Thoughts About Monopoly As A Teaching Tool

We have been playing Monopoly with my 1st grader.

A hierarchy of useful lessons

  • Arithmetic

I make Zak be the banker so he gets lots of practice making change. It’s harder than 1st-grade math worksheets so you can have fun AND cross an item off your homeschool list.

  • Probability

Dice frequencies. The first-grader knows considers stretching to build houses when you are 6,7, or 8 spaces away from his property.

  • Ownership and investment returns

Ask your child how many times a property needs to be landed on to breakeven on the purchase. For older kids, discuss investment returns as a percentage.

  • Borrowing, collateral, and interest

The whole mortgage and interest mechanism. Borrowing against incomplete property sets to improve completed sets.

  • Operational leverage

Do you stretch to buy houses? If so, your small cash cushion can get wiped out by a mistimed Chance card forcing you to fire sale your houses for half price. Throw in some dice probability discussion and the game fosters a rich learning environment.


What about trading?

I actually think Monopoly falls flat here. Deals are sporadic but highly impactful. Since the luck of the dice creates large disparities in what properties players are naturally endowed with, the prevailing logic behind too many deals is “well, if I don’t do anything I have zero chance”. The prospect of raising your odds from zero to 5% does not make for inspired dealings.

If a deal is fairly priced there’s a lot of variance around its outcome.  A dice game has too much of that already. That means the returns to skill are not only low but low resolution. Awful for learning.

In the case when deals are lopsided the game is brutal for everyone else. Worse yet, if the potential to exploit a weak player exists the game devolves into politics of “like” and may even import baggage from real life. Surely these are useful lessons but not quite what I have in mind when I want to use a game as a teaching tool.

(Monopoly would be more interesting with a side betting market on who was going to win the game. That market would suddenly spring to life when two people were negotiating a trade as the rest of the players would basically be casting their bids in the side market. The result would be a realtime “fair value” meter presiding as judge over the trade. As you tweak the cash and property sweeteners in the deal, see if everybody thinks you are overshooting fair value. For advanced players, a whole meta strategy would unlock since the side market influences the real game.)

For Mother

Yinh and I are big fans of Patrick O’Shaughnessey’s Invest Like the Best podcast. One question he asks every guest, “What is the kindest thing anyone has ever done for you?”. Listen to the show enough and it’s impossible to not wonder how you would answer if you were in the hot seat. I think I know my answer.

In the fall of 1995, I visited Cornell’s campus. For years I had known about Cornell. For whatever reason, as I was growing up my mother always spoke of me going to Cornell. I don’t know why. It’s almost like Cornell was the last name of the immigration officer when she arrived in the U.S. and when she heard there was a college with the same name it meant destiny. Whatever the case, her dream became mine. So when I visited the campus I felt like it was already familiar.

I applied early decision to maximize my chance of getting in. My safety schools were Villanova (it was a popular destination for kids in my HS) and Rutgers, my state school. In reality, my strategy was Cornell or Rutgers. Dream school or good value. I got into both and here’s where the twist came. Rutgers offered me a full scholarship. And on the other side of the ledger, Cornell sent hard numbers of what this private education was going to cost. The price spread between my two choices shook me.

I picked Rutgers. I knew I could get some loans from Cornell but I also knew my mother was going to need to come up with about 10k per year. That felt impossible. Prioritizing education my whole life, I went to Catholic school for K-12. This was going to cost 2x and things were already super tight especially with my sister about to enter HS herself.

As the day to send my letter of intent approached, my mother simply couldn’t bear this decision. She called me in to say that she’d find a way to make it work. It was a rare opportunity. Jump. If there’s a will there’s a way basically. We agreed we’d split the costs (I never worked as many hours as I did during my college summers) and she treated getting grants like a full-time job. She was tireless in writing letters about financial hardship and calling the aid office. Her persistence was epic.

That was the kindest single thing anyone had ever done for me. Not because it was Cornell. Because this was an example of what she always did. Everything she ever did was to give my sister and me a shot (my sister would attend Cornell 4 years later).

