Episode 73
Quantifying Uncertainty: A History of Financial Theory and its Implications | Daniel Peris
Episode 73
Daniel Peris
Quantifying Uncertainty: A History of Financial Theory and its Implications | Daniel Peris
summary
In this week’s episode of Hidden Forces, Demetri Kofinas speaks with Daniel Peris, a Senior Portfolio Manager at Federated Investors in Pittsburgh where he oversees the firm’s dividend-focused products. He is the author of three books on investing, most recently: “Getting Back to Business: Why Modern Portfolio Theory Fails Investors, and How You Can Bring Common Sense to Your Portfolio.” Before transitioning into asset management, Peris was a historian focused on modern Russian history. He is the author of a book and several articles on the Soviet Union in the 1920s and 1930s.
Today’s conversation is about the evolution of financial theory, beginning with the rough and tumble world of 19th-century finance with its stock syndicates, market corners, and curb exchanges. Where big personalities like Daniel Drew, James Fisk, and Jay Gould conspired and fought to take from Joe Public, and from each other, the riches afforded to them by laissez-faire capitalism and the industrial revolution.
The discussion is broken into two parts. The first deals with the world as it was before 1929 with its unregulated, unstructured, and highly inefficient markets. The second part explores the world after the Great Crash, where a confluence of forces – economic, demographic, institutional, and intellectual – supported the procurement and distribution of a new set of financial theories that promised to explain away uncertainty and guide the allocation of risk in the pursuit of profits.
As inheritors of this new world, we cannot help but function under the fallacies of its paradigms. One of these fallacies is the notion that economies are independent phenomena that operate, by and large, according to a certain set of physical laws. Most people will acknowledge that our economic and financial models are imperfect, but most people also think of them as being somewhat analogous to models developed in the natural sciences. Because of this false comparison to physics (equilibrium) and nature (normal distributions), people often remain unaware of the centrality of politics in theories of the economy. Economies are not independent phenomena that answer only to the laws of nature. They are political and social phenomena that exist within a political system. Theories of the economy that do not take into account the system within which they operate are flawed…in some cases, significantly so.
Austrian theories of money and credit, for example, are better at describing how the banking system operates in a laissez-faire society, whereas Modern Monetary Theory is better at describing how it works in our current, fiat-based system of unrestrained credit growth. What often happens is that devotees of these different schools are actually advocating for a specific set of policies, under the pretense that their views are scientific and that their policies derive logically from some objective view of how an ideal economy operates, when in fact, they are based on political values and societal ideals. The MMT school is full of progressive social-democrats who want governments to play a larger role in the economy, whereas the Austrian school is full of conservative libertarians who want less government. This sorting along political lines is not a coincidence. Investment theories operate rather differently than theories about the economy, in that there is no argument in the investment world about what matters most. It’s profits.
In light of this fact, the discrepancies between various investment theories require alternative explanations that do not rely on political ideology or moral sentiment. It would seem sufficient to declare that the widespread adoption of theories like Modern Portfolio Theory (MPT), the Efficient Market Hypothesis (EMH), Capital Asset Pricing Model (CAPM), etc., was enabled by the growth of a large middle class with excess income available for investment that had not directly experienced the boom and bust of the Roaring 20’s and accelerated by the Employee Retirement Income Security Act (ERISA) of 1974. Entrepreneurially minded financial industry professionals saw an opportunity, but this opportunity required a more streamlined approach to investing and one that would put themselves, and their clients, at ease.
The need to bring order to the chaotic world of prices has encouraged the adoptions of systematic investment strategies that claimed the ability to quantify risk. When it comes to investing other people’s money, having a more coherent, easy-to-understand theory that provides the illusion of control is a very valuable tool. From an evolutionary point of view, it is no wonder how theories purporting to quantify risk and target reward proliferated so quickly. It was in everyone’s interest that they do so.
How these theories came together to form the dominant, ideological template of risk-adjusted-return measured against exposure to the broader market is the essence of today’s episode. Its significance can be found in the implications associated with equating diversification with correlation: trading idiosyncratic risk for systemic risk and what happens when everyone is doing it.
