Small Changes Creating Massive Ripple Aftershocks

http://www.lmcm.com/pdf/FatTailsandNonlinearity.pdf
Many of you probably have seen this but there was a couple of things that I thought were especially insightful.

Critical points help explain our perpetual surprise at fat-tail events: We don’t see them coming because the state change is much greater than the perturbation suggests. Water does not undergo a dramatic change as it drops from 35 to 33 degrees Fahrenheit, but two degrees of additional cooling changes its state from liquid to solid. Likewise, large changes can occur in markets without visible manifestation in asset price change, while small additional changes can flip the price switch.

After writing my annual letter I have received some feedback expressing surprise that I said I thought a depression was close to a 10% chance. Is that really so surprising? Think about it. If we have the same circumstances 100 times, ten of them will turn into a depression. How often are you going to get such rampart abuse of the foundation of the economic system? As I said in the letter I do not think a depression is coming but the 10% number may be to low. Maybe it is 20% or 30%. Thirty times out of 100, with this much abuse, you enter into a depression. Seems logical to me. How often do you get such abuse? Well looking at the 1900s you had, being really liberal, 1998 with LTCM (I woud argue this doesn't really qualify but I will throw it in), Late 1980s early 1990s and the S&L crises, 1920s, and 1907. You could also throw in the 1970s with an outcome opposite of depression, massive inflation. That is 4 maybe 5 major abuses. One of them turned into a depression. So 25%. Obviously that logic and reasoning is full of holes but just trying to make a point.

As this article points out, when water gets to 33 degrees one slight incremental change in temperature can drastically change the outcome of the state of water.