In truth, I have a bigger example of her sacrifice. But it’s not a story I’ll tell. But if she’s reading this she’ll probably know.

5’2″ and a force of nature.

Happy Mother’s Day to all the mama’s out there.

Shorting Bimodal Stocks


My friend and former colleague Jason took exception to the viral tweet I referenced last week about how shorting a bi-modal company is like an option. Not because it isn’t but because all equity is an option.

In short, the entire viral tweet is a tautology.

Jason joined Twitter to respond to it. Jason’s gripe was that all equity is effectively a call option struck at zero (you can argue that a positive book value sets the call strike higher but it doesn’t materially change the point).

Jason argues that if the viral tweet pretends it is saying anything beyond “being short stock is like being short an option”, you are mistaken. There are several reasons why, and I’ll use my intro to twitter to go thru them…(Jason’s reply)

Where do I stand?

I liked the original @HedgeDirty tweet because I am just a fan of presenting ideas in different ways. The flaws in the tweet are real and technical but it conveyed a correct impression even if it got there incorrectly. To Jason and @HedgeDirty the riskiness of shorting a bimodal company whose equity is probably worthless is obvious. I appreciated the narrative style which reinforced that point. Even if it’s self-evident to anyone who shorts stocks.

But I also see learning opportunities in deconstructing the flaws in the tweet.

You can read Jason’s reply to see the flaws he found. Especially resonant was the observation that the 0 strike call is a 100 delta call. It has no gamma or theta. The original tweet claimed otherwise.

What would I focus on?

1) Let’s do a little math to find the annualized vol. The first thing to note is how the bi-modality creates a very volatile stock. 125% per year standard deviation.

(Warning: it doesn’t make much sense to use standard deviation based on a normal looking return when we already stated it was bi-modal but the obvious takeaway is “damn, this thing is going to make large moves in return space.” If you know nothing else, you know going short this thing is like barebacking a bucking bull. Size appropriately.)

2) My biggest gripe with the example. The stock doesn’t trade for $185 because it’s hard to be short stocks.

If the stock is trading for $185 the market is implying different distribution. Either the 80% and 20% are not true, the stock’s upside is more than $250 (1.25B EV), or the recovery value is much higher.

It’s not trading for $185 with a theta that pushes towards zero or anything like that. We don’t need to invoke Greeks for an alleged $50 fair stock trading for $185. If it’s trading $185 the market doesn’t agree with the assumptions that compute a $50 fair value. Full stop.


Despite the flaws, I enjoyed the original tweet. You can read plenty of @HedgeDirty threads and see it’s a good account to follow. For example, the Why You Should Never Hold Levered ETFthread is great. I’ve written about the brutal math of levered, especially inverse levered funds before.

Shorting bi-modally distributed stocks is hairy. If it feels like it’s being short an option it’s only because the stock is volatile, equity is an option, and being short options is volatile. Nobody shorting stocks should have needed an education from that tweet. For everyone else, they should be aware of errors in mapping it to option theory even if I think overall the thread was net positively educational.

As for Jason who has been trading options since the late 90s, I imagine he felt that @HedgeDirty borrowed his bass and played it with a pick. Only Paul McCartney gets away with that.

Wooderson’s Commencement Speech

That’s what I love about these high school girls, man. I get older, they stay the same age. – Wooderson

Many might recognize the Moontower “branding” of this email and my website (pic) as a tribute to the 1993 comedy Dazed and Confused. I first saw it when I was about 16 and have fond memories of having the VHS play in the background during a Florida vacation as my sister and her friend Deez Nutz (sorry Diana, we were young) ran games of Monopoly back-to-back late into the night.

Back to Wooderson. He was that creeper who hangs around the HS crowd years after he’s graduated. Guessing he didn’t pay much attention to the commencement speech. And here’s irony coming around the corner — my favorite all-time commencement speech is by the guy who played Wooderson, Matthew McConaughey.

Presidents, great scientists, Steve Jobs. I can’t imagine the pressure of having to deliver timeless wisdom in the tradition of such minds and achievers. And yet McConaughey, at ease, perched on a barstool, delivers a talk worth your 45 minutes. Watch it with the fam. Even better if you have a grad in your house.

