Physics, Financial Models, and Predicting the Unpredictable

This essay is principally a review of the book The Physics of Wall Street: A Brief History of Predicting the Unpredictable, 2012, James Owen Weatherall. The first part of the review summarises the key individuals from physics that have made a contribution to financial economics. I then touch briefly on a negative review of Weatherall’s book, noting the complete omission of the important contributions made by non-physicists. The review then turns to a controversial topic – whether models can or should be used when there are extreme and seemingly unpredictable events (“Black Swans”). The thesis of the book is that the assumptions underlying models need to be understood, the models need to be regularly tested, and that better models can be built. Rupture models have been empirically shown to predict when crises will occur, turning the unpredictable Black Swans into predictable “Dragon Kings”). I conclude with some personal comments.

Selected Contributions by Physicists to Financial Economics

In The Physics of Wall Street: A Brief History of Predicting the Unpredictable, 2012, James Owen Weatherall provides a very interesting, if selective, history of the contribution of physicists to quantitative finance. Key contributors covered in the book are: