There but for the grace

by CarlD

It warms my heart that we live in a society that provides employment of great consequence and social honor to the socially challenged. We all have our weaknesses but this is no reason to waste our strengths. As perhaps a case in point here’s a piece of a conversation on NPR’s “Marketplace” between host Kai Ryssdal and Robert Whaley, professor of finance at Vanderbilt. They’re talking about Whaley’s VIX, or Market Volatility Index, which essentially uses activity in portfolio insurance instruments to measure how “freaked out” the stock markets are. (I’ve modified NPR’s sloppy transcript very slightly so it makes more sense and accords with my memory.)

Ryssdal: All right, well let me ask you this, then: Is it not possible that knowing what’s coming creates more volatility, [that] a rising VIX creates a rising VIX?

Whaley: Oh, can you frame that question a little differently?

Ryssdal: Sure. Is it possible that this thing, knowing how nervous people are, makes people more nervous?

Whaley: Um, that would a behavioral type of interpretation. What makes me more nervous, actually, is sort of the movements that we’re seeing in the stock market on a daily basis. This VIX is just telling you that they suspect those types of movements to persist. But yes, I mean, you’re seeing that the price of insurance is going up, and so it makes you wonder, if you’re seeing the price rise, whether people smarter that know there’s going to be an event, so you might jump in too.

The question just doesn’t track at first for Whaley, who clearly hasn’t thought of the matter that way and whose strength is therefore clearly not ‘behavioral types of interpretation’ — that is, what people actually do and why.

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9 Comments to “There but for the grace”

  1. It is very odd, indeed, to be sixty-seven years old and to have a little money in the markets. Not too much. I favor Taleeb’s black swan strategy. Keep what you need as safe as you can. Go a little crazy and play with the rest. Do not make yourself the Dao’s straw dog by buying index funds that gyrate with the market as a whole.

    From this perspective, watching the recent gyrations in the markets is, yes, disturbing, but also entertainment.

  2. Because of the way it’s set up, a little bump in the VIX drives up the volatility almost logarithmically! It’s just a big loop. And to me it seems absolutely bizarre that the economists haven’t (seemed) to figure out that indexes like the VIX just create these huge swings because they’re self fulfilling prophesy!

    Yes, someone needs to let the number wonks out of their cages/cubicles/offices and remind them what real life is like.

  3. @McCreery

    Yep—Taleb’s barbell investing (95/5 % split) is nice insurance against anything too crazy happening. As long as you’re cool with loosing the 5%, and protect the 95% against inflation.

  4. In fairness to economists, it should be noted that the study of positive feedback loops was initiated by folks like Brian Arthur at the Santa Fe Institute at least a couple of decades ago. The problem is one of academic lag sustained by still teaching Econ 101 almost exclusively in terms of negative feedback, leading to equilibrium solutions. Odd that, since the lack of equilibrium in the real world is evident to anyone who pays attention. Conventional statistics courses are also to blame, since they contribute to the belief that the “normal” distribution is, in fact, a normal state of affairs, when fat tails and power laws are far more common than are dreamed of in most introductory courses.

  5. @Palazzi And, of course, the trick to being in that position is finding yourself in a place and time when losing 5% is not a big deal. In my case, arriving in Japan with a lucky connection at the start of the bubble going up put me where I am today. What I have to keep in mind is what I was teaching my students, back when I had students to teach. We were talking about what was then hot news, the Asian financial crisis of 1997. I pointed out to the students that losing 10% of your income if you were a Javanese peasant living on the edge of survival was not the same thing as losing 10% of your income if you were living in Japan, where the difference it made was from obscenely well off to comfortably well off. What is truly obscene about the current situation is that those who can least afford it, the nickeled-and-dimed, are being the hardest hurt.

  6. Unfortunately the Taleb model also assumes that your 95% is enough to do the trick, so there’s no motivation but ignorance or greed to leave it where the black swans can take it. But as someone with a barely professional salary and a late start on full-time employment and retirement saving, I’m here to tell you that if the Dao of the market doesn’t trend significantly upward over the next twenty years I’m going to be working until they carry me out on a plank.

  7. When you’ve got people trusting in the farce that is conventional—or even the so-called “advanced”—statistical tools, which put more trust in predictive modeling (hah!) than Mandelbrotian reality that is life, you’ve got a serious problem.

    And don’t even get me started on the obscene interdependence of today’s Market (with a capital ‘M’).

    @McCreery You make a great point that the few who can’t afford to loose are the ones loosing…and unfortunately they’re (often) loosing a bigger chunk than just 10% of their assets.

  8. @Carl (Taleb advises to only invest what you’re okay with loosing completely—not necessarily the 5% I said) but that aside, you’re absolutely right.

    And when even things like T-Bills are suspect in their ability to protect the 95% against inflation…it might be better to stay away from the market.

  9. Well that’s the thing. I can neither afford to lose my retirement savings nor to protect them, because they’re too meager to actually enable a retirement and will with certainty continue so if I can’t get a better-than-safe return on them. In effect my retirement plan is my continued ability and willingness to work, at which point safe investing has very little upside, while the downside of failed speculation is also obviously unattractive. My point is that one can be fully and rationally aware of black swan dangers and still be in a position where the possibility of a decisively better outcome is marginally preferable to [hedging against] the risk of bust.

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