Making Sense of Chaos: A Better Economics for a Better World by J. Doyne Farmer

Author:J. Doyne Farmer [Farmer, J. Doyne]
Language: eng
Format: epub
Tags: Business & Economics, Economics, Theory, Econometrics, Forecasting, General, Science, Chaotic Behavior in Systems, Philosophy & Social Aspects
ISBN: 9780241201985
Google: ZyvNEAAAQBAJ
Publisher: Random House
Published: 2024-04-24T18:30:00+00:00

The theory of market ecology

My musings about market anthropology and our experience measuring market impact led me to a theory of market ecology.2 In my spare time at Prediction Company I began scribbling and solving equations, which eventually led to a paper titled ‘Market Force, Ecology and Evolution’, which I finished and posted online in 1998. In a nutshell, the basic ideas are that:

Financial traders are boundedly rational, so they use specialized strategies. Their strategies can be sorted into groups, like species in biology, even if the boundary between groups can be fuzzy.

Financial strategies feed off inefficiencies and interact through prices. Trading has market impact, which changes prices and affects the profits of each strategy.

As a result, the wealth of each strategy evolves through time. As the wealth invested in a strategy becomes larger, it has a bigger effect on the market.

This causes market inefficiencies to evolve through time. While markets may tend toward an efficient state, the path there is bumpy, the journey is slow and they never really reach their destination.

If a destabilizing strategy becomes too dominant, it can unsettle the market and cause it to malfunction. To understand why markets malfunction we need to classify financial strategies, understand how they affect the market and track their evolution through time.

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