His lessons are both earnest and earned. His stories are fun, relatable, and scratch a behind-the-scenes curiosity too. (Link)

If you can’t wait to get to it, there’s a transcript, but you are missing out on his masterfully droll delivery. (Link)

My Favorite Tips From Wooderson

#1:  Life’s not easy…don’t try and make it that way.

“It’s not fair, it never was, it isn’t now, it won’t ever be. Do not fall into the entitlement trap of feeling you are a victim, you are not. Get over it and get on with it. And yes, most things are more rewarding when you break a sweat to get em.”

#3:  The difference between happiness and joy.

“Happiness is an emotional response to an outcome — If I win I will be happy, if I don’t I won’t. An if-then, cause and effect, quid pro quo standard that we cannot sustain because we immediately raise it every time we attain it. You see, happiness demands a certain outcome, it is result reliant. If happiness is what you’re after, then you are going to be let down frequently and be unhappy much of your time. Joy, though, is something else. It’s not a choice, not a response to some result, it is a constant. Joy is “the feeling we have from doing what we are fashioned to do,” no matter the outcome.”

#4: Define success for yourself.

“How do I define success? For me, it’s a measurement of five things — fatherhood, being a good husband, health, career, friendships. These are what’s important to me in my life. So, I try to measure these five each day, check-in with them, see whether or not I’m in the debit or the credit section with each one. Am I in the red or in the black with each of them?”

#5: A roof is a man-made thing

“You ever choked? You know what I mean, fumbled at the goal line, stuck your foot in your mouth once you got the microphone, had a brain freeze on the exam you were totally prepared for, forgot the punch line to a joke in front of four thousand graduating students at a University of Houston Commencement speech? Or maybe you’ve had that feeling of “Oh my God, life can’t get any better, do I deserve this?” What happens when we get that feeling? We tense up. We have this out-of-body experience where we are literally seeing our self in the third person. We realize that the moment just got bigger than us. You ever felt that way? I have. It’s because we have created a fictitious ceiling, a roof, to our expectations of ourselves, a limit — where we think it’s all too good to be true. But if we stay in the process, within ourselves, in the joy of the doing, we will never choke at the finish line. Why? Because we aren’t thinking of the finish line, we’re not looking at the clock, we’re not watching ourselves on the Jumbotron performing the very act we are in the middle of. No, we’re in the process, the APPROACH IS THE DESTINATION… and we are NEVER finished. Bo Jackson ran over the goal line, through the end zone and up the tunnel — the greatest snipers and marksmen in the world don’t aim at the target, they aim on the other side of it. We do our best when our destinations are beyond the “measurement,” when our reach continually exceeds our grasp, when we have immortal finish lines. When we do this, the race is never over. The journey has no port. The adventure never ends because we are always on our way. Do this, and let them tap us on the shoulder and say, “hey, you scored.” Let them tell you “You won.” Let them come tell you, “you can go home now.” Let them say “I love you too.” Let them say “thank you.” TAKE THE LID OFF THE MAN MADE ROOFS WE PUT ABOVE OURSELVES AND ALWAYS PLAY LIKE AN UNDERDOG.”

#12. Give your obstacles credit.

“Instead of denying your fears, declare them, say them out loud, admit them, give them the credit they deserve. Don’t get all macho and act like they’re no big deal, and don’t get paralyzed by denying they exist and therefore abandoning your need to overcome them. We’re all destined to have to do the thing we fear the most anyway. So, you give your obstacles credit and you will find the courage to overcome them or see clearly that they are not really worth prevailing over.”

More Graduation Inspiration

1) James Clear’s list of great speeches. (Link)

That David Foster Wallace “This Is Water” speech is in there. Wallace was a famously tortured soul who took his own life. I see this speech cited all the time. Justifiably. The bit about driving to the supermarket has always resonated with me. Not because I have a short fuse but because I explicitly don’t.