Producer & Host: Demetri Kofinas
Editor & Engineer: Stylianos Nicolaou
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bio
Daniel Peris, Ph.D., CFA, is Senior Vice President and Senior Portfolio Manager at Federated Investors, Inc., in Pittsburgh. Before transitioning into asset management, Peris was a historian focused on modern Russian history. He is the author of two prior books on investing, The Strategic Dividend Investor, and The Dividend Imperative, as well as a study of early Soviet history.
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Duo Reges: constructio interrete. Nescio quo modo praetervolavit oratio. Virtutibus igitur rectissime mihi videris et ad consuetudinem nostrae orationis vitia posuisse contraria. Ergo infelix una molestia, fellx rursus, cum is ipse anulus in praecordiis piscis inventus est? Sed ille, ut dixi, vitiose. Eadem nunc mea adversum te oratio est. Non enim quaero quid verum, sed quid cuique dicendum sit.
Est, ut dicis, inquam. Multa sunt dicta ab antiquis de contemnendis ac despiciendis rebus humanis; Haec para/doca illi, nos admirabilia dicamus. Verum hoc idem saepe faciamus.
Expressa vero in iis aetatibus, quae iam confirmatae sunt. Si stante, hoc natura videlicet vult, salvam esse se, quod concedimus; Non enim quaero quid verum, sed quid cuique dicendum sit. Hoc loco discipulos quaerere videtur, ut, qui asoti esse velint, philosophi ante fiant.
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Eam stabilem appellas. Num igitur utiliorem tibi hunc Triarium putas esse posse, quam si tua sint Puteolis granaria? Duo Reges: constructio interrete. Ea, quae dialectici nunc tradunt et docent, nonne ab illis instituta sunt aut inventa sunt? Itaque nostrum est-quod nostrum dico, artis est-ad ea principia, quae accepimus. Aufert enim sensus actionemque tollit omnem.
Te enim iudicem aequum puto, modo quae dicat ille bene noris. Compensabatur, inquit, cum summis doloribus laetitia. Ego quoque, inquit, didicerim libentius si quid attuleris, quam te reprehenderim. Nam si propter voluptatem, quae est ista laus, quae possit e macello peti? Ut placet, inquit, etsi enim illud erat aptius, aequum cuique concedere. Restincta enim sitis stabilitatem voluptatis habet, inquit, illa autem voluptas ipsius restinctionis in motu est. Negat esse eam, inquit, propter se expetendam. Sed ad haec, nisi molestum est, habeo quae velim.
Hunc vos beatum; Egone non intellego, quid sit don Graece, Latine voluptas? Nec vero pietas adversus deos nec quanta iis gratia debeatur sine explicatione naturae intellegi potest. Non igitur bene. Itaque contra est, ac dicitis; Isto modo, ne si avia quidem eius nata non esset. Et quidem iure fortasse, sed tamen non gravissimum est testimonium multitudinis. Huic ego, si negaret quicquam interesse ad beate vivendum quali uteretur victu, concederem, laudarem etiam;
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Hanc quoque iucunditatem, si vis, transfer in animum; Cum ageremus, inquit, vitae beatum et eundem supremum diem, scribebamus haec. Quantam rem agas, ut Circeis qui habitet totum hunc mundum suum municipium esse existimet? Quid, si non sensus modo ei sit datus, verum etiam animus hominis? Stulti autem malorum memoria torquentur, sapientes bona praeterita grata recordatione renovata delectant. Summum ením bonum exposuit vacuitatem doloris;
Deque his rebus satis multa in nostris de re publica libris sunt dicta a Laelio. Est autem etiam actio quaedam corporis, quae motus et status naturae congruentis tenet; Quare hoc videndum est, possitne nobis hoc ratio philosophorum dare. Quae cum dixisset paulumque institisset, Quid est? Iam doloris medicamenta illa Epicurea tamquam de narthecio proment: Si gravis, brevis; Quod autem in homine praestantissimum atque optimum est, id deseruit.
