IT’S A GAMBLE: UH ECONOPHYSICISTS
MELD SCIENCE, ECONOMICS
Joseph McCauley Only Physicist Invited to Upcoming
Financial Workshop of Economists in Italy
HOUSTON, Nov. 30, 2006 – Predicting financial markets is
more of a gamble than traditional economists will admit, and making
sense of such numbers is more like trying to decipher noise blasting
from a loudspeaker, says one University of Houston econophysicist,
who leads one of the world’s most preeminent groups of its
kind.
Joseph McCauley, a UH physics professor with a dual appointment
as a senior fellow in the economics department at the National University
of Ireland, Galway, leads the UH group. The team’s main discovery,
backed up by empirically based modeling of market dynamics, is that
financial markets are unstable. Associate Professor Kevin Bassler,
Professor Gemunu Gunaratne and Professor George Reiter – all
of the physics department – round out the UH econophysics
group that applies their newly discovered models and methods to
solve problems in economics.
McCauley will be the only invited physicist to speak in an economic
workshop – “Financial fragility and technological progress
with heterogeneous agents and social interactions” –
Dec. 14-15 in Trento, Italy. He will weigh in with his perspective
on the subjects of macroeconomics (the overall aspects and workings
of a national economy) and microfoundations (in which the macroeconomic
model is built up from the actions of individual agents).
McCauley and his colleagues contend that a market is made up of
“noise” in the strictest mathematical sense of a random
and persistent disturbance that obscures clarity. Using techniques
developed in physics such as entropy – the study of randomness
or disorder – challenges the common belief in economics that
market statistics have structure and tend toward equilibrium.
“Traditional economics is based far less on empirical studies
than its econophysics counterpart,” McCauley said.
“For instance, deregulation is an example of economists relying
on a belief and not hard analyses. Also, histograms – a traditional
economist’s tool – do not represent normal distributions.
Even Nobel Prize-winning economists approach market statistics with
a wrong mathematical model already in mind, and the model always
fails. Physics helps us understand the information that goes into
these models better.”
Gunaratne uses the analogy of a pollen grain being heated up in
water to illustrate how the randomness of motion is analogous to
what happens in a market. Just as a physicist observes the increase
and decrease in the temperature of water as variables that agitate
or slow the motion of a pollen grain in an experiment, an econophysicist
applies these sorts of principles to other such variables in a financial
market. In trying to understand this randomness, he said, it is
apparent that markets are not bell-shaped curves with symmetry and
normal distribution. Instead, financial markets are more like radio
static, but with non-bell-shaped noise, with stock prices continually
moving up and down in ways that puzzle standard statisticians.
Focusing primarily on the foreign exchange (FX), a 24-hour-a-day
traded world market, McCauley, Gunaratne and Bassler say studying
the FX yields better information as the largest, most liquid market
that dominates other markets because of its sheer volume and volatility.
They model both the market dynamics and option pricing by deducing
correct models from real market statistics, which is the opposite
of what economists do. Broadening the UH econophysics program, their
colleague Reiter focuses more on models of the economy, including
production and consumption with results that show how individuals’
preferences adapt to economic circumstances, a part of reality he
said is missing from standard economic models.
“Whatever the specific focus, this relatively young subfield
that merges the two disciplines of physics and economics helps us
move toward applicable models for use in analyzing markets and economies
more effectively and accurately,” Bassler said.
Having established one of only a handful of Ph.D. programs across
the globe with a specialization in econophysics, UH’s physics
department in the College of Natural Sciences and Mathematics has
recognized a need for educating physics students in this area since
the modeling, analytical and computational skills of physicists
are exactly the skills needed to study financial markets and the
dynamics of the economy in a practical way.
“We realize this is still met with skepticism in more traditional
arenas, but we’re convinced econophysics will play the leading
role as world economies become increasingly more complex and harder
to decipher, and the misleading notion of ‘self-regulating
markets’ will be slaughtered,” McCauley said. “To
the extent possible in the social realm, we want to create economic
theory as science and avoid the ‘mathematized ideology’
– as I’ve coined it – of mainstream economics
that is currently the ideology used in the unregulated free market.”
For more information on econophysics at UH, visit http://phys.uh.edu/econophysics.htm.
To receive UH science news via e-mail, visit www.uh.edu/admin/media/sciencelist.html.
For more information about UH visit the universitys Newsroom
at www.uh.edu/admin/media/newsroom.
|