Warning: Physics Envy May be Hazardous to Your Wealth!
73 Pages Posted: 5 Mar 2010 Last revised: 15 Mar 2010
There are 2 versions of this paper
Warning: Physics Envy May be Hazardous to Your Wealth!
Warning: Physics Envy May Be Hazardous to Your Wealth!
Date Written: 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.
Keywords: Quantitative Finance, Efficient Markets, Financial Crisis, History of Economic Thought
JEL Classification: G01, G12, B16, C00
Suggested Citation: Suggested Citation
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