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'The Physics of Wall Street': The Most Arrogant Book in the World? Part 18

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Thinking like a physicist.

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This is only half of what Weatherall means by thinking like a physicist. He also means that physicists develop models using simplifying assumptions, then use them to predict. They are aware of the shortcomings of the models and they use deviations from model predictions to come up with improved models. In finance he claims people instead take models developed by physicists and implement them without being aware of their defects. They ignore the deviations from models until they cause a disaster. They are stuck on first and second generation models, while physics has moved on to third and fourth generation.

It is easy to come up with examples that fit Weatherall's paradigm in physics as well as other fields. Isaac Newton assumed an inverse square law for gravitation and considered two incompressible perfect spheres with nothing else in the universe. This allowed him to compute the orbits of the planets to tolerable precision. Deviations from these predictions taught us new things: unexpected changes in the orbit of Uranus led to the discovery of Neptune, the anomalous precession of the perihelion of Mercury's orbit became one of the major proofs of general relativity. We now have far more sophisticated models of gravity than Newton's, and are working on refining them further.

But you can also tell this story another way. Newtonian orbits gave rise to the idea of a clockwork universe, which turned out to be deeply misleading. In the actual solar system, tidal forces and the influence of other planets on orbits mean that orbits are constantly changing. The solar system does appear to be reasonably stable, but for an entirely different reason than the one suggested by the simplified two-body problem. The adoption of important ideas was delayed due to over-rigid Newtonian thinking.

Obviously Newtonian gravity was a tremendous intellectual advance, and probably a necessary step to further progress in physics. So it is good that some people think this way. But it is also good that some people thought other ways and were willing to come out of left field with inconsistent ideas rather than working on refining existing models. Intellectual history is filled with advances that came about because someone insisted stubbornly that inconvenient observations were correct, and other advances that came about because someone had the courage and insight to ignore observations.

Weatherall looks at finance and sees bad physics. He mistakes a vigorous intellectual diversity for stupidity. He credits all the parts he likes to physicists, independent of the historical evidence. Everything else is bad physics. He blames the failures on bad physics, but failure is the way applied fields progress. As civil engineering professor Henry Petrosky wrote, no one wants to learn from failure, but we don't learn enough from success to advance the state of the art.

I will close by returning a favor to Weatherall and discussing the economics of physics, which I think explains a lot about his attitude toward finance. Why does someone get a PhD in physics? Economists are apt to answer the question in terms of signaling. An educational credential takes investment. While some of that effort may pay off directly in learning skills, the investment seems disproportionate to the skill gain. That is, you could learn all the physics you learn in a PhD program faster and with less effort if you didn't have to worry about courses, exams, papers, qualifying exams, dissertations, teaching, departmental politics, interdepartmental politics, and other things. That's especially true when you add in all the effort of the people who do not complete the degree, which in an economic sense form part of the cost. Some people disagree and claim PhD programs teach intangible skills essential for a life of productive research and there is no way to do that more efficiently, but I know of no evidence to back that up, and a lot of evidence against it (none specifically about physics PhDs, but plenty about other educational credentials).

The wasted effort is a costly signal. A credential has a value, and it will look like a good deal to people who find the cost low, but a bad deal to people who find the cost high. Getting a physics PhD proves you are the kind of person who finds the effort less objectionable (or more pleasurable) than most people. Employers observe the credential and can trust it, because the kind of people who hate the kind of stuff you have to do to get a physics PhD, won't get one, even if the career value is high.

We can rule out about 95% of the population because they don't have the quantitative aptitude to get B grades in the basic physics courses PhD programs require, at least not with reasonable effort. The remaining 5% could get PhDs in other quantitative fields, or do something that does not require a doctorate. With the exception of a few pure theoretical physicists (who probably choose the field for non-economic reasons anyway) almost anything you study in physics you can study in another field as well. The main thing that distinguishes physics is the demand by government. Roughly a third of physicists in the US work directly for the government in the defense department, NASA, national laboratories and other places. Another third are university faculty or researchers, virtually all supported directly or indirectly by the government. Of the remaining third of physicists, who work in private industry, about half work in government-related fields like defense contracting or health care. These are current statistics; government employment, especially military, was higher in the past, when many current physicists chose their field. Other developed countries have a broadly similar picture.
No positions in stocks mentioned.
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