Comments on: Knightian Uncertainty and the Resilience-Stability Trade-off

By: Evolvability, Robustness and Resilience in Complex Adaptive Systems at Macroeconomic Resilience

Thu, 16 Jun 2011 13:04:59 +0000

[...] uncertainty for macro-economic outcomes that is the focus of this blog – In previous posts (1,2) I have elaborated upon the resilience-stability tradeoff and its parallels in economics and [...]

By: Stability and Macro-Stabilisation as a Profound Form of the Moral Hazard Problem at Macroeconomic Resilience

Mon, 27 Sep 2010 09:18:40 +0000

[...] it neglects the principal’s option to walk away. A much better explanation that I mentioned here and here is the role of extended periods of stability in creating “moral hazard-like” [...]

By: Natural Selection, Self-Deception and the Moral Hazard Explanation of the Financial Crisis at Macroeconomic Resilience

Thu, 18 Feb 2010 14:13:01 +0000

[...] Jeffrey Friedman’s analysis of how Cioffi and Tannin clung to their beliefs in the face of mounting evidence to the contrary until the “threshold” was cleared and they finally threw in the towel is a perfect example of this phenomenon. In Ramachandran’s words, “At any given moment in our waking lives, our brains are flooded with a bewildering variety of sensory inputs, all of which have to be incorporated into a coherent perspective based on what stored memories already tell us is true about ourselves and the world. In order to act, the brain must have some way of selecting from this superabundance of detail and ordering it into a consistent ‘belief system’, a story that makes sense of the available evidence. When something doesn’t quite fit the script, however, you very rarely tear up the entire story and start from scratch. What you do, instead, is to deny or confabulate in order to make the information fit the big picture. Far from being maladaptive, such everyday defense mechanisms keep the brain from being hounded into directionless indecision by the ‘combinational explosion’ of possible stories that might be written from the material available to the senses.” However, once a threshold is passed, the brain finds a way to revise the model completely. Ramachandran’s analysis also provides a neurological explanation for Thomas Kuhn’s phases of science where the “normal” period is overturned once anomalies accumulate beyond a threshold. It also provides further backing for the thesis that we follow simple rules and heuristics in the face of significant uncertainty which I discussed here. [...]

By: Mark-to-Market Accounting and the Financial Crisis at Macroeconomic Resilience

Mark-to-Market Accounting and the Financial Crisis at Macroeconomic Resilience — Sun, 07 Feb 2010 19:14:52 +0000

[...] assets and prevent collapse? One answer which I discussed in my previous note is the role of extended periods of stability in reducing system resilience. The narrowing of the [...]

By: Iohannes

Iohannes — Mon, 01 Feb 2010 06:49:38 +0000

Great thoughts. Thanks much!

By: admin

admin — Sun, 31 Jan 2010 11:45:12 +0000

David – you make some great points. Diversity is one of the most important determinants of resilience in a complex adaptive system.

One of the key concepts in the stability-resilience tradeoff is that stability reduces system resilience by reducing diversity in the system. Essentially,adaptation or natural selection in a constant environment will reduce diversity as only one strategy will “win”. As a result, the very existence of variability in the environment increases diversity and promotes robustness.

I’ll explore these themes in more detail in a later post.

By: admin

admin — Sun, 31 Jan 2010 11:09:34 +0000

Shrek – Thank you! All we’re doing is substituting many low intensity crises with an eventual high-intensity crisis. The best and most relevant example in ecology is the history of forest fire suppression in the United States which has prevented frequent low-intensity fires at the expense of eventual high-intensity fires that cause systemic collapse.

And the SocGen episode was an example of the tendency we’ve seen from the Fed all through the last two decades, to use monetary policy as a blunt instrument to put every fire, no matter how minor.

By: admin

admin — Sun, 31 Jan 2010 11:00:23 +0000

Iohannes – Yes, I think many people have used “Ambiguity Aversion” as an explanation to the equity premium puzzle. Having said that, I tend to believe that equity risk premium is time-varying and frequently approaches zero. But that’s another post entirely!

And yes, in my view the main problem with SEU and modern finance/macro is not that it ignores irrationality/”animal spirits”, but that it ignores uncertainty and more specifically evolution/adaptation under uncertainty.

By: David Merkel

David Merkel — Sun, 31 Jan 2010 05:53:32 +0000

Another good post. I have a few sayings:

A healthy market ecology has multiple strategies that are working in separate areas at the same time.

The more entities manage for total return, the more unstable the financial system becomes.

Stability only comes to markets in a self-reinforcing mode, from buy and hold (and sell and sit on cash) investors who act at the turning points.

Markets are more akin to ecologies than physics experiments. When the ecology is diverse, but with variability, it is most robust.

By: shrek

shrek — Sun, 31 Jan 2010 00:46:35 +0000

Nice post. Keep up the good work. No doubt there are a lot of people buying bank debt and other instruments based on the no lehmans polcies. The biggest surprise of the next year could be the a run on a major bank and the inability of the government to save the institutions. I see a very complancent attitude that the government can indeed prevent all tail events, but reality is the damn they are trying to plug is getting absolutely massive with few policy tricks left.

How dumb was the interest rate cut in january 2008 because of SocGen?
There are no bullets left.