Financial markets are somewhat like weather
YALE --- MANDELBROT, BENOIT --- Professor / Academic
>> welcome back to television.% current financial theory tends% to underestimate risk. that’s the view of benoit mandel mandelbreath, father of fractile geometry.
>> a factile is pattern or shape whose parts echo the whole. and its power lies in its ability to expression complex data in a few simple formulas. ban wasays―benoit says that financial markets are somewhat like weather.
>> has to go step by step and the phenomena which science has conquered are phenomena which are not varying badly and are well defined to measure the loudness, the picture by frequency and color by frequency and heaviness by number, et cetera. one aspect of reality which science has not touched until my work is roughness and roughness is everywhere so i immediately, to explain the riskiness of markets , i’m obglijed to speak of the riskiness of the weather.
>> your work points out that conventional theory would predict index swings of the dow of more than 7% in one day should come once every 300,000 years but in fact the 20th century so 48 such days alone so clearly there’s a difference between theory and reality and that leads me to the question on prices. bubbles, you claim, in terms of pricing, are inevitable.
>> bubbles are inevitable for the reason that price is a quantity which is specific economics. many aspects of everyday life, financial life, are intrinsic, a number of shaped that are well defined but prices depend upon participation. in ordinary physics, the dissonant events don’t count much but you’re interested in the bell curve.
>> you’re a basher of the bell curve.
>> because the bell curve represents the data so poorly on the stock market and so poorly the data on the weather. the weather can be extraordinarily bad, well beyond anything on the bell curve. you can say the very bad weather doesn’t belong to the same universe of thinking as odinary odinary―ordinary weather but i don’t like this attitude because it’s giving up the outliers and giving to another field of research. the outliers, the large values are very, very common and i don’t see why to separate them and the rest and if i tell, say that outliers are somebody else’s business, i get very little business for myself because the bell curve, although it concerns most cases, does not concern the most important cases so in this sense, the big difference between established thoughts of physics and the newer parts of science which include economics, finance and include certainly the weather and many other things is in extreme cases, extreme events are the most important ones and also extreme events can be handled.
>> how do you address your critics who say that fractile analysis and fractiles really are not valuable in terms of how they do their day-to-day work?
>> well, they may perhaps should maybe should change their way. but the big issue is not only to increase one’s income but to avoid ruin and risk ruin are completely very strongly linked. very often a portfolio which is very daring and increases one’s income has xaerlgged -- extraordinarily higher risks of a ruined ending and the probability of ruined is extremely essential and perhaps more essential for a bank or country than it is for an individual because the individuals ruin, ruins the individual and maybe some other individuals but does not create general havoc whereas the ruin of a big major bank certainly creates conditions which are extreme and very often unacceptable. the same way as the analogy for the weather, the question is not how to predict the next storm and intensity of the next torm, it’s a question of how to live comfortably in a place for a long period of time. you build a house to last a certain amount of time. and if you build it on the conditions that are too dangerous, it’s not going to last long enough.
>> spoken only like he can, his work suggesting that the basis of modern financial theory, bob, is wrong. so there you have it.
>> it’s always good to mix things up a bit, that’s how you have fun in this business.
>> absolutely.
>> the fractile theory of finance is spelled out in this book, “the misbehavior of markets ,” it’s a fractile view of risk and reward. one heating oil buyer says he has sticker shock. the energy department predicting this will be the coolest winter ever for heating oil.
