These soldiers would be in Eastern Europe for exactly the same reason we stationed US soldiers in West Berlin during the Cold War: they are there to die. In the event of a Russian attack, their job is to be killed so that the resulting hue and cry would guarantee an all-out NATO military response. Color me nervous. Third, there is one redeeming quality about the game of Chicken — it takes a long time to play. Chicken is a game played through a glass, darkly. Take your time in dis-engaging from the game. Yes, a game of Chicken is inherently unpredictable and hence inherently un-investable, but you have plenty of time to exit.
Moreover, the passage of time can often make the ultimate car crash much less painful. In other words, it is virtually impossible for a single signal to push the outcome into either Nash equilibrium. When does time run out in a game of Chicken? The Golden Age of the Central Banker is a time for investment survivors, not investment heroes, and the ubiquity of inherently unstable games of Chicken is a big reason for that advice.
Time for a new set of lenses, one that takes seriously the patterns of strategic interaction and behavioral dynamics that rocked the world in the s, the s, the s, and … I suspect … the years immediately ahead of us. Neurosis is the inability to tolerate ambiguity. To learn which questions are unanswerable, and not to answer them : this skill is most useful in times of stress and darkness.
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Is everything connected, so that events create resonances like ripples across a net? Or do things merely co-occur and we give meaning to these co-occurrences based on our belief system? I remember when I was a very little girl, our house caught on fire. I stood there shivering in my pajamas and watched the whole world go up in flames.
And when it was all over I said to myself. I call our world Flatland, not because we call it so, but to make its nature clearer to you, my happy readers, who are privileged to live in Space.
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How is it possible that the deepest and most important securities in the world are currently displaying all the trading stability of a biotech stock? As with all market questions of singular importance and vast attention, these are questions of meaning. We are — all of us — convinced that this market behavior must mean something profound.
Surely this insane quivering within the bond market means that we are on the cusp of a quantum shift in the market landscape. Surely this is the rumbling of a deep tectonic plate that presages a massive earthquake. Surely, as more than one Master of the Universe proclaimed at SALT the other week, the long-awaited bear market in government debt is nigh.
Or maybe all those Masters of the Universe are just talking their book. I know … shocking. This is the most hated bull market in history, precisely because we all believe that it is a creature of policy and Narrative, and when the Voices are silent or they say conflicting things, we start to freak out. We run from pillar to post, getting whipsawed at every turn.
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Or more precisely, a system can be volatile or unstable in a local sense but highly stable in a global sense. Or Deckard, who sure seems like a replicant to me. From a local perspective these bond market gyrations make it seem as if we are totally unmoored and markets are on the brink of some life-altering change. From a global perspective, however, this is a tempest in a teacup.
Or to paraphrase the late, great Peggy Lee, is that all there is to a bond market fire? Translation, please? Information Theory is, in fact, the beating heart of Epsilon Theory. That said, one of the beautiful things about releasing content into the wild is that readers can do with it what they will. As a corollary, the more confident you are in a certain view of the world, the more new information is required to make you have the opposite view of the world and the less information is required to confirm your initial view.
Information is neither true nor false. As a result, the informational strength of any signal is relative. The same signal may make a big difference in my assessment of the future but a tiny difference in yours. In that case, we are hearing the same message, but it has a lot of information to me and very little to you. So you do nothing.
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But you start reading analyst reports about Apple or you build a cash-flow model … whatever it is that you typically do to gather information about a potential investment decision. Of course, your assessment of Apple is not a single event and does not take place at a single point in time. As an investor you are constantly updating your opinion about every potential investment decision, and you are constantly taking in new signals. Each new update becomes the starting point for the next, ad infinitum, and as a result all of your prior assessments become part of the current assessment and influence the informational impact of any new signal.
The graph below shows how Information Theory represents the amount of information required to change your mind from here. The higher the wall, the more information required in any given signal to get you to change your mind in a big way about Apple. What does an information surface look like for strategic decision-making, where your estimations of the future state of the world are contingent on the decisions you think others will make, and where everyone knows that everyone is being strategic?
Two criminals are placed in separate rooms for questioning by the police, and while they are both better off if they both keep silent, each is individually much better off if he rats his partner out while the partner remains silent. Because both players know that this pay-off structure exists and are always told that it exists by the police , the logical behavior for each player is to rat out his buddy for fear of being the sucker.
Both the Row player and the Column player have only two decision choices — Rat and Silence — with the joint pay-off structures shown as Row , Column and the equilibrium outcome Rat , Rat shaded in light blue. The same equilibrium outcome is shown below on the right as an informational surface, where both the Row and the Column player face an expected utility hurdle of 5 units to move from a decision of Rat to a decision of Silence. Below, new information of 2 units changes the perceived utility of the current Rat decision for the Row player from -5 to Maybe he hears from his lawyer that the Mob intends to break his legs if he stays a Rat.
This new Silence , Rat outcome is an equilibrium because neither the Row player nor the Column player perceives a higher expected utility outcome by changing decisions. It is still a weak equilibrium because the informational hurdle to return to Rat , Rat is only 1 informational unit, but all the same it generates a new behavior by the Row player: instead of ratting out his partner, he now keeps his mouth shut.
This change in utility pay-offs over time can be mapped as:. But only if the new signal is sufficiently large whatever that means in the context of a specific game will the decision outcome move to a new equilibrium and result in stable behavioral change. In the first structure, there is enough informational strength to the signal to overcome the upside informational wall and push the market to a higher and stable price equilibrium. In the second structure, while the signal moves the market price higher briefly, there is not enough strength to the signal to change the minds of market participants to a degree that a new stable equilibrium behavior emerges.
Following this negative event, however, the market then receives a set of public media signals — a Narrative — asserting that in response to this bad ISM number the Fed is more likely to launch additional easing measures. This Narrative signal is repeated widely enough and credibly enough that it changes Common Knowledge about future Fed policy and moves the market to a new, higher, and stable level.
Well, it looks something like this:. The market equilibrium today is like a marble sitting on a glass table.
It is an extremely unstable equilibrium because the informational barriers that keep the marble from rolling a long way in either direction are as low as they have been in the past five years. Even a very weak signal is enough to push the marble a long way in one direction, only to have another weak signal push it right back.
Why are the informational barriers to equilibrium shifts so low today? Because levels of Common Knowledge regarding future central bank policy decisions are so low today. The Narratives on both sides of the collective decision to buy or sell this market are extremely weak.
What does everyone know that everyone knows about Abenomics? Very little. What does everyone know that everyone knows about Fed tapering? What does everyone know that everyone knows about the current state of global growth? Everything I wrote about the informational surface of the equity market in early summer is exactly applicable to the informational surface of the bond market in early summer The bond market today is like a marble sitting on a glass table. There are very few informational structures or barriers to keep the price of US bonds from skittering this way or that, within a price range as expressed in yield terms of, say, 2.
Maybe the locally unstable price range of the US year as expressed in yield terms goes to 2. Among market participants today there is almost unanimity of belief that central bankers Will. But at the same time there is also almost unanimity of belief that central bankers Can. That unanimity of belief establishes a global informational equilibrium of unparalleled strength and stability , or at least unparalleled in my experience.
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