Volatility and the Allegory of the Prisoner’s Dilemma

Chris Cole from Artemis Capital delivered a presentation with the title, Volatility and the Allegory of the Prisoner’s Dilemma.  In a nutshell the Prisoner’s Dilemma relates to game theory and explores why two rational individuals might not cooperate even if it appears that it is in their best interest to do so.

There were three points that Cole wanted to get across during his presentation –

  • Investors are trapped in a Prisoner’s Dilemma
  • Volatility is the only real asset class
  • Volatility is your only escape from the Prisoner’s Dilemma

He states that global central banks are in an arms race of devaluation which results in suboptimal outcomes for all parties and great systemic risk.   With respect to volatility as the only asset class, he states that the result of taking positions either has you short volatility or long volatility.  He noted that the diversification investors expect with stocks and bonds has not been as beneficial over a longer period of history.  The perception that bonds and stocks move in opposite directions is based on recent history (last 20 years).  He noted that the price of volatility seems to be impacted by four factors – emotional, monetary, macro, and regulatory.   He finished up his presentation by noting that we seem to be in an environment where the odds for a potential volatility event have been increasing and we are seeing a regime shift for volatility.