I just came over a new book titled “A Time to Dance a Time to Die” by John Waller. The book is about the history of the extraordinary dancing palgue of 1518, from the book

“There’s been a strange epidemic lately

Going amongst the folk,

So that many in their madness

Began dancing,

Which they kept up day and night,

Without interruption,

Until they fell unconscious.

Many have died of it.”

The book gives historical evidence that there actually was a dancing epidemic going on in the 1500, and that people danced until their wear of the skin on their feats, and yes some died. Well you should read the book I guess I only skimmed through some of it.

The book reminded me of a little personal dancing experience I had some years back. I like to dance, mostly to trance-dance type of music; I like music with fast rhythm, with a lot of fire. It is not often I go out hitting the discos, but over the years the number of times add up. I am just an okay dancer, I have never exactly been noticed on the dancing floor for my dancing.

Well that was until a few years ago when I went on a trip to Turks and Caicos in the Caribbean. One night I decided to hit the outdoor dancing floor. It was about 200 people there, may be 100 of them were dancing, the rest of them hanging around the bar next to the dancing floor. I felt very energized that evening, I started dancing. The DJ that evening plaid very good techno-trance.

I was dancing faster and faster, suddenly a few people started watching me and I got more space to dance, I guess this must have encouraged me to danced a bit wilder. The DJ must have noticed this and switched to some even faster techno, even more people stopped dancing and watched me dancing. The DJ was speeding up the music even faster, and I danced faster and wilder. Suddenly I noticed every single person on the dance floor had stopped dancing. It was now a crowd of about 100 to 200 people watching me dancing. I danced even faster and wilder. A security guard came to stop me, but I ignored him and just kept dancing. The DJ played faster and faster techno-trance and it went on for quite some while until I decided to stop dancing. I went to the bar and had a glass of orange juice.

A bit later I walked back to my hotel room. An American couple walked just in front of me (I could hear it from the accent). They had not notice me walking just behind them. Then I heard the girl saying something like “How can he dance like that, he must have been on drugs”…

The funny thing I have never ever in my life used drug and I had not even had a drink with alcohol that night. I was probably the only one sober.

The next day I when I waked up I could basically not walk, the pain in my Achilles was intense. It took about 2 years for it to heal completely. But yes it help me understand personally how people can dance to death. My theory is this: the more you dance the more endorphins you release, endorphins are excellent pain killers and makes you happy, it triggers more dance, more endorphins. The question is how you reach the first level when you hardly can stop dancing, this is partly based on coincidently situations I think, if I not had felt so energetic that evening, if not people had stopped dancing to watch me dancing, if the DJ not had played faster and faster music, if the security guard just had stopped me, well then I would not have to gone around two years with hurting Achilles.

I even heard from a fried that was there on the dancing floor that I had done several 360 degrees flips in the air during my dance. This is however not really true, it was not a flip, it was just some old Judo tricks that I just mixed into my dance steps, well it was a 360 degree flip of some sort, but very simple actually.

If you ever should end in the same situation stop in time! Two years of pain in the Achilles region was it worth it, oh yes for sure. I almost felt like Michael Jackson, but dancing yourself to death is not worth it. So yes this was my first and last dance show I think.

To bad I not have it on Youtube! Not every option trader can dance like that!

I was also bitten by several mosquitos down there I remember, may be there actually is some type of dancing palgue virus, well at least I recovered! I am not making this up, strange things happen more often than you think

I have an old manuscript that is published in very few copies that is about the statistical properties of various skull shapes.

I can personally guarantee you that the distribution of human like skull shapes is leptokurtic. If you think it is Gaussian distributed it is because you not looked close enough at enough skulls!

For example elongated skulls are more common than you would think based on the Gaussian skull-model.

Well also mixture of Gaussians give fat-tails, did you mention Aliens ?

I swear at the same time I walked into this strange store in New York city looking at this replica of an elongated skull a woman with elongated head shape walked into the store and looked strangely at me ( it was a bit scary, a bit too much of a black swan event, but there was no impact.).

Elongated head shapes (skulls) are out of fashion, but looks like still fashion in tiny parts of the world. There is lots of archeological evidence that elongated heads (headshaping) were popular in big parts of the world in the ancient past.

