Economics: Rethink or Sink

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Presentation transcript:

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…

“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”

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

How RATIONAL are we?

Which Option Will You Take?

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

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!

Computational Finance and Economics, Tutorial 27/04/2018 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 Edward Tsang, All Rights Reserved

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

Computational Finance and Economics, Tutorial 27/04/2018 Changes In The Market Stock Exchange New Instruments e.g. Options, CFDs Edward Tsang, All Rights Reserved

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

Markets have changed Now what? Can we study market as a hard science?

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

How Long is a Coastline?

Market Physics We don’t know where people might add weights 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!

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

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

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

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/