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Singularly Complex. The Catch with Hybrid Finance
BY ABHIJNAN REJ
A Jurassic Park in the Canary Wharf?
On the 6th of May, 2010, at around 2:45 pm, the Dow fell unusually rapidly losing over 9% of its total value in a couple of minutes without any perceptible external information input. After a circuit-breaker in the Chicago Mercantile Exchange was switched on for a few seconds, the markets started climbing back up and by 3:00 pm most of the 600 points or so that were lost was regained as traders recalibrated their mental and computational models. There are many conflicting accounts around what might have caused this event—jazzily named the Flash Crash—but almost everybody agrees that high-frequency algorithmic traders had a large role to play. Since algorithms have a much faster reaction time to market movements than humans, at first sight of the unexpectedly hectic buying and selling amidst a large sell-order by Proctor & Gamble, a large number of algorithmic traders decided to exit the market in a classic display of herding behavior (“the herders”) while others continued selling vigorously. At the final reckoning, most of the temporary losses during the couple of hours since the Flash Crash have been attributed to them.
Over the last few years, a small group of experts have built a parallel description of financial markets that go much beyond the orthodox dogma taught in a typical MBA finance course. These researchers have uncovered a very rich set of analogies with ecological and other biological systems which have helped us understand the mechanism behind financial crashes—both Flash and the more prolonged purges—and given us a comprehensive notion of the global human/machine hybrid financial system which is, to use a very bold word, living. Building models and theories that cut across disciplinary boundaries, and through extensive computational modeling, these researchers, including early pioneers of chaos theory such as Robert May and Doyne Farmer, have presented us with a narrative about the future of finance that is, again to use a bold word, alarming. Recognizing that complex systems display unexpected and un-programmed features, these researchers (much like the fictional Dr. Ian Malcolm of Jurassic Park) have argued that introducing financial innovations of increasing complexity (much of which is machine- or high-frequency algorithmically driven) is, more than ever before, making the global financial network fragile and prone to fractures both big and small.
The Need for Speed
More than 70% of equity trades in the US are executed through algorithmic trading. For example, the mathematician-turned-financier James Simons’ Renaissance Technologies, a hedge fund mostly driven by automated trading, manages about 23 billion US dollars--their Nova Fund is completely electronic and potent enough to invite the apocryphal story that on a certain day their trades accounted for 14% of all trades in NASDAQ.
Basically for an algorithmic trader to make a profit, one needs three technical tools- imaginative trading strategies, extremely fast computer programs that can execute those strategies and finally for international funds, cutting-edge communication tools—all three taken together form a formidable weapon to hunt for market mispriced assets, i.e., identical assets selling for two different prices at the same time in two different markets. This is known as an arbitrage opportunity in the finance jargon. The idea is actually quite simple: suppose I know that a certain stock is selling for more in London than in New York at the same time. I’d immediately buy a certain amount of this stock in New York and simultaneously sell it in London pocketing the risk-free difference.
The catch to such a sweet deal is the following: you have to be the first to know of the arbitrage opportunity before all others. Once this information is available to all other traders, they will quickly move in with a similar strategy with the inevitable result that the two prices will converge to one. This is the sacred Efficient Market Hypothesis (EMH) around which much of contemporary finance is built around. It assumes all traders possess the same amount of information at any given point in time, something which is routinely invalidated in the real-world. In practice, the amount of risk-free money you will make through arbitrage is a function of how fast your information channels are (that is, how much more you know about the state of the markets) and how quickly your algorithms can trade. (Often arbitrage opportunities exist only for milliseconds, much smaller than the average human response times.) Increasingly, large funds are beginning to invest in newer technologies that will optimize arbitrage opportunities, including a specially designed chip that prepares and executes trades at 740 nanoseconds and a new transatlantic cable that reduces communication time between Canary Wharf and Wall Street by five milliseconds. These new techniques don’t come cheap, with some estimates of building the transatlantic cable alone running close to a billion dollars. However given the number of arbitrage opportunities, for large banks and funds the price is just right.
