applications of financial ideas to everyday life
The capital assets pricing model (CAPM) was developed by Bill Sharpe in 1964. The basic idea is, your expected rate of return on an investment is proportional to the risk you take:
The derivation of CAPM assumes a lot of things, for example that you are on the “efficient frontier.” The efficient frontier means you will maximize your returns if you make smart risky bets. For example, playing russian roulette is extremely risky, but it only pays off if you’re a character in the Deer Hunter -otherwise Russian roulette is very far from most people’s efficient frontier.
Like most “laws” of finance, CAPM is only approximately true, but it is still a broadly useful model. If you look at stocks with big rates of return, and run the machinery, you see that they have a high beta: a high risk versus the market average risk. It’s easier to think about with a concrete example: if you bought GE shares in 1998 and sold them in 2007, you’d make a little money. If you bought Ebay shares in 1998, you’d have made bank. Of course, you may have bought Pets.com in 1998, in which case you would have lost your entire investment. Both Pets.com and Ebay were inherently risky propositions, as nobody really knew if they were ideas which would take off, let alone of they were well run companies. If you gamble on risk, you might get a big payout, or you might get nothing.
People make a big deal about the philosophical implications of weird things in physics. For example, the seeming psychedelic unreality of quantum mechanics is often used by mush-headed people to justify whatever solipsistic spiritual nonsense they believe in. This was great discovery to me when I was a dorky grad student. When I discovered that women who believe in “new age” ideas will find you incredibly interesting if you mention Hilbert space, I’m pretty sure Alzo Sprach Zarathustra was playing in the background, like when the Ape-man in 2001 discovered that you can kick ass using bone clubs. At last I found a way to use Hilbert space for something in my everyday life! I’m pretty sure my discovery is the source of all the quantum mechanical mystical gobbledygook out there; surely other people noticed this as well. Certainly my theory makes more sense than the idea that quantum mechanics as weird mysticism has anything to do with actual reality.
“This is what it was like when I discovered an application of Hilbert space to everyday life!”
Regardless of the prurient uses of Hilbert spaces, the fact of the matter is, life is a lot more like finance than it is like misunderstandings of post 1920s physics. Finance is a purely human endeavor, so you’d expect the laws of finance to have some bearing on everyday life.
In ordinary life, CAPM is a useful law. People who take risks have more rewarding lives than people who don’t. People who don’t take risks end up living lives with the consistency of bland porridge, and are often struck down by the chances of fortune no matter how hard they try to live an orderly life. I am pretty sure that the only time your life will be risk-free is when you are dead, sort of like your financial life is only risk free when you have no money. The closer you get to a risk free life, the closer to waiting for death you are. It’s an odd phenomenon that people who live in modern societies are so often miserable. I used to think it was because life was too soft. Now I think it’s more related to the fact that modern life doesn’t contain enough perceived risk to make it seem worth living. Human beings are adapted to a world of random chance; we like taking chances. Deprived of chance, we become miserable.
Most people don’t think of themselves as gamblers; they prefer to think of themselves as people who make deliberate and rational choices in a deterministic world. Modern society is set up to give us all the illusion that we can be protected from all risk. Tort law in America is set up with the assumption that everything works in a Cartesian fashion, for example. There is very little allowance for randomness and fate: someone or something is always held responsible for bad things. The way modern people think about life, if you don’t eat enough broccoli, you’ll die of cancer, or if you eat too much bacon, your heart will explode. The reality of things is you will probably die of cancer, stroke or a heart attack no matter what you do. If not, you got into a car wreck: driving cars is a risk most people willingly take which is much more serious and deadly than eating bacon.
