* This book, written by Benoit Mandelbrot and Richard Hudson, is a critical book on orthodox financial theory. Regular readers of my blog may remember that I had already commented on a book on the same theme, that of Taleb. After reading the Mandelbrot, I can tell you that Taleb's book deserves nothing but the trash because it is ultimately the same thing, except that Taleb says the arrogance and widespread criticism of any science without economic or the arguments nor the knowledge to make a relevant critical.
Let us leave aside Taleb and talk about this new book. What he tells us interesting?
It begins with a history of the Orthodox financial theory with a very clear statement on its foundations. It includes it depends quite critical of several key assumptions, including the price moves following a normal, that is to say that once we have identified their volatility, we know so specific enough in how often they will change. We particularly appreciate the fact that it is beyond the rhetoric "Oh dear, but it's completely stupid, how economists (they are stupid) could believe such a thing?!. "Instead, Mandelbrot shows how financial theory is built around this assumption then has slowly degenerated to the point where they forgot how the assumptions were demanding. Scientists were attracted by the simplicity of the model and the financial sector players were attracted by its flexibility and convenience (including asset valuation exotic).
Then It dismantles the edifice. He shows us with relatively convincing evidence (again, he prefers we use solid scientific work rather than turning into ridicule the theory) that the standard theory in finance, systematically underestimate the risk. By its very construction, the theory gum significant changes in large-scale asset prices such as those observed during the last crisis.
Then he introduced the application of fractal geometry to finance. He said he had not yet fully developed theory, but the initial results are very encouraging. Her disappointment is rather on the fact that there is little research programs that attempt deepen this work.
His theory does not explain asset prices but sets a simple goal: to understand the statistical laws that govern their development and find a way to describe this evolution. The most interesting aspect of his theory concerning the question of time. For him, time is not a homogeneous market. There are times "quiet" during which courses are relatively stable periods of "turbulence" during which events are accelerating.
It shows, for example to support, how the models' time multifractal "can reproduce these alternations of calm and turbulent periods. It is thus possible to describe the" peaks "in the development of courses that may not appear in the standard theory.
I'm not going further in the presentation of his theory, already because I did not very well understood myself, and secondly because this is probably not the most interesting part of the book, except perhaps for economists finance.
What we remember from the book is that we (finally) a full and coherent, based on the history of economics, which explains why financial theory was planted in 2007 in style. It does not seek to transform it into an ideological battle, or to humiliate the inventors of the classical theory. It does not simplify either for the purpose of caricature, but instead offers a fairly detailed description of the standard theory so as to make critical targeting model assumptions. Moreover, it does not just criticize the assumptions but also shows how approximate models may have led to such an underestimation of risk in financial markets.
As for blame, it does not really bother to hide the fact that "sells" his theory through this book, since it is still the inventor of fractal geometry. Can you blame him? I think not. It's a way to show that there are other avenues of research that the classical pathway. Also, note that passage, he throws a few extra picks against the standard theory by attacking the rationality of agents and the assumption of homogeneity of the agents. This is not the most interesting point of his criticism as these assumptions can be relaxed without undermining entire building, which is not the case with the assumption of normality (heart of the criticism of Mandelbrot). We feel that it adds a bit to give more weight to his words, knowing well that these additional arguments not survive the confrontation with the most recent advances in the standard theory. Strangely, I did not upset. Perhaps because the character was not a tone full of arrogance, as is too often the case in this kind of work.
In short, this is a reference book if you seek to understand the real criticism that can be done in modern finance. And it is all the more credible that the author does not need to use any ounce of aggression to convince the reader (even a pure orthodox like me!).
* I have read to me the English version of the book. I do not know what is the French translation.
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