I expected that question: <Show me an equation that we can both test for this “Financial Relativity Theory.” I’m game. If I see anything like oil = gold, then we’re done before we’ve really started.> You are mathematically competent, so you know maths is a language used to describe reality. The chains of calculations are logic in progress. Like sentences in action. Which demonstrate causal relationships. Like these ones. Maths is a flow of thinking leading to conclusions.
Maths isn't the imagination which precedes the words. Maths comes after the ideas, and words which can normally be used to describe ideas. In water mechanics, first, one observes water, waterfalls, flow in rivers, narrow channels, pipes. You are putting the cart before the horse.
Roman aqueduct engineer says: "Hey looky there. When the water is flowing slowly through a big smooth aqueduct, it goes in laminar flow, but when it's going fast through a narrow one where the surface of the stones is rough, it's turbulent and we get less water through. To maximize flow, we need to keep our aqueducts and pipes the right size, steepness downhill, and get those stone masons to make the wetted surface smooth."
Then a mathematician invents maths to describe the process via Reynolds Number. That was millennia later in 1851. George Stokes en.wikipedia.org
I have not come up with an equation to define Financial Relativity Theory Reynolds numbers. I have just done the first part. Let's start with first principles. You probably agree that financial systems can be in laminar flow, with buying, selling, lending, pricing, building, making, inventing, taxing, proceeding smoothly along. You probably agree that sometimes things go awry and prices fall, loans are canceled, hoarding happens, buying stops, manufacturing stops, markets clear, bankruptcies ensue, lawsuits begin. There is financial turbulence and economic activity slows, sometimes, dramatically, and even goes into fighting and all out war.
Bank reserves are kept at a level sufficient to avoid turbulent flow in financial systems. Newly issued money is restrained enough to avoid inflation and instability. House buyers keep loans at manageable levels as people don't want to go bust and lose their equity in their house. But greed drives increased flow so the governments increase the new money they give themselves, banks increase lending and fractional reserve risk, people speculate on assets so increase their loans expecting leveraged capital gains, taxes are increased because opm is very popular, derivatives are invented so speculative "investing" can increase. Prices rise. Profits ensue. Taxes boom. Wheeee!!!
One day the courts can't handle the increasing number of cases. The assets are put in storage while the legal process is delayed. The markets can't clear. Sales which were going to happen don't. Derivatives prices drop. Loans are called. More assets are put into liquidation. Politicians get into the argument and cancel securities on loans so creditors go bust. A sudden economic flip to turbulent flow happens. Arrrggghhh!!!
So our Financial Relativity Theory Reynolds Number needs to have a variable to define loan levels. You can probably think of various factors which influence and cause the transition to turbulent flow in the financial system. I'm not a paid up mathematician these days and economics is full of economic mathematics, so we could probably find an economics book which tries to put some equations on the transition from laminar flow to turbulent flow and what can be done to maintain laminar flow such as injecting a high viscosity fluid onto the surface which is apparently what fish and dolphins do: <The laminar flow of polymer solutions is exploited by animals such as fish and dolphins, who exude viscous solutions from their skin to aid flow over their bodies while swimming. It has been used in yacht racing by owners who want to gain a speed advantage by pumping a polymer solution such as low molecular weight polyoxyethylene in water, over the wetted surface of the hull.> If the government sprays polyoxyethylene over people and banknotes, that might keep financial flow laminar. There might be better ideas.
I'm not going to try to come up with an actual mathematics equation to define the process. I'm just explaining how it works, like people knew how water flow works before George Stokes [near enough was good enough]. My guess is that coming up with a mathematical model would be like trying to come up with climate change models, but with the added complexity of billions of people doing anything they can think of.
Regarding the definition of "flash" as in crash. <Flash crashes are those stock variations which occur within a few seconds, and not those which happen over many months. I think you don’t want to accept what the word “flash” means.> I'm an engineer so I'm interested in what makes things tick, rather than being distracted by irrelevances such as "gosh that crash was quick, it must have been a flash one." The reasons for the crash are what's interesting. I haven't seen anyone except me explain what goes on. Others think in terms of system failures, evil-doers, more regulations being needed, trades canceled.
Those down and back up changes happen over shorter and longer times. The amplitudes vary a lot too. You could arbitrarily define "flash crash" to mean one that happens in less than a second, or minute, or hour, or day, or week, or month, or year. But the time is irrelevant. What matters is the process and what to do to profit and avoid losing.
Since the supersonic million mile a minute HFT computers are hunters they use techniques to flush out game. For example they know that people put in Stop Loss orders to sell if prices drop 10% or some amount. They know that people have margin accounts and sometimes those accounts are excessively leveraged and not too far from margin call time. They know that market falls cause people to panic and sell. And more circumspect people to buy. They know regulators respond in predictable ways [canceling trades and otherwise swindling people for example]. They know that other million mile a minute computers are doing the same thing and will be trying to hunt their competitors.
The mathematicians who design the HFT computer processes test their theories because as you know, a theory has to match reality, even if the theory is pages of beautiful mathematics and screeds of computer programme.
So they run tests, doing little flash crashes to see what happens and to make sure they have winning models.
They can then increase the scale of their tests to see how things vary. For example there are probably lots of Stop Loss orders at something like 10% but not many at 30%. Margin accounts are kept "safely" at "sensible" levels. To really get action, the HFTs need to get into stop-loss and margin-call territory, but they have to watch out for other HFTs which will sabotage them and bid the opposite, stopping the process. It's a cannibalistic process, like when the dinosaurs ruled, and now. The herd feeds on grass, trees and CO2 processors. The predators feed on them. Other predators feed on the predators. In the ocean the top predators are the great white sharks and killer whales. The killer whales are no doubt the top-most as they are smarter, in a gang and tougher, than great whites which are stupid, solitary and smaller.
Regular people are the herbivores, investing their hard-earned money by buying income-producing shares. They sometimes get adventurous and try being predators too. But HFT killer whales are top predators. They introduce financial relativity theory waves into the process to dislodge those lower down the pecking order [to totally mix metaphors] so they can eat them. Like this: youtube.com The seal didn't allow for such waves when investing in that ice floe using borrowed time, leveraged up.
Oil = gold is a reasonable equation. As you know, mathematics doesn't totally define reality. There are normally assumptions. For example, "Assume a spherical cow". Newtonian mechanics defines reality near enough for government work. But if things get going fast, or high precision is required, we have to get into relativity theory mathematics.
More precisely, the equation for oil and gold is defined as follows
Pg = price of gold, Po = price of oil.
Pg = 10Po
But that's just a Newtonian equation. We need to get into financial relativity theory and financial Reynolds Number to be more precise.
Hopefully you are persuaded.
You can put it to the test. Don't have loans and see if you get shaken off your investment ice floe when the killer whales come with their flash crash waves. Or, more fun, see if you can catch fish way out in the ocean and hang on to small floes when the killer whales come. Borrow big, get into high volatility shares, wait for the killer whales then ride their wave to catch little sprats that they dislodge but they don't eat, because they are focused on the main meals.
Mqurice |
