Econophysics

- Siddhartha Ghose (IMA Economics, IV Year)

Started by physicists working in the field of statistical mechanics in the mid 1990s, econophysics is an interdisciplinary field applying theories and methods developed by physicists in solving stochastic problems in economics. The euphemism here is to ascertain asset price fluctuations and the neoclassical idea of economic general equilibrium.

Though econophysics might sound new to many, its origin paints a picture of an age old intercourse between the two disciplines that it takes under its wing. At a cursory glance, any plot of commodity prices belies the idea of market equilibrium – the value wildly fluctuates. Neoclassical theory however regards these fluctuations as background ‘noise’ caused by unpredictable shocks which are external to the economic system. Such fluctuations were explained borrowing the concept of random walks from statistical physics as early as 1900. This in fact was pursued further by Einstein to explain Brownian motion. The final seal on this is the work of Adam Smith which often compared the circulation of commodities with the circulation of the planets and that of Francis Edgeworth and Alfred Marshall that drew upon the idea that the economy achieves an equilibrium state, like that described for gases by Maxwell and Boltzman.

The restrictive ideas of economic general equilibrium and rational-utility-maximizing individuals accounts for the virtue of econophysics. Contrary to mainstream economics which assumes market ‘noise’ to be a Gaussian process and exogenous, most econophysics models are non-equilibrium ones where attempts are made to endogenize such fluctuations which are regarded as being larger than that predicted by a Gaussian distribution.

While most economists and physicists are oblivious to the existence of econophysics, an analogy may well be drawn between statistical physics which describes the behavior of bulk matter based on the play of forces between atoms and molecules, and economics which harps upon the interactions between economic agents. Thus there are similar problems between drawing thermodynamic laws from inter-atomic forces and deriving microeconomic principles from the behavior of individual agents. Admittedly, the latter is more complex, but this has been connivingly bypassed by incorporating grossly simplistic mainstream assumptions.

In spite of being such a promising tool to iron out many of the anomalies of mainstream economics, econophysics is pursued by only a handful of people all over the world. This primarily stems from the fact that while economics tolerates unorthodoxy, it also isolates it from the core theory taught and practiced by academics. Most mainstream journals are closed to the topic and physicists’ contribution to financial and industrial economics is seen as passé.

Slow progress and lack of sustained success in this field has left many physics-friendly heterodox economists disillusioned. But given the fact that an increasing number of Wall Street speculators are doctorates in physics, it would be anything but surprising to see this field get more and more attention from all sections of the academic and industrial community.