If you truly understand the seed of randomness you understand a lot about randomness, some randomness are particular beautiful, other randomness are ugly.

The photo is Astilbe arendsii Paul Gaarder, a beautiful flowery Astilbe plant that carry the name after my grandfather Paul Gaarder that first discovered this particular Astilbe plant. He did not directly develop this plant, but as I understand he was playing with the seed of randomness. In plant seeds there are some type of randomness and some type of deterministic process that results in a great variety of plants produced by seeds. Then if one experiments with many seeds from the same plant (plant family) one will get many different outcomes, some more probable than others. If one keeps doing this over an over one can suddenly come over a particular nice variety (a beautiful tail event), this is basically what my grandfather did. Then after finding a nice variety the plant could be copied by cloning, that is simply dividing the plant and you have a genetic copy. Cloning in the plant farming business is probably at least 1000 of years old? Or actually many plants also clone themselves naturally in the nature.

Everyone should have an Astilbe arendsii Paul Gaarder in their garden! It gives great Feng Shui.

Plant seeds are like a dice with an very large (astronomical) amount of different sides (outcomes).

Cloning is a way to cheat the randomness process. One of my first businesses as a teenager was to produce Iris plants by cloning.

In a few cases during my life I have experienced Impact-Canceling Tail Events (ICTE). This is when two(or more) tail events strike about simultaneously and cancel out what otherwise would be massive impacts (for something that is important to you). The result is little or no impact, except for potential impact on your learning curve and respect for nature and the laws of randomness (financial markets are no different they are part of nature).

When I was about 6 years old I was on a winter vacation with my parents and brother in the Norwegian mountains. Down from the mountain hut it was a great hill for snow sledding. With my little brother sitting in front of my sledge we rushed down the hill. The hill ended in a road that we not had though about, anyway the road had close to no traffic. But of course just now a sizable white truck was coming up the road, hard to see against the snow.

We went too fast to be able to stop; we went underneath the truck just behind the front wheels and by a miracle came out on other side, my brother with a miniscule scratch. My brother and me understood we had done something wrong and was running as fast as we could. We were running up to the mountain cabin where we felt reasonably safe from what we expected to be an angry tuck driver not would find us. About fifteen minutes later someone knocked at the door. It was the tuck driver. He looked surprisingly happily to see us (why?) and told my parents he had been sitting in the car for some time before he had got the courage to walk out and look under his car.

What we had experienced was Impact-Canceling Tail Events, where one bad-impact tail event: getting “hit” by a car had been canceled by an even more extreme tail event; going underneath the car and coming out on other side. No this is not a fairy tail.

Impact-Canceling Tail Events also happens in the market from time to time. For example when the effect of a piece of information that on its own would have big negative impact on the market is canceled out by a piece of good news coming out about simultaneously. Impact-Canceling Tail Events are in general good news if you are short options and bad news if you are long options. (for long options loss of opportunities if canceling information not had happened simultaneously and opposite for short)

Impact-Canceling Tail Events naturally never show up directly in the price statistics etc., because the tail-events was canceling each other out and had no or minimum price impact, you have to be there live it and feel it to know it happen (or potentially extract it from other types of data....).

Also if you not are watching the market all the time and two events with different impact-sign hits the market (but you are not taking advantage/disadvantage of it because you simply not are watching the market) then such events will typically have same practical effect (on profit and loss) as if it was Impact-Canceling Tail Events. In other words if you had a long “gamma” position you missed out of some great opportunities to capture some wild fluctuations (unlucky, lazy, and you would feel like an idiot…), and if you where short “gamma” you where a lucky fool (feel like a genius). (PS: If exchange traded and time-gap was longer than intraday and you had short option postion you would possibly get killed by margin requirements).

Our world is filled with tail events, but most of us ignore most of them. People are mainly concerned about tail events that have big impact on something they consider important, and most people think of money as very important (they don't know better). Let me give you an example.

Assume you are a trading stock options. Going out for lunch, the first thing you see when leaving the building is a Zebra running around. You soon figure out the Zebra has escaped from the local zoo. It is a tail event. It has little or closes to no impact on the market price of financial assets, you have a laugh, eat your lunch and return to your trading desk.

Of course for the Zoo keeper that forgot to close the door could get fired, for him/her it is a big-impact tail event.

Zebra escapes from Tokyo zoo

Hi hi, I have been out in Utah skiing, flying out tonight, and I agree Utah has some of the best powder skiing in the world (at least this year, they supposedly got about 570 inches of snowfall so far this year). Less spectacular than alps, the after skiing is way behind what you will find in most of Europe, but yes fantastic powder snow. I have been skiing for many years without ever having a serious head injury, and I never used a helmet. So based on my experience and long and great track record I could easily conclude no need for helmet? Or do this simply mean I have been ignoring the tail risk that I actually knew about for too long? This year I finally took this in over me I had just been a lucky fool, this was the first year I decided to cut my tail risk and use a helmet.

