Abstract

http://ssrn.com/abstract=1563882
 
 

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Last comment: December 1, 2010

 


 



Warning: Physics Envy May be Hazardous to Your Wealth!


Andrew W. Lo


Massachusetts Institute of Technology (MIT) - Sloan School of Management; Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL); National Bureau of Economic Research (NBER)

Mark T. Mueller


Massachusetts Institute of Technology, Center for Theoretical Physics

March 12, 2010


Abstract:     
The quantitative aspirations of economists and financial analysts have for many years been based on the belief that it should be possible to build models of economic systems - and financial markets in particular - that are as predictive as those in physics. While this perspective has led to a number of important breakthroughs in economics, physics envy has also created a false sense of mathematical precision in some cases. We speculate on the origins of physics envy, and then describe an alternate perspective of economic behavior based on a new taxonomy of uncertainty. We illustrate the relevance of this taxonomy with two concrete examples: the classical harmonic oscillator with some new twists that make physics look more like economics, and a quantitative equity market-neutral strategy. We conclude by offering a new interpretation of tail events, proposing an uncertainty checklist with which our taxonomy can be implemented, and considering the role that quants played in the current financial crisis.

Number of Pages in PDF File: 73

Keywords: Quantitative Finance, Efficient Markets, Financial Crisis, History of Economic Thought

JEL Classification: G01, G12, B16, C00

working papers series


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Date posted: March 5, 2010 ; Last revised: March 15, 2010

Suggested Citation

Lo, Andrew W. and Mueller, Mark T., Warning: Physics Envy May be Hazardous to Your Wealth! (March 12, 2010). Available at SSRN: http://ssrn.com/abstract=1563882 or http://dx.doi.org/10.2139/ssrn.1563882

Contact Information

Andrew W. Lo (Contact Author)
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)
HOME PAGE: http://web.mit.edu/alo/www
Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)
Stata Center
Cambridge, MA 02142
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Mark T. Mueller
Massachusetts Institute of Technology, Center for Theoretical Physics ( email )
77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States
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