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When laws of physics, markets collide

Marketplace Staff Jul 3, 2007

When laws of physics, markets collide

Marketplace Staff Jul 3, 2007


Doug Krizner: There certainly has been a lot of volatility in the stock market lately, and the key to understanding it may be econophysics. That’s where physics is used to solve problems in economics. This week physicists and economists are meeting Lisbon to discuss its usefulness, as Geoff Brumfiel reports.

[ Sound of New York Stock Exchange’s opening bell, traders on the floor]

Geoff Brumfiel: When most people hear that sound, they think of individual traders buying and selling stocks. But not Boston University physicist Gene Stanley. He thinks of data.

Gene Stanley: You can imagine the total number of transactions that takes place in even one market like the New York Stock Exchange per hour and then multiply that by the number of hours in a day and days in a week and weeks in a month and months in a year and so forth. You get a staggering amount of data.

Now, physicists like Stanley love data. It’s not uncommon for them to gather information on, say, trillions of colliding particles. And once they get their data, they start looking for things.

Stanley: We try to extract from a mass of data some sort of regularity, some sort of pattern that is valid.

Economists do similar things, but not on the same scale that physicists can. About a decade ago, Stanley combed through mountains of trades over a span of years to find patterns in world markets. He turned up a new statistical way to describe not just little market fluctuations, but the rare big correction.

Now, he couldn’t predict when or where exactly a crash would occur. But he could help people better understand how to spread their investment portfolio risk.

And that impressed Princeton economist Jose Scheinkman.

Jose Scheinkman: They brought the way the physicists analyze data, which is an interesting way, an important way, but mixed that with what economists know about how markets work.

But physicists have also made missteps, like coming up with rules to predict the next big crash. Those efforts have, for the most part, flopped.

Scheinkman says he thinks this is because markets are driven by people, who are, well, unpredictable.

Scheinkman: The main flop is just trying to fit data to kinda equations without thinking that that data was being generated by the action of human beings.

This week’s conference in Lisbon may help. Economists and physicists will talk about how people drive markets. And of course, there will be plenty of port wine on hand. That can help even the most predictable physicist become a little more erratic.

In Washington, I’m Geoff Brumfiel for Marketplace.

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