2) Alexey Guzey’s What You Should Do With Your Life? Directions and Advice is a compilation of amazing resources. Even if none of the resources suit you, at least some of the recommended assays will. (Link)

3) Investor Howard Lindzon’s bullets of advice (Link)

My three favorite:

  • If you can’t code, write.
  • If you can code…don’t forget to write.
  • There is no retirement anymore. Pace yourself.

4) Quotes I keep in mind

  • You are the average of the 5 people you spend the most time with
  • If you never fail, you’re only trying things that are too easy and playing far below your level.
  • Kipling: “If you don’t get what you want, you either didn’t really want it, or you tried to negotiate over the price”
  • Galloway: “The ratio of time you spend sweating to watching others sweat is a forward-looking indicator of your success.”

Maxen Turns 4

My younger son Maxen turned 4 yesterday. We had some family over. I realize we are felons now.

Max is my puzzle. My boys fit a common pattern of families with 2 sons. The older one, Zak, is the sensitive type. The rule-follower and pleaser. I can relate to that child well because I was one. But the second son’s personality is a mystery. He is more destructive, stubborn, and manipulative. Birth order effects in play. He’s more advanced. But what’s plain is Max ends up the center of most of our stories.

He’s been known as El Chapo amongst our loved ones for years. And his total obsession with Thanos and asserting his will on the universe is par for Max. He’s a brute. He is so physical with his older brother. And Zak would never hit him back. Zak would cry from frustration before lashing out.

You get strange glimpses of our nature as people when raising such different kids. Max has a devil’s smile. People gravitate to him in a way that Zak doesn’t quite receive. Zak is such a happy kid. A goofball. A pleasure to be around. But Max evokes more emotion. Like you want his approval. Like you can’t wait to see what he does or says next. My mother finds his personality so magnetic and it’s partly because of his wicked streak.

I think one of the great joys of being a parent is watching how these puzzles unfold. I always use the Chris Rock line that with Max I’m saving bail money not college money. It doesn’t seem fair to me that Max sparks so much interest from others relative to Zak despite not being as nice. I think back to when Max was born and we’d send him to the nursery so Yinh could rest in-between feedings. All the nurses warned us of his will. His Hyde-like nature would come out as he screamed for his next feeding. This animal has been nothing if not consistent.

Don’t let that smile fool you.

Money and Inflation Musings

This is not my favorite topic but it’s impossible to watch the stimulus plans since 2008 and not think about the meaning of money and credit. This tweet-gif reminds us of what is happening. And this tweet-gif will set the appropriate mood before I continue. Ok, here we go. A friend sent me this post because it was formative for him in how to think about the nature of money from first principles. I agree it’s fantastic.

Enjoy Moneyness. (Link) (With my highlights)

Key points that resonated:

  • The distinction between credit (economy’s money) vs monetary base (bank’s money which credit references) and how expanding the base dilutes the credit which rests on it
  • Money is not wealth
  • The difference between accounting plane vs physical plane and his identity relating deficits to balance of payments
  • Gold is not money. It’s a tradeable asset that references money.
  • Hyperinflation is the catch-up period when prices zoom up to match the expansion of the monetary base which it typically lags in the beginning. Requires feedback loop of lack of confidence leading to expanding base more


Inflation Hedges 

 I have been thinking about hedges to inflation. Not because I expect it but because if it happens it will be painful. Same reason I buy homeowner’s insurance. I don’t expect a fire. In thinking about inflation I maintain skepticism of traditional hedges. Not for a specific reason but just because I’m paranoid about consensus solutions to any macro voodoo.

Let me give 2 examples of why I’m skeptical.

1. Elliott Management’s Q1 letter wonders about the conventional wisdom of commercial real estate being an inflation hedge. Yes, it’s a real asset. Yet they write:

Take real estate, for example. Of course, it is “real,” and you might think that it is a slam-dunk to preserve value in a serious inflation. But commercial real estate is a peculiar asset. It looks real because kicking it can break your toes, but it is generally highly leveraged and depends upon the relationship between rents and costs. If there are rent controls or moratoria, formal or forced by circumstances, and no controls on costs, commercial real estate can produce rapid insolvencies. A little thought will reveal many more examples of the complexities involved in a period of monetary destruction such as the one that is possible in the near future.

