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Econophysics: making sense of a chimera

  • Paper in History and Philosophy of Science
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Abstract

The history of economic thought witnessed several prominent economists who took seriously models and concepts in physics for the elucidation and prediction of economic phenomena. Econophysics is an emerging discipline at the intersection of heterodox economics and the physics of complex systems, with practitioners typically engaged in two overlapping but distinct methodological programs. The first is to export mathematical methods used in physics for the purposes of studying economic phenomena. The second is to export mechanisms in physics into economics. A conclusion is drawn that physics transfer is often justified at the level of mathematical transfer but unjustified at the level of mechanistic transfer.

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Notes

  1. I borrow this term from Boumans (1993) who described the attempts of physicist Paul Ehrenfest and the economist Jan Tinbergen to apply the formalism of Hamiltonians and the adiabatic method to business cycles analysis.

  2. See History of Political Economy (1993) Volume 25, Supplementary Issue 1 for further discussion.

  3. See Mirowski (1984) for more on physics transfer in the ‘Marginalist Revolution’ period of the latter half of the 19th-century.

  4. ‘exp(x)’ refers to ex, where e is Euler’s number.

  5. Notice that this is not a Gaussian distribution.

  6. Cited in Sinha & Chakrabarti (2012, 46).

  7. Since at least as early as 2006, the University of Houston has launched the first PhD program in the United States for the study of econophysics. The East China University of Science and Technology also has a Research Center for Econophysics using methods from physics to understand high-frequency trading data (Yu & Li, 2010).

  8. The percentage of articles with the term ‘econophysics’ in Physica A began as low as 0% in 1996 and increased to highs of 18% in 2004 and 20% in 2007, with a modest upward trend between 1996 - 2009 (Jovanovic & Schinckus, 2013, 448).

  9. See Cockshott et al. (2009), section 7.1.1, for further discussion.

  10. Here, the symbol ‘∝’ is to be understood as ‘proportional to’.

  11. It is worth noting that Wilson was the PhD supervisor of Belal Baaquie, who is a notable contemporary econophysicist active in applying the mathematical formalisms, but not mechanisms, of quantum field theory for application in financial modelling (Baaquie, 2004, 2018). Baaquie’s work is nonetheless criticized at length in Arioli and Valente (2021) for misapplying several key formalisms.

  12. Here, the symbol ‘≈’ is to be understood as ‘approximates to’.

  13. This at least is the charitable interpretation of the JLS model. In the original paper, Johansen et al. (2000, 220) write: “The individual trader has only 3 possible actions (or “states”): selling, buying or waiting.” However, this would render their model strongly disanalogous to the physical systems they are inspired by, as the spin of ferromagnets in physical models have only two possible states (up and down).

  14. However, even on this point, Baaquie’s work has recently been criticized by Arioli and Valente (2021) for inappropriately applying quantum field theory’s mathematical formalism, specifically with respect to the usage of imaginary units in the Schrödinger equation, given that ‘interference phenomena’ do not exist in finance in the way this occurs in the quantum realm. And yet, these authors agree with my analysis that “what helps one justify the empirical success of quantum econophysics is just the fact that the applied models lose some of their characteristic quantum-mechanical components” (Arioli & Valente, 2021, 3).

  15. See chapter 5 of Jovanovic and Schinckus (2017) for further examples.

  16. See also Kincaid (2021) for a recent systematic overview of how diverse conceptions of mechanisms remain in economics and the social sciences.

  17. Two mainstream economists Smith & Foley (2008, 27) make a related criticism concerning attempts to relate economic utility to physical concepts: “The most direct way to understand why utility cannot be a counterpart to energy is to recognize that energy, along with volume or other conserved quantities, defines the surface of possible configurations of aggregated systems”.

  18. A family of related objections have been made toward mainstream neoclassical economics as well, specifically from the ‘critical realism’ school of social science (Lawson, 1997).

  19. I thank an anonymous referee for drawing my attention to this work.

  20. For example, see a recent institutional analysis in Volume 3, Issue 1 of the Journal of Financial Crises (2021) for a set of papers outlining in great detail how the Federal Reserve Bank of New York bailed out American International Group, Inc., one of the world’s largest insurance corporations which was brought to the brink of bankruptcy in the 2008 financial crisis.

  21. In this same paper, Cross further criticizes several prominent usages of time-irreversible mechanisms which have been appropriated from physics for usage in economics, such as hysteresis effects in electromagnetic phenomena and a purported analogy to international trade in the presence of exogenous shocks (Cross (1995), 130).

  22. For example, consider Irving Fisher’s well known false prediction in 1929 that the stock market would not crash (Sornette, 2003b, 13-14), when it did, or 1995 Nobel Memorial Prize winner Robert Lucas’s naive remark just prior to the 2007-2008 recession that ``the central problem of depression-prevention has been solved” (Krugman, 2009). This is so despite Joseph Schumpeter once remarking of Fisher: “I venture to predict that his name will stand in history principally as the name of this country’s [the United States] greatest scientific economist” ([1952] 1997, 223). If mainstream economics cannot be relied upon to make predictions of critical economic phenomena such as market crashes, it is unclear that alternative approaches such as econophysics should be optimistic of their ability to do so either. While it is a contention by econophysicists that mainstream economics is fundamentally flawed in its approach, especially in avoiding usage of fat-tailed distributions, strong claims require stronger evidence than is arguably on hand.

  23. It is highly doubtful many scholars of finance would find an alleged physical explanation explanatory for market crashes. In a systematic review of what they describe as pervasive ‘physics envy’ in mainstream economics and finance, Lo & Mueller (2010, 50-57) provide a detailed discussion of several competing narrative explanations of the 2007-2008 financial crisis. See also Kotz (2009) for a detailed ‘institutional economics’ analysis that, according to Google Scholar, has been cited 565 times at the time of writing, and which articulates the mechanisms, and their respective parts, of the effects of neoliberal policies leading to the crisis, that have nothing to do with analogies from physical mechanisms.

  24. See for instance Challet et al. (2001) for a representative minority game study conducted by econophysicists. See also Chakraborti et al. (2011) for a systematic review of agent-based models in econophysics.

  25. See Guala (2005) for a detailed overview of the methodology of behavioral economic study and the extent at which what occurs in the laboratory can be rationally believed to occur outside the laboratory and in the real economic world.

  26. Finance scholars Lo and Mueller (2010) agree, writing in their criticisms of physics transfer in mathematical finance that: “Today’s financial system is considerably more complex than ever before, requiring correspondingly greater concerted effort and expertise to overhaul. By comparison, the Large Hadron Collider — as complex as it is — is a much simpler system...the accelerator, detectors, and computers that constitute the Collider are governed by physical laws that are either perfectly certain or fully reducibly uncertain” (49).

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Acknowledgements

Thanks to the following for constructive feedback: Chris Atkinson, Joseph Berkovitz, Tim Cejka, John B. Davis, Jesse Hall, Julia Lücke, Soroush Marouzi, Michael E. Miller, Mark S. Peacock, Kate Tong, Tracy Wan, two anonymous referees, and audience members attending my talks at the 46th Annual History of Economics Society Meeting at Columbia University (Aug 2019), the 1st Winter Institute for the History of Economic Thought at Arizona State University (Jan 2020), and the 1st Philosophy of Physics Graduate Conference at the University of Oxford (Feb 2020). I thank the IHPST for funding and the University of Cambridge History & Philosophy of Science Department for an academic home where this paper was written.

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Yee, A.K. Econophysics: making sense of a chimera. Euro Jnl Phil Sci 11, 100 (2021). https://doi.org/10.1007/s13194-021-00413-1

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