Similarly, people misunderstand the role of risk and randomness in their professional lives. Most people, for example, get jobs. A job seems like a relatively risk-free lifestyle. Jobs certainly remove virtually all upside potential, so you’d expect to be compensated with lower volatility. I think a lot of people are now finding out they mis-calibrated their job volatility risk. Is a job on the efficient frontier? Probably not as often as you might think. For example: if you attempt a career in physics in the 21st century, your chances of having a nice life are fairly low. The probability of actually getting a job in physics is fairly low. Even if you manage a job in physics by being lucky, marshaling all of your military and naval power, and having no life for a couple of decades, you’ve basically gotten yourself a job which pays about the same as being a cop or an auto mechanic (I know: I’ve done all three). Job security … well, tenure appears safe for now, but I’m of the opinion that higher education is another speculative bubble: so, best of luck with that. Some might argue that the potential for great discoveries outweighs all these low expectations; guts for glory as it were. By my calculations, moving to Hollywood and getting a job as a waiter in hopes of becoming a celebrity has a higher probability of success than hoping to become an immortal in the world of physics. How many great breakthroughs in physics have you heard of in the last 50 years? Can anyone name any? Yet, there are 47,000 members of the American physical society, each one of them at least secretly hoping at one time or another to win the lottery. I guess probability theory isn’t taught correctly in physics grad school. That’s probably a factor in why nobody understands quantum mechanics. A fun irony of all this: their career choice makes modern physicists much more the gamblers than, say, quants. I’d like to think this is because quants understand CAPM.
When you come to appreciate the fact that life inherently involves randomness and gambling, you can start taking risks that make sense. The casino is a great metaphor for life; potentially filled with fun and games, but random and with a mean expectation of zero. Once you understand that your life is governed by the laws of probability rather than Cartesian determinism, it becomes easier to accept the vicissitudes of fate. Once you realize that most decisions in life involve significant risk and uncertainty, you can start making intelligent decisions about your life. Once you understand the applications of CAPM to your life, you can realize your own efficient frontier. People may think I’m some sort of mad scientist for advocating treating your life as a gambling game, but you can see this at work in many individual lives.
If life worked according to Cartesian determinism, you’d expect chess players to do very well in life, and gamblers to do poorly. What we observe in life is the exact opposite. Great chess players who are capable of calculating complex moves many steps ahead have horrible chaotic lives. They think they can plan things and understand the world using determinism, and this world view fails them. Poor Bobby Fischer, one of the greatest chess wizards who ever lived, had a miserable life. His belief in determinism turned him into a raving madman, hardly capable of the simplest of human interactions. Gary Kasparov, a man capable of beating supercomputers at chess, tried his hand at Russian politics and failed miserably. By contrast, the colossi who rest their feet upon the world of politics, finance and industry are gamblers: almost every last one of them. From Julius Caesar to T. Boone Pickens; games of chance have taught great men how to win in life using probability theory. Gambling games teach you to remain calm in the face of fortune and keep your wits about you, as you wait for the right time to place your bets. Autistic deterministic games like chess may train logic and the memory, but they teach you nothing about life.
“It is a great piece of skill to know how to guide your luck even while waiting for it.” -Baltasar Gracian
Locklin on science 
I think when you use the term “people” you are engaged in some unintentional equivocation here. Comparing chess champions and successful gamblers means comparing the extreme ends of two bell curves. “Most people” understand this intuitively, whether explicitly or not. This is why a place like Vegas is filled with people who strove to get jobs and then play the nickle slots. They believe in chance and gambling, they just don’t believe in their own ability to make the right choices in high stakes games.
You also don’t address the fact that life’s returns aren’t quantifiable or consistently desirable across individual psychologies. Based on your Amazon reviews, I’m guessing that your position on marriage for men is that, once men understand the uncertainty involved, they can start making the intelligent choice to avoid marriage. But this assumes that men ultimately want things that can be gained without marriage.
Another application is represented by a coworker of mine who had marriage and family as a goal. Not virile or endowed, he was persistent in gambling on relationships until he scored a truly hot babe as a wife. Now he has other problems, rather like lottery winners who have to deal with the vagaries of winning.
“smart risky bets” means risk with reduced risk.
Well, it’s rather helpful to compare people who are very different on the “skill in dealing with uncertainty” axis if you want to see an effect at all. People who play sports aren’t all that different from gamblers either. You see a lot more sporting types doing well in life than you do chess players.
Everyone has their own utility functions for life, whether they realize it or not. There are all kinds of ways to choose a proper wife, if you want a wife and kids. I had an acquaintance like that when I worked at LBL. He decided to shack up with a former junkie who had a kid already. He died of Hepatitis-3 a few years afterwords. Why didn’t he pick some boring, fertile librarian who would have made a decent psychological match to him and who was rather less likely to give him a lethal disease? I suppose because nobody told him that shacking up with a junkie was rather far off the “marriage and family” efficient frontier.
Probably I just don’t understand your post, but your example seems to be an argument against applying the concept of the efficient frontier to life decisions.