2. Since the Fed can control the short end of the yield curve it’s reasonable to think a curve steepener trade via options would be an effective inflation hedge under the dual premise that the Fed will be slow to raise rates and they can’t control the long rate anyway. But then I learned about the Fed Yield Curve Control Policy. That’s a mouthful. From an era without acronyms like TARP. I humbly offer FUCC. Not so much because it fits the words that well, but because what it would have done to a curve steepener.

You see, shortly after the US entered WWII, the Fed pinned the long rate at 2.5% to keep borrowing costs low. To an option trader, this means vol goes to zero. You think you have the right hedge on but forgot to read the rule that says the Fed can change the rules. Nothing like getting a prediction right and losing a ton of money on how it plays out.

When Smart People Have Bad Ideas

The last time I watched Curb Your Enthusiasm regularly I didn’t even have a Facebook account. It was was one of my favorite shows, but I’m not that committed to keeping up with TV. So stop me if the following phenomenon is something Larry David has lampooned. It seems like the kind of thing he would. The phenomenon is a very modern form of cringe.

The moment you find a conspiracy theory boosted on your friend’s timeline. You know the feeling. “Ewww. Really? You think 5G spreads coronavirus?”

If this is all too common on your timeline you can just mute them. That’ll take care of the symptoms, but getting new friends is the only cure for that particular affliction. Luckily, this probably isn’t a big problem for most of you. But it’s adjacent to a far more interesting question.

What if the promoter of an awful idea is very smart?

How to think about awful ideas by smart people

Marvel comics’ Thanos strikes me as a brilliant general. He also wanted to see half of humanity die in what sounds like a militantly green agenda. Based on the return of air quality and coyotes during COVID lockdowns, Thanos’ road to hell is not without good intention and grains of truth. There has always been overlap between brilliance and bad ideas. Nazism, religious fundamentalism, the occult have had their share of genius subscribers. The Unabomber’s Manifesto is a fascinating read.

The above examples are extreme. We can lower the stakes and the tension remains. Have you ever dismissed an idea from a person because your entire perception of them is dominated by a bad idea or prediction they had? But you’ve probably heard that “If you are always right, you are not taking enough chances”. Intolerance for bad takes is not compatible with the experiments of progress. So how do we strike an acceptable balance?

Here are a few  ideas on how to come to your own reconciliations:

1) Slatestarcodex on how to Rule Genius In (Link) (With my highlights)

  • On the scarcity of great ideas: “Coming up with a genuinely original idea is a rare skill, much harder than judging ideas is.”
  • On the asymmetry of the problem: “Positive selection – a single good call rules you in – as opposed to negative selection, where a single bad call rules you out. You should practice positive selection for geniuses and other intellectuals.”
  • On “intellectual outrage culture”: “How can you possibly read that guy when he’s said [stupid thing]?” I don’t want to get into defending every weird belief or conspiracy theory that’s ever been [stupid thing]. I just want to say it probably wasn’t as stupid as Bible codes. And yet, Newton. Some of the people who have most inspired me have been inexcusably wrong on basic issues. But you only need one world-changing revelation to be worth reading.”

2) Elon Musk is a lightning rod. From one angle he’s Tony Stark from another he’s a liar in the tradition of P.T. Barnum. Check Morgan Housel on “Natural Maniacs” (Link)

  • No one should be shocked when people who think about the world in unique ways you like also think about the world in unique ways you don’t like. 
  • A mindset that can dump a personal fortune into colonizing Mars is not the kind of mindset that worries about the downsides of hyperbole.
  • Some people are natural maniacs, and you can’t ask for the maniac parts you like without realizing there are maniac parts that might backfire.


My Take

When you meet a person the context gives you a prior about them. If we met in detention vs meeting in a dorm at Cornell I’m going to ascribe a different starting value to your judgment. In all our relationships, we ascribe something akin to Bridgewater’s “reliability scores” to people’s opinions. You continuously update against a prior.

