Fragility vs Anti-Fragility

Decay in life comes through stability.....
O Ashuji....

Nassim Nicholas Taleb does wonderful job of explaining concept of anti-fragility in the book Anti Fragile. His central thinking that randomness/volatility is anti-fragile and stability is fragile is far more applicable to current times.

We can simplify the relationships between fragility and anti-fragility as follows. When you are fragile, you depend on things following the exact planned course, with as little deviation as possible-for deviations are more harmful than helpful. This is why the fragile needs to be very predictive in its approach, and conversely, predictive systems cause fragility. When you want deviations, and you don't care about the possible dispersion of outcomes that the future can bring, since most will be helpful, you are antifrangile. (Anti-Fragile - Nassim Taleb)

The central illusion in life - that randomness is risky and is a bad thing

Volatility is Anti Fragile....

Artisans, say, taxi -drivers, carpenters, plumbers, tailors, and dentists, have some volatility in their income but they are robust to a minor professional Black Swan, one that would bring their income to a complete halt. Their risks are visible. Not so with employees, who have no visibility, but can be surprised to see their income going to zero after a phone call from the personnel department. Employees' risks are hidden.

Thanks to variability, these artisanal careers harbor a bit of anti-fragility: small variations make them adapt and change continuously by learning from the environment and being, sort of, continuously under pressure to be fit. (Anti-Fragile - Nassim Taleb)

In Market Context, Traders/Hedge Fund Managers are anti-fragile because inefficient and inept ones are forced to leave while survivors constantly adapt and learn. Unlike analyst from brokerage house or Economists who are most fragile because they fail to learn and have grand illusion that everything in life is and should be predictable. These brilliant scholars have great love for equilibrium and constantly strives to quantify human behavior into equations. Analysts can calculate fair price for everything using wonderful tools like average (and historical) P/Es, CashFlows...except they fail to arrive at fair price of their own existence in markets. These guys are fragile because they are try to get predictability into everything and when big moves happen in asset markets and they can always blame external factors. In one sense analysts/economists are robust (not anti-fragile) is despite being always wrong in their "forecasts" , they continue to survive and in some cases thrive.

Traders/Hedge Fund Managers would love volatility because Volatility has huge optional value. It's because of existence of such  participants (analysts/economists/policy makers, etc), vast asymmetries  arises in options markets. Volatility will be under-priced or over-priced because

1) Recent behavior of asset prices will be extrapolated by spinning new stories (new normal, great rotation out of bonds into equities, India growth story...blah blah)

2) Most forecasts/recommendations by so called analysts/economists are far different than actual behavior of asset prices historically or otherwise. For eg in case of currencies, many will have yearly forecast in range of 4-7% depending on currencies. In reality many months will have such wide swings in currencies. Option tend to under price such swings after long period of calmness. In case of equities these guys will do lot of hard work and analysis but most of them will have similar targets plus/minus 5%.

Creating Fragile Asset Markets by Instilling Predictability into Everything...

Why Central Bank actions around the world are sowing seeds of huge volatility...

Central Banks across the world rightly acted during financial crises of 2008 by injecting large doses of liquidity and taking various other measures. Since, then it was essential for these central banks to increase to their balance sheet size due to broad de-leveraging in other part of markets and falling of velocity of money. With reasonable success at their efforts in taming the crisis, central bankers are now trying to instill predictability into everything be it direction of interest rates, timing of direction, conditions necessary to undertake various decisions, etc. Most participants spend more time analyzing "what Ben Bernanke will do" than anything else. Instilling belief that central bankers are in control of everything is dangerous because it creates illusion of calmness among participants. Taking Variability/Volatility from economic variables or creating such illusion makes system highly vulnerable to sudden and very sharp swings. We have seen how asset market can swing even at hint of variability by these central bankers. Recent behavior of fixed income markets, precious metals, etc is just but sign of times to come.