Top positive review
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An excellent book for anyone trying to understand the processes that drive economics and financial markets
on 25 May 2013
As a financial market professional who has been trying to forecast economies and markets for much of the past quarter century, I can heartily recommend Forecast to anyone who wants to think about how economies and financial markets actually work, rather than just accepting the conventional wisdom about how economists believe that they should work.
"Forecast" follows on from Buchanan’s earlier book "Ubiquity" by showing how financial markets follow the same type “power laws” that are found in natural events, such as earthquakes and extreme weather, rather than the well behaved distributions assumed by classical economic analysis.
The key issue Buchanan has with modern economics is its reliance on the concept of “equilibrium”. Whether this concept is based on the DGSE approach of Arrow-Debreu, or the Rational Expectations approach of Lucas and Sargent, it does not correspond to empirical reality. Markets rarely appear to be in any kind of stable equilibrium and the work of Kahneman and others shows that market participants tend to be far from the rational beings assumed in the economic models!
What Buchanan does very well is to bring together the work from other fields, which have already had to grapple with phenomena which are both complex and dynamic, notably nuclear physics and the world of meteorology.
He uses the history of these disciplines to show how simpler models of the origins of dynamic processes might help model complex interactions of agents more adequately than the detailed, mathematically elegant, but fundamentally flawed, models of conventional economics.
Buchanan’s most important contribution is to highlight how adaptive learning models which have positive feedback loops at their core might provide a much more likely route to understanding the dynamics of financial markets and how such models can replicate events such as the flash crash. An important message for market participants and policy makers alike is the way that these models show that high frequency trading, low volatility and leverage can interact to provide a dangerous cocktail which can readily result in unstable dynamic processes, where crashes are triggered seemingly out of nowhere.
A brief review such as this cannot do justice to a book that is as broad as "Forecast" in its ambition and multidisciplinary approach. While some might prefer more technical detail on various approaches or models, the comprehensive notes allow the interested reader (with the technical skills) to follow-up the original sources with their own research.
In summary therefore, this is an important and challenging book. It is not so much a book about forecasting economies or financial markets per se, rather it is a book about how economics and the forecasting models that the economists of the future might employ, could develop.
Buchanan’s message is clear…if policy makers remain mired in the world of conventional economic models, their efforts to understand the complex interactions of the real economy, financial systems and financial markets will likely result in failure. If, however, they embrace a broader approach, based in a more multidisciplinary framework which seeks to understand reality, rather than being built on elegant, but false, economic assumptions of equilibrium, there is some hope that we will find greater understanding of the processes drive markets to have similar characteristics to other complex natural process such as weather patterns and earthquakes! We had all better live in hope...