For regulators such as the US Securities and Exchange Commission (SEC), such technologies are frightening for many reasons. One, they are simply not equipped to monitor such high speed/high frequency/high-volume trades. Two, they are not sure if such technologies can be used for insider trading, and finally, a recent paper by Neil Johnson and others demonstrate that such ultrafast technologies are in fact making and driving financial black swans such as the Flash Crash and, even more scarily, making large investment banks susceptible to contagion exposure. Simply put, what Johnson and collaborators are arguing is that flash crashes are increasingly becoming more and more common and, in analogy to engineering, these Flash Crash-type micro-fractures are building up to a much larger and violent fractures in the global financial market.
Towards an Ecology of Hybrid Finance
The quest to understand the global human/machine hybrid financial market as an ecological system goes back to the early days of chaos and complexity theory. Indeed both financial markets and ecological systems share many common features, such as spontaneous emergence of unexpected patterns without any exogenous input,in-built fragilities and instabilities driven by increasing complexity. Over the recent years, Didier Sornette of Swiss Federal Institute of Technology Zurich (ETHZ) has become a vocal advocate of this point of view, arguing that crashes and extreme financial events can be best modeled through local interactions and positive feedback loops, and one of the biggest drivers of these crashes are herders and noise traders.
Very recently in January, along with Vladimir Filimonov, Sornette had put forward a very interesting model for flash crashes that draw as much from the study of evolution of human societies as to nuclear engineering. Building on an idea of George Soros about market prices being self-fulfilling prophecies, they have created a model in which a given price data stream can be linearly decomposed into two parts—a part that depends on the “exogenous”, such as “game-changing” input information of geopolitical or economic nature, and an “endogenous” part which arises from the self-excitation of the market due to such input information which triggers a branched cascade of price movements. According to Filimonov and Sornette, it is this endogenous part of the price movement that is responsible for flash crashes. In fact, they go on to suggest a single parameter, n, called the “branching ratio”, in analogy to nuclear processes, whose value determines whether or not we are going into a flash crash regime simply by looking at the price stream over a 10 minutes interval.
The branching ratio measures the internal system dynamics directly. For example, n>0.9 indicates that more than 90% of the price movements can be attributed to the system’s intrinsic dynamics alone; this was precisely the case during the Flash Crash of 2010. Interestingly enough, through the analysis of historical data, Filimonov and Sornette show that the growth of n directly coincides with the rise of high-frequency algorithmic trading. Extrapolating their analysis in light of the news of the upcoming ultra-fast electronic trading devices and accessories such as the transatlantic cable as well as the analysis of Johnson and others presents us with a very worrying picture of finance of the future.
In the past few years, another related set of analysis on the “ecology” of the financial markets addressing similar problems have come from A.G. Haldane of the Bank of England in collaboration with the mathematical biologist and chaos theorist Robert May. In a model published in the science journal Nature last year, they show how, given a sudden external shock, the liquidity crunch cascades through the financial network which is viewed as a random graph (that is, a random collection of nodes representing banks and line segments between nodes that represent inter-banking transactions.) Building on earlier studies in ecology, they conclude that instability and fragility are a direct consequence of increasing complexity and connectivity of the financial network with a few banks (nodes) controlling a large fraction of the total capital in the market. Their view of a financial crash is one of an information cascade where, in the event of external shock, a big failing bank passes its liquidity crunch onto slightly smaller banks that, through all the way down, pass the crunch to the smallest banking/quasi-banking entity and ultimately to individuals--at each step “amplifying the liquidity shock”. A worrying part of the story is that there has been a steady decline in the amount of actual physical or monetary assets that banks have held over the years, severely degenerating their capacity to absorb an external shock or an endogenous perturbation; simply put, a bank might only hold as assets instruments that derive their value from instruments generated by other banks equally susceptible to any crisis! In this era of “post-modern finance”, such destructive closed loops should be the first ones regulators need to break into.
Haldane and May’s research contain several insights. First, they argue that adding each layer of complexity in terms of the introduction of highly-leveraged exotic financial instruments erodes systemic stability by a significant amount and after reaching a critical level of liquidity crunch, the whole network is likely to collapse in one go. Haldane and May (echoing the famous words of Warren Buffet about derivatives being weapons of mass financial destruction) also, understandably enough, hold credit derivatives such as the infamous Credit Default Swap (CDS) responsible for much of the fragility of the financial system; as they aptly note, “CDSs have outpaced Moore’s law of growth”. Second, given that values of derivatives are highly correlated, shocks can propagate smoothly across the entire financial sector making the system very unstable even with large fluctuations in the value of a single derivative. Third, they argue that banks too taken as wholes are highly susceptible to “herding”, which experts such as Didier Sornette have time and again identified as drivers of crashes.
