The Physics of Finance and Extreme Weather: Interview with Mark Buchanan, Part I
Author and Physicist Mark Buchanan makes the case for economies as natural, patterned systems.
Mark Buchanan is a former editor at Nature and New Scientist, and currently writes monthly columns for Bloomberg View and Nature Physics. He received the LaGrange Prize for writing on issues in complexity science in 2009. Buchanan brings physics-inspired thinking to the understanding of financial systems.
Mr. Buchanan will speak about his work at the 3rd Annual Social Mood Conference April 13 in Atlanta. Reserve your seat today >>
JMN: Your latest book compares the physics of meteorology to the trajectory of modeling financial markets. Forecast will publish this spring, but how long ago did these ideas begin to crystallize?
MB: I started writing about a year ago. But I suppose I started reading about all the material and doing the research maybe 15 years ago.
Physicists began to model financial markets in a new way about 15-20 years ago. The old traditional economic models look at an economy as a system in equilibrium, or a kind of balance. Each individual in the market has certain aims, and they try to act in a way to reach those aims. Of course, not everyone’s aims can be met at the same time, but… all the forcescome together and find a balance point where everyone is satisfied as well as they can be.
[But markets] aren’t like that. If you look in the real world, they’re hardly peaceful systems that you would describe as tranquil and at rest.
JMN: Hardly.
MB: Rather, they’re churning around every day, crazy things are happening, they’re very unpredictable, there’s kind of wild chaos in the markets. So how can you understand that? Equilibrium theory has the simplest conceptual way of understanding that. They say, “[The market] would be in perfect, calm rest if it weren’t being perpetually knocked about from the outside. There are always new inventions, new companies being started, new managers being hired, and new products come to market. All of this creates information and knowledge that shakes up the market every day…
JMN: Okay, so why is this standard, traditional/fundamental explanation wrong? It does offer a narrative…
MB: That’s a very simple way of thinking. It’s more or less akin to the way physicists think about very simple systems — like the water in a bathtub… It’s smooth on the surface, but if you smack it with your hand it stirs a bunch of waves. There’ll be chaotic motion on the surface for a short period of time and then it will gradually relax into a smooth, stable [resting point]…
JMN: But that’s assuming it’s a simple system, right?
MB: Right: it’s really simple…. The physics of the water in the bathtub is really old physics: it’s a centuries-old understanding. I’d say in the past century, physics has moved on… to thinking about systems that inherently will not come to a state of rest or balance, and have their own internal dynamics…
One of the most obvious [examples] is the weather. If you look at the weather, of course, sometimes we have nice blue skies and sunny days and calm atmospheres. But other days, out of those blue skies — for normal, ordinary reasons– you get storms that brew big weather systems…
Three centuries ago, people tried to understand the weather as an equilibrium system: just a bunch of air being heated near the equator. That warm air rises into the upper atmosphere and travels up toward the poles, and then descends again. [People] tried to think of a system that has a really nice, stable flow of air… really simple (kind of like water in a bath) just sitting there in a very stable pattern. But that doesn’t explain almost anything about the weather.
JMN: Right. It doesn’t explain the more dynamic weather systems…
[And] these continual, churning storms and systems make the weather and the atmosphere very interesting. That was only understood, amazingly enough, starting around the 1950s. It took some of the early computers [for us] to start to understand where weather systems come from.
The basic story is that there are “positive feedbacks” — what we can call “instabilities” by which, if you have a system with no interesting pattern. So everything looks the same, and blue sky is everywhere — if you perturb that a little bit, the disturbance has a tendency to create forces which make it grow, so you get more of a delineation…more of a deviation creates forces again which act again to create positive feedback. You get a driving force that disrupts the nice, stable equilibrium pattern and creates these churning storms and weather systems…
The system has natural forces within it which are continually churning up new patterns that haven’t existed before, creating change. You don’t need anything coming from the outside to “smack the system around.” You don’t need those shocks from the outside in order to have perpetual change and perpetual chaos in the system.
And this is basically true not only in the atmosphere, but also in nearly everything we know in the biological and physical world. It’s true in the human body, in the oceans, even in the way the sun interacts with the earth (solar wind). It’s just true everywhere.
It would be a shock, really, if somehow the economy was the one system in the world that didn’t conform to the same kinds of patterns. In fact, it does not conform to the equilibrium picture. It also falls into this class of disequilibrium systems which have their own internal dynamics.
JMN: And this is where your physics background meets financial theory…
MB: [Instead of] building models of parcels of air being heated and rising and falling in the atmosphere, you build models of individuals or firms acting (within some economy) where they make decisions every day to undertake certain projects, or to buy and sell in a stock market, and they’re looking to the past and forming theories about how they might act best in their own interest. They then take some actions. …
To learn about what Mark Buchanan has found at the intersection between physics and finance, watch this space for Part 2 of the interview…To see him at the 2013 Social Mood Conference, REGISTER NOW>>
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