The European Physical Journal Special Topics

, Volume 225, Issue 17–18, pp 3187–3210 | Cite as

Can there be a physics of financial markets? Methodological reflections on econophysics

Regular Article
Part of the following topical collections:
  1. Discussion and Debate: Can Economics be a Physical Science?

Abstract

We address the question whether there can be a physical science of financial markets. In particular, we examine the argument that, given the reflexivity of financial markets (i.e., the feedback mechanism between expectations and prices), there is a fundamental difference between social and physical systems, which demands a new scientific method. By providing a selective history of the mutual cross-fertilization between physics and economics, we reflect on the methodological differences of how models and theories get constructed in these fields. We argue that the novel conception of financial markets as complex adaptive systems is one of the most important contributions of econophysics and show that this field of research provides the methods, concepts, and tools to scientifically account for reflexivity. We conclude by arguing that a new science of economic and financial systems should not only be physics-based, but needs to integrate findings from other scientific fields, so that a truly multi-disciplinary complex systems science of financial markets can be built.

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  1. 1.
    E. Derman, Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life (Free Press, New York, 2011)Google Scholar
  2. 2.
    G. Soros, The Alchemy of Finance: Reading the Mind of the Market (John Wiley and Sons, Hoboken NJ, 1987)Google Scholar
  3. 3.
    E. Grunberg, F. Modigliani, J. Polit. Econ. 62, 465 (1954)CrossRefGoogle Scholar
  4. 4.
    H.A. Simon, Public. Open. Quart. 18, 245 (1954)CrossRefGoogle Scholar
  5. 5.
    R.C. Buck, Philos. Sci. 30, 373 (1963)CrossRefGoogle Scholar
  6. 6.
    M.K. Vetterling, Philos. Sci. 43, 278 (1976)CrossRefGoogle Scholar
  7. 7.
    E. Grunberg, Am. J. Econ. Sociol. 45, 475 (1986)CrossRefGoogle Scholar
  8. 8.
    G. Soros, J. Econ. Methodol. 20, 309 (2013)CrossRefGoogle Scholar
  9. 9.
    Y.C. Zhang, Physica A 269, 30 (1999)ADSCrossRefGoogle Scholar
  10. 10.
    J.P. Bouchaud, Quant. Finance 1, 105 (2001)CrossRefGoogle Scholar
  11. 11.
    E. Derman, My Life as a Quant: Reflections on Physics and Finance (John Wiley and Sons, Hoboken NJ, 2004)Google Scholar
  12. 12.
    J.D. Farmer, T. Lux, J. Econ. Dyn. Control 32, 1 (2008)CrossRefGoogle Scholar
  13. 13.
    F. Jovanovic, C. Schinckus, Hist. Polit. Economy 45, 443 (2013)CrossRefGoogle Scholar
  14. 14.
    I. Newton, The Principia: Mathematical Principles of Natural Philosophy: A New Translation (University of California Press, Berkeley, 1999)Google Scholar
  15. 15.
    A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, edited by R.H. Campbell, A.S. Skinner, W.B. Todd (Oxford University Press, Oxford, 1976)Google Scholar
  16. 16.