A standard dogma in financial theory is that prices of derivatives of stocks, by definition, depend on the price of the underlying stock in some predictable way and not the other way around (this is the famous Black-Scholes-Merton model), something that has, in practice, turned out to be false. In reality, there are positive feedback loops by which stock prices are influenced by the prices of options that derive their value from these very stocks. (EMH holds that stock prices are random in nature and, if large informational shocks from the outside are absent, immune to tinkering by traders. Even though using derivatives to maneuver stock or other assets such as commodities prices is illegal in almost all Western countries, it is nevertheless, as many traders in their private conversations with the author have confided, practiced on a day-to-day basis. Part of the problem in analyzing such positive feedback loops is their mathematical intractability, and given that almost all profitable trading strategies are proprietary, it is unavailable for scrutiny of regulators and investors alike. All of these, taken together, have given us a financial system that is opaque not because of the number of entities involved but by the very fact that as a network it is far from being “linear”. (A more mathematical way of saying this would be that when viewed as a graph, the financial network is not a “tree” but instead has very many loops.)
Haldane and May go on to suggest several policy measures through an ecological lens. First they suggest that regulators stop looking at problems with individual funds and banks alone and start looking at systemic risks, a point also advocated by Sornette. Haldane and May compare this current attitude of regulators to the attitude of public health practitioners who may look at the contagion of infectious diseases as a matter of only isolating a couple of individuals without understanding the terrain in which these diseases may propagate. Haldane and May advocate much higher capital and liquidity requirements on banks that pose the greater threat to the system by the virtue of their higher connectivity and therefore larger “liability” to smaller entities that they are connected to. Second, they push for ``systemic diversity” by means of which shocks do not propagate so evenly in times of crisis. Finally, they call for partitioning the financial markets into modules with the idea in mind that in times of trouble, disturbances can be contained inside a given module and not be allowed to spread beyond that. It must be noted that modularity, especially in the hybrid world, brings with it its own set of problems. For example, a recent study published by Miguel Fortuna and others show non-trivial predator-prey and exclusionary relationships between different modular packages of the Debian Linux operating system. It is not clear whether a similar “life-like” phenomenon will not arise in a modular financial network increasingly driven by algorithms.
It is also important to note that there are dissidents who would ascribe to the picture described above, and yet have a very different view of how it informs regulations. For example, they may claim that in a complex system, too much interference actually increases volatility than decreases it, so the whole business of regulation without understanding the system as a whole might actually make things worse. (Nassim Nicholas Taleb and Mark Blythe also make this excellent point in the realm of geopolitics in their May 2011, Foreign Affairs article.)
Till then, our best bet still is to remember former Defense Secretary Donald Rumsfeld’s charming reformulation of Knightian uncertainty when he asked us to differentiate between the domains of “known unknowns” (where we know what can go wrong) and the “unknown unknowns” (where we do not even know where to look). If ours is to be the true hybrid era, it is the second domain that we ought to pay much more attention to, if not to predict then to simply hedge.
Abhijnan Rej is a Researcher at the Hybrid Reality Institute and on the faculty of the Institute of Mathematics and Applications, Bhubaneswar.
Inventions with revolutionary potential made by a mysterious aerospace engineer for the U.S. Navy come to light.
- U.S. Navy holds patents for enigmatic inventions by aerospace engineer Dr. Salvatore Pais.
- Pais came up with technology that can "engineer" reality, devising an ultrafast craft, a fusion reactor, and more.
- While mostly theoretical at this point, the inventions could transform energy, space, and military sectors.
The U.S. Navy controls patents for some futuristic and outlandish technologies, some of which, dubbed "the UFO patents," came to light recently. Of particular note are inventions by the somewhat mysterious Dr. Salvatore Cezar Pais, whose tech claims to be able to "engineer reality." His slate of highly-ambitious, borderline sci-fi designs meant for use by the U.S. government range from gravitational wave generators and compact fusion reactors to next-gen hybrid aerospace-underwater crafts with revolutionary propulsion systems, and beyond.
