Financial Market Complexity: What Physics Can Tell Us About Market Behaviour (Economics & Finance) [Hardcover]

Neil F. Johnson (Author), Paul Jefferies (Author), Pak Ming Hui (Author)

Book Description

ISBN-10: 0198526652 | ISBN-13: 978-0198526650 | Publication Date: September 4, 2003

Financial markets are a fascinating example of 'complexity in action': a real-world complex system whose evolution is dictated by the decisions of crowds of traders who are continually trying to win in a vast global 'game'. This book draws on recent ideas from the highly- topical science of complexity and complex systems, to address the following questions: how do financial markets behave? Why do financial markets behave in the way that they do? What can we do to minimize risk, given this behavior? Standard finance theory is built around several seemingly innocuous assumptions about market dynamics. This book shows how these assumptions can give misleading answers to crucially important practical problems such as minimizing financial risk, coping with extreme events such as crashes or drawdowns, and pricing derivatives. After discussing the background to the concept of complexity and the structure of financial markets in Chapter 1, Chapter 2 examines the assumptions upon which standard finance theory is built. Reality sets in which Chapter 3, where data from two seemingly different markets are analyzed and certain universal features uncovered which cannot be explained within standard finance theory. Chapters 4 and 5 mark a significant departure from the philosophy of standard finance theory, being concerned with exploring microscopic models of markets which are faithful to real market microstructure yet, which also reproduce real-world features. Chapter 6 moves to the practical problem of how to quantify and hedge risk in real world markets. Chapter 7 discusses deterministic descriptions of market dynamics, incorporating the topics of chaos and the all-important phenomenon of market crashes.

Editorial Reviews

Review

This book is a real gem ... very easy to digest ... I would recommend this book to philosophers who are coming to this field fresh. The explanations the authors give are well-suited to those coming to the material for the first time and, I think, to those versed in physics and a physics-type style of writing. Studies in History and Philosophy of Modern Physics 38 Overall, the book is distinguished by its lively and inspiring representation method. In combination with the wide spectrum of topics covered, these characteristics make this book a recommendable textbook. German Physics Society Journal

About the Author

Neil F. Johnson [e-mail] Clarendon Laboratory Parks Road Oxford OX1 3PU 01865 272287 fax [phone] Paul Jefferies [e-mail] Department of Physics Lincoln College Oxford OX1 3DR UK Pak Ming Hui Room 209 2nd Floor Science Centre North Block The Chinese University of Hong Kong Shatin, Hong Kong

Product Details

• Hardcover: 264 pages
• Publisher: Oxford University Press, USA (September 4, 2003)
• Language: English
• ISBN-10: 0198526652
• ISBN-13: 978-0198526650
• Product Dimensions: 9.5 x 6.5 x 0.8 inches
• Shipping Weight: 1.4 pounds (View shipping rates and policies)
• Average Customer Review: 5.0 out of 5 stars  See all reviews (2 customer reviews)
• Amazon Best Sellers Rank: #1,289,087 in Books (See Top 100 in Books)

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Most Helpful Customer Reviews

25 of 27 people found the following review helpful:

5.0 out of 5 stars Lucid, dense and sound econophysics book, June 1, 2004

By 

ws__ (Hamburg, Germany) - See all my reviews

This review is from: Financial Market Complexity: What Physics Can Tell Us About Market Behaviour (Economics & Finance) (Hardcover)

This book is written in a very dense fashion and should be compared to a math or physics text and obviously not to the advertised get rich quick books.

The style is very clear and very dense. The introduction says more about the financial market as many long texts. Also the definitions are precise and do contain content. Alone this introduction is worthwhile for anybody in the business of specifying a financial software system. It saves literally weeks of work.

As a next step a very dense overview of the "standard" finance theory is presented (first order Markov...). The authors even succeed to explain the Black Scholes option-pricing model in a few pages. I am very thankful for this.

The main impetus of the authors is to apply complexity theory to financial markets and get in return a good and existing example of a complex system. They look deeply into the limits of the independent and identical distributed probability function assumption. Also higher order correlations, the effect of competing and partly collaborating agents is discussed.

The text is accessible to most graduate students with a corresponding background in mathematics, physics ....

5.0 out of 5 stars Bottom up analysis of financial markets, March 15, 2010

By 

K. J. Broekema (Roosendaal Netherlands) - See all my reviews
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This review is from: Financial Market Complexity: What Physics Can Tell Us About Market Behaviour (Economics & Finance) (Hardcover)

This is a book for those who are familiar with the Black & Scholes formula and its use in hedging the risk of a portfolio of assets. It is well known that real financial markets do not behave according to the normal distribution on which the B&S formula is based.
A number of simple but realistic financial models are presented and their statistic properties analyzed. The most important model is based on the El Farrol problem: 100 potential visitors must choose at what day to visit the El Farrol bar with only 60 seats. This system is inherently unstable because the decision of every potential visitor depends on his estimate of what day others will choose. The financial model based on this idea is capable of replicating much real life market behavior. Other simple models, concentrating on herding behavior, are presented too. The difficult concept of volatility is analyzed bottom-up with help of these models.
The book does a very good job presenting the current state of "Econophysics". This has produced deep insight in how financial markets work but the problem is how to make results operational for market professionals. The most practical application is an alternative way to calculate the price of derivatives. As they say honestly themselves: the elegant but imperfect B&S model is thereby replaced by an ugly but more robust model. They also have nothing to say about forecasting.