Does Complexity Breed Volatility?

We have now become familiar with the VIX, the Chicago Board Options Exchange Market Volatility Index, thanks to the wild stock market volatility that has graced our television screens in the last few weeks.  Investors process incoming political and economic news, and try to assess their future implications on investments and assets.  They do so with limited information and limited knowledge.

The  Financial Times shows that increased volatility is caused by large investors correlating their bets, essentially, as Telis Demos quotes Nicholas Colas, chief market strategist at ConvergEx: “All the people on the boat are running from one side to the other over and over again”.   Buyers and sellers all agree on the direction of the market and interpret the news in similar manners all at the same time.

I submit – without much proof I admit – that this behavior is driven, in part, by the temporary inability of buyers and sellers to grasp the future implications of some news on assets, because the system is too complex – and they simply cannot isolate the impact of the news on their World.

In normal times, investors have a systematic view of their World that enables them to process news (weather, politics, war) and figure out the potential magnitude of the impact on the assets in their care (stocks, bonds, commodities, infrastructure, etc.)  Some see the news as good, some may see the news as bad, each may use a different model to predict what the future will bring.   But the system has become so complex that it has become increasingly difficult to build a functional model that can tell us what the impact will be with some certainty.  Take the debt ceiling case, for instance.  Was there a likelihood that the U.S. would be downgraded?  And what would be the significance of that? And how would that impact other countries?  And how would that impact S&P and the value of their ratings in other countries?  And ow would it affect municipalities in the U.S.? and their creditors?  And how would it affect the U.S.’ competitiveness in the long run?  And how would that affect the U.S. election?  And how would that impact the U.S. stock market in the medium term? …..too much to process….

In the end, investors will give up and follow the herd: sell when they sell and buy when they buy…until the news cools down again, and we can decompose ourselves into smaller, less complex, manageable Worlds.

Oh, by the way… the same idea applies to political candidacies… and volatility in political ideology, but that should be the topic of another blog…

Is Complexity Useful?

I was reading Michael Behe’s recent blog entitled “irremediable complexity” about complexity in nature, and I wanted to ask this simple question: is complexity useful?  That question, of course, brings a number of other questions, and so I will try to expand a bit.   Michael Behe comments on an article entitled “irremediable complexity?” by authors which includes noted biologist W. Ford Doolittle. The article asks whether nature creates complexity as part of evolution and selection perhaps, and whether some of this complexity has no value at all.  It seems to be sitting there, in the middle of organisms, for no particular purpose or reason at all, once it establishes itself through evolution.  In the World around us, the same could be asked of human endeavors.  Linkages establishes themselves between activities, and complexity arises because these links are useful: they serve a purpose, they establish human relations, data bridges, connections…, but do they maintain their usefulness as they remain?

A few years ago, bankers sought to group mortgages and create financial instruments by securitizing them to reduce risks, forever linking the real estate industry to the securities industry. These linkages also forever increased the level of complexity in the real estate industry, making it more complex to determine current and future house values, lending rates, and who can afford a loan.  We, in society, derive value from this complexity, yet, we also pay a cost for it.  Where is the balance?  It is increasingly difficult to understand if we derive value from this complexity or of we do not.

And there is another problem: One of  Michael Behe’s criticism of the Doolittle article is that the article does not contain quantitative proofs.  When everything is connected to everything else, the impacts and their causes are increasingly difficult to isolate, identify and quantify.  Thus, the value of linkages, the value of complexity, is harder to ascertain.  To paraphrase Michael Behe, what is the value of the associate director of licensing delays in the Department of Motor Vehicles (ADLD/DMV)?   To the Director, plenty, I am sure.

Trying to find out if the ADLD/DMV is useful may be, in itself, such a complex task, that it – the measurement – may not be reliably computed, anyhow.  This task may require observations that may be skewed by their very nature,  the very fact that the Associate Director is observed, and that the Director had to be asked for her permission…   What are we to do?  It is no wonder that in this sea of complexity, cries for simplistic “know-nothing” “authentic” approaches to the World seem appealing…