Epsilon Theory Manifesto | Epsilon Theory
return = alpha + beta + epsilon
"We can’t squeeze much more juice out of the alpha fruit, and we know that beta gives no sustenance to the active investor. But what about epsilon? What about ε? We pejoratively call this an “error” term, and the goal in any applied econometric exercise is to make this term as small and inconsequential as possible."
But the epsilon is the thing that's hard to express in "the language of factors and regression" "these dynamic behavioral characteristics." ← but we can express these ideas:
Telescopes (a tool) are pretty good at detecting photons, but not dark matter. 🌌 "But that does not mean that these strategic human behaviors are unpredictable or unknowable. It simply means that we need an entirely different tool kit, and that’s what game theory is."
Narrative and Common Knowledge (CK) are the core concepts of Epsilon Theory. Narrative is "has no inherent notion of truthfulness and is simply a public representation of a set of public statements made by influential people about the world."
TK check with Tim Wu - The Master Switch for more details on narrative as a "post-modern idea" that "lacks any inherent Truth with a capital T." -BH
Another factor is the Constant Hot Take 🔥 culture.
Propoganda = former CK.
& CK is second-order consensus. "What you’re trying to figure out is the degree to which everyone believes that everyone else is relying on the original survey as an accurate view of the world..."
Sheep Logic | Epsilon Theory
Ben Hunt, Flock vs Pack
"Once you start looking for the Jukebox Effect — the intentional effort to force you into other-regarding flock behavior — you see it everywhere."
Why Mass Shootings Keep Happening
Why debate gun control? "enormous political efficacy for both the Left and Right."
Dogs have shame (pack) sheep do not (flock).
The Classic Thought Experiment: Island of Blue and Green eyed people.
"The power source of the Common Knowledge Game is the crowd seeing the crowd, and the dynamic structure of the Common Knowledge Game is the dynamic structure of the flock."
"What matters is what everyone thinks that everyone thinks about the Fed. That’s how sheep logic, aka the Common Knowledge Game, works in markets."
🔥 And the Constant Hot Take is the chance to join in the CKG. The two most powerful emotions, jealousy and schadenfreude.
American Bandstand | Epsilon Theory
"Clark didn’t poll America to determine their taste in music. He told them their taste in music … not directly, but by creating common knowledge – ideas that a crowd believes that the crowd believes."
the crowd seeing the crowd, ""is the most potent force in the social world."
"All of your fundamental indicators that show (correctly) that Italy and Spain are ridiculously overvalued at current prices relative to, say, Germany don’t matter in the least. Or rather, they matter, but they evaporate like dew when the Draghi sun shines at a press conference. Note to Jeremy Grantham: it costs Draghi nothing to use “unexpectedly strong language” to keep this game going for a looonnng time."
→ psychology is the cheapest form of change.
A Game of Sentiment | Epsilon Theory
Stocks (CKG, "Sentiment") ≠ companies.
Keynes did not like this game, believing it took too much energy. What Keynes called NBC is "known to modern game theory as a variant of the Common Knowledge (CK) game."