Solving for $ by Floyd Norris
The New York Times Book Review, January 6, 2013
This article is a critical review of James Owen Weatherall’s
book The
Physics of Wall Street: A Brief History of Predicting the Unpredictable.
“Ever since the financial crisis, James Owen Weatherall
writes in his new book, “The Physics of Wall Street,” “words like ‘quant,’
‘derivative’ and ‘model’ have taken on some nasty connotations.” He is out to
change that.
What finance and economics need, he says, is more physics,
not less. So what if the quantitative models that underlay such products as
mortgage-backed securities blew up, nearly bringing down the world financial
system in the process? Models always have assumptions; it is up to the users to
pay attention to whether those assumptions hold.”
He describes that the first part of the book on the history
of the use of quantitative modeling in economics is well written.
“But Weatherall has a grander aim. “The Physics of Wall
Street” “is a book about the future of finance,” he writes in his introduction.
“It’s about why we should look to new ideas from physics and related fields to
solve the ongoing economic problems faced by countries around the world. It’s a
story that should change how we think about economic policy forever.”
This is a lofty goal, made all the more ambitious by the
blunders of physicists on Wall Street in recent decades, blunders he describes
well but with an extremely generous view. Sure, he concedes, the crisis “was
partly a failure of mathematical modeling,” but he declares that the real
problem “was a failure of some very sophisticated financial institutions to
think like physicists.””
Norris writes, “He has little use for Nassim Taleb, whose
best-selling book “The Black Swan” argues that the models used by traders
disastrously underestimated the possibility of very negative outcomes — the
black swans. To say that a model failed, Weatherall contends, is not to say
that no models can work. “We use mathematical models cut from the same cloth to
build bridges and to design airplane engines, to plan the electric grid and to
launch spacecraft,” he writes. If you don’t trust them, why are you driving
over the George Washington Bridge? “After all, at any moment an unprecedented
earthquake could occur.””
This thought by Weatherall demonstrates his lack of
knowledge of complexity science. His examples are certainly complicated but are
far from being a complex system like a market or an economic system.
Norris ends his short article with, “The world’s economic
problems are far too complex to be reduced to a matter of physics and mathematics.
Reading this book brought to mind the adage that if all you have is a hammer,
every problem looks like a nail.”
It is amazing to me how most economists consistently refuse
to think that economic systems are complex systems in a state of criticality,
and hence not subject to cause and effect rules we normally live by.