Of course, the existence of patents does not mean these technologies have actually been created, but there is evidence that some demonstrations of operability have been successfully carried out. As investigated and reported by The War Zone, a possible reason why some of the patents may have been taken on by the Navy is that the Chinese military may also be developing similar advanced gadgets.
Among Dr. Pais's patents are designs, approved in 2018, for an aerospace-underwater craft of incredible speed and maneuverability. This cone-shaped vehicle can potentially fly just as well anywhere it may be, whether air, water or space, without leaving any heat signatures. It can achieve this by creating a quantum vacuum around itself with a very dense polarized energy field. This vacuum would allow it to repel any molecule the craft comes in contact with, no matter the medium. Manipulating "quantum field fluctuations in the local vacuum energy state," would help reduce the craft's inertia. The polarized vacuum would dramatically decrease any elemental resistance and lead to "extreme speeds," claims the paper.
Not only that, if the vacuum-creating technology can be engineered, we'd also be able to "engineer the fabric of our reality at the most fundamental level," states the patent. This would lead to major advancements in aerospace propulsion and generating power. Not to mention other reality-changing outcomes that come to mind.
Among Pais's other patents are inventions that stem from similar thinking, outlining pieces of technology necessary to make his creations come to fruition. His paper presented in 2019, titled "Room Temperature Superconducting System for Use on a Hybrid Aerospace Undersea Craft," proposes a system that can achieve superconductivity at room temperatures. This would become "a highly disruptive technology, capable of a total paradigm change in Science and Technology," conveys Pais.
High frequency gravitational wave generator.
Credit: Dr. Salvatore Pais
Another invention devised by Pais is an electromagnetic field generator that could generate "an impenetrable defensive shield to sea and land as well as space-based military and civilian assets." This shield could protect from threats like anti-ship ballistic missiles, cruise missiles that evade radar, coronal mass ejections, military satellites, and even asteroids.
Dr. Pais's ideas center around the phenomenon he dubbed "The Pais Effect". He referred to it in his writings as the "controlled motion of electrically charged matter (from solid to plasma) via accelerated spin and/or accelerated vibration under rapid (yet smooth) acceleration-deceleration-acceleration transients." In less jargon-heavy terms, Pais claims to have figured out how to spin electromagnetic fields in order to contain a fusion reaction – an accomplishment that would lead to a tremendous change in power consumption and an abundance of energy.
According to his bio in a recently published paper on a new Plasma Compression Fusion Device, which could transform energy production, Dr. Pais is a mechanical and aerospace engineer working at the Naval Air Warfare Center Aircraft Division (NAWCAD), which is headquartered in Patuxent River, Maryland. Holding a Ph.D. from Case Western Reserve University in Cleveland, Ohio, Pais was a NASA Research Fellow and worked with Northrop Grumman Aerospace Systems. His current Department of Defense work involves his "advanced knowledge of theory, analysis, and modern experimental and computational methods in aerodynamics, along with an understanding of air-vehicle and missile design, especially in the domain of hypersonic power plant and vehicle design." He also has expert knowledge of electrooptics, emerging quantum technologies (laser power generation in particular), high-energy electromagnetic field generation, and the "breakthrough field of room temperature superconductivity, as related to advanced field propulsion."
Suffice it to say, with such a list of research credentials that would make Nikola Tesla proud, Dr. Pais seems well-positioned to carry out groundbreaking work.
A craft using an inertial mass reduction device.
Credit: Salvatore Pais
The patents won't necessarily lead to these technologies ever seeing the light of day. The research has its share of detractors and nonbelievers among other scientists, who think the amount of energy required for the fields described by Pais and his ideas on electromagnetic propulsions are well beyond the scope of current tech and are nearly impossible. Yet investigators at The War Zone found comments from Navy officials that indicate the inventions are being looked at seriously enough, and some tests are taking place.
If you'd like to read through Pais's patents yourself, check them out here.
Laser Augmented Turbojet Propulsion System
Credit: Dr. Salvatore Pais
The experience of life flashing before one's eyes has been reported for well over a century, but where's the science behind it?
At the age of 16, when Tony Kofi was an apprentice builder living in Nottingham, he fell from the third story of a building. Time seemed to slow down massively, and he saw a complex series of images flash before his eyes.