Non semper, inquam; Duo Reges: constructio interrete. Rapior illuc, revocat autem Antiochus, nec est praeterea, quem audiamus. Dolor ergo, id est summum malum, metuetur semper, etiamsi non aderit; Sed eum qui audiebant, quoad poterant, defendebant sententiam suam. Quis est, qui non oderit libidinosam, protervam adolescentiam?
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Lorem ipsum dolor sit amet, consectetur adipiscing elit. Et quidem iure fortasse, sed tamen non gravissimum est testimonium multitudinis. A quibus propter discendi cupiditatem videmus ultimas terras esse peragratas. Igitur neque stultorum quisquam beatus neque sapientium non beatus. Nonne igitur tibi videntur, inquit, mala?
Utinam quidem dicerent alium alio beatiorem! Iam ruinas videres. Non quaeritur autem quid naturae tuae consentaneum sit, sed quid disciplinae. Quid, si etiam iucunda memoria est praeteritorum malorum? Ait enim se, si uratur, Quam hoc suave! dicturum. Illa argumenta propria videamus, cur omnia sint paria peccata. Quid est, quod ab ea absolvi et perfici debeat? Cur tantas regiones barbarorum pedibus obiit, tot maria transmisit? Videamus animi partes, quarum est conspectus illustrior;
Duo Reges: constructio interrete. Videamus animi partes, quarum est conspectus illustrior; Ex ea difficultate illae fallaciloquae, ut ait Accius, malitiae natae sunt. Sint ista Graecorum; Quasi ego id curem, quid ille aiat aut neget. Cur deinde Metrodori liberos commendas?
Te ipsum, dignissimum maioribus tuis, voluptasne induxit, ut adolescentulus eriperes P. Cur ipse Pythagoras et Aegyptum lustravit et Persarum magos adiit? Sed potestne rerum maior esse dissensio? Quid in isto egregio tuo officio et tanta fide-sic enim existimo-ad corpus refers?
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Lorem ipsum dolor sit amet, consectetur adipiscing elit. Sic consequentibus vestris sublatis prima tolluntur. Sed ille, ut dixi, vitiose. Duo Reges: constructio interrete. Quid dubitas igitur mutare principia naturae? Illa enim, quae prosunt aut quae nocent, aut bona sunt aut mala, quae sint paria necesse est. Sed ne, dum huic obsequor, vobis molestus sim. Magni enim aestimabat pecuniam non modo non contra leges, sed etiam legibus partam. Expressa vero in iis aetatibus, quae iam confirmatae sunt. Qui autem esse poteris, nisi te amor ipse ceperit? Quod non faceret, si in voluptate summum bonum poneret.
Quod non faceret, si in voluptate summum bonum poneret. Itaque a sapientia praecipitur se ipsam, si usus sit, sapiens ut relinquat.
At ego quem huic anteponam non audeo dicere; Quae cum praeponunt, ut sit aliqua rerum selectio, naturam videntur sequi; Bonum liberi: misera orbitas. Ergo illi intellegunt quid Epicurus dicat, ego non intellego? Sint modo partes vitae beatae. Quid enim me prohiberet Epicureum esse, si probarem, quae ille diceret?
Non igitur potestis voluptate omnia dirigentes aut tueri aut retinere virtutem. Satisne ergo pudori consulat, si quis sine teste libidini pareat? Quod, inquit, quamquam voluptatibus quibusdam est saepe iucundius, tamen expetitur propter voluptatem. Quasi vero, inquit, perpetua oratio rhetorum solum, non etiam philosophorum sit. Ex quo, id quod omnes expetunt, beate vivendi ratio inveniri et comparari potest. Transfer idem ad modestiam vel temperantiam, quae est moderatio cupiditatum rationi oboediens. Fortasse id optimum, sed ubi illud: Plus semper voluptatis? Sin kakan malitiam dixisses, ad aliud nos unum certum vitium consuetudo Latina traduceret. Quid turpius quam sapientis vitam ex insipientium sermone pendere? Haec quo modo conveniant, non sane intellego. Unum nescio, quo modo possit, si luxuriosus sit, finitas cupiditates habere. Si enim ita est, vide ne facinus facias, cum mori suadeas.