    P.S. Laplace, in Philosophical Essay on Probabilities: Translated from the Fifth French Edition of 1825 with Notes by the Translator, edited by A.I. Dale (Springer, New York, 1995)Google Scholar
  17. 17.
    A. Quetelet, A Treatise on Man and the Development of his Faculties, edited by T. Smibert (Cambridge University Press, Cambridge 2013)Google Scholar
  18. 18.
    S. Galam, Y. Gefen, Y. Shapir, J. Math. Sociol. 9, 1 (1982)CrossRefGoogle Scholar
  19. 19.
    S. Galam, Sociophysics: A Physicist‗s Modeling of Psycho-political Phenomena (Springer, Berlin, 2012)Google Scholar
  20. 20.
    B. Ingrao, I. Israel, The Invisible Hand: Economic Equilibrium in the History of Science (MIT Press, Cambridge MA, 1990)Google Scholar
  21. 21.
    J.D. Farmer, J. Geanakoplos, Complexity 14, 11 (2009)MathSciNetCrossRefGoogle Scholar
  22. 22.
    D. Sornette, Rep. Prog. Phys. 77, 062001 (2014)ADSCrossRefGoogle Scholar
  23. 23.
    V. Pareto, in Oeuvres Complètes de Vilfredo Pareto, edited by G. Busino (Librairie Droz, Geneva, 1981)Google Scholar
  24. 24.
    B. Mandelbrot, The Fractal Geometry of Nature (W.H. Freeman, San Francisco, 1982)Google Scholar
  25. 25.
    P. Bak, How Nature Works: The Science of Self-organized Criticality (Copernicus, New York, 1996)Google Scholar
  26. 26.
    D. Sornette, Critical Phenomena in Natural Sciences, Chaos, Fractals, Self-organization and Disorder: Concepts and Tools, 2nd edn. (Springer, Berlin, 2004)Google Scholar
  27. 27.
    R. Perline, Stat. Sci. 20, 68 (2005)MathSciNetCrossRefGoogle Scholar
  28. 28.
    A. Clauset, C.R. Shalizi, M.E.J. Newman, SIAM Rev. 51, 661 (2009)ADSMathSciNetCrossRefGoogle Scholar
  29. 29.
    L. Bachelier, in Louis Bachelier‗s Theory of Speculation: The Origins of Modern Finance, edited by M. Davis, A. Etheridge (Princeton University Press, Princeton NJ, 2011)Google Scholar
  30. 30.
    A. Einstein, Ann. Phys. 322, 549 (1905)CrossRefGoogle Scholar
  31. 31.
    M.F.M. Osborne, Oper. Res. 7, 145 (1959)CrossRefGoogle Scholar
  32. 32.
    P.A. Samuelson, Indust. Manag. Rev. 7, 41 (1965)Google Scholar
  33. 33.
    H. Markowitz, J. Finance 7, 77 (1952)Google Scholar
  34. 34.
    W.F. Sharpe, J. Finance 19, 425 (1964)Google Scholar
  35. 35.
    F. Black, M. Scholes, J. Polit. Economy 81, 637 (1973)MathSciNetCrossRefGoogle Scholar
  36. 36.
    R. Merton, Bell J. Econ. 4, 141 (1973)MathSciNetCrossRefGoogle Scholar
  37. 37.
    A.W. Lo, M.T. Mueller, J. Portfolio Manage. 8, 13 (2010)Google Scholar
  38. 38.
    P.A. Samuelson, Foundations of Economic Analysis (Harvard University Press, Cambridge MA, 1947)Google Scholar
  39. 39.
    J.D. Farmer, J. Econ. Methodol. 20, 377 (2013)CrossRefGoogle Scholar
  40. 40.
    Y.C. Zhang, Europhys. News 29, 51 (1998)Google Scholar
  41. 41.
    H.E. Stanley, L.A.N. Amaral, D. Canning, P. Gopikrishnan, Y. Lee, Y. Liu, Physica A 269, 156 (1999)ADSCrossRefGoogle Scholar
  42. 42.
    H. Takayasu, H. Miura, T. Hirabayashi, K. Hamada, Physica A 184, 127 (1992)ADSCrossRefGoogle Scholar
  43. 43.
    J.P. Bouchaud, D. Sornette, J. Phys. I France 4, 863 (1994)CrossRefGoogle Scholar
  44. 44.
    D. MacKenzie, An Engine, Not a Camera: How Financial Models Shape Financial Markets (MIT Press, Cambridge MA, 2006)Google Scholar
