Reviews for Fractals And Scaling In Finance

The average rating for Fractals And Scaling In Finance based on 2 reviews is 4 stars.

Review # 1 was written on 2010-08-17 00:00:00 Keryn Hamilton I first heard about the efficient market theory in Law School. I remember thinking at the time what obvious bullshit it was. But it was academia, and it was pretty harmless bullshit, so let the economists play whatever games they want. What difference did it make? The theory goes that the markets already consolidate all the information available to them, so that price already incorporates all the information available to the market. From there, we get the random walk theory -- that prices will move in a random fashion, so that each price move is basically the flip of a coin. And from these premises, we then get modern financial theory, including the idea that risk is the same as statistical variance, which leads to the Sharpe ratio for evaluating an assets value, and also leads to the Black Scholes method for pricing options, and to modern portfolio theory (by which a portfolio is designed around the appropriate level of risk for an individual investor). The math for doing this seems very sophisticated, and variations on these approaches have served as the backbone for the financial industry. But there's a slight problem. The basic assumptions underlying all this theory is wrong. Prices don't vary like the flips of a coin. They are much wilder that tossing a coin. According to conventional theory, Black Monday in 1987 should have occurred perhaps once in an eon. In 1997, there were three days in a short period of time that had moves which the theory would predict should occur only once every 10,000 years or so. And the same thing again for the recent financial collapse. Wall Street adopted these economic theories. They were relatively easy to use. They have an air of scientific knowledge to them. There are nobel prizes awarded to the developers of them. But, they don't fit the data at all. They grossly underestimate risk, largely because they insist that data should fit a bell curve, when it simply doesn't fit. And they then took risks, this time with their own money, based on these false economic engineering ideas. The result was the near collapse (and the jury may still be out on this) of the entire world financial system. Mandelbrot, the author of this book, is a mathematician. He invented the field of fractal geometry, and is probably most notable for the Mandelbrot set, which yields incredibly intricate and beautiful fractal designs. As far back as the early 1960s, Mandelbrot did extensive study on Cotton markets. For some reason, there is good data on daily cotton prices going back to the mid 1800s. As a result of his studies, Mandelbrot concluded that markets are more fractal than continuous, and that the assumptions that economists used were simply wrong. He started complaining about this 40 years ago, and as recent history shows, people still are not listening. He claims to have written this book to bring his case directly to the public. (The same process worked pretty well for him in popularizing the idea of fractals in the first place, and ultimately getting them accepted in academia, where math departments were skeptical of geometry with practical application.) The book is very well written, and easy to understand, especially since it deals with a field where people tend to be abstruse and to obfuscate whenever possible. (Have you ever read any statement by Alan Greenspan, for example?) The criticisms of standard financial theory seem perfectly sound. However, when it comes to giving practical advice, the book seems on much shakier grounds. He calls for more open minded study of markets, which would not be a bad thing, especially since we now know that the market making companies are all too big to fail. On the last page, he calls for a "coordinated search for patterns in the financial markets." And this is fine. But at several places he makes fun of "chartists, " precisely because chartists think that they have found discernible patterns in the markets. He doesn't offer any evidence to show that they cannot have done so, and his call at the end shows that he thinks there may be such patterns. Overall, I think this book is worth reading for anyone who is interested in the behavior of markets. And its fun for people, like me, who are deeply skeptical of the usefulness of anything that comes out of an economist's mouth.

Review # 2 was written on 2011-08-10 00:00:00 nathan Kroll Benoit Mandelbrot is the inventor of the mathematical concept of fractals. His earlier book The Fractal Geometry of Nature was a truly groundbreaking book about fractals and how they are seen in nature. In The Misbehavior of Markets he turns his attention to the application of fractal concepts to markets. Mandelbrot shows that price fluctuations: 1) are not independent from one time period to the next 2) appear to be the same, regardless of the time scale involved (hours/days/months/years) 3) do not obey a Gaussian (normal bell-like) distribution, but instead follow a power-law distribution. These characteristics are exactly the opposite of the assumptions that are normally used in financial circles. As a result, most financial models severely under-estimate financial risk. Most financial models use certain parameters (like the beta factor) that purport to measure price volatility. Mandelbrot shows that many of these parameters are worse than useless; they are so wrong, they are dangerous and can lead to world-wide financial ruin. This book is also somewhat of a biography; Mandelbrot details some of the fascinating aspects of his life, and that of his parents. One of the reasons contributing to his move from France to the U.S. is the disdain of French mathematicians to applied research. The only problem with this book is that Mandelbrot writes in a tone that is too strident for my taste. Nevertheless, I strongly recommend this book to anyone with an interest in applied mathematics or finance.