volatility and the allegory of the prisoner's dilemma

artemiscm |  Artemis is pleased to release our latest research paper:  “Volatility and the Allegory of the Prisoner’s Dilemma: False Peace, Moral Hazard, and Shadow Convexity”  explores conceptual ideas of convexity and self-reflexivity in modern markets with a specific focus on equity volatility andtail risk hedging. The paper utilizes data going back hundreds of years in addition to drawing from disciplines in the worlds of quantitative finance, art, cinema, and literature to communicate an investment ideology and provide actionable ideas in today’s markets. 

We’ve appreciated the strong response to previous research papers and hope that the recent report is thought provoking and useful. 

“Dorothy Thompson once said “peace is not the absence of conflict”. Never forget there is a form of peace and stability reinforced by a foundation of underlying volatility. Game theorists call this the paradox of the Prisoner’s Dilemma, and it describes a dangerously fragile equilibrium achieved only through brutal competition. The Prisoner’s Dilemma is the most important paradigm for understanding shadow risk in modern financial markets at the pinnacle of a multi-generational debt cycle unparalleled in the history of finance.

Global Capitalism is trapped in its own Prisoner’s Dilemma; fourty four years after the end of the Bretton Woods System global central banks have manipulated the cost of risk in a competition of devaluation leading to a dangerous build up in debt and leverage, lower risk premiums, income disparity, and greater probability of tail events on both sides of the return distribution. Truth is being suppressed by the tools of money. Market behavior has now fully adapted to the expectation of pre-emptive central bank action to crisis creating a dangerous self-reflexivity and moral hazard. Volatility markets are warped in this new reality routinely exhibiting schizophrenic behavior. The tremendous growth of the short volatility complex across all assets, combined with self-reflexive investment strategies, are creating a dangerous ‘shadow convexity’ that will fuel the next hyper-crash.  We are nearing the end of a thirty year “monetary super-cycle” that created a “debt super-cycle”, a giant tower of babel in the capitalist system. The next great crash will occur when we collectively realize that the institutions that we trusted to remove risk are actually the source of it. In the Prisoner’s Dilemma, global central banks have set up the greatest volatility trade in history.”