The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen WeatherallAfter the economic meltdown of 2008, Warren Buffett famously warned, “beware of geeks bearing formulas.” But as James Weatherall demonstrates, not all geeks are created equal. While many of the mathematicians and software engineers on Wall Street failed when their abstractions turned ugly in practice, a special breed of physicists has a much deeper history of revolutionizing finance. Taking us from fin-de-siecle Paris to Rat Pack-era Las Vegas, from wartime government labs to Yippie communes on the Pacific coast, Weatherall shows how physicists successfully brought their science to bear on some of the thorniest problems in economics, from options pricing to bubbles.
The crisis was partly a failure of mathematical modeling. But even more, it was a failure of some very sophisticated financial institutions to think like physicists. Models—whether in science or finance—have limitations; they break down under certain conditions. And in 2008, sophisticated models fell into the hands of people who didn’t understand their purpose, and didn’t care. It was a catastrophic misuse of science.
The solution, however, is not to give up on models; its to make them better. Weatherall reveals the people and ideas on the cusp of a new era in finance. We see a geophysicist use a model designed for earthquakes to predict a massive stock market crash. We discover a physicist-run hedge fund that earned 2,478.6% over the course of the 1990s. And we see how an obscure idea from quantum theory might soon be used to create a far more accurate Consumer Price Index.
Both persuasive and accessible, The Physics of Wall Street is riveting history that will change how we think about our economic future.
James Owen Weatherall, The Physics of Wall Street: A Brief History of Predicting the Unpredictable
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What finance and economics need, he says, is more physics, not less. So what if the quantitative models that underlay such products as mortgage-backed securities blew up, nearly bringing down the world financial system in the process? Models always have assumptions; it is up to the users to pay attention to whether those assumptions hold. Did some so-called quants — investors who use sophisticated mathematical models in deciding what and when to buy and sell — lose their shirts? Indeed they did. But others did not. Weatherall points to Renaissance Technologies, a hedge fund founded by James Simons, who was an esteemed mathematician before he became an esteemed investor.
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I am a physicist, mathematician, and philosopher. I am the organizer of the Southern California Philosophy of Physics Group , which meets several times a quarter in Irvine. It was published in January by Yale University Press. We also discuss how these same social factors can be manipulated by industrial and political agents. I am the author of two other books. My first book, The Physics of Wall Street , explains how ideas have moved from physics into financial modeling over the last century.
As I hinted obliquely a little while back , I don't have a terribly high opinion of Wall Street or Wall Street traders. Given that, I'm not the most obvious audience for a book titled The Physics of Wall Street , and truth be told, I wouldn't've picked it up on my own. The publisher sent me an advance copy back in August, though, and I had a plane trip coming up to go play golf with some guys who work in business, so I thought it might make a decent read and possible conversation topic, and took it along. I was very pleasantly surprised to find that it contains much more physics than Wall Street. That is, it's a book about the physicists who have migrated into the world of finance and made important contributions, and only sort of incidentally about Wall Street itself.