Was bad maths to blame for the crisis?

Cover of The Physics of Wall StreetThe Physics of Wall Street

By James Weatherall
Published by Houghton Mifflin Harcourt

The global downturn is often blamed on the City’s overreliance on complicated financial models. Yet the conclusion of The Physics of Wall Street by James Weatherall, an academic at the University of California, is that finance’s main problem is a lack of knowledge of mathematics. No wonder his book has drawn a wide range of views.

Anna Kuchment of Scientific American says the book “traces the evolution of the mathematical ideas behind derivatives and hedge funds”. It also proposes that “economists and physicists must work together to prevent future crises”. As such, Floyd Norris of The New York Times thinks it works as a history of maths and finance.

“Weatherall does an excellent job of describing how Fischer Black and Myron Scholes figured out a model to value stock options.” The section on Edward Thorp, who used maths to develop card-counting techniques in blackjack is, “fun”.

But the conclusion that “the blame for the financial collapse lies not with sophisticated mathematical models but with those who misused them” is contentious. “The world’s economic problems are too complex to be reduced to a matter of physics and maths,” says Norris.

Others echo his scepticism. “True, the discovery of the calculus enabled us to build planes that travel faster than the speed of sound,” says Andrew Hacker of the New York Review of Books. “But thus far I’ve found scant evidence that mathematics and physics have a capacity to give us a deeper understanding of human and social behaviour.”

Even if maths helps individuals make better decisions, Brown questions whether society will benefit. “It’s not clear if Weatherall is saying that decisions based on Bernoulli will allocate capital more efficiently, and hence serve the commonweal.”

Aaron Brown of Minyanville.com pulls fewer punches. This book “must rank among the most arrogant” of all time as “it contains the crudest forms of the basic errors many people with quantitative training and zero experience in any form of risk-taking make when first considering finance”.

Weatherall, he says, is wrong about the origin of derivatives, overplays the influence of physicists on the post-war financial revolution, and doesn’t even seem to understand what a derivative is.

Nonetheless, if you want an accessible guide to the history of science and finance, “this is a fun book”, mainly for its “engagingly written” profiles, says Chad Orzel of Scienceblogs.com. Weatherhall’s explanations of mathematical theories walk the line “between including enough detail to be rigorous and chasing readers away”. The book “hasn’t really changed my overall opinion of the world of finance”, but it’s “an enjoyable read”.

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Weatherall. Published by Houghton Mifflin Harcourt, £16.85.

MoneyWeek magazine

Latest issue:

Magazine cover
Heading higher?

Or are house prices set to fall?

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

'Would you rather upset God, or have Him just ignore you?'

In the first of three interviews with Merryn Somerset Webb, Hugh Hendry, manager of the Eclectica Fund, talks about what it takes to be a good hedge fund manager – and how he learned to stop worrying and love central banks.

Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.

21 November 1969: The first permanent Arpanet link

A milestone in the formation of the internet, the first permanent Arpanet link was established on this day in 1969 between researchers in the United States.