All models by necessity distort reality in one way or another. A sculptor, when modelling in stone or clay, does not try to clone Nature; he highlights some things, ignores others, idealizes or abstracts some more, to achieve an effect. Likewise a scientist must necessarily pick and choose among various aspects of reality to incorporate into a model. An economist makes assumptions about how markets work, how businesses operate, how people make financial decisions. Any one of these assumptions, considered alone, is absurd. There is a rich vein of jokes about economists and their assumptions. Take the old one about the engineer, the physicist, and the economist. They find themselves shipwrecked on a desert island with nothing to eat but a can of beans. How to get at them? The engineer proposes breaking the can open with a rock. The physicist suggests heating the can in the sun, until it bursts. The economist’s approach: “First, assume we have a can opener. . . .” The assumptions of orthodox financial theory are at least as absurd, if viewed in isolation. Consider a few: 1) Assumption: People are rational and aim only to get rich. . . . . 2) Assumption: All investors are alike. . . . . 3) Assumption: Price change is practically continuous. . . . . 4) Assumption: Price changes follow a Brownian motion. Benoit B.
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All models by necessity distort reality in one way or another. A sculptor, when modelling in stone or clay, does not try to clone Nature; he highlights some things, ignores others, idealizes or abstracts some more, to achieve an effect. Likewise a scientist must necessarily pick and choose among various aspects of reality to incorporate into a model. An economist makes assumptions about how markets work, how businesses operate, how people make financial decisions. Any one of these assumptions, considered alone, is absurd. There is a rich vein of jokes about economists and their assumptions. Take the old one about the engineer, the physicist, and the economist. They find themselves shipwrecked on a desert island with nothing to eat but a can of beans. How to get at them? The engineer proposes breaking the can open with a rock. The physicist suggests heating the can in the sun, until it bursts. The economist’s approach: “First, assume we have a can opener. . . .”
The assumptions of orthodox financial theory are at least as absurd, if viewed in isolation. Consider a few:
1) Assumption: People are rational and aim only to get rich. . . . .
2) Assumption: All investors are alike. . . . .
3) Assumption: Price change is practically continuous. . . . .
4) Assumption: Price changes follow a Brownian motion.