the author of this article did. On Sat, Oct 4, 2008 at 3:38 PM, Perelman, Michael <[EMAIL PROTECTED]> wrote: > Does anybody remember the study about the 50 largest single-day price > movements since World War II? > > -----Original Message----- > From: [EMAIL PROTECTED] > [mailto:[EMAIL PROTECTED] On Behalf Of Jim Devine > Sent: Saturday, October 04, 2008 3:14 PM > To: Pen-l > Subject: [Pen-l] here's a new idea... > > ... applying the scientific approach to economics. > > The New York Times / October 1, 2008 > > Op-Ed Contributor > This Economy Does Not Compute > By MARK BUCHANAN > > Notre-Dame-de-Courson, France > > A FEW weeks ago, it seemed the financial crisis wouldn't spin > completely out of control. The government knew what it was doing - at > least the economic experts were saying so - and the Treasury had taken > a stand against saving failing firms, letting Lehman Brothers file for > bankruptcy. But since then we've had the rescue of the insurance giant > A.I.G., the arranged sale of failing banks and we'll soon see, in one > form or another, the biggest taxpayer bailout of Wall Street in > history. It seems clear that no one really knows what is coming next. > Why? > > Well, part of the reason is that economists still try to understand > markets by using ideas from traditional economics, especially > so-called equilibrium theory. This theory views markets as reflecting > a balance of forces, and says that market values change only in > response to new information - the sudden revelation of problems about > a company, for example, or a real change in the housing supply. > Markets are otherwise supposed to have no real internal dynamics of > their own. Too bad for the theory, things don't seem to work that way. > > Nearly two decades ago, a classic economic study found that of the 50 > largest single-day price movements since World War II, most happened > on days when there was no significant news, and that news in general > seemed to account for only about a third of the overall variance in > stock returns. A recent study by some physicists found much the same > thing - financial news lacked any clear link with the larger movements > of stock values. > > Certainly, markets have internal dynamics. They're self-propelling > systems driven in large part by what investors believe other investors > believe; participants trade on rumors and gossip, on fears and > expectations, and traders speak for good reason of the market's > optimism or pessimism. It's these internal dynamics that make it > possible for billions to evaporate from portfolios in a few short > months just because people suddenly begin remembering that housing > values do not always go up. > > Really understanding what's going on means going beyond equilibrium > thinking and getting some insight into the underlying ecology of > beliefs and expectations, perceptions and misperceptions, that drive > market swings. > > Surprisingly, very few economists have actually tried to do this, > although that's now changing - if slowly - through the efforts of > pioneers who are building computer models able to mimic market > dynamics by simulating their workings from the bottom up. > > The idea is to populate virtual markets with artificially intelligent > agents who trade and interact and compete with one another much like > real people. These "agent based" models do not simply proclaim the > truth of market equilibrium, as the standard theory complacently does, > but let market behavior emerge naturally from the actions of the > interacting participants, which may include individuals, banks, hedge > funds and other players, even regulators. What comes out may be a > quiet equilibrium, or it may be something else. > > For example, an agent model being developed by the Yale economist John > Geanakoplos, along with two physicists, Doyne Farmer and Stephan > Thurner, looks at how the level of credit in a market can influence > its overall stability. > > Obviously, credit can be a good thing as it aids all kinds of creative > economic activity, from building houses to starting businesses. But > too much easy credit can be dangerous. > > In the model, market participants, especially hedge funds, do what > they do in real life - seeking profits by aiming for ever higher > leverage, borrowing money to amplify the potential gains from their > investments. More leverage tends to tie market actors into tight > chains of financial interdependence, and the simulations show how this > effect can push the market toward instability by making it more likely > that trouble in one place - the failure of one investor to cover a > position - will spread more easily elsewhere. > > That's not really surprising, of course. But the model also shows > something that is not at all obvious. The instability doesn't grow in > the market gradually, but arrives suddenly. Beyond a certain threshold > the virtual market abruptly loses its stability in a "phase > transition" akin to the way ice abruptly melts into liquid water. > Beyond this point, collective financial meltdown becomes effectively > certain. This is the kind of possibility that equilibrium thinking > cannot even entertain. > > It's important to stress that this work remains speculative. Yet it is > not meant to be realistic in full detail, only to illustrate in a > simple setting the kinds of things that may indeed affect real > markets. It suggests that the narrative stories we tell in the > aftermath of every crisis, about how it