  45. 45.
    R.J. Shiller, Am. Econ. Rev. 71, 421 (1981)Google Scholar
  46. 46.
    R.J. Shiller, Market Volatility (MIT Press, Cambridge MA, 1989)Google Scholar
  47. 47.
    S.F. LeRoy, R.D. Porter, Econometrica 49, 555 (1981)CrossRefGoogle Scholar
  48. 48.
    P. Krugman, The Self-Organizing Economy, 2nd edn. (Wiley-Blackwell, Oxford, 1996)Google Scholar
  49. 49.
    W.B. Arthur, Am. Econ. Rev. 84, 406 (1994)Google Scholar
  50. 50.
    J. Voit, The Statistical Mechanics of Financial Markets (Springer, Berlin, 2005)Google Scholar
  51. 51.
    R.N. Mantegna, H.E. Stanley, Introduction to Econophysics: Correlations and Complexity in Finance (Cambridge University Press, Cambridge, 2000)Google Scholar
  52. 52.
    R. Cont, Quant. Finance 1, 223 (2001)CrossRefGoogle Scholar
  53. 53.
    A. Chakraborti, I.M. Toke, M. Patriarca, F. Abergel, Quant. Finance 11, 991 (2011)MathSciNetCrossRefGoogle Scholar
  54. 54.
    J.P. Bouchaud, M. Potters, Theory of Financial Risk and Derivative Pricing: From Statistical Physics to Risk Management, 2nd edn. (Cambridge University Press, Cambridge, 2003)Google Scholar
  55. 55.
    B. Mandelbrot, Quart. J. Econ. 76, 57 (1962)CrossRefGoogle Scholar
  56. 56.
    B. Mandelbrot, J. Bus. 36, 394 (1963)CrossRefGoogle Scholar
  57. 57.
    B. Mandelbrot, J. Bus. 39, 242 (1966)CrossRefGoogle Scholar
  58. 58.
    E.F. Fama, J. Bus. 36, 420 (1963)CrossRefGoogle Scholar
  59. 59.
    E.F. Fama, Manag. Sci. 11, 404 (1965)CrossRefGoogle Scholar
  60. 60.
    P.A. Samuelson, J. Finan. Quant. Anal. 2, 107 (1967)CrossRefGoogle Scholar
  61. 61.
    J.P. Bouchaud, D. Sornette, C. Walter, J.P. Aguilar, Int. J. Theor. Appl. Finance 1, 25 (1998)CrossRefGoogle Scholar
  62. 62.
    P.H. Cootner, The Random Character of Stock Market Prices (MIT Press, Cambridge MA, 1964)Google Scholar
  63. 63.
    D. Colander, M. Goldberg, A. Haas, K. Juselius, A. Kirman, T. Lux, B. Sloth, Crit. Rev. 21, 249 (2009)CrossRefGoogle Scholar
  64. 64.
    J.L. McCauley, Dynamics of Markets: Econophysics and Finance (Cambridge University Press, Cambridge, 2004)Google Scholar
  65. 65.
    S. Keen, Physica A 324, 108 (2003)ADSCrossRefGoogle Scholar
  66. 66.
    M. Gallegati, S. Keen, T. Lux, P. Ormerod, Physica A 370, 1 (2006)ADSMathSciNetCrossRefGoogle Scholar
  67. 67.
    P. Ball, Nature 441, 686 (2006)ADSCrossRefGoogle Scholar
  68. 68.
    J.B. Rosser, J. Econ. Perspect. 13, 169 (1999)CrossRefGoogle Scholar
  69. 69.
    T.C. Schelling, Am. Econ. Rev. 59, 488 (1969)Google Scholar
  70. 70.
    T.C. Schelling, J. Math. Sociol. 1, 143 (1971)CrossRefGoogle Scholar
  71. 71.
    T.C. Schelling, Micromotives and Macrobehavior (W.W. Norton, New York, 1978)Google Scholar
  72. 72.
    R. Frigg, J. Reiss, Synthese 169, 593 (2009)MathSciNetCrossRefGoogle Scholar
  73. 73.
    J.M. Epstein, Generative Social Science: Studies in Agent-Based Computational Modeling (Princeton University Press, Princeton NJ, 2006)Google Scholar
  74. 74.
    Z. Burda, J. Jerzy, M.A. Nowak, Acta Phys. Pol. B 34, 87 (2003)ADSGoogle Scholar
  75. 75.
