Go long shadow convexity

Artemis Capital published an absolutely brilliant piece on volatility this fall (it's worth reading through in its entirety). Of particular interest to me was their interpretation of convexity*. You would expect a hedge fund to write about financial matters, but they went one step further and made a connection with real life. FT Alphaville picked it up and ran with it. Here they are:

There are two types of institutions in this world: institutions that are short convexity and institutions which are massively short convexity. In the real world, people go short convexity when they ignore all the bad behaviours known to shorten life duration on an incremental basis. They go massively short convexity when they purposefully put themselves in harm’s way, like being tight rope walkers or stuntmen.

But, says Cole, they can also go long convexity if — by way of a daily cost to themselves vis-a-vis everyone else — they indulge in good behaviours which are known to extend life. Think of that like the opportunity cost of not going out on a Saturday night when all your mates are down the pub. Or in corporate terms, knowingly choosing to do the morally or environmentally sound thing at a cost to yourself for the sake of the long-term positive return.

There is, however, another form of convexity in the system. It’s what Cole calls shadow convexity. From the report:

In life shadow convexity exists when fragility or robustness is incentivized to such a degree that it becomes unknowingly institutionalized within a system of interactions. For example, when someone abuses drugs he or she is making an individual short convexity choice. Over time that individual may be ostracized by friends who do not wish to associate with that behaviour and is drawn into a network of other abusers amplifying the original risk. Likewise shadow positive convexity can be a driving force for good. Many people seek out networks that share and reinforce positive values. When an organization achieves a positive culture this can exponentially magnify the results of a pre-existing positive process.

It's all common sense, of course, but how often do we think about these matters in this way? Not often enough, I think. I've been avoiding negative people that bring me down and tell me things aren't possible for a number of years now. That's a principle that Nassim Taleb calls removal of the negative (I think he introduced that thought in his latest book, Antifragile). The basic premise here is to strip out all the negative so you live longer and have a better quality of life, so that the positive things in your life have a greater impact and don't get cancelled out by the negative. However, I find it's time to have another look at my personal habits and figure out what kind of a person I want to be and which of these habits are holding me back. The weekend is the best time to do that. For those of you that like new year's pledges, this is the best time of year to get a head start.

*From Wikipedia: In mathematical finance, convexity refers to non-linearities in a financial model. In other words, if the price of an underlying variable changes, the price of an output does not change linearly, but depends on the second derivative (or, loosely speaking, higher-order terms) of the modeling function. Geometrically, the model is no longer flat but curved, and the degree of curvature is called the convexity.
So basically when we're talking about convexity in general we are referring to small changes in lifestyle and consumption habits that have a large, non-linear effect on our lives down the line.