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Reflexive Modeling and Systemic Risk

This study explores how dissonance and disagreement among traders can lead to the discovery of new resources of value, and examines the reflexive use of models and devices in trading rooms to mitigate the fallibility of models. The study highlights the performative nature of financial models and the importance of reflexivity in arbitrage trading.

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Reflexive Modeling and Systemic Risk

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  1. Devices for Dissonance: Reflexive Modeling and Systemic Risk Daniel Beunza & David Stark

  2. Dissonance Dissonance fosters discoveryby prompting reflexivity.

  3. Dissonance Dissonance fosters discoveryby prompting reflexivity. Disagreement about what is valuablemakes it possible to discover new resourcesof value.

  4. How do traders deal with the fallibility of their models?

  5. In the literature, disasters are traced to the behavior of traders, depicted as 1) reckless

  6. In the literature, disasters are traced to the behavior of traders, depicted as • reckless • and as • 2) overly cautious (“herding”)

  7. Processes that provoke doubt can lead to overconfidence

  8. Reflexivity about Models

  9. This is a pipe organ in largest hall of Moscow House of Music. Posted by Irina at 20:55 Labels: instuments, theatre

  10. [a declarative speech act] This is a pipe organ in largest hall of Moscow House of Music. Posted by Irina at 20:55 Labels: instuments, theatre

  11. “I apologize.”

  12. “I apologize.”[a performative speech act]

  13. Performativity in economic sociology: Financial models are not representations. They are interventions that format, shape, perform markets. Their use brings new economic objects (markets) into being. Models are market making.

  14. “This is the way that people get from point A to point B.”

  15. A model is performative when its use increases its predictive capabilities.

  16. This is a pipe organ.

  17. A financial model is not a representation;

  18. A financial model is not a representation; it is an intervention.

  19. The arbitrage traders we studied do the same.

  20. The trading room is populated with devices for doubt.Traders do not simply use models and devices that perform the market. They also create and use devices for reflexivity. This reflexivity is not exterior to (or above) the structures of socially distributed calculation but is an integral part of it.

  21. Arbitrage is a (reflexively) skilled performance. And this reflexivity is not of the individualbut is social and material.

  22. Epistemic challenges of using models in arbitrage

  23. Methodological constraint: a single morning at a single desk in an abritrage trading room.

  24. Calculation in merger arbitrage involves • the dissonance between two sets of probability estimates: • probability estimates derived at the desk using proprietary models, databases, and instrumentation. • 2) “implied probablity” – the aggregate probability estimates of the trader’s rivals

  25. a given trading desk makes probability estimates based on models, proprietary databases, and instrumentation

  26. V= (1-)PNS +PS

  27. The trader’s models and instrumentation are powerful scopes for viewing the markets.

  28. But scopes that reveal can also conceal. If you take your model for granted, you can lose your shirt.

  29. To avoid cognitive lock-in, the traders turn to socio-technical networks outside the trading room.

  30. relation between the trader and his rivals

  31. The spread plot in merger arbitrage

  32. The spread plot is a representation of an economic object that does not have a price and is otherwise not observable, co-produced by the positioning of actors who use it to confront their interpretations and re-evaluate their positions.

  33. $ Acquirer Target time Decoding the spread plot “Backing out” implied probability

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