The question is how hard to update. How sticky is the prior? Getting into a selective college is a form of proof-of-work. Same with a strong SAT score. It’s a useful data point. But the usefulness of that data point decays at different rates depending on our own biases or views. There are over 20 years of reasons why nobody cares how a 40-year-old did on a test on a random Saturday morning in a classroom they’d never seen, with a proctor they’ve never met.

Ultimately how I update is usually domain-dependent. If you are innumerate I won’t transfer the demerits to your views on relationships. But I’m probably not asking you for help with my taxes. I am trying to refrain from taking holistic views of people’s opinions. I’ve aged into this approach. My experience of getting older is that empathy usually makes more sense. Once you have controlled for domain-knowledge, it seems that the difference in people’s views is often just path-dependence. Experience. The more dismissive you are, the fewer chances you get to learn from others’ lives. If you start a conversation with “I’m a Capricorn”, I’ll keep listening. But I’ll stop when the subject veers to stock tips (honestly, if that topic comes up you’ve probably lost me no matter who you are — I prefer type II errors in that realm).

The Stars Among Us

Today, I’m far more sympathetic to athletes and movie stars who squander their money. This is also Bayesian. Stars who shine bright burn for the same reasons they ever had a chance to shine in the first place. We should probably be surprised when stars don’t go bankrupt. We all benefit when talented pursue their dreams against long odds. We should root for them to get guidance when they succeed. Nothing will have prepared them for that. And most of us sensible people wouldn’t know a thing about what it takes to fly close to the sun. Housel ties this all back to his “natural maniacs” in a great essay Getting Rish Vs Staying Rich (Link).

This gets very hairy when morality comes into play. The 80s rockstars I like all seem like bad dates. Then you get R. Kelly and Michael Jackson. Yinh and I just watched Louis CK special that he released on his website. I’m not putting him in the same category as these other people. But the question remains, how do we separate the artists from the art? What responsibility do we bear? Truthfully, I have always put my head in the sand. Rationalizing the artist as nothing more than a conduit for the art. As if the art was always awaiting a host. Not how I think it works, but that’s why it’s a rationalization. A logic that allows me to keep enjoying the music. My friend Rebecca is the biggest MJ fan I know. And as sick he was, as difficult as his own childhood was, she can’t help but acknowledge how his fans’ support enabled him. Support that led to children suffering.

Open to perspectives if you got them. Especially how you draw your lines.

Lord Acton Quotes
There is no error so monstrous that it fails to find defenders among the ablest men. Imagine a congress of eminent celebrities, such as More, Bacon, Grotius, Pascal, Cromwell, Bossuet, Montesquieu, Jefferson, Napoleon, Pitt, etc. The result would be an Encyclopedia of Error.
Judge talent at its best and character at its worst.

Li Lu on China-US Relations

Excerpts from part 2 of Li Lu’s series Discussion of Modernization:

A Look at the Future of Sino-US Relations

Link to paper

The paper traces the parallel histories of the land and nation known as the United States in the West and China in the East. An especially interesting thread was how Lu charts the shift from land to market economies. The backdrop and ensuing developments in the 20th century set the current stage and inform possible futures.

On America’s “Soft” Power

As the creator of the American Order, the United States has always retained the rights to make rules for the market, admit membership to access the market, and impose and lift sanctions on states that violate the rules. At the same time, it has borne most of the costs – military and economic – of safeguarding this global market. Rights and obligations together form the core of this American Order.

The United States has also established and promoted her set of ideological values, which we now know as her soft power. In Agrarian Civilization, imperial China established a political system structured around Legalism, and a belief system rooted in the values of Confucius and Mencius. This system of beliefs was intended to achieve the willing submission of its people through subtle cultural and spiritual influence. Similarly, the American ideology promotes freedom, democracy, human rights, constitutional government, the rule of law, free markets, free competition, free trade, and the sanctity of private property. These universal values are so powerful that they have been adopted by almost everyone in the world. It is the very combination of hard and soft power that has brought the United States such tremendous success.

