From time to time, I grab a book from a few years ago and browse through it. This time ‘The New Paradigm for Financial Markets’ of George Soros (2008) was the lucky one. Although the Alchemy of Finance is the standard book here, this little book also contains some nice wordings.

As a side note: AQR recently published a paper Alternative thinking: Superstar investors. They basically explore the exposures/sensitivities of a set of return patterns generated by super star investors such as Buffett, Gross and Lynch. The returns of the Quantum fund confirm Soros way of seeing the world:

“Soros is known for developing a theory of boom/bust cycles and reflexivity, based on negative and positive feedback between prices and fundamentals (emphasizing the role of self-reinforcing positive feedback).”

“Not surprisingly, trend/momentum factors go a long way in explaining the average returns over the period.”

From the first chapter of the book already, I just wanted to highlight the following parts.

[…] our understanding of the world in which we live is inherently imperfect because we are part of the world we seek to understand […]

[…] People with imperfect understanding interact with reality in two ways. On the one hand they seek to understand the world in which they live. I call this the cognitive function. On the other hand, people seek to make an impact on the world and change their situation to their advantage. I used to call this the participating function, but for some purposes I now consider it more appropriate to call it the manipulative function. […]

[…] the idea that financial markets are self-correcting and tend towards equilibrium remains the prevailing paradigm on which the various synthetic instruments and valuation models which have come to play such a dominant role in financial markets are based. I contend that the prevailing paradigm is false and urgently needs to be replaced.  […]

[…] Reflexivity can be interpreted as a circularity, or two-way feedback loop, between the participants’ views and the actual state of affairs. People base their decisions not on the actual state of affairs. People base their decisions not on the actual situation that confronts them but on their perception or interpretation of that situation. Their decisions make an impact on the situation (the manipulative function), and changes in the situation liable to change their perceptions (their cognitive function). The two functions operate concurrently, not sequentially. […]