started and spread, and about > who's to blame, may lead us to miss the deeper cause entirely. > > Financial crises may emerge naturally from the very makeup of markets, > as competition between investment enterprises sets up a race for > higher leverage, driving markets toward a precipice that we cannot > recognize even as we approach it. The model offers a potential > explanation of why we have another crisis narrative every few years, > with only the names and details changed. And why we're not likely to > avoid future crises with a little fiddling of the regulations, but > only by exerting broader control over the leverage that we allow to > develop. > > Another example is a model explored by the German economist Frank > Westerhoff. A contentious idea in economics is that levying very small > taxes on transactions in foreign exchange markets, might help to > reduce market volatility. (Such volatility has proved disastrous to > countries dependent on foreign investment, as huge volumes of outside > investment can flow out almost overnight.) A tax of 0.1 percent of the > transaction volume, for example, would deter rapid-fire speculation, > while preserving currency exchange linked more directly to productive > economic purposes. > > Economists have argued over this idea for decades, the debate usually > driven by ideology. In contrast, Professor Westerhoff and colleagues > have used agent models to build realistic markets on which they impose > taxes of various kinds to see what happens. > > So far they've found tentative evidence that a transaction tax may > stabilize currency markets, but also that the outcome has a surprising > sensitivity to seemingly small details of market mechanics - on > precisely how, for example, the market matches buyers and sellers. The > model is helping to bring some solid evidence to a debate of extreme > importance. > > A third example is a model developed by Charles Macal and colleagues > at Argonne National Laboratory in Illinois and aimed at providing a > realistic simulation of the interacting entities in that state's > electricity market, as well as the electrical power grid. They were > hired by Illinois several years ago to use the model in helping the > state plan electricity deregulation, and the model simulations were > instrumental in exposing several loopholes in early market designs > that companies could have exploited to manipulate prices. > > Similar models of deregulated electricity markets are being developed > by a handful of researchers around the world, who see them as the only > way of reckoning intelligently with the design of extremely complex > deregulated electricity markets, where faith in the reliability of > equilibrium reasoning has already led to several disasters, in > California, notoriously, and more recently in Texas. > > Sadly, the academic economics profession remains reluctant to embrace > this new computational approach (and stubbornly wedded to the > traditional equilibrium picture). This seems decidedly peculiar given > that every other branch of science from physics to molecular biology > has embraced computational modeling as an invaluable tool for gaining > insight into complex systems of many interacting parts, where the > links between causes and effect can be tortuously convoluted. > > Something of the attitude of economic traditionalists spilled out a > number of years ago at a conference where economists and physicists > met to discuss new approaches to economics. As one physicist who was > there tells me, a prominent economist objected that the use of > computational models amounted to "cheating" or "peeping behind the > curtain," and that respectable economics, by contrast, had to be > pursued through the proof of infallible mathematical theorems. > > If we're really going to avoid crises, we're going to need something > more imaginative, starting with a more open-minded attitude to how > science can help us understand how markets really work. Done properly, > computer simulation represents a kind of "telescope for the mind," > multiplying human powers of analysis and insight just as a telescope > does our powers of vision. With simulations, we can discover > relationships that the unaided human mind, or even the human mind > aided with the best mathematical analysis, would never grasp. > > Better market models alone will not prevent crises, but they may give > regulators better ways for assessing market dynamics, and more > important, techniques for detecting early signs of trouble. Economic > tradition, of all things, shouldn't be allowed to inhibit economic > progress. > > Mark Buchanan, a theoretical physicist, is the author, most recently, > of "The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and > Your Neighbor Usually Looks Like You." > > Copyright 2008 The New York Times Company > -- > Jim Devine / "Nobody told me there'd be days like these / Strange > days indeed -- most peculiar, mama." -- JL. > _______________________________________________ > pen-l mailing list > [email protected] > https://lists.csuchico.edu/mailman/listinfo/pen-l > _______________________________________________ > pen-l mailing list > [email protected] > https://lists.csuchico.edu/mailman/listinfo/pen-l >
-- Jim Devine / "Nobody told me there'd be days like these / Strange days indeed -- most peculiar, mama." -- JL. _______________________________________________ pen-l mailing list [email protected] https://lists.csuchico.edu/mailman/listinfo/pen-l
