Wednesday, December 14, 2011

Physics Envy?

This is a rather interesting article. It is actually a book review of Emanuel Derman's "Models Behaving Badly". In it, he looked at why mathematical models used for human behavior, such as in economics and the financial world, are really not the same as mathematical models and theories done in physics. And this is written by someone who has a background in physics, and has worked in the financial world.

Mr. Derman's particular thesis can be stated simply: Although financial models employ the mathematics and style of physics, they are fundamentally different from the models that science produces. Physical models can provide an accurate description of reality. Financial models, despite their mathematical sophistication, can at best provide a vast oversimplification of reality. In the universe of finance, the behavior of individuals determines value—and, as he says, "people change their minds."
The basic problem, according to Mr. Derman, is that "in physics you're playing against God, and He doesn't change His laws very often. In finance, you're playing against God's creatures." And God's creatures use "their ephemeral opinions" to value assets. Moreover, most financial models "fail to reflect the complex reality of the world around them."

Other than his unfortunate use of the term "God" in this case, this is a fairly accurate reflection of my view when something like this is used to model human activities and interactions. I find that the effort in trying to find analogies from physics to fit itself into such human fields to be a bit strange and sometime amusing, thus generating the possibility of some of them having this "physics envy".


1 comment:

rob said...

on the other hand, if there were 6.02x10^23 people in the economy, the models might behave better.