How many of us waited in long food lines at the supermarket in early March as the world came to grips with the coronavirus pandemic’s global spread? Why were you waiting in those food lines? You want food, other people want food. There very likely is enough food for everyone, but do people trust that others will behave rationally and show restraint to buy only what they need, or are they fearful that others may look to hoard as much as possible? What are the parallels to financial panics like the one we have been experiencing?
Mike Nigro, Two Sigma’s Head of Client Solutions Research (the group that is also responsible for the research and methodologies applied in Venn), and David Cohen, Two Sigma’s Global Head of Investor Relations, recently published “Unwinds, Diversification, and Constraints: The Mechanics of Financial Panics.”
In summary, the authors unpack the mechanics of financial panics. They outline two concepts that contribute to panics: constraints and diversification. Constraints are limitations or restrictions that may get in the way of otherwise optimal choices. Examples of constraints include leverage and liquidity. Diversification means that problems in one area of the market can adversely affect other seemingly unrelated markets. When combined in a multi-player setting, both constraints and diversification can turn formerly unrelated markets into interconnected panic zones. It is important for both asset managers and asset owners to better understand these mechanics in order to build context for why performance can be outside typical expectations during panic episodes.
This article is not an endorsement by Two Sigma Investor Solutions, LP or any of its affiliates (collectively, “Two Sigma”) of the topics discussed. The views expressed above reflect those of the authors and are not necessarily the views of Two Sigma. This article (i) is only for informational and educational purposes, (ii) is not intended to provide, and should not be relied upon, for investment, accounting, legal or tax advice, and (iii) is not a recommendation as to any portfolio, allocation, strategy or investment. This article is not an offer to sell or the solicitation of an offer to buy any securities or other instruments. This article is current as of the date of issuance (or any earlier date as referenced herein) and is subject to change without notice. The analytics or other services available on Venn change frequently and the content of this article should be expected to become outdated and less accurate over time. Any statements regarding planned or future development efforts for our existing or new products or services are not intended to be a promise or guarantee of future availability of products, services, or features. Such statements merely reflect our current plans. They are not intended to indicate when or how particular features will be offered or at what price. These planned or future development efforts may change without notice. Two Sigma has no obligation to update the article nor does Two Sigma make any express or implied warranties or representations as to its completeness or accuracy. This material uses some trademarks owned by entities other than Two Sigma purely for identification and comment as fair nominative use. That use does not imply any association with or endorsement of the other company by Two Sigma, or vice versa. Click here for other important disclaimers and disclosures.