Ben Hunt is a writer.
More precisely, Ben Hunt is a thinker who writes. Extraordinarily well, as it happens.
There are thinkers who don’t write - Socrates springs to mind - but they tend to end up in lunatic asylums and writers who don’t think - most journalists for instance, but by and large the category of “writers” is an almost perfect subset of “thinkers”. I am not going to hazard a guess as to what proportion the category of “thinkers” represents in our species of which it is a wholly subordinate sub -category, but let us assume that there exists a substantial remainder who do neither. (And for “write” we can substitute “create” in any form, just in case the artists, sculptors et al start to get on my case.)
But Ben Hunt is a writer. And a damn good one, if I hadn’t already mentioned it. Ben and his parter Rusty Guinn, who is also a writer and a damned good one, publish their thinking on website called Epsilon Theory which Ben launched exactly ten years ago to the week with his first piece, pretentiously entitled “Manifesto”. The Manifesto sets out the particular aim of the enterprise that started as a website with one essay set up by an erstwhile game theory professor turned hedge fund manager turned ex-hedge fund manager into.. well, a writer, I guess. Here is the essence:
Our times require an investment and risk management perspective that is fluent in econometrics but is equally grounded in game theory, history, and behavioral analysis. Epsilon Theory is my attempt to lay the foundation for such a perspective.
The name comes from the fundamental regression equation of modern portfolio management: y = α + β+ ε where the return of a security (y) is equal to its idiosyncratic factors (alpha) plus its co-movement with relevant market indices (beta) plus everything else (epsilon).
further down the essay - sorry, Manifesto - or, in his current, more humble understated parlance, better befitting his Yoda-like status amongst the thinking elite, “note”, we find the expansion of “epsilon” thus
Instead, I think we should be looking outside the confines of factor-based investment analysis. We can’t squeeze much more juice out of the alpha fruit, and we know that beta gives no sustenance to the active investor. But what about epsilon? What about ε? We pejoratively call this an “error” term, and the goal in any applied econometric exercise is to make this term as small and inconsequential as possible. That makes perfect sense if we are trying to predict the future states of, say, decaying nuclear particles, where it seems unlikely that there is any agency or causal process outside of the particles themselves (i.e., outside the physical universe). But it makes no sense at all if we are investigating a social phenomenon such as a financial market, where strategic human behavior and decision making play a crucial role, but a role largely exogenous to the observed characteristics of the financial universe.
It’s the epsilon term that I want to explore, because it includes anything that cannot be expressed easily in econometric terms – things like strategic decision-making and shifting behavioral preferences. Modern portfolio theory ignores these dynamic behavioral characteristics by assumption, as the epsilon term is defined as residual and random information from the perspective of the static factors nt defined within the alpha and beta terms. Because decision-making and behavioral characteristics cannot easily be expressed in the language of factors and regression, they are essentially invisible to the econometric eye.
~ Ben Hunt “Manifesto” - Epsilon Theory June 2013 [emphasis, presumptuously, mine]
So Ben in 2013 is a writer still conditioned by his experience applying his prodigious thinking ability within the financial market frame of reference, looking to expand the greek letter at the tail end of the core formula for financial asset pricing - the irreducible truth around which everything else is built - in which, to use a term favoured by economists, especially those with a PhD “all the shit we can’t explain coz we don’t have a formula for it” is compacted.
Keep reading with a 7-day free trial
Subscribe to Pitchfork Papers to keep reading this post and get 7 days of free access to the full post archives.