Extreme Events Theory and Application

Extreme Events Theory and Application

DOI: 10.4018/978-1-5225-3259-0.ch004
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In standard statistical methodologies, the probability that the extreme event will occur is very small. But the expected losses in real world markets are higher and sometimes with catastrophic outcomes. Here it seems that the fact that we could lose a certain amount of money 95% or 99% of the time tells us absolutely nothing about what could happen the other 5 or even 1 percent of the time. For that reason, instead of estimating the certain loss, as the standard statistical methodologies account, we introduce a technique known as a “tail risk protecting strategy” or “the barbell investment strategy.” In this chapter, analyzing the copper market movements I understand that the market has been conditioned to believe that the copper demand will exceed its supply. Therefore, I suggest to protect against a growing price-inflation risk. The analyses are conducted using the statistical software STATA 11 and Excel Spreadsheets.
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Our thoughts, our behaviours, our decisions and our emotions are influenced by our physical sensations, by the things we touch, the texture of the things we touch, the temperature of the things we touch, the colours, the smells,’ she says. ‘All these, without our awareness, influence our behaviours and thoughts and emotions. (Thalma Lobel, Sensation: the New Science of Physical Intelligence, 2014u)


The Destruction: A Short Story Of The Human Nature

It is difficult to get a man to understand something, when his salary depends upon his not understanding it. (Upton Sinclair, 1994)

After decades of inquiry on the issue of pollution, hunting and environment loss, scientists asserted that human action is responsible for pushing life on our shared planet toward mass extinction, and categorize us as a most destructive specie living on the earth. Yes, it is us. Wilson (2002) calculated the Earth would lose half its higher life forms by 2100 if the current rate of human disruption continued. A similar conclusion is a given by a biologist Todd Palmer from the University of Florida. He wrote an e-mail to The Washington Post pointing that: “The smoking gun in these extinctions is very obvious, and it’s in our hands.”

Now let us go a bit further. Let’s talk about the artificial intelligence and its possibilities. Did you watch the movie “Transcendence”? If you have not, then I highly recommended you watch it. In this movie, Dr. Will Caster (Johnny Depp) is a scientist who researches the nature of death and sentience, including artificial intelligence. He and his team work to create a sentient computer; he predicts that such a computer will create a technological singularity, or in his words “Transcendence.” His thirst for knowledge evolves to an infinite quest for power, and his loved ones soon realize that it may be impossible to stop him.

While many moviegoers might embrace the power of artificial intelligence displayed in the movie as just science fiction, world famous physicist Stephen Hawking along with computer scientist Stuart Russell, physicists Max Tegmark and Frank Wilczek say it could be an indication of humanity's doom. He also wrote that “one can imagine such technology outsmarting financial markets, out-inventing human researchers, out-manipulating human leaders, and developing weapons we cannot even understand. Where the short-term impact of Artificial Intelligence (AI) depends on who controls it, while the long-term impact depends on whether it can be controlled at all”. Meaning this “biggest event in human history” could be humanity’s last unless “we learn how to avoid the risks.”

Now let us go back to economics. What we know about human behavior, when we talk about economics? Can we really learn how to avoid the risk? I personally don't think so.

For example, the Wall Street crash of 1929, “Black Thursday,” was an event that sent the US and indeed the global economy into a tailspin, contributing to the Great Depression of the 1930s. By the time the market had reached bottom at 1932, 90% had been wiped off the value of shares. It took 25 years before the Dow Jones industrial average recovered to its 1929 level.

Let us remember the most recent event, the “Black Friday” in 2008. The shock collapse of the Lehman Brothers Bank, which held assets worth $600 billion, became the symbolic start of the most dramatic financial crisis since the Great Depression. It has destroyed 40% of world wealth and the economies are still recovering.

So what went wrong here? Why did we not see it coming? Can we link this the crashes/destructions with the human nature?

It is interesting how some question turns out to be significant after we hit the bottom, and then when we find our self’s again in the boom we simple forget everything that we learned and the process of destruction start all over.

Hancock and Zahawi (2011), explicitly explain how the human behavior is important in the construction of the buble that most of us do not recognize how serious it can be. From their book, is chosen the following three instances that we deal with you.

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