From: Henry Baker <hbaker1@pipeline.com> Subject: [math-fun] Financial Crisis = Mathematical Malpractise ?

FYI -- According to Nassim Nicholas Taleb, [...] most of the blame for the current financial crisis can be laid at the feet of the "quants" [...].

There is a crisis this month, and everybody who had their head in the sand last month wants a theory to explain why they were not informed. http://blogs.cgdev.org/globaldevelopment/2008/09/crisis_not_if_we_take_a_lon... The term "black swan" is a favorite of mine because of the Black Swan River in Australia. Australians are sometimes puzzled by the name (I have heard) since "Black" is redundant for Australian swans.

From: "Fred lunnon" <fred.lunnon@gmail.com>

The remark about globalisation raises an issue which I have never seen explored technically: the network aspects of financial markets. Even as crude a model as a resonant electrical circuit is sufficient to

To me, "resonant circuit" implies a simple circuit with a sharp peak in frequency response, while "globalization" suggests lots of connections with different time constants, blurring out the response.

suggest that, left to its own devices, such a network is certain --- under (in)appropriate conditions --- to become unstable.

But these conditions could be as rare as the ones that cause all the air molecules to rush to the corner of the room.

An engineer equipped with a suitable model may able to design the network to avoid this development. In the situation to hand, there is (as far as I am aware) no engineer in charge.

While a market is loosely similar to an electrical circuit, that doesn't mean an engineer could design anything so complex. But we do know that good, highly-complex designs exist without intelligent designers.

Another feature of networks [from percolation theory rather than basic physics] is that they go critical: as traffic approaches the maximum capacity, a small increase traffic precipitates sudden gridlock over a large region. As a result, a crisis arising from other causes is intensified by the inability of the participants to communicate at all.

It seems a shame that we cannot make more use of the mathematics and physics we already have!

Not sure of the percolation model's applicability to financial crises, but complexity theorists (including Mandelbrot himself, as Henry mentions) are swarming all over economics. --Steve