Sunday, March 20, 2005

The Luddite of Quantitative Finance

Confession time.

I'm a Luddite that wants to destroy the mathematical machines of economics.

Yes, one of my degrees is in Finance, and yes I enjoy the beauty of math and it's implementation in science.

In the "hard sciences."

Academics love the validity they accrue by applying math to sociology, anthropology, or economics. They have to assume so much, and modify math or the discipline so much; that either the math or the reality it supposedly represents becomes a joke.

Economics has become the art of building ugly mathematical structures and calling them elegant. The models used are full of fallacies, the final product is obscene. I know, you want to know what I really think.

Economics is about people. Finance is about people. We are people, and we know that a lot of what we do is not rational. All of us irrational beings do not suddenly become rational when we form a large group. We become even less rational as a mob.

An economist would look at a large population of lemmings in a field. He could watch them for years. He could create an elegantly formulated model of lemmings travel patterns, and how close they stay to home. After all, lemmings are just rodents. Mathematically we could prove they never roam far. And then. .....

They suddenly start acting like a human mob, and run amok.

Humans can be rational alone if they work at it. Put them in a large group, be it in a broker's office, entering the housing market, or walking through a casino; and kiss reason goodbye.

Do you want a concept that may hold some promise? Prechter's work on Socionomics may hold some promise for unraveling history, but it's promise is not likely to be fulfilled by predicting next week's markets action. It may very well give some heavily veiled clues to the long term. Prechter at the core of his work realizes that markets are about the people in the markets.

Perhaps Hari Seldon of the Foundation is waiting in the wings. But we will have to wait to see if our normally aberrant behavior can be synthesized and still leave room for when the mob leaves it's senses.

If the above links don't work for Robert Prechter's Socionomics or Isaac Asimov's Foundation trilogy, stick these names in the search engine to the right. They read well and complement each other.

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