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Theory of Financial Risks "Theorie des Risques Financiers"

Jean-Philippe Bouchaud and Marc Potters

posted on 10 April 1999

reviewed by Dietrich Stauffer

This book is based on a success story: The finance company Science & Finance was
co-founded by Bouchaud and employs the other author as well as four other PhD
physicists (see Physics World January 1999, page 26). It shows that physicists
should not only complain about not having enough of it; they can do something
to understand why some are rich and they are not. Even if physicists are not
interested in doing research in this area, they should know that another
earthquake in Tokyo, like that of 1923, will create financial, not geophysical,
waves in Europe threatening our economies. Thus extreme risks are not just
for experts.



The book starts with an introduction to probabilities, followed by a
quantitative analysis of real market data, by the portfolio theory which tries
to minimize risks, and ends for the practicing finance expert with a description
of options, a type of financial instruments to shift risks.



Also a statistical physicist can learn a lot of techniques for his own work
outside finance. I personally do not remember having learned of the maximum
likelihood method in physics, and I remember that once I spent an hour in the
library trying in vain to find for my student a definition of kurtosis. And I
have not yet applied extreme value theory. Here it is explained.



But the real aim of the book is of course how to deal responsibly with money.
We see lot of plots showing the distribution of changes in the Standards and
Poor's 500 index, or in the value of the deutschmark compared to the US dollar;
they neither follow a Gaussian nor a Levy distribution, but something in
between (here: power laws truncated by a simpl exponential). We are introduced
to the portfolio theory of Markowitz, which they base on the advice not to put
all eggs into one basket.



Lot of more mathematical paragraphs are put into small print, to make the
essentials better visible. Unfortunately only few sections are denoted by
a star indicating they can be skipped.



Microscopic market models, based on decisions of single traders, are missing
except for the percolation model of Cont and Bouchaud; most of these theories
were published only after the authors wrote this book.



The book seems to me the best printed textbook for econophysics courses (the
competition of Mantegna and Stanley is still in press). Thus it is regrettable
that it was written in French. Sure, La Francophonie dominates within Europe in
the field of econophysics; but how can the native tribes of the underdevelopped
neighbouring countries, knowing only English, learn from this book? I hope the
translation, already in preparation, will appear this summer, as promised.






YOUR OPINION ?


  • It is nice that a translated version already come out.
  • This book is essential reading for everybody who is seriour about modelling financial markets. Well documented and fundamental research and applications. (philippe.debrouwer@fimgroup.com)
  • Had I written the book, I would have tried to make math a little more rigorous
  • Write by jad@altern.org the July 14 2000 :

    Ou peut-on se procurer cet ouvrage (a Paris) ?
    Merci.