On America’s “Hard” Power

America’s hard powers also include its global network of military bases, the sheer size of its economy, its huge domestic market, its open investment climate, its competitive tech sector, and its world-class universities. So, whenever a global financial crisis strikes, investors around the world will flock to the safe havens of the US Dollar and American assets. This remains true even after what happened in the 2008 crisis.

Whenever the US becomes less confident, it dispenses with the niceties of soft power, and unabashedly resorts to hard power. Those on the receiving end of American hard power are likely to conclude that while the US implements democracy at home, internationally it resorts to hegemony. As the creator of the American Order, its prerogatives include market access, market denial, and selective sanctions and penalties. These special privileges are constituent elements of American hard power.


Trump’s Lack of Subtlety In Wielding Power

The election of Trump has revealed the true nature of American hard power in the context of the American Order.

With China rising rapidly, areas of incompatibility between China and the US have become increasingly pronounced. In the global arena, China has presented a challenge to American dominance, and conflicts have arisen. On the economic stage, a China-led system of international institutions has been established and often without the participation of the United States. China has also pursued the militarization of the South China Sea. The US economy accounts for 25% of the global GDP, but it bears the lion’s share of military costs associated with the maintenance of the global market. From the American perspective, China’s share of global GDP is 15%, but her share of the cost is de minimis, making her a free rider. And to make matters worse, as bilateral frictions mount, the cost of maintaining the American Order has only gone up. To the US, China is becoming more and more like Russia.

One of US economic hard powers is the US Dollar as the default currency of global trade, finance, and settlement…This is why American sanctions are so effective, as evidenced by the developments following Trump’s announcement of America’s unilateral withdrawal from the Iran nuclear deal. ZTE and Huawei, two Chinese companies, have also fallen victim to American sanctions”.

4 Schools of Thought on China Policy

  1. Engagement
  2. Practical
  3. Hawkish
  4. Populist

The four schools have always had divergent views. But in recent years, in light of all the developments in China, there has been a gradual convergence. Whatever the case may be, the reality of Sino-US relations is that today the American perception of China is approaching its perception of Russia.


American Order Focuses on Economic Power

The American Order is mainly preoccupied with the rules of access to and exit from the global market. It doesn’t wield much power over other nations’ political choices. The UN Charter states “the Organization is based on the principle of sovereign equality of all its Members”. So in fact, under the American Order, different political systems may develop, provided that they do not directly challenge America’s superpower status. The rapid growth of China’s share of global GDP (from less than 2% to 15%) is proof of this. Indeed, there is plenty of room for sustained growth.


Outstanding follows for China coverage: 

Michael Pettis

Dan Wang 


Why You Don’t Get Paid For Diversifiable Risks?

Finance theory dictates that an investor does not get paid for “diversifiable” risk. You do not get paid for idiosyncratic risk, only systematic risk. I have not formally studied the CAPM pricing model and prefer more intuitive explanations anyway. So I went to #fintwit:

Twitter Roundup

You can click on the Tweet to see the responses. Here’s a roundup of the Tweets that most informed my understanding.

Here’s @Value_Quant:

Here’s @spreekaway:

My Take

The responses helped me consolidate my own non-technical understanding. I’ll walk through my own take and how I’ve seen the idea that you do not get paid for diversifiable risks in practice.

A Bidding Game

First, a quick game derived from this Bogleheads thread:

Imagine there are 2 boxes. One of them holds 100k and one is empty.

You have a net worth of $50,000. Multiple people are allowed to bid and none of them has more than $50,000.

How much would you bid for each box?

This is an extremely risky bet. Perhaps you bid $40,000 for one of the boxes, for an implied 25% return (you are buying an asset worth $50k for $40k)?

In this narrow example, a box will trade for a healthy discount to its fair value but at the price that the least risk-averse investor is willing to pay.

What happens if everyone in the world is invited to bid?

Jeff Bezos will bid $99,999.99 to buy both boxes and have a guaranteed profit. Even if he were only allowed to bid on a single box, he would bid $49,999.99 since he still has positive expected value and the potential loss is an invisibly small percentage of his net worth.

This Is A Good Model For How Markets Actually Work

Think of how market-making firms profit.

