I listened today to a video talking about market vol. The range of the VIX for the year is 11 to 36 and today it’s 13. In the video he spoke about AI’s effects. AI is a Bayesian like engine that reprices risk according to constant real time data streams and then trades on the picture the data paints based on likelihood. What does that statement mean?
Imagine you’re on a boat several miles off shore from your little island. You go out fishing every day to catch your family some supper and to have some fish to trade for other goods say maybe a bottle of white. You bases your life on the day in day out probabilities that today will be not unlike yesterday. Today however there was an under sea earthquake 2000 miles away which generated a tsunami headed to your island. While you’re out fishing the wave passes under you. Monstrous energy passes you but only a couple feet of vertical translation is all that you perceive. You just keep fishing since today is just like yesterday, maybe stay out an extra hour to get a few more fish to sell so the kids can have Christmas. Soon enough the wave hits the bottle neck and the energy dispersed across a huge area is all concentrated on your islands shore line and your island is destroyed. Your day was just like yesterday. Your boat is still intact, you have a load of fish, but you no longer have a home or a family, you just don’t know it yet.
This is how AI works. It creates a most likely picture and trades into that picture without the ability to understand reality. It relies on the presumption that the picture it creates is an accurate representation of reality, and the more days that picture goes unchallenged the more the AI scales it’s investment into the picture being actual reality. Since it has a huge presence in the market it’s picture of reality carries a lot of weight, in the pricing of risk based on it’s rules. The AI doesn’t care, it doesn’t understand beauty, it doesn’t understand families or islands or tsunami’s. It has some know ledge of tsunami’s but has no sensitivity to that risk to the picture given the preponderance of days and days of the same ol’ same ol’.
The data it is fed suffers under the same delusion as the passive investor. The passive investor doesn’t have an understanding nor a sensitivity for tsunami’s either. The crash hits and he’s plowing yet more money into a train wreck based on the picture a blog narrative painted for him. Why the future is like the past! But wait, no island exists.
In 1989 on Christmas Eve at 3:39 in the morning my house burned down. My picture I used to judge my normalcy burned up. It gives you great pause when in 5 minutes you go from having a complete life to having no toothbrush or underwear or shoes and it 25 degrees outside. But you are grateful you didn’t get burned up and your wife didn’t get burned up. You attend midnight Mass wearing smokey stuff you manage to find in a box under some rubble. YEP 4 x 25… I heard it in a love song.. heard it in a love song… can’t be wrong