Wednesday, May 26, 2010

"WARNING: Physics Envy May Be Hazardous To Your Wealth!"

I had a similar, albeit intuitive rather than empirical, thought in the June '09 post "Climateer Investing on Carbon Trading and Traders":
...Just as an economist using the tools of science (mathematics) doesn't make economics a science, carbon traders using the tools of markets doesn't make carbon trading market based....
From the abstract at Physics arXive:
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...
HT: Improbable Research
See also:
After the Crash: How Software Models Doomed the Markets

Insurance: "CEO FORUM: Gen Re's Tad Montross on model dependency" (BRK.A)

"Airspace Closure Was Exacerbated by Too Much Modeling, Too Little Research"
and more generally:
The problem with models?:

"The map is not the territory"...

-Alfred Korzybski

Some of our prior posts on models:

The Financial Modelers' Manifesto

After the Crash: How Software Models Doomed the Markets

How Models Caused the Credit Crisis
Quants Lose that Old Black (Box) Magic
Finance: "Blame the models"
Climate Models Overheat Antarctica, New Study Finds
Climate modeling to require new breed of supercomputer
Computer Models: Climate scientists call for their own 'Manhattan Project'
Computer Models: " Misuse of Models" and "No model for policymaking"
Climate prediction: No model for success
Climate Models and Modeling
Based on Our Proprietary "What's on T.V." Timing Model...
How many Nobel Laureates Does it Take to Make Change...And: End of the Universe Puts
The New Math (Quant Funds)
Modeling*: The Map is Not the Territory
Inside Wall Street's Black Hole
Computer Models: Models’ Projections for Flu Miss Mark by Wide Margin
Obama: Swedish Model Would Be Impossible Here

The Swedish Model

As the [college] site that I lifted the picture from said:

(okay, sorry we know its tacky)

[hey, come on we're an all boy's team, what'd you expect!]