Thursday, September 22, 2005

Econophysics

Not too long ago I tried to make the argument that physical principles may be useful in the analysis of human behavior, as well as societal and cultural phenomena. Well-known physics concepts such as inertia, momentum, force and impulse seem to have analogs in the social and behavioral sciences. There are other reasons that suggest a deeper connection between the physical realm and social realm, as seen in the fields of network theory and complexity. Common mathematical relationships and structures have been discovered over a remarkable range of systems, from the Internet to social networks to business networks, and even in food webs and metabolic chemical networks.

Further evidence of deep links between physical systems and economic models have also been discovered. In the September issue of Physics Today, an article entitled “Is Economics the Next Physical Science?” is featured. Yale professor Martin Shubik and Santa Fe Institute researchers Doyne Farmer and Eric Smith have been working on econophysics, where well-established mathematical methods used by physicists over many years have been used to establish better dynamical economic models. For example, the study of chaotic systems in physical systems as economic analogs in the sense that an economic market can follow very different paths if there are relatively minor changes in the initial conditions of the market. The mathematics used in this type of analysis follows techniques used in physics. The observation of numerous power laws in physical systems and networks (i.e. scale-free networks) over a number of years has led to more refined analysis tools, which are now being used to understand newly discovered power laws in economic theory. These power laws include analysis of price movement in stocks over short periods of time as well as income distributions in capitalistic economies. Production and distribution networks of large corporations have been shown to follow characteristic power laws associated with scale-free networks. What may seem like random trading patterns in the stock market that lead to market swings and patterns may be analogous to random motions of many-body systems that show emergent behavior. Statistical mechanics relationships are being used to study various types of economic models (since probability distribution functions rule).

While standard physics analyses may provide some leads into the deeper understanding of economics, there is still the difficulty of including human beings into the mix. It is not clear that we will be able to model human responses that are based not on logic or deterministic physical laws, but rather raw emotion and the possibility of random response decisions to evolving market conditions that are built around strategies that may or may not be well thought out. We are not yet at the point of creating a Foundation like Harry Seldon did in Isaac Asimov’s classic ‘Foundation Trilogy,’ but this is a fascinating new way of thinking about the possible universality of physical and social sciences.

3 comments:

Mark Vondracek said...

sextus - You are right about 'superficial' connections in terms of the very different reality of a physical/mechanical system (deterministic) compared to a social/human system (nondeterministic). When I mention 'deep' connections, however, this is in reference to the mathematical descritptions of such systems. The curious thing about the work being done in complexity theory is that the same mathematics keep appearing over and over in entirely different contexts...enough to lead many scientists to suggest the possibility there is more than coincidence at work. This is a relatively new way of thinking and a relatively new area of research, so no one knows where it will lead.

If the fundamental mathematical relationships between seemingly different and unconnected systems have the same structure, there are numerous examples in the history of physics where new insight and understanding have been attained...it may mean some sort of symmetry principle, such as what is seen in electromagnetic theory or even the connection between mechanical systems with certain electronic circuits. Some times the mathematical similarities we see have allowed us to place things in the same box, so it is worth taking a look to see where all this takes us.

mark said...

Hey Von,

Take a look at this:

http://singularity.com/

Robert (Bob) Klapetzky SYSTEMIC RISK CONSULTING said...

Econophysics is real. Dr. Shubik’s work with Per Bak is very significant:
“Price Variations in a Stock Market with Many Agents”, and “The Dynamics of Money”

The essence of Econophysics is contained within Per Bak and Maya Paczuski’s:
“Complexity, contingency, and criticality” 1994
Deterministic views could not explain stock price changes having fat tails deviating from the Gaussian distribution. Benoit Mandelbrot: MIT
“The variation of certain speculative prices”, and “Fractals and Scaling in Finance”
Those fat tails correspond to avalanches of volatility that could not be explained by Fundamental economics. Robert Shiller; Yale
“Market Volatility”
Quoting from Complexity, Contingency, and Criticality: Large dynamical systems tend “to organize themselves into a critical state, with avalanches” of all sizes. “Biology, history, and economics can be viewed as dynamical systems”. “In the critical state, events which otherwise be uncoupled become correlated”. “General Equilibrium Theory (Nash), has not been explicitly formulated for biology”
There are countless references for hysteretic behavior of large groups within the social sciences.
The out of hand dismissals regarding econophysics remind me of what my father told me, (tongue in cheek) about numbers and statistics when we lived in Los Alamos. Go to the kitchen, put one hand on the hot stove, and one hand in the freezer. Now, statistically, on average, you should be comfortable, because of the average temperature between the two. Of course there are assumptions to this theory. (1) That everybody has long arms. (2) A teenager would actually listen to a parent. Kind of like the underlying assumptions the efficient market theorists have.
Interestingly, and recently a physicist has explained human heavy tailed behavior albeit not in financial markets. Albert Laszlo Barbaras; Notre Dame.
“The origin of bursts and heavy tails in human dynamics”

Sincerely,
Bob Klapetzky