Review The Misbehavior of Markets

Regarding applications in finance, there are some traders out there using fractal strategies, and this book brings some sense to it and a growing interest to continue exploring the area. One would think they were entirely man-made, about as far removed as you could get from the laws that govern nature. Yet if you look closely enough at the kind of share price charts that you might see online or in newspapers – as Mandelbrot certainly has – you might be in for a surprise. There are nobel prizes awarded to the developers of them.

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The theory goes that the markets already consolidate all the information available to them, so that price already incorporates all the information available to the market. From there, we get the random walk theory — that prices will move in a random fashion, so that each price move is basically the flip of a coin. The math for doing this seems very sophisticated, and variations on these approaches have served as the backbone for the financial industry. Mandelbrot lends his name to this pop sci title which elaborates on how fractal theory can be applied to modelling financial markets.

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Edger Peters, another asset manager believes in fractals and has written two books on them. However he does not use them in his funds as he says that his conservative clientele were not interested. In the hindsight of so many crisis that have happened, conservative clientele should have been more than interested in fractals as it comes close to actually explaining the market behavior. The authors talk about three pillars of modern finance that is taught all over the universities, i.e. CAPM, MPT,BSM. The first was developed by Markowitz, the second by Sharpe and the third by Fischer Black,Myron Scholes and Robert Merton.

And second, the number of events taking place in the tails is underestimated; the bell curve assumed is far too simplistic for modeling actual market returns. This book was published in 2004 and the author criticizes VAR at length. The author is somewhat pleased that Extreme value theory is being used by some people for risk management. However he says that Long memory behavior is not being incorporated in to such theories. CAPM or its variants are all driven by mild randomness assumptions.

I thoroughly enjoyed the explanation of how the physics of wind turbulence were used to derive a blueprint for measuring Review The Misbehavior of Markets the turbulence or volatility in Markets. The realism of Mandelbrot’s philosophy is very enlightening.

As someone with no background in economics, I found this book really interesting and thankfully it provides just about enough explanation to make Review The Misbehavior of Markets sense of the technical jargon. Don’t be put off if you can’t tell a stock option from a swap, no prior knowledge is needed to enjoy this book.

The Random Walk Theory of prices does a half-decent job describing the behaviour of markets in general. But if you want to get specific, it does have a couple of key problems. First, it assumes price changes are independent of each other, which statistical studies have shown to be false.

Review The Misbehavior of Markets

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  • They would fool any professional “chartist.” Likewise, bubbles and crashes are inherent to markets.
  • Additionally, the charts of commodity prices, for example, will look the same as those of currency exchanges or the Dow Jones Industrial Average.
  • They are the inevitable consequence of the human need to find patterns in the patternless.
  • Instead of deviating from an average in a well-mannered linear way (as one might see in a Gaussian bell-shaped distribution) prices tend to rocket up and down according to a power law.

Perhaps this is due to his valiant conquest against the establishment. For the proponents of the efficient market hypothesis, modern portfolio theory, Black-Sholes model, the Sharpe ratio measure, random walk and many other orthodox theories the author gives the opportunity to think it over. I like when somebody succeeds in illustrating that life is not always arranged by the bell-curve.

Mandelbrot further expands on his revolutionary idea, the fractal, and asserts that the notion should be applied to modern financial frameworks. Mandelbrot concludes with a proposal that modern financiers adopt a multifractal model, which allows one to compare price variations across time while considering the pace of volatility in the market. For more than two decades Olsen and his team ( of mathematicians have been analyzing high frequency data. Olsen started his firm after having a sense of frustration with the way financial models have been modeled and used.

Review The Misbehavior of Markets

In conclusion, ‘The misbehavior of markets’ will change your perspective on the standard tools of finance. To his credit, Mandelbrot avoids any tricky financial mumbo-jumbo. Review The Misbehavior of Markets Many ideas, especially those related to the bell curve, may not sound altogether new to the reader, but that’s only because others have worn out Mandelbrot’s ideas.

Currently she is with Avendus Capital as “National Sales Head” for their Wealth Management business. She has in-depth knowledge on Financial Planning, Investment Management and Indian Stock Market & Economy and is a frequent speaker at various forums on these and related subjects. A Gold Medalist Electronics Engineer, she has an MBA from “The Indian School of Business, Hyderabad “.

For example, some are growth investors, who tend to buy stocks of companies that appear to be growing quickly in comparison to their competitors. Sometimes this even means paying somewhat higher prices or receiving no dividends for a period of time.

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CAPM dealt with dishing out portfolios to investors based on their risk appetite. MPT simplified CAPM and dished out a market portfolio, that later became the bedrock for index funds, and BSM was a framework for valuing options. The crux of each of the pillar goes back to Bachelier’s work. No one was willing to criticize the component of Brownian motion that was used in all these frameworks.

Mandelbrot seems to imply that they would; but I think it may be that he is so enamored of the magic of his fractals that he sees what he wants to see. Bubbles develop and burst and individual stocks have market values totally out of line with their assets, revenue and Review The Misbehavior of Markets profits. One had only to live through the go-go high tech market of the 1990s to know that. Mandelbrot claims that part of this inexplicably erratic behavior is due to the markets having a memory of sorts. He calls it “dependence,” an hitherto underappreciated quality.

Item 5 The Misbehavior Of Markets : A Fractal View Of Financial Turbulence By .. 5

It does not matter whether you have heard of the name of the author of the above two quotes, but it matters if you are dealing with finance and financial markets. The sole drawback could be the technical part where Mandelbrot gets into the nuts and bolts of the fractal theory. Unless you are well-versed with charts and graphs, the exercise to comprehend the fractals could prove cumbersome. Nonetheless, the wonkish part makes up less than 20% of the text, and you can still glean loads of wisdom from the rest of the book.