Devices for Dissonance: Reflexive Modeling and Systemic Risk Daniel Beunza & David Stark

Dissonance Dissonance fosters discovery by prompting reflexivity.

Dissonance Dissonance fosters discovery by prompting reflexivity. Disagreement about what is valuable makes it possible to discover new resources of value.

How do traders deal with the fallibility of their models?

In the literature, disasters are traced to the behavior of traders, depicted as 1) reckless

In the literature, disasters are traced to the behavior of traders, depicted as reckless and as 2) overly cautious (“herding”)

Processes that provoke doubt can lead to overconfidence

Reflexivity about Models

This is a pipe organ in largest hall of Moscow House of Music. Posted by Irina at 20:55 Labels: instuments, theatre

This is a pipe organ in largest hall of Moscow House of Music. [a declarative speech act] This is a pipe organ in largest hall of Moscow House of Music. Posted by Irina at 20:55 Labels: instuments, theatre

“I apologize.”

“I apologize.” [a performative speech act]

Performativity in economic sociology: Financial models are not representations. They are interventions that format, shape, perform markets. Their use brings new economic objects (markets) into being. Models are market making.

“This is the way that people get from point A to point B.”

A model is performative when its use increases its predictive capabilities.

This is a pipe organ.

A financial model is not a representation;

A financial model is not a representation; it is an intervention.

The arbitrage traders we studied do the same.

The trading room is populated with devices for doubt The trading room is populated with devices for doubt. Traders do not simply use models and devices that perform the market. They also create and use devices for reflexivity. This reflexivity is not exterior to (or above) the structures of socially distributed calculation but is an integral part of it.

Arbitrage is a (reflexively) skilled performance. And this reflexivity is not of the individual but is social and material.

Epistemic challenges of using models in arbitrage

Methodological constraint: a single morning at a single desk in an abritrage trading room.

Calculation in merger arbitrage involves the dissonance between two sets of probability estimates: probability estimates derived at the desk using proprietary models, databases, and instrumentation. 2) “implied probablity” – the aggregate probability estimates of the trader’s rivals

a given trading desk makes probability estimates based on models, proprietary databases, and instrumentation

V= (1-)PNS +PS

The trader’s models and instrumentation are powerful scopes for viewing the markets.

But scopes that reveal can also conceal But scopes that reveal can also conceal. If you take your model for granted, you can lose your shirt.

To avoid cognitive lock-in, the traders turn to socio-technical networks outside the trading room.

relation between the trader and his rivals

The spread plot in merger arbitrage I feel I have not seen enough visualizations so far. So I’d like to start with the visualization that I am going to discuss today. This is a spread plot. I won’t explain what a spread plot is. But I will tell you what it does. This visualization allows users to see the invisible. Now let me give you the background of when I saw this, the research that I made and what I found.

The spread plot is a representation of an economic object that does not have a price and is otherwise not observable, co-produced by the positioning of actors who use it to confront their interpretations and re-evaluate their positions.

Decoding the spread plot time $ Target Acquirer Here, make the case of the difference between the spread plot and the price plot. It gives an advantage “Backing out” implied probability

The spread plot instantiates the diversity of dispersed anonymous actors.

dissonance

Reflexive modeling Dissonance disrupts. It prompts reflexivity. Each of the (materially mediated) relations provokes reflexivity about the other.

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re-search

Reflexive modeling Differs from ‘herding’ Here, dissonance prompts re-search

Reflexivity is not self-awareness or conceptual transcendence. So as not to be captive of an epistemic trap, traders use devices for dissonance.

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WARNING

The same devices for doubt can also be devices for overconfidence, leading to arbitrage disasters. WARNING

The strength of reflexive modeling is based on the fact that it leverages the cognitive independence among dispersed and anonymous actors.

The strength of reflexive modeling is based on the fact that it leverages the cognitive independence among dispersed and anonymous actors. But this same process suggests the possibilities of cognitive interdependence among the rival traders in the professional arbitrage community.

Just as reflexive modeling can typically be a source of correction, so this same cognitive interdependence among traders can, in rare but dramatic instances, lead to the amplification of error.