The argument seems to be that people who are successful in life are risk-takers, and that, if people understood this, they would start taking risks to avoid bland porridge lives. But if finance really worked like this, Goldman-Sachs (or whatever is an appropriate institution) could recruit randomly rather than from Wharton (or wherever appropriate institution recruits). Indeed, random recruiting would be indicated from theory. But over the long term successful gamblers are good gamblers rather than lucky ones. And good gamblers are the ones that know when not to bet, right?
It seems to me most people understand this and are betting they’re the ones who don’t know when not to bet. (Which is a good bet.) Most people, rather than trying to be Caesar, are trying to avoid being Pompey.
Or is your argument that the success of gamblers proves that all life is risk-taking, and that, therefore, all decisions should be approached as risk? Marriage then having a rather low return for any extra risk in mate selection. This makes more sense but then we are back to the difference between measurable returns and life. If your friend married the boring fertile librarian, he would have to know himself and the future well enough to know that he would still be happy with a boring wife in X years. Is hottie junkie mommy more like psychological insurance? It would be rather like if, in investing, returns weren’t measurable sets but simply further bets. Don’t markets get queasy when there’s monetary uncertainty?
If my thinking on this is cloudy and mistaken, it might explain why it was a good decision for me to go back to school for nursing rather than trying to make my way in finance!
The point is, you can’t realize any large returns without taking risks. Want a boring life? Get a job as a dentist. You’ll make decent money with little downside risk. Want an exciting life? Start a hedge fund.
You can’t realize any returns if you don’t take smart risks. My lab pal wanted to be married, which is a way of reducing certain kinds of volatility in life. He married a junkie dirtbag basically because he figured no other woman would have him, which was wrong and silly. Marrying a junkie is like playing Russian roulette; no good can come of it. Had he stayed single and learned how to be charming, rather than shacking up with some broad he probably picked up for $20 on San Pablo avenue, his mean expectations would certainly have been higher than their present state. While my pal’s example is an extreme one, I honestly think most people who get married make similar bets. Men choose out of relief that some woman will have them and put order to their lives. Women choose because they’re selling an option which expires at 35 or so if they want a family.
Goldman’s utility function is towards low volatility. For large companies, this is smart for reasons which are now obvious. Bear Stearns, by contrast, picked a lot of working class wild cards and filtered them by how hard they work. They ended up with a CEO who was a total idiot, unfortunately. For someone starting a hedge fund with 3-4 people, they’re inherently not doing what Goldman does, so they want those wild cards. They of course want SMART wild cards, but they aren’t going to get far hiring a couple of boring dudes. They will get farther hiring a couple of guys with crazy ideas who will work their asses off, more on the Bear Stearns model.
from what i’ve read and seen of kasparov, he looks like someone who understands non deterministic games and probabilities too. Probably not the right example to use. I don’t think he is down and out yet.
Maybe, but I never heard of him playing poker or excelling at sports. Putin was good at sports (Judo has huge non deterministic components to it), and apparently used to bankroll his gambler friends as well.
Off topic, but the phrase ‘Gary Kasparov, a man capable of beating supercomputers at chess’ is spectacular. Only a decade ago, we had the exact opposite: ‘Deep Blue, a computer capable of beating Garry Kasparov’. The ironies of (modern) life, heh…
Well, you know, I never could beat my TRS-80, so perhaps I’m easily impressed in this regard.
Very interesting article. I like your insights that we crave risk. Unfortunately, I don’t think we have a clue on how to manage risk. I have found Taleb’s writings on this to be quite insightful. He would advocate 80% of activities in the “safe” zone (treasuries) and 20% in the risk zone (options on biotech stocks.) Talk about negative covariance. He also takes issue with all academic finance. As for me, I gain insights from both sides.
I think we have some things we can eliminate, and some other things we should be worrying about. For example: I eat a lot of bacon, but I take a lot of professional risks, like making fun of Taleb on the interbutts. I’m pretty sure most people wouldn’t dream of making fun of such a learned magnifico, and a lot of right thinking people think bacon will make their hearts explode.
[…] (from his blog post: Applications of Financial Ideas to Everyday Life) […]
Great article, reminds me of a book called Fooled by randomness. I forgot who the author was, but I’m sure you like him too.. 🙂
Jokes aside, I really think your blog is quite interesting.
The book “Poker Face of Wall Street” was much more the inspiration. In addition to being a better writer than me or Taleb, Aaron is also not an asshole.
How did I not know you had this blog before? Solid stuff.
Well, you know, it took me a while to get ’round to it.
So true about the mush-headed spiritual interpretations of QM ! Gary Zukav’s The Dancing Wu Li Masters was one of stupidest books I ever read (forgive me, I was young).
Don’t feel too bad, Andrew: I got a couple of novenas I owe the god of common sense for that and other infractions.
“Youth is a blunder; manhood a struggle; old age a regret. ” -Disraeli
To be fair, our idiot brain isn’t really designed to handle probability – making deterministic explanations for things is it’s default behavior.
Well, I certainly agree with that. Brains are stuck on determinism; that could be a subject for many rants, and I suppose it has been. I remember some guy talking about how the brain evolved from a sort of feedback mechanism for controlling muscles, so it makes sense that it would do this.
Still, that is all the more reason to play games with strong elements of randomness baked into them. Since your brain isn’t naturally equipped to deal with uncertainty, learning how to do it is an important life skill.
Interesting blog, keep up the well written and provocative articles.
Scott, what a great post. I am giving up my job to become a full time currency trader (after two years of careful preparation of course!). Reading your thoughts is very inspiring!
I wish you the best of luck on that! “…if you try it, you will be lonely often, and sometimes frightened. But no price is too high to pay for the privilege of owning yourself”
Casino = “mean expectation of zero” isn’t right. House cut, double zero, zero, etc. etc.
The mean expectation on entering a casino is some negative number.
Except when I enter a casino. Because I loan the casino money in the form of high yield bonds.
I’m not sure what the existential version of the Bond salesman is, but I’m going to give that one some thought.
Your conclusion concerning chess players and gamblers — upon which some of your argument rests — is based on urban legend, not reality.
Bobby Fischer was mentally ill, and had been so most of his life. His later descent into complete madness and paranoia had little to do with the rules of the game of chess and much more to do with the pressures of worldwide fame. Truth is, he was probably destined to become a raving street person, chess or no chess, due to what was probably a genetic predisposition for schizophrenia and obsessive-compulsive disorder. Same was true of his 19th-century predecessor, Paul Morphy.
And as for Garry Kasparov, who is at least Bobby Fisher’s equal chess-wise, he is entirely sane and of sound mind. Using the fact of his “failure” at Russian politics as some sort of evidence for his dementia or inability to function in the world is a false premise. He failed at Russian politics because everybody who attempts Russian politics fails at Russian politics, from Czar Nicolas to Trotsky to eventually even Stalin himself. Kasparov failed to take over the Russian government because Putin runs a KGB-esque police state and will not tolerate any viable opposition. But aside for his predictable inability to seize power in Russia, Kasparov has a completely normal, respectable and highly successful life.
Furthermore, the myth of the “crazy anti-social chess genius” is and always has been nothing more than that — a myth. Most chess players are completely normal people; some excel at life, some fail, some are sociable, some are loners, some are a bit nuts, some are totally sane; all in all, they’re pretty much average. Will you find a higher percentage of Asperger’s Syndrome and mild autism among chess players? Probably, because the nature of the game appeals to people who like obsessing over little details. But the same could be said of many other games and hobbies.
Take a look at the current crop of top world-class chess players, and you won’t find a single nutcase among them. And most of these guys are so good (the level of play has risen dramatically in recent years) they could probably whip Fischer during his prime. Sure, there are a few drunks, a few assholes, a few loners — but at no greater percentage than the general population. But most are just regular ol’ folks who just happen to be incredibly fluent in the language of chess. People like Anand, Aronian, Carlsen, Gelfand, Shirov — they are not freaks, madmen or losers. And they disprove by their normalcy your argument that the rigid-minded manner of thinking required to excel at chess leads inevitably to insanity and social dysfunction.
And on the flip side of the coin, regarding gamblers being the successful entrepreneurs of the world: Have you ever spent any time at a race track in Hong Kong? A card room in Emeryville? A non-tourist casino in Sparks? You have never seen such a collection of down-and-out pathetic washed up obsessive losers in your life. A propensity for gambling in most people is an almost sure sign of a loser-in-the-making. The Warren Buffets of the gambling world are very very rare indeed.
Otherwise, your essay made some good points, but your really tripped over yourself at the conclusion.