Stochastic Fashion Headshaping

Financial markets are partly shaped by humans (part by nature, nature catastrophes etc), human skulls are also partly shaped by humans and partly by nature. They both have leptokurtic distribution, but there is much more to it.

Step out of your office, travel this wonderful world, observe, observe, yes there are still people with elongated head shapes out there, they are not aliens, well for someone spending most of his life at the university campus a lot of phenomena are Alien, they exclude it and end up living with their Gaussian models, changes in head shapes over time is not stochastic volatility it is stochastic fashion.

Okay I am soon heading far east, wonder what skull shapes I will observe there.

"Gaussian bloggers” post with Gaussian frequency that is they post every other day or so, then some times a little bit more frequent. It is like they try to adjust to the readers that possibly on average want the information to arrive smoothly and nicely, not too often, not too seldom.

Others bloggers are more leptokurtic, they do not post for a long time, then suddenly they post a lot of blogs in one day! ;-)

No more blogs today, I am running out of battery!

Influenza 1918

In New Scientist an article claiming we have no clue about tail-event probabilities for some catastrophic events. Reading the first few lines I would though it was Nassim Taleb article, but it was someone else. The article start out pointing how horrible things went in finance where people supposedly had very sophisticaded models. The article use this as a warning signal that we possibly also are under estimating and have little clue about the exact probabilities also for catastrophes.

I fully agree with the author we have no clue about exact probability calculations in catastrophes. Still finance and catastrophe theory people are possibly among the most knowledgeable in applied probability theory, and still most of them are horrible in abusing the wrong models and assumptions.

Other scientific fields are just even more horrifying when it comes to use abuse and misunderstandings when it comes to probabilities, statistics etc.. (more concrete and horrifying examples will be given over time).

The cover story in the same magazine is about how Darwin's Tree of Life theory probably was incorrect, or at least very incomplete. In every scientific and not so scientific field people from time to time and over and over again seems to get big surprises how bad their models actually work. Then the models are replaced with something else, something better(?) and again people get very confident that they know almost everything. Until again the real world proves the model wrong. Or at least partly wrong on a little assumption that make the model fail big time just when the model is most needed. In economy the consequences is billions and billions and billions lost, in catastrophe theory the possibility of the lots of dead and suffering people that potentially could be avoided etc.

Personally I think finance, physics, cosmology, medicine, biology... still at best are at very primitive stages of what is possible to actually understand. No I do not have the answers myself (well possibly some of them ;-). The more I study the more I understand I do not understand and also that others do not understand. And even if we should get close to the ultimate truth in some scientific disciplines there are good reasons to believe there sooner or later will be a massive crash in also knowledge. Even mountains die. If you look for the exact probability for such a knowledge crash you have missed the main point. Well hopefully such a knowledge crash will not happen for many more generations to come, well that bad models crash is good, hopefully new and better ones will replace them, and hopefully the generations to come will get a glimpse of the ultimate models before it all crashes again.

I recently heard a finance professor telling it was basically absolutely no difference between paper money and electronic money under today’s monetary system. Well he is right for 99% of the time, but I am not interested only in 99% of the time, I am interested also in the tail events, in particular when we are in the middle of a tail event. When it comes to bank runs there is a massive difference between electronic money and paper money. What I am thinking about is the two types of potential bank-runs that exist under today’s monetary system. Most bank-runs so far have been electronic, but what the banking system feared the most was a good old time massive paper currency bank run.

Today’s monetary system is a fractional banking FIAT money system. FIAT money basically means the money is backed with nothing, but faith in the government and the central bank. Fractional reserve banking basically mean the banking system can increase the initial reserve money supply by about 10 times (well based on the reserve requirements in each country, credit expansion), this is not my fantasy, but is described in several well known books on macro economy. Well that is in theory, the banks have often found ways around this to increase the money supply much more than the restrictions set by the reserve requirements would initially allow. The high-powered fractional banking was one of the main causes of the massive bubble that now is bursting. Supply and demand to set the price of money does not work well in a fractional banking system. But that is another story (with many opinions), now back to electronic money, paper money and bank-runs.

A bank run is when people loose faith in the banking system or in a bank or in series of banks and run to the bank to take out their money. But with more than 90% (such a ratio could change quickly) of all money only consist as numbers in computers there is several types of bank runs:

Bank-run type-1 This is the ‘good old fashion’ bank run where people line up outside the banks to take their money out in cash, that is in paper currency. In a massive bank run people do not trust the banking system and they put their paper-money in their safety deposit box or hide them under the mattress and keep them there until the turbulence is over. There has been some hording of cash in this financial crisis, but I would think minimal compared to the total amount of fractional reserve money.

