The "Paradox of Prudence" - It is real and needs your attention

Our thinking about systematic risk has to be in two dimensions: one, the time-series impact, and two, the cross-sectional impact. These financial insights are coming from Markus Brunnermeier in his piece "Paradox of Prudence". The time series component focuses with the build-up of risks, and the cross-sectional component focuses with the transfer of risks. This leads to two paradoxes. 

• The "volatility paradox": low volatility today leads to more risk-taking and higher leverage, which will lead to more volatility tomorrow. Low volatility encourages more risk-taking, making the economy more sensitive to shocks. The seeds of tomorrow's risk are found in today's low volatility. 
• The "Paradox of Prudence": each firm tries to reduce risk exposure and be micro-prudent, but this leads to greater systemic risk and is macro-imprudent. While some behavior can be market-risk tampering, risk management can also be risk-amplifying for the economy as a whole. Attempting to control your risk will spill over to other firms. 

We usually focus on the time series, but the actual risk lies in the networks between firms and in firms' behavior in response to a specific risk shock. A shock to any firm will propagate through the economy through firm linkages. 

The potential advantage of global macro and managed futures comes from their ability to capitalize on cross-asset-class risk spillover. An equity shock may spill over to bonds, which can impact currencies. The global macro manager can trade these differences.