The traditional notion that financial markets are efficient,
self-regulating, self-correcting systems based on rational human
decisions is eroding. But scientists don't think market behavior is
random or mysterious either. Proponents of a new field called
econophysics view markets as complex systems much like earthquakes and
hurricanes that are characterized by nonlinear dynamics.
One such scholar is Didier Sornette
a professor of geophysics, physics and finance, who has studied
earthquakes, epileptic seizures, and the popularity of YouTube videos. A
Wall Street Journal feature by Eleanor Laise
describes Professor Sornette as man who enjoys personal and
professional risk and has a passion for predicting events in complex
systems. He likes to windsurf, water ski and ride motorcycles at
frightening speed. He also likes to contemplate how similar principles
might underlie such diverse phenomena as the rupture of rocket tanks and
disruptions of financial crashes. Last year he launched a
controversial Financial Bubble Experiment
to show that financial markets are not impenetrable and that reasonable forecasts are possible.
Sornette is director of the Financial Crisis Observatory
at the Swiss Federal Institute of Technology in Zurich. In the
experiment, he and colleagues predicted that four specific assets would
form financial bubbles within a six month period.
A PhysOrg.com story
notes that to date, no one has a reliable method of saying whether a
particular market or asset is in a bubble state, and further, no
universal agreement exists on what a bubble is. Research by Sornette and
his group, whose members view the question through the lenses of
physics, math, geology, earth science, and economics, may change that.
Their experiment shows financial markets have an identifiable
structure, and are subject to phases of growth that can change slowly or
radically. They call the changes "regime shift," and a crash is an
extreme example. The PhysOrg story reports all four of the selected
assets experienced regime shift as Sornette and colleagues predicted,
and two were in bubble state. A bubble
is said to occur when the price of any commodity rises far above its actual value.
understanding of markets and bubbles can help prepare for economic
upheavals, these scientists believe. Financial and geological
earthquakes change environments. In a New York Times
story "A Richter Scale for Markets" by Eric Dash
Sornette is quoted as saying: "Great earthquakes shape landscapes.
Great crashes shape regulation, the perception of risk, and the
psychology of people."
But forecasting is still ambiguous and
the impact of a major event can have extraordinary reach. The Times
story notes that a group of econophysicists wrote to billionaire philanthropist George Soros
urging his support for a multidisciplinary approach toeconomics.
financial crises, they wrote, have "damaged the economic system to the
extent that several countries are on the verge of bankruptcy, and
social systems have become dangerously vulnerable. The problem we have
seen may be just the beginning of a larger crisis. The situation may get
totally out of control, endangering social peace and cultural
achievements." They urged support for FuturIcT
a trans-disciplinary initiative in which scholars from all over the
world will attempt to build computer simulations to develop new
understanding of economic and social systems.