Another physicist takes a crack at finance and macroeconomics

I hope he's figured it out, but I won't be holding my breath.

On New Year's Day 1995, a single giant wave hit the Draupner oil platform in the North Sea off the coast of Norway. By chance, the platform was fitted with laser measuring equipment which recorded the height of waves as they passed by. This one measured in at an unprecedented 25.6 metres, about the size of a seven storey office block. The Draupner event finally confirmed the existence of rogue waves, previously known only to science through the anecdotal evidence of the few who had seen and survived them.

Curiously, the existence of rogue waves was predicted mathematically more than ten years earlier by Howell Peregrine at the University of Bristol in the UK. The theoretical prediction and the observational confirmation should have generated an obvious question: shouldn't rogue waves also occur in other wave-like systems?  . . . .

But what of more abstract systems? Today Zhenya Yan at the Institute of Systems Science in Beijing says that rogue waves can also occur in financial systems, and in particular in equity markets. Traditionally, econophysicists have modelled equity pricing using the Black-Scholes economic model, in which prices change stochastically, like the movement of particles under Brownian motion.

Researchers have long known that the Black-Scholes model cannot account for the observed volatility of the real market but had no alternative to turn to. However, earlier this month, Vladimir Ivancevic at the Defence Science & Technology Organisation in Australia proposed a nonlinear wave model as an alternative to Black-Scholes

Comments

[kyle8]

It is a notion worthy of some study, but ultimately I think it is a mistake to view markets like some sort of random force of nature. Markets are not random. They react to real world events.

[Ironman]

It's an interesting approach, whose main advantage would be in recognizing a good portion of the inherent complexity in the markets. When I saw the post title however, I thought this might be the article to which you were referring:

http://www.sciencedaily.com/releases/2009/11/091123083704.htm

[TheBigHenry]

Ivancevic misspells "Schrödinger". Otherwise, his nonlinear wave alternative for the standard Black-Scholes option-pricing model makes sense.

[anon]

I think that most practitioners/academics have moved on from the constant volatility black-scholes model about 15-20 years ago.

Do a google search for stochastic volatility and option pricing.