The Music of the Spheres and the Alchemy of Finance
July 7, 2013·4 comments
For 1,400 years the Ptolemaic model of the universe worked despite not fitting observed data. It survived because it was useful and aligned with powerful institutions. Modern finance faces an identical crisis: Modern Portfolio Theory is fracturing under structural market changes, yet no coherent replacement exists. The question is not whether a paradigm shift is coming, but what framework will finally succeed it.
• Markets are abandoning their theoretical foundations. Bulge bracket firms built on trading volumes are collapsing as flows disappear. Fund-of-funds and consultants have become irrelevant. The entire intermediary class that profited from the Modern Portfolio Theory era is being disintermediated, but no one has articulated what comes next.
• Technical analysis has been dismissed as intellectually inferior, yet this bias may be the biggest obstacle to market evolution. Traders understood price behavior through pattern recognition while theorists clung to equations. The divide between how markets actually behave and how academia models them has become irreconcilable.
• Price data itself is a form of information, not just an outcome to be explained. When a stock moves on no news, something real is happening in how participants process uncertainty and respond to each other's behavior. Treating this as noise rather than signal has crippled both technical analysis and behavioral finance.
• Reflexivity explains market instability better than any equilibrium model ever could. A stock falls slightly, creating a signal that triggers selling, which creates another signal. In retrospect it seems irrational. In the moment it feels entirely real and most frameworks have no language for it.
• Information theory provides the missing vocabulary to unify price patterns, behavioral dynamics, and market psychology into a single framework. This is not about predicting direction. It is about understanding how markets absorb signals and shift from one stable state to another. Whether this sparks a real paradigm shift depends on whether institutions are ready to abandon what got them here.v
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Comments
Then felt I like some watcher of the skies, When a new planet swims into his ken… so glad I read this. Thanks Ben!
Suppose I discovered the financial analog of a robust new heliocentric model based on information theory. By reflexivity itself, my sharing of this model would make all reasonable people better at catching mice. But then this would seem to distort the model and decrease my ability to catch mice.
So, assuming such a model was possible, why would anyone ever share it?
Mostly asking as a way to better understand Soros. Alchemy of Finance is next up on my reading list, but I don’t have a background in finance and as many have complained, Soros’ writing is a bit dry.
I’d think a similar example is the decreased effectiveness of factor investing since it’s become more popular over the past few decades. (Recovering Boglehead here.)
Price is a very important part of our capitalism originated political universe.
Common knowledge of next-gen predictive tools could change the nature of capital markets’ relationships with society.
Dimensional computer modelling of information fields might graphically demonstrate complex system structures and probable outcomes with an unhelpfully high level of certainty, for our current deep flaws. Perhaps only an army of angels begets a level of competitive advantage so great. Indeed, the act of developing these tools risks the label of pre-crime, by inductive regression.
Sophistry.
It does matter if you have a mouse problem because white cats are easily seen by the mice and catch less. of them. They are objectively inferior at vermin control.
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