Reverse City
Didier Darcet
1 September 2019

Theory of Financial Fragility-Free Energy Arbitration

In our early letters on “Antifragility Revisited”, we demonstrated evidence of a linear relationship between many financial assets’ excess return and their variance at all probability levels. Such a relationship was conspicuously absent from the considerations of Modern Portfolio Theories. This required a transgression to Professor Taleb’s description of fragility and anti-fragility. But where does this relationship come from? This letter uses physics to explain the concepts of fragility and antifragility from a theoretical standpoint. Fragility and antifragility emerge as a natural consequence of market competition;  they provide a financial variable which discriminates winners and losers in various market regimes. A few simple equations can be used to highlight the theory, and demonstrate how one calculates the physical variables, such as fragility. Readers who are not familiar with mathematics need not worry. The equations are even simpler than the ones used in traditional portfolio theories − that is to say, very simple!