As he described it, “In my mind's eye I saw many, many things: children that I hadn't even had yet, friends that I had never seen but are now my friends. The thing that really stuck in my mind was playing an instrument". Then Tony landed on his head and lost consciousness.
When he came to at the hospital, he felt like a different person and didn't want to return to his previous life. Over the following weeks, the images kept flashing back into his mind. He felt that he was “being shown something" and that the images represented his future.
Later, Tony saw a picture of a saxophone and recognized it as the instrument he'd seen himself playing. He used his compensation money from the accident to buy one. Now, Tony Kofi is one of the UK's most successful jazz musicians, having won the BBC Jazz awards twice, in 2005 and 2008.
Though Tony's belief that he saw into his future is uncommon, it's by no means uncommon for people to report witnessing multiple scenes from their past during split-second emergency situations. After all, this is where the phrase “my life flashed before my eyes" comes from.
But what explains this phenomenon? Psychologists have proposed a number of explanations, but I'd argue the key to understanding Tony's experience lies in a different interpretation of time itself.
When life flashes before our eyes
The experience of life flashing before one's eyes has been reported for well over a century. In 1892, a Swiss geologist named Albert Heim fell from a precipice while mountain climbing. In his account of the fall, he wrote is was “as if on a distant stage, my whole past life [was] playing itself out in numerous scenes".
More recently, in July 2005, a young woman called Gill Hicks was sitting near one of the bombs that exploded on the London Underground. In the minutes after the accident, she hovered on the brink of death where, as she describes it: “my life was flashing before my eyes, flickering through every scene, every happy and sad moment, everything I have ever done, said, experienced".
In some cases, people don't see a review of their whole lives, but a series of past experiences and events that have special significance to them.
Explaining life reviews
Perhaps surprisingly, given how common it is, the “life review experience" has been studied very little. A handful of theories have been put forward, but they're understandably tentative and rather vague.
For example, a group of Israeli researchers suggested in 2017 that our life events may exist as a continuum in our minds, and may come to the forefront in extreme conditions of psychological and physiological stress.
Another theory is that, when we're close to death, our memories suddenly “unload" themselves, like the contents of a skip being dumped. This could be related to “cortical disinhibition" – a breaking down of the normal regulatory processes of the brain – in highly stressful or dangerous situations, causing a “cascade" of mental impressions.
But the life review is usually reported as a serene and ordered experience, completely unlike the kind of chaotic cascade of experiences associated with cortical disinhibition. And none of these theories explain how it's possible for such a vast amount of information – in many cases, all the events of a person's life – to manifest themselves in a period of a few seconds, and often far less.
Thinking in 'spatial' time
An alternative explanation is to think of time in a “spatial" sense. Our commonsense view of time is as an arrow that moves from the past through the present towards the future, in which we only have direct access to the present. But modern physics has cast doubt on this simple linear view of time.
Indeed, since Einstein's theory of relativity, some physicists have adopted a “spatial" view of time. They argue we live in a static “block universe" in which time is spread out in a kind of panorama where the past, the present and the future co-exist simultaneously.
The modern physicist Carlo Rovelli – author of the best-selling The Order of Time – also holds the view that linear time doesn't exist as a universal fact. This idea reflects the view of the philosopher Immanuel Kant, who argued that time is not an objectively real phenomenon, but a construct of the human mind.
This could explain why some people are able to review the events of their whole lives in an instant. A good deal of previous research – including my own – has suggested that our normal perception of time is simply a product of our normal state of consciousness.
In many altered states of consciousness, time slows down so dramatically that seconds seem to stretch out into minutes. This is a common feature of emergency situations, as well as states of deep meditation, experiences on psychedelic drugs and when athletes are “in the zone".
The limits of understanding
But what about Tony Kofi's apparent visions of his future? Did he really glimpse scenes from his future life? Did he see himself playing the saxophone because somehow his future as a musician was already established?
There are obviously some mundane interpretations of Tony's experience. Perhaps, for instance, he became a saxophone player simply because he saw himself playing it in his vision. But I don't think it's impossible that Tony did glimpse future events.
If time really does exist in a spatial sense – and if it's true that time is a construct of the human mind – then perhaps in some way future events may already be present, just as past events are still present.
Admittedly, this is very difficult to make sense of. But why should everything make sense to us? As I have suggested in a recent book, there must be some aspects of reality that are beyond our comprehension. After all, we're just animals, with a limited awareness of reality. And perhaps more than any other phenomenon, this is especially true of time.
