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'The Physics of Wall Street': The Most Arrogant Book in the World? Part 3

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To see the world in a grain of sand, to see the financial system in a roulette wheel.

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A roulette wheel attempts to solve the problem with a precisely engineered wheel to ensure uniformity. Chaos is used to simulate randomness in two ways. First, a human spins the wheel and the ball in different directions and there are so many revolutions of each that small changes in initial conditions-that is, slightly different speeds of the wheel or the ball or a slightly different time gap between the time the wheel and ball are spun-make a large difference to the final outcome. Differences in initial conditions that are too small to detect by eye make a difference of more than a full revolution of the wheel by the time the ball finally drops, so the process is essentially random-unless you have electronic help. There are people who claim to be able to make useful predictions without devices, but I have never seen this demonstrated convincingly and do not believe it personally.

Chaos reenters the process once the ball descends from the lip. The ball skips and spins erratically before it finally settles down into a slot. While the outcome of this process cannot be predicted even with lots of information and computing power-meaning it is random in practice even to someone with electronic aids-it is nowhere near uniform. Ed and Shannon bypassed the first chaotic input by measuring the system after the spin began, used the uniformity of the next phase to their advantage, and exploited the non-uniformity of the final phase to make bets that were profitable on average.

In a sloppily built wheel-say, one that is not quite circular, or is slightly tilted, or wobbles a bit, or is made of materials with varying elasticity, hardness, and friction-the initial measurement would be useless. However, such a wheel would be likely to favor some numbers over others. In a perfectly built wheel, or say, a computer simulation of an ideal wheel, it would be possible to compute the final number given precise measurement of the initial conditions. In any wheel in between that anyone has ever built, some combination of those approaches results in significant advantage to the bettor.

People have attacked every form of casino-generated randomness using the same conceptual approach. Where things are non-uniform, exploit it by betting the patterns. Where things are uniform, exploit the precision required to ensure uniformity by building useful inferences from observations casinos think are too small to matter. Shuffles, dice, wheels, drawing of balls or slips of paper and electronic random number generators have all been beaten, at one time or another.

This brings us to one of the reasons I reacted so strongly to Weatherall's claim that physicists were responsible for reengineering the global financial system. It's not that I think people from other fields made larger contributions. That happens to be true, but it's a sterile debate. After all, "physics" can cover the entire range of quantitative science, and there is no dispute that it was quants who did the job. Everyone involved was at least pretty good at physics, and some were fully-qualified professional physicists, and others were considerably better at physics than most fully-qualified professionals.

The problem is naming any field suggests that the change in the financial system was an intellectual achievement, brought about by people importing ideas. The real common denominator, apart from quantitative ability, was an engineer's hubris: a combination of insistence on clear objective validation, a desire to push all limits, and an unlimited willingness to bet on oneself. In Ray Bradbury's words, we were people who believed in jumping off cliffs and building our wings on the way down.
No positions in stocks mentioned.
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