In a recent article for the Financial Times, Gillian Tett observed that discussions about finance tend often to rely upon turns of phrase taken from nuclear physics. From “toxic assets” and “meltdown”, to the “containment” of the “fall-out” from a bank run or a sovereign debt default, the language of finance mirrors that of hard science.
A perfect illustration of Tett’s point is Robert Harris’s recent thriller, The Fear Index. Known for historical thrillers such as Fatherland (a book based on the premise that the Nazis won the Second World War), Harris’s new book is closer to science fiction. The main character is Alex Hoffmann, a Princeton-trained scientist working at the CERN research centre just outside Geneva. Interested in developed automated processes run entirely by machines that include a capacity for learning and adaptation on the part of the computers themselves, Hoffmann was sacked from the CERN after his research ran out of control. Approached by an English banker looking to break into the world of hedge funds, Hoffmann ends up running an incredibly successful company, Hoffmann Investment Technologies. The key to the success of this hedge fund is its faith in its own algorithms: the fund’s office is a far cry from the noisy bustle of a trading floor. It is made up of quantitative experts who oversee – but do not intervene in – the trading automatically generated by Hoffmann’s own algorithms. The algorithms themselves are based on the simple idea that one of the human emotions that most dominates financial markets is fear. And that with the steady digitisation of all aspects of our existence, fear can – along with most other emotions – be calculated and measured. Bringing all the existing data together, Hoffmann’s hedgefund makes money by exploiting the role of fear in financial transactions.
As an introduction into the heady world of finance, Harris’s book is worth a read. He explains well the way hedge funds are inherently risk averse: they aim to maximise returns at the same time as minimizing risks. Rather than just betting on one outcome (e.g. that a particular stock loses its value) a hedge fund will also insure itself against the opposite, namely a rise in the value of that stock. It will thus hedge its bet, hoping that it can make a small gain but making sure that if it loses it will only make a small loss. Large sums are in play but at any one time there are no large, one-way bets. Harris is also clever to pick fear as the human emotion tracked by the Hoffmann hedge fund. The assumption is that financial markets are driven not by rational calculations but by fear. Sprinkled throughout the book are scientific commentaries on the particular physical manifestations of fear. As Harris writes in his book, this is behavioural finance but of a special kind.
Less convincing is the book’s sci-fi plot. The book is ultimately a reflection on the relationship between man and machine, between human beings and technology. Whilst there are some pretty bewildering sides to contemporary finance, its technological development is nevertheless contained by a prevailing set of social relationships. Instead of exploring the social conditions that gave rise to hedge funds, Harris invests the computers themselves with agency and imagines a world where algorithms – initially written by human beings – develop a life of their own. This leaves the book with a chilling open-ended conclusion: would not a hedge fund based on exploiting fear in the market have an interest in stoking that fear? Or indeed of generating some kind of market collapse? In the end, Harris’s book leaves us with same feeling about finance as a strange off-shoot of nuclear physics that Gillian Tett commented on. This works well for thriller writing but is less convincing as an explanation of where hedge funds come from and why they have become such powerful symbols of contemporary finance.