The physicists of Wall Street
Jun. 10th, 2023 08:49 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
qatsiBook Review: The Physics of Wall Street, by James Owen Weatherall
There was a hiatus in posting, due to an extended broadband outage, so I am behind with reviews. This had been on my to-read list for a while and was a Christmas present. I'd read some years ago (if I remember correctly it was an April edition of Scientific American) that many economic models and theories are based on classical thermodynamics; I wasn't sure whether to believe that or not, but thought this would be a good opportunity to find out more.
Equities - stocks and shares - are relatively simple things. You buy a share in a company, you get a share of its profits. The price of the stock rises and falls according to the consensus of whether that profit is likely to rise or fall in the future - somewhat due to the company itself but also due to factors in the wider economy. But then, options, futures and derivatives are more complicated: if you buy one of those, then you have an agreement to buy or sell something at a known, fixed price at some time in the future, regardless of what the market then thinks. As the author points out, this can have advantages for the buyer and seller of the option. But things get more complicated. Quants build models that say you should buy some amount of stock, and some amount of options on that stock, then your overall chances of making a profit are increased. To be honest, if something sounds too good to be true, it usually is, although some people have made a lot of money that way.
In fact, although this is an interesting read, it is much more about personalities than physics - the physicists of Wall Street, perhaps. A lot of it is about clash of personalities, and theories. Physicists look down on simplistic economic models; economists assert that physicists' models are too mathematically complex to mean anything in the real world. In any case, models have limited ranges of operability, and when pushed beyond those boundaries they may become unreliable. There is some information on how physicists have fitted mathematical distributions to some economic behaviours; it's not straightforward, and it's implied (and almost certainly true) that many financial institutions have more complex, opaque and proprietary models. This book was written in the aftermath of the 2008 financial crisis, and implies that the lack of co-operation and understanding between these two groups, and the US government, played a part in that crisis, but it doesn't have any great revelation or conclusion.
There was a hiatus in posting, due to an extended broadband outage, so I am behind with reviews. This had been on my to-read list for a while and was a Christmas present. I'd read some years ago (if I remember correctly it was an April edition of Scientific American) that many economic models and theories are based on classical thermodynamics; I wasn't sure whether to believe that or not, but thought this would be a good opportunity to find out more.
Equities - stocks and shares - are relatively simple things. You buy a share in a company, you get a share of its profits. The price of the stock rises and falls according to the consensus of whether that profit is likely to rise or fall in the future - somewhat due to the company itself but also due to factors in the wider economy. But then, options, futures and derivatives are more complicated: if you buy one of those, then you have an agreement to buy or sell something at a known, fixed price at some time in the future, regardless of what the market then thinks. As the author points out, this can have advantages for the buyer and seller of the option. But things get more complicated. Quants build models that say you should buy some amount of stock, and some amount of options on that stock, then your overall chances of making a profit are increased. To be honest, if something sounds too good to be true, it usually is, although some people have made a lot of money that way.
In fact, although this is an interesting read, it is much more about personalities than physics - the physicists of Wall Street, perhaps. A lot of it is about clash of personalities, and theories. Physicists look down on simplistic economic models; economists assert that physicists' models are too mathematically complex to mean anything in the real world. In any case, models have limited ranges of operability, and when pushed beyond those boundaries they may become unreliable. There is some information on how physicists have fitted mathematical distributions to some economic behaviours; it's not straightforward, and it's implied (and almost certainly true) that many financial institutions have more complex, opaque and proprietary models. This book was written in the aftermath of the 2008 financial crisis, and implies that the lack of co-operation and understanding between these two groups, and the US government, played a part in that crisis, but it doesn't have any great revelation or conclusion.