Impossible Staircase Hedge Funds and Traders

The impossible staircase was more or less invented by the Swedish artist Oscar Reutersvard in the early 1950s. The impossible staircase was independently re-discovered by Lionel and Roger Penrose in 1958 that inspired the famous Dutch graphic artist Maurits Cornelis Escher to make several artistic pieces based on it. The first time a friend of mine made me aware of his work on impossible staircases I immediately could see close parallels to quantitative finance. In the impossible staircase you can climb upwards step by step month by month without actually getting anywhere. While climbing the staircase it is always small probability you will fall of the “cliff”, if you not have invested in a handrail.

The impossible staircase is simply an illusion due to the fact that we try to get a three-dimensional world into a two-dimensional one ignoring a real dimension. Many funds and traders are simply generating excess returns by ignoring hidden risk dimensions (and in finance there are many many risk-dimensions). These risk-dimensions will sooner or later show up, with the result of funds and traders suddenly and unexpected blowing up. That is unexpected for funds, traders and investors that do not know how to robustly hedge their risk!

Hidden risk-dimensions and impossible staircase hedge funds (positive carry traders with great Sharpe ratios) is the topic of my article "The quasi-Alchemy of Finance" in the March issue of Wilmott magazine, soon going in print!

Many funds, traders, and investors are monitoring risk based non-robust models, it could be unrealistic quantitative models or models in their own head based on 2, 5 or 20 years of experience... More about all this in my future work!

Most funds and traders are generating excess return by "counterfeiting gold" a fake so good they themselves believe in it (positive carry traders selling hidden risk dimensions). This is what I will call the quasi-alchemy of finance. There are a few real financial Alchemists out there knowing the true alchemy of finance. However if you do not know how to look at risk and how to hedge your risk in a ROBUST way it is hard to detect quasi-alchemist from real alchemists. At least before after the fact, that is after you lost your money!