    K. Arrow, P. Anderson, D. Pines (eds.), The Economy as an Evolving Complex System (Addison Wesley, Reading MA, 1988)Google Scholar
  76. 76.
    W.B. Arthur, S. Durlauf, D. Lane (eds.), The Economy as an Evolving Complex System II (Addison Wesley, Reading MA 1997)Google Scholar
  77. 77.
    L. Blume, S. Durlauf (eds.), The Economy as an Evolving Complex System III (Oxford University Press, New York, 2006)Google Scholar
  78. 78.
    P.W. Anderson, Science 177, 393 (1972)ADSCrossRefGoogle Scholar
  79. 79.
    J.M. Coates, The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust (Penguin Press, New York, 2012)Google Scholar
  80. 80.
    D. Sornette, Why Stock Markets Crash: Critical Events in Complex Financial Systems (Princeton University Press, Princeton NJ, 2003)Google Scholar
  81. 81.
    T. Kaizoji, D. Sornette, in Encyclopedia of Quantitative Finance, edited by R. Cont (John Wiley and Sons, Hoboken NJ, 2010) (long version at http://arXiv.org/abs/0812.2449)
  82. 82.
    S. Durlauf, Econ. J. 115, F225 (2005)CrossRefGoogle Scholar
  83. 83.
    W.B. Arthur, in Complexity and the Economy, edited by W.B. Arthur (Oxford University Press, New York, 2014)Google Scholar
  84. 84.
    D.A. Hsieh, J. Bus. 62, 339 (1989)CrossRefGoogle Scholar
  85. 85.
    D.A. Hsieh, Financ. Anal. J. 51, 55 (1995)CrossRefGoogle Scholar
  86. 86.
    D. Sornette, P. Cauwels, Rev. Behav. Econ. 2, 279 (2015)CrossRefGoogle Scholar
  87. 87.
    A. Hüsler, D. Sornette, C.H. Hommes, J. Econ. Behav. Organ. 92, 304 (2013)CrossRefGoogle Scholar
  88. 88.
    T. Kaizoji, M. Leiss, A. Saichev, D. Sornette, J. Econ. Behav. Org. 112, 289 (2015)CrossRefGoogle Scholar
  89. 89.
    M. Leiss, H.H. Nax, D. Sornette, J. Econ. Dyn. Control 55, 1 (2015)CrossRefGoogle Scholar
  90. 90.
    D. Sornette, Physica A 284, 355 (2000)ADSMathSciNetCrossRefGoogle Scholar
  91. 91.
    A. Johansen, D. Sornette, O. Ledoit, J. Risk 1, 5 (1999)CrossRefGoogle Scholar
  92. 92.
    A. Johansen, O. Ledoit, D. Sornette, Int. J. Theor. Appl. Finance 3, 219 (2000)Google Scholar
  93. 93.
    Z.Q. Jiang, W.X. Zhou, D. Sornette, R. Woodard, K. Bastiaensen, P. Cauwels, J. Econ. Behav. Organ. 74, 149 (2010)CrossRefGoogle Scholar
  94. 94.
    D. Sornette, R. Woodard, W. Yan, W.X. Zhou, Physica A 392, 4417 (2013)ADSCrossRefGoogle Scholar
  95. 95.
    D. Sornette, P. Cauwels, J. Risk Manag. Finan. Institutions 8, 83 (2015)CrossRefGoogle Scholar
  96. 96.
    D. Sornette, Phys. World 15, 50 (2002)CrossRefGoogle Scholar
  97. 97.
    D.T. Campbell, in Studies in the Philosophy of Biology, edited by F.J. Ayala, T. Dobzhansky (University of California Press, Berkley, 1974)Google Scholar
  98. 98.
    G.F.R. Ellis, T. Roy. Soc. S. Afr. 63, 69 (2008)CrossRefGoogle Scholar
  99. 99.
    U. Frisch, Turbulence: The Legacy of A. N. Kolmogorov (Cambridge University Press, Cambridge, 1996)Google Scholar
  100. 100.
    N. Goldenfeld, Lectures on Phase Transitions and the Renormalization Group (Addison-Wesley, Boston, 1992)Google Scholar
  101. 101.
    D. Delli Gatti, E. Gaffeo, M. Gallegati, G. Giulioni, A. Palestrini, Emergent Macroeconomics: An Agent-Based Approach to Business Fluctuations (Springer, Milan, 2008)Google Scholar
