Apr

24

 I just did a quick read of Fisher's Crashes, Crises, and Calamities: How We Can Use Science To Read the Early-Warning Sign s. Although I found it to be light on applied theory, I thought some of the general ideas put forth in it were worth some additional investigation.

He discusses the impact of negative and positive feedback on systems. In really simple terms, negative feedback is generally a stabilizing influence on a system but it needs to be applied quickly as a series of rapid small changes versus a larger more gradual one, and positive feedback near a transition point can cause a system to suddenly change states.

One of the more interesting phenomenon he talks about is the Allee effect in which a population can grow if it is above a certain level, but will enter freefall if it is below that cutoff density. He talks about a problem with flamingos breeding at a certain zoo due to this effect which was alleviated through the use of mirrors to give them the illusion of a higher density.

One of the other areas of interest is the idea of resilience in systems, and the fact that it is the loss of it that leads to rapid state changes in systems as they are more easily pushed through a tipping point. Loss of resilience leads to a system that is slow to recover from an initial assault, and less able to maintain equilibrium after a subsequent one.

He argues that there are 5 key early warning signs indicating a loss of resilience:

1) Increasing occurrences of extreme states

Fluctuations near a critical point can drive huge jumps between alternative states.

2) Fluctuations between different states

3) Critical slowing down

A progressively slower ability to recover from small perturbations as a crisis approaches. Under this section, he mentions Parkinson and his concept of injelititis as a disease that brings down companies. Parkinson's Law and injelititis are a subject worth an entire discussion on in their own right:

4) Changes in spatial patterns

5) Increasing skewness in the distribution of states

He also spends some time on Toynbee and his idea of the life cycle of societies corresponding to a musical rhythm of three and a half beats to the bar. This plays out as a period of initial growth followed by some event that marks an end to growth, and then a three and a half beat pattern of collapse…recovery…collapse…recovery…collapse…recovery…final collapse.

Overall, I found some interesting food for thought here.

Ralph Vince adds: 

Interesting post Dylan, thanks. I would add to this, though, a very simple amendment note– crashes in commodity prices are most often preceded by a contraction in open interest. 

If, in the midst of a price run-up (typically, what we would call a "parabolic-style" run-up, and OI begins to roll over (because a run-up is typically seen with expanding OI), as OI decreases and the price continues its rise, it's about over, and likely to come down symmetrically with how it ran up. I am speaking only of hard commodities here, not financial ones.

Henry Gifford writes:

This is similar to my old trick of watching the thickness of the multiple listings book to gauge interest in real estate, now there are gauges such as average time between listing and sale of property, etc. Proxy for OI.
 


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