## Thursday, August 16, 2007

### Not my two cent

Not only that theoretical physicists should be able to estimate any number (or at least its exponent), we feel that we can say something intelligent about almost any topic especially if it involves numbers. So today, I will give a shot at economics.

As a grad student, I had proposed to a friend (fellow string theory PhD student) that I would guess that with about three months study it should be possible to publish a research paper in economics. That was most likely complete hybris but I never made the effort (but I would like to point out that still my best cited paper(364 and counting) was written after only three months as a summer student stating from scratch in biophysics (but of course with great company who, however at that point were also biophysics amateurs)).

About the same time, I helped a friend with the math (linear inequalities mostly) his thesis in macro-economics only to find out his contribution to money market theory was the introduction of new variable to the theory which he showed to be too important to neglect but which unfortunately is not an observable... (it was about the amount of a currency not in its natural country but somewhere else which makes the central bank underestimate the relative change when they issue a certain absolute amount of that currency into the market. For example about two thirds of the US$760 billion are estimated to be overseas and the US dollar is even the official currency in a number of countries other than the US according to Wikipedia). Economics is great for theoretical physicists as large parts are governed by a Schödinger equation missing an i (a.k.a. diffusion equation or Black-Scholes equation) and thus path integral techniques come in handy when computing derivative prices. However, it's probably the deviations from BS where the money is made as I learned from a nice book written by ex-physicists now making money by telling other people how to make money. Of course this is a bit worrying: Why do consultants consult rather than make money directly? This is probably connected with my problem of understanding economic theory at stage one: All these derivations start out with the assumption that prices are fair and there cannot be arbitrage which is just a fancy way of saying that you cannot make profit or at least that prices immediately equalize such that you make the same profit with whatever you buy. If there is a random element involved it applies to the expectation value and the only thing that varies or that you can influence is the variance. This just means that you cannot expect to make profit. So why bother? There are however at least four possibilities to still make profit: • You counsel other people how to make money and charge by the hour. Note that you get your money even if your advice was wrong. And of course it can be hard to tell that your advice was wrong: If you suggest to play Roulette and always put money on red and double when you lose most people will make (small) money following these instructions. Too bad a few people (assuming the limit is high enough) will have big losses. But in a poll many people will be happy with your advice. You don't even have to charge by the hour, you can sell your advice with full money back guarantee, in that way you participate in winnings but not in losses and that's already enough. • You could actually produce something (even something non-material) and convert your resources (including your time and effort) into profit. But that's surplus and old fashioned. Note that at least infinitessimally your profit at time t is proportional to the economic activity A(t), i.e. as long as there is demand the more sausages the butcher produces the more money he makes. • You trade for other people in the money market and receive a commission per transaction. As transactions are performed when the situation changes your will make profit proportional to the (absolute value) of the time derivative of A(t). Thus you have an interest that the situation is not too stable and stationary. This includes banks and rating agencies and many more. • Finally, there is the early bird strategy: You get hold of a commodity (think: share in a dot-com company or high-risk mortgages) and then convince other people that this commodity is profitable so they as well will buy it. The price goes up (even if the true value is constant or zero) and indeed the people early in the game make profits. Of course if the true value is zero these profits are paid by the people who join too late as in any other pyramid scheme or chain letter. The core of all these models of course is as Walter Kunhardt pointed out to me Give me$100. Then you can ask two other people to give you \$100.
Of course, people following strategy three above like it if there is some activity of this type going on...

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Lumo said...

A funny - or troubling - event. At Asymptotia, your comment was edited. The good news is that TeX works. The bad news is that the content - e.g. comment about my - was erased. ;-)

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