  102. 102.
    R. Cont, in Fractals in Engineering, edited by J. Lévy-Véhel, E. Lutton (Springer, London, 2005)Google Scholar
  103. 103.
    M. Gallegati, in Econophysics of Markets and Business Networks, edited by B.K. Chakrabarti, T. Kaizoji, Y. Wang, Y. Fujiwara, S. Sinha, J. Mimkes (Springer, Milan, 2007)Google Scholar
  104. 104.
    W. Hildebrand, A. Kirman, Equilibrium Analysis: Variations on the Themes by Edgeworth and Walras (North-Holland, Amsterdam, 1988)Google Scholar
  105. 105.
    D. Sornette, P. Cauwels, Risks 2, 103 (2014)CrossRefGoogle Scholar
  106. 106.
    M. Friedman, Essays in Positive Economics (University of Chicago Press, Chicago, 1953)Google Scholar
  107. 107.
    D.M. Cutler, J.M. Poterba, L.H. Summers, J. Portfolio Manage. 15, 4 (1989)CrossRefGoogle Scholar
  108. 108.
    D.M. Cutler, J.M. Poterba, L.H. Summers, Rev. Econ. Stud. 58, 529 (1991)CrossRefGoogle Scholar
  109. 109.
    J.A. Schumpeter, Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process (McGraw-Hill, New York, 1939)Google Scholar
  110. 110.
    P. Mirowski, More Heat than Light: Economics as Social Physics, Physics as Nature‗s Economics (Cambridge University Press, Cambridge 1991)Google Scholar
  111. 111.
    C. Schinckus, Quant. Finance 12, 1189 (2012)MathSciNetCrossRefGoogle Scholar
  112. 112.
    C. Schinckus, Contemp. Phys. 54, 17 (2013)ADSCrossRefGoogle Scholar
  113. 113.
    A. Chakraborti, I.M.T. Patriarca, F. Abergel, Quant. Finance 11, 991 (2011)MathSciNetCrossRefGoogle Scholar
  114. 114.
    P. Bak, M. Paczuski, M. Shubik, Physica A 246, 430 (1997)ADSCrossRefGoogle Scholar
  115. 115.
    S. Mike, J.D. Farmer, J. Econ. Dynam. Control 32, 1 (2008)CrossRefGoogle Scholar
  116. 116.
    Y. Yura, H. Takayasu, D. Sornette, M. Takayasu, Phys. Rev. Lett. 112, 098703 (2014)ADSCrossRefGoogle Scholar
  117. 117.
    Y. Yura, H. Takayasu, D. Sornette, M. Takayasu, Phys. Rev. E 92, 042811 (2015)ADSCrossRefGoogle Scholar
  118. 118.
    J.D. Farmer, P. Patelli, I.I. Zovko, Proc. Natl. Acad. Sci. USA 102, 2254 (2005)ADSCrossRefGoogle Scholar
  119. 119.
    B. LeBaron, in Handbook of Computational Economics Volume II: Agent-Based Computational Economics, edited by L. Tesfatsion, K.L. Judd (North-Holland, Amsterdam, 2006)Google Scholar
  120. 120.
    T. Lux, M. Marchesi, Nature 397, 498 (1999)ADSCrossRefGoogle Scholar
  121. 121.
    T. Lux, M. Marchesi, Int. J. Theor. Appl. Finance 3, 675 (2000)MathSciNetCrossRefGoogle Scholar
  122. 122.
    T. Lux, Working Paper No. 1425, University of Kiel, 2008Google Scholar
  123. 123.
    W.X. Zhou, D. Sornette, Eur. Phys. J. B 55, 175 (2007)ADSMathSciNetCrossRefGoogle Scholar
  124. 124.
    G. Harras, D. Sornette, J. Econ. Behav. Organ. 80, 137 (2011)CrossRefGoogle Scholar
  125. 125.
    H.A. Simon, in Proceedings of the American Philosophical Society 106, 467 (1962)Google Scholar
  126. 126.
    D. Sornette, in Extreme Events in Nature and Society, edited by S. Albeverio, V. Jentsch, H. Kantz (Springer, Berlin, 2005)Google Scholar
