A site of endless curiosity

Posts Tagged ‘Physics Envy

Physics Envy and the Taxonomy of Uncertainty

with one comment

What is Physics Envy and who has it?

Physics Envy is what Economists and Financial analysts get when they find out what physicists can do.  Physicists have a model, a collection of mathematical formulas and, with a set of initial conditions, they can (essentially) predict the future.  At least predict the future to a level of practical utility, certainty, and repeatability that they can land a man on the Moon and get some rovers to Mars.

Wow!  Even though Econ and Finance folks have models and they can crank a lot of math they can’t do that in their discipline.  When Econ and Finance people turn the crank on their models they don’t get much of anything – at least anything for the predictability of  financial markets at the level of certainty that would be the analogue of getting a man on the moon, a rover to Mars, landing an Intercontinental Ballistic Missile to within a 1/2 mile of target from the other side of the globe launched from an underwater submarine, or predicting an eclipse of the sun a millennium into the future to an accuracy of about 1 minute.  Why?  Why can’t Econ and finance folks crank this level of certainty?

Overconfidence in models for financial markets

Not that economists and finance folks have not tried to do what physicists have accomplished.  In fact, they have tried.  And they believe in the model and the math.  But the results predicted by the  model don’t always fit the facts (Reality is a bummer).  You might want to ponder if the financial crises of the past, present, and perhaps into the future are caused by an overconfidence on the part of economists, finance folks, and those that push the great levers of federal and global financial policy who believe in these models and that they can predict the future or know the future  in the same way as Classical Newtonian Physics.

To cite just one example, the Efficient Market Hypothesis.

Those who defend quants insist that markets are efficient and the actions of arbitrageurs impose certain mathematical relationships among prices that can be modeled, measured, and managed. Is finance a science or an art?

Richard Feynman knows

So, here is the rub, from Nobel Prize winning Physicist Richard Feynman

Imagine how much harder physics would be if electrons had feelings!
– Richard Feynman, speaking at a Caltech graduation ceremony

That’s exactly to the point.  Economics and finance are about people – not the laws of nature.  People have feelings, make mistakes, are driven by emotions, and are fallible..  They are not predictable as are billiard balls or planets.   This is why models in finance or economics  will never reach the level of certainty of Physics.  Thus, Physics Envy.  To skin these cats ( all deference to Schrödinger’s cat ) requires a careful and rigorous understanding of uncertainty.

Taxonomy of Uncertainty

All of this cames from (or at least the first I heard of it) was a lecture delivered at the MIT Innovations in Management Conference back in 2007.  I recently found that a new draft (March 2010) of a paper on this subject is now available ( link at the end of this posting)

This paper is long (74) pages but it is a good read especially if you can remember some high school physics on Hooke’s Law for springs and simple harmonic motion.  The authors use this simple physics example (block of mass M on a frictionless 1-D surface connected to a spring  attached to a wall with the system obeying Hooke’s Law – a fully deterministic system) to demonstrate how adding “noise” (unknowns) into the system can take a model that is capable of predicting to complete certainty down to nothing.  What is the “noise” in the system?  Take it as Feynman’s “electrons with feelings” – people and this idea of (see below) “Reflexivity”.

Taxonomy of Uncertainty
1: Complete Certainty
2: Risk without Uncertainty
3: Fully Reducible Uncertainty
4: Partially Reducible Uncertainty
5: Irreducible Uncertainty
∞: Zen Uncertainty

Here is a little more meat from the paper
Read the rest of this entry »

Written by frrl

November 23, 2010 at 7:04 pm

%d bloggers like this: