Tuesday, March 31, 2009

Neo At The Quantum Casino - Part III

Foreword to Part III

The Greek letter gamma (γ) is used in finance to denote correlation, the "connectedness" of two separate events. For example, if patient A dies of malaria, how likely is it that patient B will, too? If it is absolutely certain that he will, correlation is total and γ has a value of +1. If it is certain that he will not, then the two events are completely uncorrelated and γ has a value of -1.

Assigning proper correlation values is crucial in the design of tranched derivative products that contain many separate instruments. For example, CDOs structured from thousands of individual home mortgages, auto or student loans.

For an excellent story on correlation see this Wired magazine article: Recipe for Disaster: The Formula That Killed Wall Street by Felix Salmon.

It did not take Neo very long to become adept at dealing craps the Quantum Casino way. All he had to do was call the shots - just a split second before every gambler at his table had a chance to "see" how the dice lay. Neo's manipulation of perception created reality as he - and the Casino owners - wished it to be.

And in the Quantum Casino's version of reality almost every gambler got properly "skinned" the old-fashioned way: by regular and frequent swaps between greed and gloom.

Cartoon by KAL

Not content with swindling the same old geezers, Neo soon tired of the regular games and looked for added excitement. He designed a brand new game employing multiple variables that provided small, but regular, payoffs every time the variables did not align together - which was most of the time. But when they did converge everyone lost big, including their prior winnings. He called it The Correlation Game - and it proved to be a bonanza.

Neo realized that people loved repetition of familiar patterns - the herd mentality, he called it - and supplied it with gusto. He skillfully manipulated results and repeated gains to create a seemingly simple and profitable pattern - until he led everyone right over the edge, of course.

Not long thereafter, and based on the tremendous profits his new game racked up for Quantum Casinos, Inc., Neo was made a partner. His future was set.

The End


A few - very few - professionals have tried to explain how they "see" markets but their work is usually ignored or scorned by the "reality-based" community of professors, analysts and consultants who prefer deterministic theories, such as random portfolio, etc.

Here are two examples of really smart guys that "got it":
Needless to say, both individuals were extremely successful. In addition, Soros' premier hedge fund is named The Quantum Fund. A coincidence?

I will say it again: it is perception that shapes reality and not the other way around. Does this apply to today's crisis? Yes, it does. If we believe that "this is the biggest crisis since the Great Depression", then our belief will be realized because our behaviour will be altered to fit our preconception.

Therefore, one has to seriously wonder why all the smart analysts are crying oceans of tears for all the horrible things that are supposedly coming our way, while Neo (aka Fed, Geithner and Co.) are furiously pumping trillions of fresh dollars into the system.
P.S. From our This Is Just Too Good Of A Cheap Shot To Pass Up department:

Yes, she's back. Who? Goldman's strategist Abby Joseph Cohen has just said that US banks are "still not in the clear".

This is what I wrote about her in a post back in December 4, 2007.

"Abby Joseph Cohen of Goldman Sachs and 1999-2000 stock bubble infamy, just came out saying that the S&P 500 will climb to a record 1,675 by the end of 2008, extending the longest stretch of annual gains since the 1980s.

She is one of the best contrary indicators in the strategist camp. Back in 2000-01 I made a point of shorting every time she came out with a bullish hoo-hah. I think she stayed bullish until 2003 and then turned bear. Just in time."

S&P 500 was at 1,510 when she made that pronouncement and managed a 10 point rise over the next couple of days. It then went a whole lot lower, of course. The index is now at 798 and she thinks "it's not over", eh?

Well, I bet she's still the best contrary indicator around - and fervently hope Goldie keeps her on the payroll forever. And ever.


  1. There are 1,000 Trillion worth of derivatives set loose on the planet. So far, they have only thrown out 1% of that amount or about 10 trillion.

    This thing is way too big to bail. Once we see a big player go down, it will cascade the whole system down to nothing.

    The big killer of derivatives is due to their complex interdependancies with no model in play to deal with it. They did not model the end game. Period.

    Joe M.

  2. Joe, I am as against certain derivatives as Warren Buffet (WMD). But there aren't 1,000 trillion of them around - not by a very, very long shot.

    The vast majority of derivatives are forward rate agreements, interest rate swaps and FX swaps - completely normal, day to day stuff that has been around for ages and are priced precisely, all the time.

    It's the CDSs that killed the cat, however - now around 50 trillion.


  3. A small nit pick in the first paragraph:
    A Gamma of -1 does not indicate they are uncorrelated. It indicates inverse correlation, B does not die because A did. A Gamma of 0 means uncorrelated. We have do idea whether or not B will die if A dies.

  4. Factors affecting reserve currency status:


  5. Hell,

    You seem to start going on the optimist side (correct me if I am wrong).

    I see this in waves:

    1. sub-prime failure
    2. financial failure
    3. industrial and world trade failure (we are here now)
    4. mass unemployment
    5. unemployment triggers mass credit defaults
    6. repeat for one or two iterations

    I remember you saying that unemployment was fundamental for things to break (as people are maxed out on credit and unemployment would cause immediate default, triggering a vicious cycle).

    From my point of view we are not even in the worse (mostly with human consequences) part of the crisis.

    Are you seeing light at the end of the tunnel already?

