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Microscopic Simulation of Financial Markets

Haim Levy, Moshe Levy, Sorin Solomon Wiley (2000)

posted on 10 December 2000

reviewed by

"Levy, Solomon and Levy's Microscopic Simulation of Financial Markets points us towards the future
of financial economics. If we restrict ourselves to models which can be solved analytically, we will be
modeling for our mutual entertainment, not to maximize explanatory or predictive power."

-Harry M. Markowitz, President, Harry Markowitz Co., and Nobel Laureate in Economics

"Many theoretical physicists now try to apply their research techniques to problems in finance; this is a
book to help them in such computer simulations. In contrast to earlier "econophysics" books, Levy et al.
emphasize the modeling of individual traders, and they give credit to economists who used such methods
already before."

-Dietrich Stauffer, Cologne University, Cologne, Germany

This book contains the first fully comprehensive treatment of Microscopic Simulation in Finance. The
authors make a compelling case that this technique, originally used in physics to solve otherwise
intractable problems, is destined to become a standard tool in finance. It is particularly well-suited for
highly complex financial problems in behavioral finance where standard methods are inadequate."

-Richard Roll, University of California at Los Angeles, U.S.A.

Microscopic Simulation (MS) uses a computer to represent and keep track of individual ("microscopic")
elements in order to investigate complex systems which are analytically intractable. A methodology that
was developed to solve physics problems, MS has been used to study the relation between microscopic
behavior and macroscopic phenomena in systems ranging from those of atomic particles, to cars, animals,
and even humans. In finance, MS can help explain, among other things, the effects of various elements of
investor behavior on market dynamics and asset pricing. It is these issues in particular, and the value of an
MS approach to finance in general, that are the subjects of this book. The authors not only put their work in
perspective by surveying traditional economic analyses of investor behavior, but they also briefly examine
the use of MS in fields other than finance.

Most models in economics and finance assume that investors are rational. However, experimental studies
reveal systematic deviations from rational behavior. How can we determine the effect of investors'
deviations from rational behavior on asset prices and market dynamics? By using Microscopic Simulation,
a methodology originally developed by physicists for the investigation of complex systems, the authors are
able to relax classical assumptions about investor behavior and to model it as empirically and
experimentally observed. This rounded and judicious introduction to the application of MS in finance and
economics reveals that many of the empirically-observed "puzzles" in finance can be explained by
investors' quasi-rationality.

Researchers will use the book because it models heterogeneous investors, a group that has proven
difficult to model. Being able to predict how people will invest and setting asset prices accordingly is
inherently appealing, and the combination of computing power and statistical mechanics in this book
makes such modeling possible. Because many finance researchers have backgrounds in physics, the
material here will be accessible.

ISBN: 0124458904

Title: Microscopic Simulation of Financial Markets


Cover: CaseBound

Published: June 2000

US Price: $69.95

Academic Press Database Book Details