Second day skiing (naturally on the last trip of that day) suddenly and unexpected I was approaching another skier (no not Nassim even if I heard rumors he had been there a few days earlier, wonder if he now also use helmet, he did not use helmet when I went skiing with him years back) that like me was skiing way too fast. We both tried to avoid each other by making a quick turn, the problem was both turned the same way .... and SMACK.

Basically I blacked out for a fraction of a second and my head was hurting and one of my poles where broken. This was even with helmet on. Thanks to my tail protection (helmet) I was up and skiing again the next day, timing is everything ( or more likely I was a lucky fool putting on my helmet just in time). The powder skiing is amazing, but do not let many years excellent track record make you overconfident.

If just Bear Stearns had been thinking along these lines. I would not be surprised if they actually were offered a helmet in good time, or at least part of a helmet, but based on their long and great historical track record without using helmet they probably though there was no need for one.

Timing is everything. It is better to be lucky than smart.

Many people are flying "home" visiting family for Christmas time. I went on my flight to Bergen today.

About 15 minutes after take off the flight captain is coming on the speaker

"Cabin personnel prepare for emergency procedures"

Did I hear right??

Next oxygen masks are falling down, and everybody are quickly working to get it on, some with more luck than others. Some children are crying. The flight is taking a quick dive, WHAT are we going to emergency land in the mountains, not good not good...

few minutes later captain again "We are now at safe altitude".....

Cabin pressure felt (air leak) and we had to go down from 24 000 feet to 10 000 where there is more air, and we returned to base.

Marry Christmas and have safe flight!

Norwegian news paper story

Photo: No this was not a Halloween party. PS my yellow jacket was matching the oxygen mask, some people know how to fly with style.

Believe it or not I was just standing face to face with the president, okay the former (and cooler) president Bill Clinton.

He was in same bookstore as me, I tell you I could see he walked straight by The Black Swan with no interest; neither did he pick up The Complete Guide to Option Pricing Formulas ;-(.

Next I met him again in the bookstores coffee shop, I could not see he had bought any books at all. For a second I was thinking of asking if he looked for Models on Models, but first of all it was sold out in this store, second one of his body guards looked a bit nervous from seeing me again. Walking closer than 1 meter I was afraid I would make him scared.

Fantasy, no this is real life fat-tails.

Today I got back to the Norwegian finance minister (in DN 4 Mai, largest Norwegian business news paper) concerning her latest article (Dn April 26) where it seems like she underemphasize low probability events, forget to take into account potential massive impact. I suggest building Black-Swan monument in front of the “parliament” building as a reminder of low probability big impact events.

I was naturaly referring to Nassim and his book “The Black Swan: The Impact of the Highly Improbable”. Unfortunately I see the newspaper had removed this just before print. :(

For the few of you that read Norwegian it has been a little debate going on between me and the Norwegian finance minister in the press (DN). In the latest comment from the finance minister she seems to be strongly under emphasize tail probabilities because the probability is so low, she seems to forget that we also need to take into account the impact of potential tail events, and the impact from a Black-Swan can be considerably.

Nassim's book “The Black Swan: The Impact of the Highly Improbable” should be mandatory reading for politicians and decision makers. They don’t have to agree on every detail, but I think and hope it could be an eye opener.

The answer from the finance minister is also re-printed at the ministery of finance web page Ministery of Finance

Did I really want to build Egyptian style pyramids? or was it a symbol for something else.....

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!

In many countries ocean front, or even better on the water is priced sky high above properties even slightly in the inland. Yes fantastic view (especially if some beach babes are swimming by). However to have your luxury apartment basically on the ocean will likely also expose you for a higher tail probability of getting washed out. No not washed out of the stock market, but washed out of your apartment by extreme weather. Is this priced into the beach property prices? I agree they should be priced up for their wonderful beach babe view, but also discounted by a higher risky rate due to higher tail risk than many inland estates.

The most prestigious old beach properties where typically placed on a cliff, close to ocean but still considerably above ocean, today on the ocean seems to be the hottest product.

Of course people that can afford mansions with beach view typically also have a nice house or two in the inland. However many living in luxury apartments on the ocean have probably put all their money (and the banks money) in a positive carry trade. They get stable high returns over an expected long period of time, in form of spectacular view etc. but they run a higher tail risk of getting washed out by that 200 year wave that actually happen every 50 years? due to fat-tails.

There was a article in Norwegian News paper today how regulators starts to rethink building projects on the ocean….of course after they recently observed some extreme weather and figured out their Gaussian models did not fit the data that well...

Going short a few apartments on the ocean and long an old mansion on the cliff with ocean view could be a good relative value spread trade (dollar neutral)! We need a better-developed real estate derivatives market.