  • They are willing to trade for mere basis points of edge. Often it’s simply rebates.
  • They make thousands of trades a day that get thrown into a giant pool of positions.
  • The systematic risk or beta is hedged out so that they are left with a diversified, offsetting portfolio of idiosyncratic risks. Over time the law of large numbers crystallizes the expected edge into hard p/l dollars.
  • This model validates the idea that providing liquidity is a long-term positive expectancy.

The business model rests on two concepts.

  1. Bet an appropriate fraction of the bankroll for a given amount of edge.
  2. Diversification

It’s just like the casino business. The house doesn’t care what happens on any individual bet as long as the bet is a small fraction of its bankroll.

Competition Drives Efficiency

Competitive equilibrium will mean that the casinos who can bid the highest for the “customer” is the house that can:

a) source the most uncorrelated offsets to the wager


b) has the biggest bankroll

In the trading business, condition A is satisfied by the market makers with the best data/analytics and “see the most flow”. A firm entrenched in both equity markets and futures markets with licenses from both the SEC and CFTC is going to be more efficient at laying off the risks it acquires from serving tourists regardless of the venue they choose to play in.

A and B will create a virtuous loop. The best players will build larger bankrolls which allow them to outbid competitors further which earns them first look at the flow which improves their models and so forth.

Note the role of bankroll and diversification in the following examples:


Banks are able to trade options outside the bid/ask when they do bi-lateral deals with energy companies. The resources they pour into doing custom deals and loans earns them the extra spread. They create a high touch VIP area with fatter margins. They do this by being horizontally integrated across credit and derivatives markets 1


Bookies are able to take the other side of Mayweather’s sports bets because they have offsetting flow (phrased differently: they can make 100% negative correlated bets). They can take their vig between many offsetting bets providing an ample cushion to justify sweating the residual position they cannot expect to hedge…the actual outcome of the game.

Life Insurance

By pooling risk, insurance companies can underwrite policies at an affordable premium that still leave room for an actuarial profit. If you, as an individual, wanted to write an insurance policy for your neighbor you would not be able to offer a price that was simultaneously affordable to your neighbor and compensated you enough to tolerate the risk of their premature death. And even if you had enough money to insure a hundred people, you’d need the infrastructure to source them from multiple geographies so as to minimize the correlation between the deaths in the event of a natural disaster, terrorist attack, localized pandemic, or asteroid.

Stock Investing

You are faced with 2 stocks with the following attributes.

The portfolio math to construct the chart is described in my earlier post.

Interesting things to note:

  • Stock B is more volatile and a much worse risk/reward as proxied by its Sharpe ratio.
  • At positive correlations, the optimal weighting is to load up on Stock A. Not surprising. In fact, the more of A you have, the better the portfolio Sharpe ratio is.
  • But when correlations flip negative, optimal weights are now recommending significant weightings of Stock B.
  • As I tinkered with combinations of assets I found that assets with low or even negative Sharpe ratios improve a portfolio if they are both negatively correlated and highly volatile.

The insight for me is that negative correlations make assets outstanding diversifiers even if they have negative expected returns. And if the asset has a negative correlation, high volatility can even be attractive.

This is one more reason to suspect that volatile assets can be justifiably overpriced and not a source of excess return premium. In fact, they are valuable despite their unattractive stand-alone attributes.


In an efficient market, prices setters:

  • Are maximally-funded or have relatively low costs of capital
  • Have broadest perspective/market access

The emergent properties of markets will lead to idiosyncratic risks being held by the player most optimized to hold it. If the risk is borne by the most efficient holder, it is by definition priced so that there is no portfolio to which the risk is more valuable. What remains are systematic risks that no entity has discovered a hedge for. Those are the premiums you are allowed to pick up.

When there is no diversification left to hide behind, the systematic risk can only be compensated by a pure risk premium. At the end of the day, there may be no hedge for getting 2 to 1 on a coin flip. The long-run is going to have to do.

Further reading:

Quant and author Aaron Brown explains on Quora (Link)

My brief post on market efficiency: Dinosaur Markets (Link)