Econophysics embodies the recent upsurge of interest by physicists into financial economics, driven by the availability of large amount of data, job shortage in physics and the possibility of applying many-body techniques developed in statistical and theoretical physics to the understanding of the self-organizing economy. This brief historical survey emphasizes that Econophysics has many historical precursors, and is in fact rooted in a continuous cross-fertilization between economics and physics that has been active in the last centuries.
Deep Dive into Econophysics: historical perspectives.
Econophysics embodies the recent upsurge of interest by physicists into financial economics, driven by the availability of large amount of data, job shortage in physics and the possibility of applying many-body techniques developed in statistical and theoretical physics to the understanding of the self-organizing economy. This brief historical survey emphasizes that Econophysics has many historical precursors, and is in fact rooted in a continuous cross-fertilization between economics and physics that has been active in the last centuries.
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Book
Encyclopedia of Quantitative Finance, edited by Rama Cont
www.wiley.com/go/eqf
Section
History of Quantitative Modeling in Finance (1st section out of 21), edited by Perry
Mehrling and Murad Taqqu
Entry
Econophysics: historical perspectives
By Gilles Daniel and Didier Sornette
Title: Econophysics: historical perspectives
Contributors: Gilles Daniel and Didier Sornette
Affiliation: ETH Zurich, Chair of Entrepreneurial Risks, Department of
Management, Technology and Economics, Zurich
Keywords: Econophysics, history, multi-collisions, random walks, diffusion,
Bachelier, Einstein, Pareto, Samuelson, Mandelbrot, Fama
Abstract: Econophysics embodies the recent upsurge of interest by physicists into
financial economics, driven by the availability of large amount of data, job shortage in
physics and the possibility of applying many-body techniques developed in statistical
and theoretical physics to the understanding of the self-organizing economy. This
brief historical survey emphasizes that Econophysics has many historical precursors,
and is in fact rooted in a continuous cross-fertilization between economics and
physics that has been active in the last centuries.
Main text
The term Econophysics was introduced circa 1994, endorsed in 1999 by the
publication of its founding book, Mantegna-Stanley’s “An Introduction to
Econophysics” (1999). The word “econophysics” suggests that there is a physical
approach to economics, perhaps even that economics can be rooted in physics,
paralleling the quests of biophysics or geophysics.
Indeed, all along its developments, from classical to neo-classical economics and till
the present time, economists have been inspired by the conceptual and mathematical
developments of the physical sciences and by their remarkable successes in describing
and predicting natural phenomena. Reciprocally, physics has been enriched several
times by developments first observed in economics. Well before the christening of
econophysics as the incarnation of the multidisciplinary study of complex large-scale
financial and economic systems, a multiple of small and large collisions have
punctuated the development of these two fields. Let us now mention a few that
illustrate the remarkable commonalities and inter-fertilization.
In his “Inquiry into the Nature and Causes of the Wealth of Nations” (1776), Adam
Smith found inspiration in the Philosophiae Naturalis Principia Mathematica (1687)
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of Isaac Newton, specifically based on the (novel at the time) notion of causative
forces.
The recognition of the importance of feedbacks to fathom the sheer complexity of
economic systems has been at the root of economic thinking for a long time. Towards
the end of the 19th century, the microeconomists Francis Edgeworth and Alfred
Marshall drew on some of the ideas of physicists to develop the notion that the
economy achieves an equilibrium state like that described for gases by Clerk Maxwell
and Ludwig Boltzmann. The general equilibrium theory now at the core of much of
economic thinking is nothing but a formalization of the idea that “everything in the
economy affects everything else” (Krugman, 1996), reminiscent of mean-field theory
or self-consistent effective medium methods in physics, but emphasizing and
transcending these ideas much beyond their initial sense in physics.
While developing the field of microeconomics in his “Cours d’Economie Politique”
(1897), the economist and philosopher Vilfredo Pareto was the first to describe, for
the distribution of incomes, the eponym power-laws that would later become the
center of attention of Physicists and other scientists observing this remarkable and
universal statistical signature in the distribution of event sizes (earthquakes,
avalanches, landslides, storms, forest fires, solar flares, commercial sales, war sizes,
and so on) punctuating so many natural and social systems [Mandelbrot, 1982; Bak,
1996; Newman, 2005; Sornette, 2006].
While attempting to model the erratic motion of bonds and stock options in the Paris
Bourse in 1900, mathematician Louis Bachelier developed the mathematical theory of
diffusion (and the first elements of financial option pricing) and solved the parabolic
diffusion equation five years before Albert Einstein (1905) established the theory of
Brownian motion based on the same diffusion equation (also underpinning the theory
of random walks). The ensuing modern theory of random walks now constitutes one
of the fundamental pillars of theoretical physics and economics and finance models.
In the early 1960s, mathematician Benoit Mandelbrot (1963) pioneered the use in
Financial Economics of heavy-tailed distributions (Lévy stable laws) as opposed to
the traditional Gaussian (Normal) law. A cohort of economists, notably at the
University of Chicago (Merton Miller, Eugene Fama, Richard Roll), at MIT (Paul
Samuelson) and at Carnegie Mellon
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