“A Beautiful Mind” (2001), biopic of game theorist John Nash (1928 – 2015).

The Game Of Chicken - Inherent Vice1. If people do not believe that mathematics is simple, it is only because they do not realize how complicated life is.

2. Young man, in mathematics you don’t understand things. You just get used to them.

3. There’s no sense in being precise when you don’t even know what you’re talking about.


4. It is just as foolish to complain that people are selfish and treacherous as it is to complain that the magnetic field does not increase unless the electric field has a curl. Both are laws of nature.

– Four from John von Neumann(1903 – 1957), the father of modern game theory.

I’m interested in the fact that the less secure a man is, the more likely he is to have extreme prejudice.

Clint Eastwood (b. 1930)

Insecurity is the worst sense that lovers feel; sometimes the most humdrum desireless marriage seems better. Insecurity twists meanings and poisons trust.

Graham Greene, “The End of the Affair” (1951)

If freedom is short of weapons, we must compensate with willpower.

– Adolph Hitler (1889 – 1945)

One constant among the elements of 1914 – as of any era – was the disposition of everyone on all sides not to prepare for the harder alternative, not to act upon what they suspected to be true.

– Barbara Tuchman, “The Guns of August” (1962)

In a significant move to deter possible Russian aggression in Europe, the Pentagon is poised to store battle tanks, infantry fighting vehicles and other heavy weapons for as many as 5,000 American troops in several Baltic and Eastern European countries, American and allied officials say.

New York Times, “US Is Poised to Put Heavy Weaponry in Eastern Europe“, June 13, 2015

Be careful who you call your friends. I’d rather have four quarters than one hundred pennies.

Al Capone (1899 – 1947)

We are all impaled on the crook of conditioning.

– James Dean (1931 – 1955)

There’s nothing stable in the world; uproar’s your only music.

– John Keats (1795 – 1821)

Shasta Fay: I went on a boat ride.
Doc: A three hour tour.
Shasta Fay: They told me I was precious cargo that couldn’t be insured because of inherent vice.
Doc: What does that mean?
Shasta Fay: I don’t know.
Doc: Inherent vice in a maritime insurance policy is anything that you can’t avoid. Eggs break, chocolate melts, glass shatters, and Doc wondered what that meant when it applied to ex old ladies.

“Inherent Vice” (2014)

I was at a conference, on deck for a presentation, and I had the chance to listen to the Q&A for the speaker ahead of me.

“Assuming no external shock, how much longer can this bull market run?”

The speaker, not exactly the most sparkling of raconteurs under the best of circumstances, first replied with the obligatory, “well, that’s a very good question”, and then proceeded to give a detailed, bone-dry explication of exactly how long he thought this market would run, the likely level of the S&P 500 top, and a few winning sectors and stock picks for good measure. It all sounded very smart, and I’m sure he was … smart, that is. But boy oh boy, if there were ever a living embodiment of von Neumann’s dictum that being precise is all too often a waste of time, this was it.

Because this wasn’t “a very good question”. It was, in fact, a pretty useless question, the functional equivalent of asking a botanist how big a tree can grow in the absence of storms, droughts, fires, blights, lightning, insects, or whatever. Answer: pretty darn big. Better answer: who cares? You don’t need my help with an investment strategy for a paradise scenario, any more than you need my help with an investment strategy for a doomsday scenario. But where we could all use some help is with an investment strategy for the Real World in-between paradise and doomsday. What we all need is a good perspective or vantage point for differentiating between this potential shock and that potential shock, for evaluating what signals to press and what signals to fade. It’s not a matter of predicting shocks, but rather a matter of reacting to incipient shocks smartly and strategically, of knowing, in the immortal words of Kenny Rogers, when to hold ‘em and when to fold ‘em. Now that’s a good question, and it’s one that Epsilon Theory is well suited to take on.

There’s a specific sort of instability in the world today – a game theoretic instability – which means that it has an identifiable pattern and rhythm you can understand in order to improve your investment strategy. It’s the instability of the game of Chicken, and once you start looking for it, you will see it everywhere here in the Golden Age of the Central Banker. Greece vs. the Troika? Chicken. Western sanctions on Russia over the Ukraine? Chicken. OPEC vs. US energy producers? Chicken. ECB vs. the Swiss National Bank? Chicken. Fed monetary policy communications to markets? Chicken. Abenomics? Chicken. US policy towards China? Chicken. ISIS vs. the world? Chicken.

Let me take a minute to describe why a game of Chicken is particularly and peculiarly unstable, because understanding the game’s dynamics is crucial for understanding how and why Chicken has become the defining strategic interaction of nations and institutions today, just as it was in the 1930s, the 1910s, and the 1870s. To make that description, I’ll be drawing on the concept of the Nash equilibrium, the most influential insight of mathematician John Nash, whose early career and lifelong struggle with mental illness was portrayed in the great movie “A Beautiful Mind”, and who was killed last month in a car accident at the age of 87 (I’d like to think that his not wearing a seatbelt while traveling on the New Jersey Turnpike was a game theoretic exercise, but that’s the Keats-ian Romantic in me talking).

The central idea of the Nash equilibrium is that a non-cooperative strategic interaction between players (for simplicity’s sake we’ll just talk about two player games, although the concept is applicable for any number of independent players) is in balance, i.e. in equilibrium, if neither player prefers to “move” from the current game position after consideration of both his preferences and potential moves AND his opponent’s preferences and potential moves AND the knowledge that both of you are thinking about the other in this manner. The Nash equilibrium takes seriously the notion that the other player is just as smart as you are and, as importantly, just as strategic as you are – meaning that both of you can look several moves ahead, and both of you are making moves that are contingent on the other player’s moves. Like all great ideas the Nash equilibrium seems simple at first blush, but it’s a deceptive simplicity, one that when applied rigorously can shed light on a raft of social interactions that otherwise seem irrational or unpredictable.

I’ll start with a common

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