The Fear Index

student reads four hundred and fifty words per minute. The really clever ones can manage eight hundred. That’s about two pages a minute. But IBM just announced last year they’re building a new computer for the US government that can perform twenty thousand trillion calculations a second. There’s a physical limit to how much information we, as a species, can absorb. We’ve hit the buffers. But there’s no limit to how much a computer can absorb.
    ‘And language – the replacement of objects with symbols – has another big down side for us humans. The Greek philosopher Epictetus recognised this two thousand years ago when he wrote: “What disturbs and alarms man are not the things but his opinions and fancies about the things.” Language unleashed the power of the imagination, and with it came rumour, panic, fear. But algorithms don’t have an imagination. They don’t panic. And that’s why they’re so perfectly suited to trade on the financial markets.
    ‘What we have tried to do with our new generation of VIXAL algorithms is to isolate, measure, and factor into our market calculations the element of price that derives entirely from predictable patterns of human behaviour. Why, for example, does a stock price that rises on anticipation of positive results almost invariably fall below its previous price if those results turn out to be poorer than expected? Why do traders on some occasions stubbornly hold on to a particular stock even as it loses value and their losses mount, while on other occasions they sell a perfectly good stock they ought to keep, simply because the market in general is declining? The algorithm that can adjust its strategy in answer to these mysteries will have a huge competitive edge. We believe there is now sufficient data available for us to be able to begin anticipating these anomalies and profiting from them.’
    Ezra Klein, who had been rocking back and forth with increasing frequency, could no longer contain himself. ‘But this is just behavioural finance !’ he blurted out. He made it sound like a heresy. ‘Okay, I agree, the EMH is bust, but how do you filter out the noise to make a tool from BF?’
    ‘When one subtracts out the valuation of a stock as it varies over time, what one is left with is the behavioural effect, if any.’
    ‘Yeah, but how do you figure out what caused the behavioural effect? That’s the history of the entire goddam universe, right there!’
    ‘Ezra, I agree with you,’ said Hoffmann calmly. ‘We can’t analyse every aspect of human behaviour in the markets and its likely trigger over the past twenty years, however much data is now digitally available, and however fast our hardware scans it. We realised from the start we would have to narrow the focus right down. The solution we came up with was to pick on one particular emotion for which we know we have substantive data.’
    ‘So which one have you picked?’
    ‘Fear.’
    There was a stirring in the room. Although Hoffmann had tried to avoid jargon – how typical of Klein, he thought, to bring up EMH, the efficient market hypothesis – he had nevertheless sensed a growing bafflement among his audience. But now he had their attention, no question. He continued: ‘Fear is historically the strongest emotion in economics. Remember FDR in the Great Depression? It’s the most famous quote in financial history: “The only thing we have to fear is fear itself.” In fact fear is probably the strongest human emotion, period. Whoever woke at four in the morning because they were feeling happy? It’s so strong we’ve actually found it relatively easy to filter out the noise made by other emotional inputs and focus on this one signal. One thing we’ve been able to do, for instance, is correlate recent market fluctuations with the frequency rate of fear-related words in the media – terror, alarm, panic, horror, dismay, dread, scare, anthrax, nuclear. Our conclusion is that fear is driving the world as never before.’
    Elmira Gulzhan said, ‘That is al-Qaeda.’
    ‘Partly. But why should al-Qaeda arouse more fear than the threat of mutually assured destruction did during the Cold War in the fifties and sixties – which, incidentally, were times of great market growth and stability? Our conclusion is that digitalisation itself is creating an epidemic of fear, and that Epictetus had it right: we live in a world not of real things but of opinion and fantasy. The rise in market