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Economics: Rethink or Sink

Economics: Rethink or Sink. Edward Tsang Acknowledgement: Much of the idea here came from Richard Olsen. Classical Economics. To model economy and prices mathematically Start with assumptions Results follow Robust… … as long as the assumptions hold….

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Economics: Rethink or Sink

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  1. Economics:Rethink or Sink Edward Tsang Acknowledgement: Much of the idea here came from Richard Olsen

  2. Classical Economics • To model economy and prices mathematically • Start with assumptions • Results follow • Robust… • … as long as the assumptions hold…

  3. “If I were the queen of France, I shall give you 1 million Euro” “If you give me a fish, I shall sing you a song”

  4. A Shaky Castle • Classical economics built on critical assumptions • Everybody is perfectly rational • Homogeneity • Computation is ignored Market has changed!

  5. How RATIONAL are we?

  6. Which Option Will You Take?

  7. Which Option Will You Take? £100 now £10 per month for 12 months …

  8. What Is Your Move? • What is the optimal move? • Rules are clearly defined • No hidden information • Shouldn’t a rational player pick the optimal move? • Problem: too much to compute!

  9. What is Rationality? • Some decisions require computation • Some computation methods are better than others • Does it mean that some are more rational than others? • If so, the statement “investors are rational” is ambiguous

  10. Dubious Assumptions • “Investors are rational”? • “Investors are homogeneous” • Computation matters but ignored … but are they close enough?

  11. Changes In The Market New Instruments e.g. Options, CFDs Stock Exchange

  12. The Amazon Butterfly Effect • Movements amplified • By increased leverage • By algorithmic trading • Chain reactions • One reaction causes more reactions

  13. Markets have changedNow what? Can we study market as a hard science?

  14. The “Biology” of Markets (Richard Olsen) • How was biology studied? • Observe • Copy • Measure • Generalize • …

  15. How Long is a Coastline?

  16. Market Physics How much weight can we put on various positions? We don’t know where people might add weights But we can study the consequences of possible actions!

  17. A Wiki-style repository of software for studying finance Data (FX rates, stock prices, interest rates, etc) Users upload / retrieve modules modules implementing models and operations Interactionbetween modules Web-based Open-source Possibly through machine learning Computer Scientist Exchanges Economist

  18. Concluding Summary • Classical economics build castles on sand • Due to unrealistic assumptions • The ground has moved • The castle is sinking • New approaches needed: • Remove unrealistic assumptions • Treat market as hard science • Infrastructure required

  19. “The Economic Crisis is a Crisis for Economic Theory” Alan Kirman CESifo Economic Studies, Vol.56, Issue 4, 2010, pp.498-535

  20. Want more? This video: http://youtu.be/zIkHjo1ubpg More info: http://www.bracil.net/finance/HFF/brief_intro.html Edward Tsang: http://edward.bracil.net/

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