I take it you play chess. Your entire analysis of my essay pretty much screams, detail oriented “chess player,” even if you weren’t so indignant about my characterization of chess versus poker. If you’re a quant, I bet you’re a structurer!
I knew some chess nerds in my day: I lived with a local champ for a while -one who broke the mold, by the way, and was also excellent at gambling. He paid for his first 3 years of astrophysics grad school sharking pool, sports bets and poker. He didn’t get much out of chess; he was just good at everything he did. I’m sure there are some like him, but I’m not going to let a counterexample get in the way of an evocative and useful metaphor. His life ended up being more chess than poker anyway, so the metaphor still works. While I don’t want to get into a long discussion of craziness and social disability among high level chess players versus high level poker or backgammon players: since you brought it up, yes, I do consider chess nerds to be more socially inept and crazy than poker players on average. If you require me to say something complimentary, chess nerds are also better at math, which is probably not unrelated to the former.
I’m well aware that most gamblers are suckers, and yeah, I have spent some time in the kinds of places you mentioned. The fact of the matter is, virtually all captains of industry and much of America’s successful leadership are gambling men. The world isn’t a cartesian chessboard: it’s a poker game. Most people are stuffing for the mattress; they’re not going to learn anything from gambling, chess or anything else. For those who want to live an extraordinary life, games which involve chance and money are better training than combinatoric games like chess. I can’t decide where Go figures into any of this, but I’d place most sports in the poker/gambling category.
If it makes you feel any better: I don’t like most games of chance any more than I like chess. I don’t gamble unless I have an edge, and I don’t feel like getting an edge in most games. I screw around with backgammon because it’s sociable and helps with mental calculation. I also liked kick boxing and brazilian jiu jitsu for a while, which is kind of like poker with exercise, but I’m too old and busy for that sort of thing any more.
Scott said:
“Your entire analysis of my essay pretty much screams, detail oriented “chess player” ”
I see you are still mired in the swamp of stereotypes of what chess players are like!
Despite what you may imagine, chessplayers are not an easily pigeonholed psychological type. There are just as many different styles of play and different “chess personalities” as there are different styles and personalities in society at large. Learning the rules of chess is just like learning a foreign language; and just because someone speaks Cantonese or French doesn’t mean “their mind works a different way.” It just means they grasp the syntax and idioms of a different culture. And it doesn’t mean you forget your native language — just as chessplayers don’t forget how to function in human society.
What you perhaps don’t know is that most chessplayers combine the no-nonsense zero-possibility-of-chance framework of chess with the statistical guesswork of gambling which you analyze in your essay. In so doing, chessplayers get the best of both worlds and often can out-compete nonchessplayers in the real world, or manipulate situations to their advantage.
The trick comes in keeping the causative logical framework of chess analysis yet replacing the rigid functions of chess moves with the more probablistic realities of human interactions. In this way, a chessplayer can look down two or even several “search trees” into the future to assess what would be the best action to take right now. If you replace “bishops always move diagonally” with “Bill is usually late for work anyway” and so on, you can end up coming to some very insightful conclusions and plans that wouldn’t occur to the non-chess player. I can’t tell you the number of times I have out-thought my competitors in the real world using chess skills, and/or guided myself through sticky social conundrums using those same skills. And it’s not like I sit down and “try to figure out these strange creatures called humans” using alien logic; but rather my mind just works this way naturally and I come to decisions in a second or two the way most people do, but using other analytic tools from the chess toolbox.
A gambler has a goal and tries to seek it; a chessplayer will often include the quest for that goal within the deconstructive analysis itself — sometimes concluding that failing to achieve the stated goal is actually a better result in a larger framework. (Re-watch the film “Loneliness of the Long-Distance Runner” for an example of this, when the lead character, just steps from the finish line, realizes suddenly that his life would be better in the long term if he lost the race rather than won it; and so he stops dead in his tracks, and refuses to finish.)
Perhaps this is why chessplayers are often perceived to be “losers,” because many of them have concluded that the relentless and intellectually empty quest for riches at all costs is not the satisfaction they are seeking in the first place, and so intentionally chose a modest life (or even a life of penury) rather than endlessly chasing after the almighty dollar (or Euro or ruble, as the case may be).
Well, if it’s so damn hard to pigeonhole chess players, how come you were so damn easy?
I deny the utility of chess dudes search trees. I knew a cab driver who was extremely good at human motivation; as good as anyone I have met. His son, a world renowned physicist, was regularly outsmarted by him, well into adulthood. He didn’t play chess. He got good at what he did from avoiding robbery in the Bronx.
