Risk-control models based on mild randomness can generate the wild randomness they deny

Evidence

It is conceivable that models of the stochastic dynamics of asset price movements may have a general counterperformative aspect if large amounts of practical action (especially in the form of risk-control measures) are based on them. In most of its forms, portfolio insurance depended on continuity in price movements; to the extent that it played a role in the 1987 crash, it generated a discontinuity. While the role of value-at-risk models in the 1998 crisis described in chapter 8 is also unclear, it is possible that sudden, widespread efforts to liquidate similar trading positions in the face of rising value-at-risk estimates contributed to price movements well beyond those envisaged in the models on the basis of which the estimates had been calculated. — Donald MacKenzie, An Engine, Not a Camera, 1168

Categorization

• XREF: Directly extends the performativity/counterperformativity framework from earlier chapters of this same book, and connects to Taleb’s black-swan critique of reliance on normal distributions in finance. — connects to: Assuming wild randomness is intended to reduce the likelihood of its disasters — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 939; Deliberately assuming wild randomness can paradoxically keep markets mild — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1169; Rare events resist prediction because their causes interact uniquely (+2 more)
• SEED: An article angle: ‘the models that are supposed to prevent crises are structurally the same models that manufacture them’ — risk management as a contributor to systemic fragility.
• QUESTION: The 1998 value-at-risk causal link is flagged as unclear here; worth chasing how VaR-based liquidation actually operated in LTCM’s collapse.

Broader Connections

• Rare events resist prediction because their causes interact uniquely #corroborates (0.85)
• Deliberately assuming wild randomness can paradoxically keep markets mild #qualifies (0.82) — Donald MacKenzie, An Engine, Not a Camera, 1169