Economics

This started out as a long entry, but it splits nicely into two parts, this being the second...

On the fitness front, things are going well, and I'm looking forward to ramping the miles up to prepare for the marathon. Last week was a lower-mileage week, so after the week's longest run (only 10 miles) I ended up going cycling along the canal this Monday for about three hours... Rather enjoyable, I still want to take a longer trip that way to Falkirk or perhaps Glasgow. Anyway, this week will be my first week doing over 60km, and I'm looking forward to getting some longer runs in. Of course time management does start to become a bit of an issue, I attended a lecture last night which meant I ended up running after dark. Forgot my head torch, quite fun and atmospheric without!

The lecture, incidentally, was rather interesting, by Donald MacKenzie. He discussed the effects of mathematical models of stock options on the markets themselves—what happens when a model becomes widely used by those taking part in the activity itself. From the talk description:

This talk will ask this question mainly in regard to the most famous model in modern financial economics, the Nobel-Prize winning Black-Scholes-Merton model of option pricing, which is the core mathematical foundation of the global market in "financial derivatives" . (At the end of June 2006, derivatives contracts outstanding worldwide totaled $454 trillion, the equivalent of nearly $70,000 for every human being on Earth.)

The talk will describe how the practical uses of the model initially had the effect of making markets more like the postulates of the model, but will discuss how this effect reversed in direction in the 1987 stock market crash, with near-disastrous consequences for the global financial system.

What I got from the talk was that if a relatively simple but accurate model is useful enough (as a decision-making tool) it may be taken up by those participating in the activity being modelled. The model will not perfectly represent the actual situation, and while there may even be more sophisticated models which are better at this, they may not be useful to practitioners. Some activity guided with the model actually has the effect of making the model more accurate (in this case "spreading"), but some activity may not—when the model is too slavishly adhered to the inaccuracy may rear its head spectacularly.

I say this all in rather abstract terms, as I'm not comfortable with the details, but the talk was given quite concretely, and entertaining in the discussion of the sociology of Chicago trading pits.

Have a look at this paper if you're interested, it seems to cover much of the content of the talk.