8/13/2019 Article - The Physics of Wallstreet

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65September/October 2013

B O O K R E V I E W

Dow Jones Industrial Average turned

in its sixth-largest single-day point loss

with a drop of 554 points. Sornette

made a profit of 400 percent.

Te Physics of Wall Streetis filled

with anecdotes and explanations of basic

ideas in physics that allow readers who

arent physicists or mathematicians to at

least sense how the mind of one works.

Te pattern is observation, model,

testing, failure, revised model, testing,

failure, followed by another revised

model and so on. Weatherall says this

is a better way to think about markets,

regulations, banking, and consumer

protection. Organizations like the

Federal Reserve and the Securities and

Exchange Commission, even the World

Bank, should be the most sophisticated

players in the game, he writes, and if

these groups are not up to the task, weneed some new research organization

devoted to interdisciplinary economic

research to help guide them.

Brooks C . Sacket t , C IM A , C FP ,

AIFA , i s pres id ent o f Ch ie f Capital

Ma nageme nt , In c . wit h of f i ces in San

Jo se , C A, and Spokane , WA . Contact

him at brooks@chie fcapi tal . com.

and investment banks are

highly secretive, and they

dont give a whit about peer

review.

Yet lucky for us,

Weatherall pursued the par-

allels of physics and finance.

In Te Physics of Wall Street,

he shares some great sto-

ries that sure make it look

reasonable to draw parallels

between the laws of nature and the laws

of markets. One of my favorites is about

physicist Didier Sornette, whose early

research focused on the failure of mate-

rials under stressspecifically Kevlar

fuel tanks used on the European Space

Agencys Ariane 4 rockets. He detected

self-organization and coordination

within the particles of the tank material

itself and observed a pattern in vibra-tions known as acoustic emissions just

before the tanks ruptured. Tis acceler-

ating signal became the basis for mod-

ern testing of pressurized fuel tanks.

Sornettes work expanded to

research on earthquake prediction. He

also studied world financial markets,

evaluating his models with real-time

data. In the late summer of 1997, he

detected a familiar pattern that indi-

cated a major event was in the offing.

Te pattern of the financial data mir-

rored that of acoustic emissions fromstressed fuel tanks. He and a colleague

sent a notice to the French patent office

on September 17, 1997, predicting a

market crash in October. He then put

his money where his mouth was and

began buying out-of-the-money put

optionslow-cost long-shot bets that

only pay off with a catastrophic drop in

share value. On October 27, 1997, the

rust in Allah and tie your

camel.

Imam at-irmidhi

James Weatherall was

teaching physics and

math at the University

of California, Irvine, when

the financial collapse of

2008 got him thinking about

physics and Wall Street. He

started reading up on Louis Bachelier,

Maury Osborne, Benoit Mandelbrot,

Edward Torp, Fischer Black, Myron

Scholes, James Doyne Farmer, Norman

Packard, and othersa legion of quants

who had come to Wall Street and

changed it forever. Te implication

was clear, he writes. Physicists on Wall

Street were responsible for the collapse.

Nonsense, you say. Weatheralls dis-sertation advisor said so, too. When

Weatherall told his advisor hed found

examples from physics that helped him

understand finance, the advisor told

him that physicists may have influenced

finance, but its impossible to do science

on Wall Street.

Weatherall gets that. He explains

how physics is a way of learning about

the world through discovery, testing,

and continuous revision. A physicist

with a new insight typically submits

a paper to a professional journal. Tepaper undergoes peer review and it

might never be published. If it does

make it into print, it may generate new

tests, models, and theoriesor it may

just collect dust; be shared but never

exploited. New insights are handled

differently on Wall Street, however.

Teyre exploited but never shared;

enjoyed but not debated. Hedge funds

The Physics of Wall Street: A Brief

History of Predicting the UnpredictableRev iew ed by Bro oks C. Sack ett , C IMA, CFP, A IFA

Te Physics of Wall Street:A Brief History of Predicting

the Unpredictable

By James Owen Weatherall

304 pages, hardcover

ISBN-10: 0547317271

ISBN-13: 978-0547317274

U.S. $27, Houghton Mifflin

Harcourt, 2013