What Models By Mandlebrot?

The New York Review of Books carries a book review by Jim Holt on the autobiography of the late mathematician Benoit Mandelbrot. I’m generally a fan of Mandlebrot but this passage by Holt stopped me in my tracks.

What is perhaps less well known about Mandelbrot is the subversive work he did in economics. The financial models he created, based on his fractal ideas, implied that stock and currency markets were far riskier than the reigning consensus in business schools and investment banks supposed, and that wild gyrations—like the 777-point plunge in the Dow on September 29, 2008—were inevitable.

Hold on a second. Let’s make one thing perfectly clear—Mandlebrot didn’t develop any financial models. He revived the idea that financial markets don’t follow the normal distributions. Mandlebrot did not invent this idea and it’s been known for over 100 years (see Louis Bachelier).

In simpler terms, a distribution of the stock market’s up and down, doesn’t match the classic bell curve. There are too many instances at either extreme, fat tails if you will. Mandlebrot suggested that instead of following a normal distribution markets were fractal, yet he never developed any models based on that idea.

Posted by on May 15th, 2013 at 2:05 pm


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