The Merchant of Venice
by George Hatjoullis
The Merchant of Venice by William Shakespeare is a thoroughly modern play. It introduces one modern concept that I have never seen discussed in relation to the Bard’s work; the fat tail. If there are other prior references do let me know as I would like to follow them up.
The play begins with Antonio, the merchant of Venice, expressing a deep felt melancholy that he cannot explain. His friends suggest it is concern for his wealth which is fully committed to ships seeking goods to sell in Venice for a large profit or other long-term (implicitly illiquid) investments. No, says, Antonio I am well diversified;
My ventures are not in one bottom trusted
Nor to one place; nor is my whole estate
Upon the fortune of this present year. [ p. 427]
The strong suspicion is that Antonio is sad because he has an unrequited and unmentionable affection for his ” most noble kinsman” [ p.427], Bassanio, a feckless young man who has the hots for the heiress Portia. Bassanio is already heavily in debt to Antonio but that does not stop him trying to stiff Antonio for a few ducats more in order to pursue the fair, and wealthy, Portia. The smitten Antonio is a soft touch.
However, as we know, and is now confirmed, Antonio is fully invested:
Thou Know’st that all my fortunes are at sea,
Neither have I money nor commodity
To raise a present sum. [ p.428]
Antonio nevertheless commits to help. Bassanio approaches Shylock for 3000 ducats for 3 months secured by Antonio’s guarantee. However, Shylock is nobody’s fool. He reads the financial pages, and knows that Antonio is fully committed. We find out how committed:
an argosy bound to Tripolis, another to the Indies…
…he hath a third at Mexico, a fourth for England, and other ventures he
hath squandered abroad.” [ p.429].
Shylock then elaborates that these are all very risky ventures. However, he agrees to the loan. Antonio is habitually an equity man and avoids debt. He only considers borrowing because he has no liquidity and wishes to accommodate Bassanio. Shylock appears to dislike him for being an equity man. What follows is a very interesting dialogue. The upshot is that Shylock will lend 3000 ducats for 3 month at no interest but with the proviso that on default Antonio will yield to Shylock a pound of flesh from a part of his body of Shylock’s choosing. Even the feckless Bassanio baulks at this deal but Antonio, who frankly is full of it, ignores the fat tail:
Why, fear not, man; I will not forfeit it.
Within these two months-that’s a month before
This bond expires-I do expect return
Of thrice three times the value of the bond. [p.431]
I make that 27,000 ducats. Antonio has a well diversified portfolio of ships at sea and other ventures. He only needs one to come in and he has covered the debt. What are the odds they will all fail to deliver in the expected time? Higher than he thought! This is, in essence, the nature of fat tails. The concept refers to the probability of extreme events being higher than is assumed. For pure equity investors fat tails mean you may lose everything. However, for leveraged or geared investors, namely those with debt, you can lose more than everything. It can be catastrophic and take you out of the game (of life in Antonio’s case).
Now Antonio is bailed out because the contract is unenforceable. The clever Portia spots that Shylock is not entitled to any blood. Indeed if Shylock “…dost shed one drop of Christian blood” [p.446] his lands and goods are forfeit under the laws of Venice. Shylock tries to nullify the contract but having already shown he intended to seek the life of Antonio he falls foul of yet another law of Venice, and half his goods go to Antonio, the other half to the state and his life is in the Duke’s hand ( surely that should be Doge, William?).
The moral of my part of this story is do not ignore fat tails, especially if you are leveraged. This is one of the main weaknesses of modern economic and financial theory. It acknowledges the existence of fat tails and then proceeds to ignore them because the mathematics is not tractable. I think The Merchant of Venice should be required reading for all economics and finance students. It should be required reading for all contemplating investment. It certainly should go on the syllabus for personal finance courses. Perhaps what has transpired in the last 12 years might have been avoided if it had been read by finance nerds and not just literary anoraks.
References taken from:
The Oxford Shakespeare, The Complete works, ed. Stanley Wells and Gary Taylor, Clarendon Press, Oxford,1998.