It's strange how I can read an article in The Economist about Benoit Mandelbrot's "multidisiplinary" approach that makes almost no mention of his work on Economics.
To be fair, most of the stuff that isn't pretty pictures goes past me. However, one thing he did do was completely eliminate the validity of the (Nobel-prize winning) Black-Scholes model.
So we have E. Fama (another Nobel prize winner) with his efficient market hypothesis, stating that in a perfectly rational market, prices are random. The loophole for economic theorists, and the basis for Black-Scholes, was that price variances were thought to be predictable. Prices were random, but their fluctuations were generally not, and could be modeled as a Gaussian distribution. Mandelbrot suggested that this a soothing inaccuracy: prices were capable of varying much more wildly than that. He suggested that a Pareto distribution was more accurate.
So then we have one of the more fundamental problems in Economics: it is not a science. It's more of a cult for math geeks, in my opinion. If you can't prove that markets follow a Pareto distribution (implying an unpredictably-random price volatility), then why should economists listen to you? Black-Scholes gives them partial results, and that's better than nothing, right?
To be fair, most of the stuff that isn't pretty pictures goes past me. However, one thing he did do was completely eliminate the validity of the (Nobel-prize winning) Black-Scholes model.
So we have E. Fama (another Nobel prize winner) with his efficient market hypothesis, stating that in a perfectly rational market, prices are random. The loophole for economic theorists, and the basis for Black-Scholes, was that price variances were thought to be predictable. Prices were random, but their fluctuations were generally not, and could be modeled as a Gaussian distribution. Mandelbrot suggested that this a soothing inaccuracy: prices were capable of varying much more wildly than that. He suggested that a Pareto distribution was more accurate.
So then we have one of the more fundamental problems in Economics: it is not a science. It's more of a cult for math geeks, in my opinion. If you can't prove that markets follow a Pareto distribution (implying an unpredictably-random price volatility), then why should economists listen to you? Black-Scholes gives them partial results, and that's better than nothing, right?
Right?
B. Mandelbrot: The Misbehavior of Markets: A Fractal View of Financial Turbulence http://www.amazon.com/Misbehavior-Markets-Fractal-Financial-...