Might as well face it, you're addicted to love.
- Many writers have commented on the addictive qualities of love. Science agrees.
- The reward system of the brain reacts similarly to both love and drugs
- Someday, it might be possible to treat "love addiction."
Since people started writing, they've written about love. The oldest love poem known dates back to the 21st century BCE. For most of that time, writers also apparently have been of two (or more) minds about it, announcing that love can be painful, impossible to quit, or even addictive — while also mentioning how nice it is.
The idea of love as an addiction is one that is both familiar and unsettling. Surely it can't be the case that our mutual love with our partner — a thing that can produce euphoria, consumes a great deal of our time, and which we fear losing — can be compared to a drug habit? But indeed, many scientists have turned their attention to the idea of "love addiction" and how your brain on drugs might resemble your brain in love.
Love and other drugs
In a 2017 article published in the journal Philosophy, Psychiatry, & Psychology, a team of neuroethicists considered the idea that love is addicting and held the idea up to science for scrutiny.
They point out that the leading model of addiction rests on the notion of a drug causing the brain to release an unnatural level of reward chemicals, such as dopamine, effectively hijacking the brain's reward system. This phenomenon isn't strictly limited to drugs, though they are more effective at this process than other things. Rats can get a similar rush from sugar as from cocaine, and they can have terrible withdrawal symptoms when the sugar crash kicks in.
On the structural level, there is a fair amount of overlap between the parts of the brain that handle love and pair-bonding and the parts that deal with addiction and reward processing. When inside an MRI machine and asked to think about the person they love romantically, the reward centers of people's brains light up like Broadway.
Love as an addiction
These facts lead the authors to consider two ideas, dubbed the "narrow" and "broad" views of love as an addiction.
The narrow view holds that addiction is the result of abnormal brain processes that simply don't exist in non-addicts. Under this paradigm, "food-seeking or love-seeking behaviors are not truly the result of addiction, no matter how addiction-like they may outwardly appear." It could be that abnormal processes cause the brain's reward system to misfire when exposed to love and to react to it excessively.
If this model is accurate, love addiction would be a rare thing — one study puts it around five to ten percent of the population — but could be considered a disorder similar to others and caused by faulty wiring in the brain. As with other addictions, this malfunction of the reward system could lead to an inability to fully live a typical life, difficulty having healthy relationships, and a number of other negative consequences.
The broad view looks at addiction differently, perhaps even radically.
It begins with the idea that addiction exists on a spectrum of motivations. All of our appetites, including those for food and water, exist on this spectrum and activate similar parts of the brain when satisfied. We can have appetites for anything that taps into our reward system, including food, gambling, sex, drugs, and love. For most people most of the time, our appetites are fairly temperate, if recurring. I might be slightly "addicted" to food — I do need some a few times per day — but that "addiction" doesn't have any negative effects on my health.
An appetite for cocaine, however, is rarely temperate and usually dangerous. Likewise, a person's appetite for love could reach addiction levels, and a person could be considered "hooked" on relationships (or on a particular person). This would put love addiction at the extreme end of the spectrum.
None of this is to say that the authors think that love is bad for you just because it can resemble an addiction. Love addiction is not the same as cocaine addiction at the neurological level: important differences, like how long it takes for the desire for another "hit" to occur, do exist. Rather, the authors see this as an opportunity to reconsider our approach to addiction in general and to think about how we can help the heartsick when they just can't seem to get over their last relationship.
Is "love addiction" a treatable disorder?
Hypothetically, a neurological basis for an addiction to love could point toward interventions that "correct" for it. If the narrow view of addiction is accurate, perhaps some people will be able to seek treatment for love addiction in the same way that others seek help to quit smoking. If the broad view of addiction is correct, the treatment of love addiction would be unlikely as it may be difficult to properly identify where the cutoff of acceptability on a spectrum should be.
Either way, since love is generally held in high regard by all cultures and doesn't quite seem to be in the same category as a bad cocaine habit in terms of social undesirability, the authors doubt we'll be treating anyone for "love addiction" anytime soon.
A brief passage from a recent UN report describes what could be the first-known case of an autonomous weapon, powered by artificial intelligence, killing in the battlefield.