  6. My schoolgirl memories say that one of the cute things about correlation is the way that two phenomena which are stuck together under the savvy expression "correlation" are often surmised to exist in a CAUSE/EFFECT relation...Dangerous assumptions...
    I have a MAJOR quibble with calling the dice, Hell.
    Neo is not "manipulating" the dice in this game, as your conclusion so aptly points out.
    HIS perception of what they are induces others to SEE EXACTLY THE SAME THING.
    The dice ? WHAT DO THEY SAY ?
    Probably about the same thing the Pythian oracle said...
    And what you see is incredibly determined by all that DOGMA out there telling you what you are, or SHOULD be seeing.
    I find it fascinating that our Western European societies have decided that the CEO's are ARISTOCRACY.
    And if you listen to the crowds, we are calling for their heads, just like in...1789.
    Sigh. Scapegoats focus people's attention so nicely away from THEIR OWN RESPONSIBILITY in this affair.
    The CEO's are being held hostage here in France.
    But, on the bright side, at least we don't have the guillotine any more...

  7. Debra,
    You made a mistake in your last sentence: in France there are several guillotines stored and ready to be used again. Needless to write, I hope that they will not be reused...
    Arnould (Rueil)

  8. To those who believe that modern civilizations problems were over looked by past generations because they were unknown at the time, not so:

    “From our cellulose waste products on the farm such as straw, corn-stalks, corn cobs and all similar sorts of material we throw away, we can get, by present known methods, enough alcohol to run our automotive equipment in the United States.”

    That sounds like something you’ve heard recently, right? Well, fasten your seatbelt because that claim was made way back in 1921. That’s when American inventor Thomas Midgley proclaimed the wonders of cellulosic ethanol...


  9. Dear Debra,

    I'm afraid you are not getting the whole quantum physics concept ;)

    Don't feel bad - I believe it was Feynman who said that if quantum physics doesn't seem totally crazy to you then you just don't understand it.

    Neo makes others see what they see and thus CREATES reality. Once again: perception creates reality and not the other way around.

    Or, to put it another way, reality does not exist until we create it by observing it. The dice SAY NOTHING ON THEIR OWN.

    That's the Copenhagen interpretation, by the way.


  10. The rabble does like to take aim at the king, and why not, when CEO gets fat bonus while the serf is made redundant?

    Heh, I'm not Russian myself, but they've got some sense of humour. So, an anecdote:

    Starving and thirsty man staggers through the desert, and when he's almost dead, he suddenly finds a golden lamp with a genie inside.
    The genie offers to fulfill three of his wishes. So, what's the first one?
    - I wan't to get home as a very rich, successful and respected businessman!
    - Your wish is my command... - and suddenly our dude finds himself at home (more accurately, a huge mansion with an entire parking lot full of RollsRoyces)
    - Impressive. You know, all this wealth and no company is no fun. I want a bunch of good pals in government and a supermodel for a wife!
    - Your wish is my command...

    Now the man contemplates his third wish.
    - You know, I have everything I could ever need, so I should think about other people, too. I want my fellow Russians to be happy!

    ... and he find himself in jail!

    - You know, nothing makes people so happy as an imprisoned oligarch, the genie explains...

  11. Hell(boy) wrote:

    "I will say it again: it is perception that shapes reality and not the other way around."

    By three full centuries, Shakespeare beat you and the whole gaggle of quantum physicists to the idea that reality is what we make it when he put the following words into the mouth of literature's most perceptive character, Hamlet.

    "...for there is nothing either good or bad, but thinking makes it so."

    For my own part that is absolutely true, except when it isn't, and therein lies the problem.

  12. Hell, I will modestly say that I think that I understood your quantum physics point, and that my comment around the Pythian oracle was rather an indication of my understanding.
    You have NOT addressed my comment about the fact that DOGMA shapes perception itself...
    YOU ARE SO RIGHT, ARNOULD, and thank you for reminding me that the guillotine is still around, (waiting to be put back into service, who knows ?)
    Great comment, Edwardo, AND Homo Sarcasticus.
    The Russians have such a GREAT sense of humor.

    The other day I was musing on this question of language, and it finally hit me, in one of those illuminations that makes you feel totally crazy (and MUCH MUCH WORSE than what you seem to feel that I should feel about quantum physics, Hell...) that all the vocabulary, or almost all the vocabulary we have to talk about...
    But I'm not sure exactly WHAT we're talking ABOUT, in detail, (probably human relations, exchanges...) can be attached to "money" and "debt".
    "to be interested in", "have an interest in", etc. The word "interest" is inextricably tied to MONEY.
    "you get what you pay for"
    "things COUNT" (i.e., they're important, and I'm SURE we're talking about the kind of counting that is "materialized" in money...)
    " to be indebted to "
    "I owe you" (an explanation, for example...)

    I'm not going to continue, because I'm going to let all of you reflect on just how far the money game has trapped our consciousness, and stamped its imprint on our perception of our mutual relations.

    To me, that is a real IDEOLOGICAL PRISON.
    And we need to collectively reflect on this.
    And I hope that we can do this, to a certain extent, on this blog.

    For those of you who are interested in Shakespeare, I have started reading the Winter's Tale with my 18 year old daughter, who has almost been turned off learning by mass public education (yuck...).
    We have spent about 4 hrs on the first two scenes.
    And you can get an idea of what I mean about debt and money in these scenes.
    They pervert human relations. Grave, as my daughter says...

  13. Capital idea, Debra. Karl Marx would have delighted in your keen insight into the way money and all that is related to it has so pervasively worked its way into the very language we use.

  14. Yes, and Edwardo, this is the clincher :
    since they are so so present in our language, they are inextricably part of the way that we SEE what is around us, and how we translate our perceptions into meaning.
    They determine what we see, and what we don't...
    Really capital ideas... ; )