2nd Qtr 2007 Review and Black Swans
THE FOLLOWING ARTICLE DOES NOT CONSTITUTE A SOLICITATION TO INVEST IN ANY PROGRAM OF CERVINO CAPITAL MANAGEMENT LLC. AN INVESTMENT MAY ONLY BE MADE AT THE TIME A QUALIFIED INVESTOR RECEIVES CERVINO CAPITAL'S DISCLOSURE DOCUMENT FOR ITS COMMODITY TRADING ADVISOR PROGRAM OR DISCLOSURE BROCHURE FOR ITS REGISTERED INVESTMENT ADVISER PROGRAMS. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
My business partner and I have recently discussed at length the anti-probabilistic theories and philosophical musings based on a book we both recently read, “The Black Swan; The Impact of the Highly Improbable” by Nassim Nicholas Taleb.
This book has recently made the rounds quite extensively in the hedge fund community because of its caustic approach about life and trading, and for having been written by one of us.
One of the points I had been making to friends and colleagues before the book came out—and ‘corroborated’ (pun intended) to a certain extent by Taleb’s thought process—is the increasing cosmogonic awareness of uncontrolled chaos around us.
This is not a soul searching exercise but part of an ongoing discussion in the intellectual vanguard of market analysis; that is, the impact that acute random events as well as seemingly trivial random events may have on the markets, and by implication on the highly leveraged trading environment we find ourselves managing.
Long-held ideas and passed-down wisdom teaches us to explain markets based on likely relationships between certain cause and effect dynamics. In the case of option theory, traders also utilize quantitative calculations based on the Black-Scholes model, Cox-Ross-Rubinstein binomial tree, and/or Monte Carlo simulations, all which stand solidly on the shoulders of conventional statistics and probability assumptions.
Taleb, however, puts forward that ‘we’ live in an increasingly complex world of unpredictability and inequality resulting in situations of huge disparity between efforts and rewards; accordingly, Gaussian bell curves are “intellectual frauds.” My contention is that ‘we’ live and trade in a world of “self-fulfilling prophecy,” until one day ‘we’ wake up to find long-held assumptions are turned upside down (‘the trend is your friend until it ends).
Regardless, this past year has certainly increased my awareness, as well as in others, of a disruption in traditionally-understood economic relationships: “When America sneezes, the rest of the world's economies may no longer catch a cold” (The Economist, “The Alternative Engine,” October 19, 2006).
Philosophy aside, our performance has been less than stellar in the first part of this year, but I do not want to sound defensive by claiming randomness as an excuse—I’m not. However, knowing that smart traders like Taleb are buying the insurance we’re selling (and for which we receive premiums) induces us in turn to prudently reinsure some of our positions.
Appropriately we have increased our S&P hedges and also made our trading more diversified than last year as a proactive way to deal with hurtful “grey swans” that may be potentially overlooked by our models. At the same time, the increase in volatility from the doldrums last year and earlier this year is generally welcomed, and we have made adjustments to capture the upside in this new environment within reasonable risk parameters.
With respect to market fundamentals, my thesis is bullish on energy, while remaining short term cautious in equities where I have assumed a more benign outlook for the intermediate term. One of the reasons for such an intermediate bullish outlook resides with the attitude of the ‘smart money.’ A number of studies tracking large commercial players show a fairly bullish set up; history has taught us that betting against these investors may be a mistake.
We are a bit disappointed with silver and gold; especially since the latter seems to trade mostly on physical demand while investment demand has waned. I also question gold’s reflection of the inflationary environment which I still believe is miserably (or should I say self-servingly?) misrepresented by the official statistics.
In conclusion, we expect volatile waters to navigate going forward but think we have trimmed our sails accordingly and look forward to the second half of 2007. Having set our compass, should we see a black swan we will kindly remind him of Black-Scholes’ greeks.
- Davide Accomazzo, Managing Director
My business partner and I have recently discussed at length the anti-probabilistic theories and philosophical musings based on a book we both recently read, “The Black Swan; The Impact of the Highly Improbable” by Nassim Nicholas Taleb.
This book has recently made the rounds quite extensively in the hedge fund community because of its caustic approach about life and trading, and for having been written by one of us.
One of the points I had been making to friends and colleagues before the book came out—and ‘corroborated’ (pun intended) to a certain extent by Taleb’s thought process—is the increasing cosmogonic awareness of uncontrolled chaos around us.
This is not a soul searching exercise but part of an ongoing discussion in the intellectual vanguard of market analysis; that is, the impact that acute random events as well as seemingly trivial random events may have on the markets, and by implication on the highly leveraged trading environment we find ourselves managing.
Long-held ideas and passed-down wisdom teaches us to explain markets based on likely relationships between certain cause and effect dynamics. In the case of option theory, traders also utilize quantitative calculations based on the Black-Scholes model, Cox-Ross-Rubinstein binomial tree, and/or Monte Carlo simulations, all which stand solidly on the shoulders of conventional statistics and probability assumptions.
Taleb, however, puts forward that ‘we’ live in an increasingly complex world of unpredictability and inequality resulting in situations of huge disparity between efforts and rewards; accordingly, Gaussian bell curves are “intellectual frauds.” My contention is that ‘we’ live and trade in a world of “self-fulfilling prophecy,” until one day ‘we’ wake up to find long-held assumptions are turned upside down (‘the trend is your friend until it ends).
Regardless, this past year has certainly increased my awareness, as well as in others, of a disruption in traditionally-understood economic relationships: “When America sneezes, the rest of the world's economies may no longer catch a cold” (The Economist, “The Alternative Engine,” October 19, 2006).
Philosophy aside, our performance has been less than stellar in the first part of this year, but I do not want to sound defensive by claiming randomness as an excuse—I’m not. However, knowing that smart traders like Taleb are buying the insurance we’re selling (and for which we receive premiums) induces us in turn to prudently reinsure some of our positions.
Appropriately we have increased our S&P hedges and also made our trading more diversified than last year as a proactive way to deal with hurtful “grey swans” that may be potentially overlooked by our models. At the same time, the increase in volatility from the doldrums last year and earlier this year is generally welcomed, and we have made adjustments to capture the upside in this new environment within reasonable risk parameters.
With respect to market fundamentals, my thesis is bullish on energy, while remaining short term cautious in equities where I have assumed a more benign outlook for the intermediate term. One of the reasons for such an intermediate bullish outlook resides with the attitude of the ‘smart money.’ A number of studies tracking large commercial players show a fairly bullish set up; history has taught us that betting against these investors may be a mistake.
We are a bit disappointed with silver and gold; especially since the latter seems to trade mostly on physical demand while investment demand has waned. I also question gold’s reflection of the inflationary environment which I still believe is miserably (or should I say self-servingly?) misrepresented by the official statistics.
In conclusion, we expect volatile waters to navigate going forward but think we have trimmed our sails accordingly and look forward to the second half of 2007. Having set our compass, should we see a black swan we will kindly remind him of Black-Scholes’ greeks.
- Davide Accomazzo, Managing Director
posted by Cervino Capital Management LLC at 7/08/2007
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