  127. 127.
    A. Joulin, A. Lefevre, D. Grunberg, J.P. Bouchaud, Wilmott Magazine 46 (Sept./Oct. 2008)Google Scholar
  128. 128.
    J.P. Bouchaud, in Lessons from the 2008 Crisis, edited by A. Berd (Risk Books, Incisive Media, London, 2011)Google Scholar
  129. 129.
    J.P. Bouchaud, Procedia Comput. Sci. 7, 22 (2011)CrossRefGoogle Scholar
  130. 130.
    A. Johansen, D. Sornette, in Contemporary Issues in International Finance, edited by F. Columbus (Nova Science, New York, 2004)Google Scholar
  131. 131.
    V. Filimonov, D. Sornette, Phys. Rev. E 85, 056108 (2012)ADSCrossRefGoogle Scholar
  132. 132.
    V. Filimonov, D. Bicchetti, N. Maystre, D. Sornette, J. Int. Money Finance 42, 174 (2014)CrossRefGoogle Scholar
  133. 133.
    A. Johansen, D. Sornette, J. Risk 4, 69 (2001)CrossRefGoogle Scholar
  134. 134.
    A. Johansen, D. Sornette, Cah. Econ. Bruxelles 53, 201 (2010)Google Scholar
  135. 135.
    D. Sornette, Phys. Rep. 378, 1 (2003)ADSMathSciNetCrossRefGoogle Scholar
  136. 136.
    D. Sornette, Int. J. Terraspace Sci. Eng. 2, 1 (2009)Google Scholar
  137. 137.
    D. Sornette, G. Ouillon, Eur. Phys. J. Special Topics 205, 1 (2012)ADSCrossRefGoogle Scholar
  138. 138.
    A.W. Lo, J. Econ. Lit. 50, 1 (2012)CrossRefGoogle Scholar
  139. 139.
    D. Sornette, Y. Malevergne, J.F. Muzy, Risk 16, 67 (2003)Google Scholar
  140. 140.
    V. Filimonov, D. Sornette, Quant. Finance 15, 1293 (2015)MathSciNetCrossRefGoogle Scholar
  141. 141.
    S. Wheatley, V. Filimonov, D. Sornette, Comput. Stat. Data Analysis 94, 120 (2016)CrossRefGoogle Scholar
  142. 142.
    P. Krugman, Eastern Econ. J. 37, 307 (2011)CrossRefGoogle Scholar
  143. 143.
    D.J. Bezemer, J. Econ. Issues 45, 1 (2011)CrossRefGoogle Scholar
  144. 144.
    C.F. Camerer, G. Loewenstein, M. Rabin (eds.), Advances in Behavioral Economics (Princeton University Press, Princeton NJ, 2003)Google Scholar
  145. 145.
    R.J. Shiller, J. Econ. Perspect. 17, 83 (2003)CrossRefGoogle Scholar
  146. 146.
    R.H. Thaler (ed.), Advances in Behavioral Finance: Volume II (Princeton University Press, Princeton NJ, 2005)Google Scholar
  147. 147.
    J.D. Farmer, Indust. Corp. Change 11, 895 (2002)CrossRefGoogle Scholar
  148. 148.
    C.H. Hommes, Quant. Finance 1, 149 (2001)MathSciNetCrossRefGoogle Scholar
  149. 149.
    A.W. Lo, J. Portfolio Manag. 30, 15 (2004)CrossRefGoogle Scholar
  150. 150.
    A.W. Lo, J. Invest. Consulting 7, 21 (2005)Google Scholar
  151. 151.
    A.W. Lo, Financ. Anal. J. 68, 18 (2012)CrossRefGoogle Scholar
  152. 152.
    S. Cincotti, D. Sornette, P. Treleaven, S. Battiston, G. Caldarelli, C. Hommes, A. Kirman, Eur. J. Phys. Special Topics 214, 361 (2012)ADSCrossRefGoogle Scholar
  153. 153.
    H.L.D. de S. Cavalcante, M. Oriá, D. Sornette, E. Ott, D.J. Gauthier, Phys. Rev. Lett. 111, 198701 (2013)ADSCrossRefGoogle Scholar

Copyright information

© EDP Sciences and Springer 2016

Authors and Affiliations

  1. 1.ETH Zurich, Department of Management, Technology and EconomicsZurichSwitzerland
  2. 2.Swiss Finance InstituteCase Postale 3 1211 Geneva 4Switzerland

Personalised recommendations