“Empty quest for riches?” Who is supposed to be trafficking in stereotypes here again? I’d say guys like Jim Simons or Ed Thorp have led more meaningful and colorful lives than any chess player you can name.
Scott said:
“Well, if it’s so damn hard to pigeonhole chess players, how come you were so damn easy?”
Well, sure, it’s easy to pigeonhole people according to stereotypes, as you have done; what’s not so easy is pigeonholing people accurately, which you have not done. Just because you tossed out a dime-store analysis of my personality doesn’t mean it was in any way true.
Scott said:
“I deny the utility of chess dudes search trees”
Great! Less competition for me. Deny all you want. That won’t make the utility go away. Denying is not the same thing as disproving.
Scott said:
“I knew a cab driver who was extremely good at human motivation; as good as anyone I have met. His son, a world renowned physicist, was regularly outsmarted by him, well into adulthood. He didn’t play chess.”
Splendid anecdote. Except — anecdotes don’t prove anything. I’ve got a zillion anecdotes going the opposite way. We could play competing anecdotes back and forth all day long and their evidentiary value would still amount to zilch.
Scott said:
““Empty quest for riches?” Who is supposed to be trafficking in stereotypes here again?”
I only said that because you were discussing gamblers and stock market players. What exactly are gamblers and traders trying to achieve by their chosen professions? Spiritual enlightenment? Athletic prowess? Intellectual stimulation? No, what they’re going after is money. That’s the definition of what they’re doing. That’s not trafficking in stereotypes, that’s simply describing what they do — strive after money.
Scott said:
“I’d say guys like Jim Simons or Ed Thorp have led more meaningful and colorful lives than any chess player you can name.”
You mean guys like Humphrey Bogart and Sergei Prokofiev and Pope John Paul II? Guys like Salvador Dali and Caspar Weinberger and Charlemagne? Gals like Anne Boleyn and Marlene Dietrich and Yoko Ono? Guys like Voltaire, Che Guevara and Albert Einstein? Guys like Sigmund Freud, Harry Houdini and Ulysses S. Grant?
Yeah, I guess you’re right. They did all lead boring lives. Jim Simons has them all beat!
Oh, and I forgot to add:
Scott will say:
“See? Your detailed rebuttal of my comments only proves that I was right about how chess players are all obsessive-compulsive rigid-thinking freaks!”
To which I reply:
Eat my shorts!
Yet, you were unable to think of a clever way around an obvious checkmate, no? Thanks for providing a live-action example and stuff.
Enjoyable discussion. All strategies are implemented in environments though. Having a chess mind works in 1950s-80s America and poker staking in the US since then maybe. Obviously maybe a distillation is that deregulated/liberal environments make gambling not just more rational, but more practical. The social darwinist understands that the best strategy is the one that adapts most to the circumstances, and not the strategy that creates the best circumstances. Although this may be chess thinking. Everyone gonna talk their book in the end.
I met a former Chevron veep who told me how the old job system worked. You get hired, and have a job for life. If it doesn’t work out, they tell you to your face and give you an office for an entire year to make the transition to a similar role in another place. Now, people are escorted out at gunpoint and replaced with helots when they make an off color joke. Sounded a lot more chess-like than the present system.
I know plenty of younger people at large institutions; you pretty much only have life sinecure at government jobs.
Scott said:
“Yet, you were unable to think of a clever way around an obvious checkmate, no? Thanks for providing a live-action example and stuff.”
No, actually, I purposely gave an emotion-based fact-free reply (“Eat my shorts!”) as evidence than I’m not entirely robotic in my narrative.
But now I can see that you’re doing the ol’ damned-if-you-do, damned-if-you-don’t game (i.e. if I unemotionally provide a logical take-down, my very logic is cited proof that I am a stereotypical chess automaton — but if I drop the logic and just speak from the gut, then that proves I have no valid rebuttal), so I’ll just recuse myself from your playground and let each of us go our separate ways in peace.
I didn’t come here looking for contentiousness or an argument! I’m sorry it turned out that way. Maybe next time (if there is a next time) we can get off on a better foot.
Hey man, it’s all fun and games until someone puts an eye out.
