Learning to love Volatility
Although Bernanke doesn’t acknowledge Mr Taleb, we still argue you reading his oice from the WSJ. Taleb is one of our favourite Derivatives free thinkers.
Several years before the financial crisis descended on us, I put forward the concept of “black swans”: large events that are both unexpected and highly consequential. We never see black swans coming, but when they do arrive, they profoundly shape our world: Think of World War I, 9/11, the Internet, the rise of Google.
In economic life and history more generally, just about everything of consequence comes from black swans; ordinary events have paltry effects in the long term. Still, through some mental bias, people think in hindsight that they “sort of” considered the possibility of such events; this gives them confidence in continuing to formulate predictions. But our tools for forecasting and risk measurement cannot begin to capture black swans. Indeed, our faith in these tools make it more likely that we will continue to take dangerous, uninformed risks.
Next Black Swan – French Revolution in China?
Could the next Black Swan event be coming from China? Well, nothing would surprise us. With inequality in China today is at its greatest since the revolution things could start getting interesting. From SMH.
China’s political leaders put stability above all else. So it’s a remarkable sign of the times that they could be passing around well-thumbed copies of a book about the sudden, bloody outbreak of the French Revolution two-and-a-quarter centuries ago.
Why would China’s modern rulers, preoccupied with the leadership handover under way in Beijing this week, be interested in Alexis de Tocqueville’s The Old Regime and the French Revolution?
They are ”fascinated by the French thinker’s writings because of what his observations say about conditions in their times,” says a visiting professor at China’s Sun Yat-sen University, Nailene Chou Wiest.
Since the Communist Party seized power in 1949 in a violent revolution, its highest priority has been to guard against what it calls ”counter-revolution”.
Black Swan Thursday
Guest post by Peter Tchir.
I just can’t talk about QE anymore. In a few hours we will know what we get and I don’t think anything is going to happen between now and then to change my view. My base case remains that the Fed delivers an incredibly dovish statement and may even introduce some “targeting” but will not have a big full balance sheet expansion at this stage.
I think large QE is reasonably built in, so the risk/reward remains biased to the downside, which is why it may be time to think about a few things that may hit the markets.
Risks to Europe
This summer basically proved you cannot have a “black swan” event when everyone is expecting a “black swan” event. The expectations were so low, and the market positioned so bearishly, that almost any action could spark a massive rally. We got that “almost any action” and the vicious short covering rally (I prefer re-coupling rally) began.
Now the market seems almost too complacent. Delays of implementation have been the kiss of death for past European market rebounds and here we are in the middle of delays. Spain should ask for the money while it is still available. The ECB may waiver. Other countries may challenge the ESM. We don’t know what the situation will look like in a month or two. I am pretty sure that once the ECB starts buying bonds the program will grow large enough that Europe will continue to buy more bonds rather than take losses on existing purchases. The slippery slope will do all the work, but Europe needs to get on that slippery slope.
Taleb’s latest on Stress testing
Nasim Taleb´s latest paper on stress testing.
Summary: This paper presents a simple heuristic measure of tail risk, which is applied to individual bank stress tests and to public debt. Stress testing can be seen as a first order test of the level of potential negative outcomes in response to tail shocks. However, the results of stress testing can be misleading in the presence of model error and the uncertainty attending parameters and their estimation. The heuristic can be seen as a second order stress test to detect nonlinearities in the tails that can lead to fragility, i.e., provide additional information on the robustness of stress tests. It also shows how the measure can be used to assess the robustness of public debt forecasts, an important issue in many countries. The heuristic measure outlined here can be used in a variety of situations to ascertain an ordinal ranking of fragility to tail risks.
Full paper here.
Bernanke Put Expiry-The next Black Swan event?
What will the Fed do this weekend? What if the Jackson Hole is another “promise you nothing” meeting? What if the Bernanke Put expires? From Biderman.
It is a bizarre stock market we live in when the wonder is who is gaming whom regarding the Fed this weekend. The Wall Street Journal’s John Hilsenrath today writes as if it is almost certain that the Fed will announce an easing in Jackson Hole. But maybe the Fed is gaming Hilsenrath’s reputation as the Fed’s unofficial mouthpiece to have him sell some more sizzle. Remember, Hilsenrath first promised a Fed easing in early June, which helped stop and reverse May’s sharp stock market selloff. Yet the Fed actually did nothing at the June meeting. Every few weeks since, seeming to coincide with a stock sell off, Hilsenrath writes another story promising an easing soon.
Video below.
The Perils of Underestimating Complexity & Mispricing Risk
Good interviews with Keith Fitz-Gerald on black swans, mispricing of risk and much more.
“If you’re rich you get a bailout. If you’re poor you get a handout. And if you’re middle class you get left out. ” That’s not a sustainable way to run the system, exclaims investment strategist Keith Fitz-Gerald.
A cancer at the core of our current economy is the magical thinking, “no pain, all gain” philosophy, pursued by those running it. They are doing all they can to remove the consequences of failure from the system — blind to failure’s essential ‘waste-clearing’ function in a healthy free market.
Full interview click here.
Enter the Swan
Guest post by Azizonomics.
Charles Hugh Smith (along with many, many, many others) thinks there may be a great decoupling as the world sinks deeper into the mire, and that the dollar could be set to benefit:
This “safe haven” status can be discerned in the strengthening U.S. dollar. Despite a central bank (The Federal Reserve) with an avowed goal of weakening the nation’s currency (the U.S. dollar), the USD has been in an long-term uptrend for a year–a trend I have noted many times here, starting in April 2011.
That means a bet in the U.S. bond or stock market is a double bet, as these markets are denominated in U.S. dollars. Even if they go nowhere, the capital invested in them will gain purchasing power as the dollar strengthens.
All this suggests a “decoupling” of the U.S. bond and stock markets from the rest of the globe’s markets. Put yourself in the shoes of someone responsible for safekeeping $100 billion and keeping much of it liquid in treacherous times, and ask yourself: where can you park this money where it won’t blow up the market just from its size? What are the safest, most liquid markets out there?
The answer will very likely point the future direction of global markets.
Smith is going along with one of the most conventional pieces of conventional wisdom: that in risky and troubled times investors will seek out the dollar as a haven. That’s what happened in 2008. And that’s what has happened throughout the era of petrodollar hegemony.
Nassim Taleb on Risk, Black Swans and much more at Princeton
Must see video from the Black Swan Master.
Hard Core Black Swans
To know the unknown. Video on real black swans below.
Taleb’s next Black Swan
While at the Black Swan subject, Taleb on his next Black Swan scenario. From CNBC.
A black swan is an event outside the realm of regular expectations. no mother person personifies the concept like telev. he has not appeared on cnbcsince 2010 to break his silence about what he fears will be ablack swan event. thanks for inviting me after all these months.we made it sound like you’ve crawled into a hole. clearly you’ve been writing, speaking. mostly finishing my new work. but, you know, i came out of this — i watched the election and something wrong is going on. only one candidate ron paul seems to have grasped the issues and is offering the right remedies for the central problems we facing. so i came out just to support – i’m not involved in politics. i’m a risk based person. but from my risk base vantage point i think one candidate represents the right policies when it comes to the big four, and that candidate is ron paul.
Full video here.
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