Bank-run type-2 During also this financial crisis there have been plenty of bank runs where people have lost their trust in a particular bank or financial institution. Almost every bank run in this financial crisis has been electronic bank runs. That is people have simply electronically transferred their money from the financial institution they are loosing faith in and into another institution they assumed where more solid. The fastest way to do an electronic bank run is basically a domestic wire. This only takes hours in many countries. Most people with a computer do not line up in front of the bank they are afraid will fail; they simply wire their money out to another institution. Of course then there are people that do not have computers, or it could be the internet cite of the bank had so high traffic when everyone wants to wire their money out that it simply did not work. These are the people lining up outside the bank. Many of them tell the teller to electronically transfer their money to another bank, many take their money out in paper currency. Next they walk over to another bank and deposit their money. All these goes under what I will call a bank-run type-2, as the money simply goes from one bank to another.

In a high-powered fractional banking system in a bank-run type-1 for every dollar taken out of the bank this drain the reserve dollars by one dollar, dollar by dollar, pound by pound. And remember each reserve dollar support a large number of high-powered dollars (credit, credit bubbles). So if there was a massive bank-run type-1 on almost every bank then the banking system would more or less collapse, well there are ways for the banking system to try keep going. On the other hand a bank-run type-2 (electronic) bank-run do not drain reserve money from the banking system as a whole, yes it can be catastrophic for the financial institution affected as they are loosing deposits supporting the bank balance, but the reserve dollar is just moving from one bank to another.

Did you wonder why the central banks bailed out so many banks and why the FDIC insurance was increased from $100 thousand to $500 thousand. Yes it was to help insure the deposit of your savings, but it was probably just as much as to “eliminate” the possibility of a bank-run type-1 and a total melt down of the financial sector and the world economy. A good old fashion bank run is now quite unlikely. Most people would prefer to have their money in a government insured savings or checking account rather than under their mattress.

But then there is potentially also a bank run type-X building up, do not ask, I will not tell you more, I told you too much already.

The Bank of Sweden prize ("Nobel Prize") has been given to a series of naive Gaussian finance models. This even after one of the great Swedish scientist attacked the Gaussian model already back in 1920

Carl Vilhelm Ludwig Charlier, Swedish astronomer and mathematician 1920:

"The responsibility for stagnation in the development of mathematical statistics until recent years rests principally upon Gauss. The great mathematcian belived it possible to demonstrate that the fluctuations of the items of a statistical series --- he was concerned chiefely with astronomical and geodeic observations – followed the simple law which was called after him, the Gaussian law of error. He belived the deviations from the law were accidential and would disapper if the obervations increased.

In the field of non-astronomical statistics Quetelet, perhaps, is the one who has applied the Gaussian law with the most important consequences. His theory of types is one of the most fundamental propositions of statistics if, from it, one must conclude that the mathematical type necessarily correspond to an actual (physical, biological) type of statistical objects. In coming to his conclusion Quetelet was guilty of gross exaggeration and, consequently, contrary to his intention, brought mathematical statistics greatly into scientific discredit, for it is not wholly free to this day."

How could it be that most popular risk measurements and hedging methods could relay on Gaussian type models in this recent time, when it at least by early 1900 was empirically observed that this was not the fact and several leading scientist attacked the Gaussian method already back then.

Almost 100 years with stagnation in the development now needs to be addressed.

My latest article "Transmutation of Jumps into Diffusion" in Wilmott magazine (september) is about how we potentially can shape the asset price distribution, and some of the limitations we will meet. That is going from passive observers to active shape-changers:

"For a long time, humans observed and described the human body. Then came the body builders— instead of simply observing the human body they decided to shape their bodies. And they have done this successfully beyond what many had dreamt possible. There are, however, strong limitations to how much a human can shape his or her body. Similarly, the asset price process can be shaped, but there are strong limitations to this. A body builder can increase the size of his biceps or pectoral muscles, but cannot (at the moment, anyway) turn his arms into the wings of an albatross. In the same way, we can transform many — but far from all — jumps into what is close to diffusion. "

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).