Advanced Search
MyIDEAS: Login

Thermodynamic analogies in economics and finance: instability of markets

Contents:

Author Info

  • McCauley, Joseph l.

Abstract

Interest in thermodynamic analogies in economics is older than the idea of von Neumann to look for market entropy in liquidity, advice that was not taken in any thermodynamic analogy presented so far in the literature. In this paper we go further and use a standard strategy from trading theory to pinpoint why thermodynamic analogies necessarily fail to describe financial markets, in spite of the presence of liquidity as the underlying basis for market entropy. Market liquidity of frequently traded assets does play the role of the ‘heat bath‘, as anticipated by von Neumann, but we are able to identify the no-arbitrage condition geometrically as an assumption of translational and rotational invariance rather than (as finance theorists would claim) an equilibrium condition. We then use the empirical market distribution to introduce an asset’s entropy and discuss the underlying reason why real financial markets cannot behave thermodynamically: financial markets are unstable, they do not approach statistical equilibrium, nor are there any available topological invariants on which to base a purely formal statistical mechanics. After discussing financial markets, we finally generalize our result by proposing that the idea of Adam Smith’s Invisible Hand is a falsifiable proposition: we suggest how to test nonfinancial markets empirically for the stabilizing action of The Invisible Hand.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://mpra.ub.uni-muenchen.de/2159/
File Function: original version
Download Restriction: no

Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2159.

as in new window
Length:
Date of creation: 2004
Date of revision:
Handle: RePEc:pra:mprapa:2159

Contact details of provider:
Postal: Schackstr. 4, D-80539 Munich, Germany
Phone: +49-(0)89-2180-2219
Fax: +49-(0)89-2180-3900
Web page: http://mpra.ub.uni-muenchen.de
More information through EDIRC

Related research

Keywords: Economics; utility; entropy and disorder; thermodynamics; financial markets; stochastic processes;

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. J.L. McCauley & G.h. Gunaratne, 2002. "An empirical model of volatility of returns and option pricing," Computing in Economics and Finance 2002 186, Society for Computational Economics.
  2. Per Bak & Simon F. Norrelykke & Martin Shubik, 1998. "The Dynamics of Money," Papers cond-mat/9811094, arXiv.org, revised May 1999.
  3. McCauley, Joseph L. & Gunaratne, Gemunu H., 2003. "An empirical model of volatility of returns and option pricing," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 329(1), pages 178-198.
  4. J. Doyne Farmer, 1998. "Market Force, Ecology, and Evolution," Research in Economics 98-12-117e, Santa Fe Institute.
  5. Gemunu H. Gunaratne & Joseph L. McCauley, 2002. "A theory for Fluctuations in Stock Prices and Valuation of their Options," Papers cond-mat/0209475, arXiv.org.
  6. Leonard I. Nakamura, 2000. "Economics and the new economy: the invisible hand meets creative destruction," Business Review, Federal Reserve Bank of Philadelphia, issue Jul, pages 15-30.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Schinckus, Christophe, 2008. "The financial simulacrum: The consequences of the symbolization and the computerization of the financial market," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 37(3), pages 1076-1089, June.
  2. Bucsa, G. & Jovanovic, F. & Schinckus, C., 2011. "A unified model for price return distributions used in econophysics," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 390(20), pages 3435-3443.
  3. Josip Stepanic, 2004. "Social Equivalent of Free Energy," Interdisciplinary Description of Complex Systems - scientific journal, Croatian Interdisciplinary Society Provider Homepage: http://indecs.eu, vol. 2(1), pages 53-60.
  4. Pichl, Lukáš & Kaizoji, Taisei & Yamano, Takuya, 2007. "Stylized facts in internal rates of return on stock index and its derivative transactions," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 382(1), pages 219-227.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:2159. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.