Curriculum·R405 Strategy Development and Validation·about 33 min
Writing rules that are actually testable
By the end of this lesson you can
- →State the reproduction test, and apply it to a strategy description
- →Name the five things a rule must specify before it can be tested at all
- →Show why a described strategy can be refuted from its own arithmetic
- →Identify the words that make a rule untestable, and replace them
Senior · enrolled learners
This lesson opens with Markopolos on Madoff, 1999 to 2008.
- What happened
- Bernard Madoff's investment business reported consistent returns from a strategy described as a split-strike conversion, being a basket of large-capitalization equities held alongside purchased index puts and written index calls. Harry Markopolos, an options professional, first presented his analysis to the SEC's Boston office in May 1999 and alerted the Commission again in 2000, 2001 and 2005. His November 2005 submission was a twenty-one page memorandum titled The World's Largest Hedge Fund is a Fraud, listing thirty red flags. The central objection was arithmetic rather than forensic: the option volume the described strategy would have required on the relevant dates exceeded the entire publicly reported volume of the market in those options. He also noted the return profile, with only three losing months against twenty-six for the broader market over the same period. The scheme collapsed in December 2008.
- The decision point
- The strategy description used the correct technical vocabulary and named real instruments, and it could not be reproduced. That is the whole test. A rule that cannot be applied by a competent third party to the same data and produce the same trades is not a strategy that has not yet been validated, it is a description that cannot be validated, and the difference between those two is the subject of this lesson. Markopolos needed no access to any account to refute it.
What you will be able to answer
- →What is the reproduction test?
- →What five things must a rule specify?
- →How was Madoff refuted from arithmetic?
- →Which words make a rule untestable?
Orientation and Year One are open: anyone can read them without an account. From Year Two onward the lessons are for enrolled learners, because progress through the later years only means anything if it is tracked against a record.
It is free. We do not sell the list and there is nothing to buy at the end of it.
Sources and review
- https://www.sec.gov/news/studies/2009/oig-509/exhibit-0276.pdf
- https://www.opalesque.com/49087/Harry_Markopolos_submission_to_the_SEC087.html?act=AMBArchive&and=show_exclusive&nr=49087
- https://www.acfe.com/fraud-magazine/all-issues/issue/article?s=2009-mayjune-harry-markopolos-interview
- https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2308659
Confidence high·Volatility low·Reviewed 2026-08-07·Owner unassigned
Contested
The three-against-twenty-six down months comparison comes from Markopolos's own analysis of the period he examined and the window is not stated identically across accounts. It is used here as the shape of the return profile rather than as a precise statistic, and the collar argument in part three does not depend on it.
The contract arithmetic in part two uses stated inputs, being an index near 600, a contract multiplier of 100 and $17B of assets, to demonstrate the method Markopolos applied. It is not a reconstruction of his figures and the assets under management at any given date are disputed. The conclusion, that the required volume exceeded the available volume by a large multiple, is the documented finding.
R405-01 owns the pipeline and the independence requirement. This lesson owns specification. R411-01 owns turning a specification into code. Keep both splits.