Epsilon Theory Manifesto
June 1, 2013·4 comments·Money
Active investment management is broken. Alpha factors have stopped working. But Hunt argues we're asking the wrong question entirely. The real action in markets happens in the space where traditional financial analysis is blind.
• Factor analysis sees the world like a telescope that only detects light. It's great for measuring static things but useless for detecting phenomena that don't fit econometric boxes. Risk-On/Risk-Off behavior exists everywhere, but it's invisible to this lens.
• Game theory explains what factor analysis can't. The framework isn't about what stocks are "worth." It's about what strategically-aware players expect other players to believe. Markets aren't solving physics equations. They're playing poker against each other.
• Narratives are the actual fuel of markets, not fundamentals. A Narrative doesn't need to be true. It needs to sound true and be widely broadcast by influential people. Central Bank Omnipotence, European Union cohesion, German economic dominance. These shape behavior more than interest rates or GDP.
• Common Knowledge is the bridge between Narrative and price movement. It's not what you believe or even what everyone believes. It's what everyone believes that everyone else believes. This is measurable through how many influential figures publicly endorse a story.
• History shows us this isn't new. It's cyclical. From the 1850s through the 1940s, investors thrived by playing the player, not the cards. Jay Gould, Andrew Carnegie, and Cornelius Vanderbilt made fortunes by understanding other investors' behavioral intentions. We forgot how to do this, but the structure that rewards it has returned.
The Why of Epsilon Theory
- Direct access to leading narrative-tracking technology across global news.
- Deep analysis of how narratives shape markets, politics, and society.
- An active online community of independent voters, investors and thinkers.
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Comments
Thanks Ben for highlighting the manifesto. For us who joined your conversation late, it is rewarding to see you outline the geography. Fun to see how Cui bono has developed…
In regard to analysis of narratives, there is a case, some years ago, in which a set of related narratives were sanded and polished and had concrete conclusions then drawn from them, namely, the detective stories of Agatha Christie. Via concordance analysis of her work, the following patterns were noted:
To see the rest of the patterns, including the remark that Christie herself was probably unaware of these patterns, follow this link:
https://www.kiangle.com/notes-from-the-agatha-christie-code/
Also, again based on concordance research, it seems that Christie was succumbing to dementia later in life (which itself is a narrative-analysis type result: “Vocabulary Changes in Agatha Christie’s Mysteries as an Indication of Dementia”). To see this discussion, follow this link:
https://www.researchgate.net/publication/242107161_Vocabulary_Changes_in_Agatha_Christie’s_Mysteries_as_an_Indication_of_Dementia_A_Case_Study
channeling Ogden Nash:
Pursuing epsilon is fraught with strife,
Frightful even for Mack the Knife.
But at this task you can safely take a whack,
If you have the pack to watch your back.
I guess that the premise of this manifesto (common knowledge and game theory) is why I liked “The Big Short” so much. Dr. Burry’s short on MBSs didn’t require guessing, strategizing, or theorizing what someone else thought, it just required some mathematics and calculating that people weren’t going to be able to repay their mortgages. Eventually no matter what people thought about housing, it goes bust if people aren’t able to pay. With stocks, even if the stock is “ugly”, as long as enough people think (or think that other’s think) that they are pretty the price can stay high.
So while I will continue to invest (play the game of anticipating common knowledge) I will save my biggest bets (investments) for where the common knowledge is just wrong and no matter what happens eventually the common knowledge will be proven wrong.
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