[…] I don’t, and I think if you want to be Einstein or Kepler, your path is clear, and is far away from a safe life of vegetable contentment, sucking at the public teat. There is a place for big science of course. […]
Man you guys use a lot of big words.
“Big words mean big thoughts” said Sesquipedalius.
Just kidding but I wondered why no one referenced The Dice Man by Luke Rinehart, if you are talking about chance and Life. It aint subtle but it pounds home the point that chance plays a huge and usually unacknowleged part in our lives.
Also that essay at Taki’s place on Stuff White People Like was THE best explication of suicidal status moves amongst educated whites in their over-educated monkeyspheres I have ever read.
Thanks
Never heard of that one; looks like a good read. Thanks for the kind words; living in Berkeley as an outsider will make you think about such things.
[…] (For more on this, see Scott Locklin’s excellent applications of financial ideas to everyday life.) […]
“deliberate and rational choices in a deterministic world” there is tension here…
Really enjoyable article Scott. I think you may be now aware in the years since that low beta stocks tend to actually provide larger returns than one would size using the CAPM theory, but that may be due to larger movements in the world, distorting the “normal” character of the relationship between risk and return.
As pertaining to life, I think we should examine the 2 CAPM components separately:
Risk: In finance, we measure risk via volatility (over a designated, oft arbitrary, period). Not liquidity risk usually, Not tail risk. Not currency/inflation etc etc. The definition of risk is a big issue. Similarly if I posit what is risky to Jim the postgrad from Boston he might say – being bankrupt, getting an STD, losing reputation, etc You then get into a complicated discussion about how different types of risk merge, correlate, or hedge out others. Or how the lattice of risk is reshaped as life progresses.
The other aspect of risk is that “risk” for a human is not uniform. Due to experience, childhood, parents wealth, testosterone levels etc, one’s ability to bear risk, or indeed invite risk makes it an unwieldy concept to say anything meaningful in generalist terms. In some cases, chasing safety rationally provides higher life returns (particularly those of an addictive personality, low impulse control or of neurotic temperament).
Reward: You may be aware of phyrric victories. Pushing all the chips onto a 200k harvard law degree to do 70 hour workweeks and destroy ones body and social life is quite common. Its hard to link risk and reward because theres often no pricing available on the rewards we seek. We also have the psychological problem of emotional investment in investment. Once you spend 3 year doing pre-med, its psychologically horrible to turn back. We also have problems with other people’s utility functions like family, spouses, friends, children and so on being a function of your reward and vice versa (and also how they manage their risk).
I say all this not to disagree. But it wouldn’t surprise that neither determinism nor CAPM are strictly speaking, completely more rational ways of attaining “reward” than say, trial and error, which is my own favoured philosophy on life (although I am comfortable this approach has no chance of exposing me to enough ‘data points’ where I can 100% maximise my “reward”), or even other ‘financial strategies’ like herd following, momentum loading, fundamental appraisal or contrarian stances.
I guess that’s why life is for me the most interesting game I’ve ever played.
“I guess that’s why life is for me the most interesting game I’ve ever played.” -amen, brother.
I’ve been meaning to write another one of these philosophical things using Black-Scholes, which is a better model than CAPM for many life situations, as it has a more explicit breakdown of different kinds of risk factors for making decisions. All of these things are, of course, models. Bad ones in fact. But as George Cox put it, “all models are wrong, some models are useful.”
Much of the game of life is blatantly or implicitly quant-like so of course the finance skills carry over and the useful ones are more poker-like than chesslike. However, a better question is about poker (or chess) versus math, physics, athletics or drug dealing as the optimal background. There is a sort of “efficient employment frontier” graph in which one axis is pure analytical power and the other something like general strategic sense, street smarts and risk taking. The high end math skillset (ultra-high general intelligence, non-autistic overall but with some math-specific cognitive abilities plus common sense) is better for some specific quant pursuits as reflected in your examples like Simons and Thorp; physics for quant trading in a more general sense; poker and athletics for general trading and so on all the way to drug dealing and Mafia work as an ideal background for pure business decisionmaking.
Teacher’s Pet type math and physics geeks don’t do as well, but those fields contain a lot of people with what I listed above as the high-end skillset and the latter do succeed on the whole in the areas of finance to which they are more suited. Of course, going into finance at all rather than submitting to whatever rituals are needed to stay in academia, or escaping into something safer and lower paying, is in itself a (mild) anti-autism filter, so we are seeing censored data.