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