Daily Speculations

The Web Site of Victor Niederhoffer & Laurel Kenner

Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.

 

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8/23/04:
Tom Ryan: Random Thoughts

Like infinite variance, which given a long enough time frame I don't have an inherent philosophical problem with, I have no problem with randomness.

Randomness to me is one quadrant of a system that also includes persistence, anti-persistence and occasionally, yes chaos. In a large complex system like multi-billion-dollar financial markets for stocks and bonds, when viewed from a top down perspective the aggregate behavior, like an index value, will at times change in what can best be described as a random manner. And we have the mathematics that can test for that. That, however, does not imply that the underlying dynamics within the system are transpiring in a random manner, which is where I think a lot of academic theory falls down.

People don't act randomly, but their aggregate effect can sometimes appear to be random. And often what looks random in one time frame is not so random in another. This is also true in a lot of natural sciences and in my field, geology, we see this often. Given enough structural events, enough time and enough phases of mineralization the grades in a mineral deposit or the storativity in a field can appear to be described well by the standard Gaussian normal distribution or by a log transform of the normal distribution with no provable geographic dependencies. Bt that doesn't mean that the original mechanics of deposition were random.

With regard to stocks, given the long-term upward drift, and the long-term inflation from a fractional reserve system, it would seem to this bad Spec that if enough people believe that the market is moving randomly so that there is no point to looking further, well it would seem that this leaves some ground unclaimed for the sharper pick to dig up a few small nuggets. The original prospectors didn't dig or drill randomly, they went after markers like quartz veining and alteration halos and major faults. But its true that ground plays out, veins are truncated by faults and cycles change. this is of course what keeps our interest in the game. from a behavioral perspective.

If the markets were random this site wouldn't exist because no one would play -- or, like Vegas, wouldn't play for long. But throw in just a dash of predictability over the short term, and you have a recipe for a nice jambalaya with plenty of ingredients and lots of cooks who think they can spice it up better than the next.