Book Review: The Physics Of Wall Street

by: David Merkel, CFA

Let me admit my bias at the start. Physics is the wrong model for financial markets and economics. The better models are ecological or biological, because people adapt to conditions that change. Perhaps we are predictable on average, but there is a wide variation in specific behaviors.

Economics and ecology deal with scarcity and plenty. Physics does not. Physics is exact, aside from the quantum and universal scales. Economics and ecology are never exact, and prediction is fraught with error.

But what of financial instruments where the math of physics might have application? Perhaps physics has some application there?

OK, sort of. Even something as pervasive as option modeling does not truly have a simple model, but implied volatility has to be re-estimated regularly for the Black-Scholes Model. A true model does not require re-estimation of a parameter, particularly when it varies by time and strike price.

What I liked about the book

I liked reading about the mathematicians who applied analogies from physics to economics. Even though the models had their flaws, they improved the explanatory power.

I also appreciated how the author kept explanations simple. He could have gone into a lot more detail, and a lot more math, and he would have lost most of his audience.

He also explained the life circumstances of the men he wrote about. That adds depth, because science does not occur in a vacuum. It is a social activity. Few men think purely abstractly, and those that do ride the edge of genius/insanity.

There are two motives for understanding how men approach markets - to explain, and to make money. The book has both sorts, and it is a strength to see one validate another.

Who would benefit from this book: If you want to learn about men who shaped the market by their knowledge of math, you will like this book. If you want a book that explains the markets, this is not it.

Full disclosure: I received a free copy from the publisher.