1 Econophysics: A Brief Review of Historical Development, Present Status and Future Trends. B.G.Sharma Sadhana Agrawal Department of Physics and Computer Science, Department of Physics Govt. Science College Raipur. (India) NIT Raipur. (India) [email protected] [email protected] Malti Sharma WQ-1, Govt. Science College Raipur. (India) [email protected] D.P.Bisen SOS in Physics, Pt. Ravishankar Shukla University Raipur. (India) [email protected] Ravi Sharma Devendra Nagar Girls College Raipur. (India) [email protected] Abstract: The conventional economic 1. Introduction: approaches explore very little about the dynamics of the economic systems. Since such How is the stock market like the cosmos systems consist of a large number of agents or like the nucleus of an atom? To a interacting nonlinearly they exhibit the conservative physicist, or to an economist, properties of a complex system. Therefore the the question sounds like a joke. It is no tools of statistical physics and nonlinear laughing matter, however, for dynamics has been proved to be very useful Econophysicists seeking to plant their flag in the underlying dynamics of the system. In the field of economics. In the past few years, this paper we introduce the concept of the these trespassers have borrowed ideas from multidisciplinary field of econophysics, a quantum mechanics, string theory, and other neologism that denotes the activities of accomplishments of physics in an attempt to Physicists who are working on economic explore the divine undiscovered laws of problems to test a variety of new conceptual finance. They are already tallying what they approaches deriving from the physical science say are important gains. The tools of physics and review the recent developments in the provide an ideal background for discipline and possible future trends. approaching problems in economics [1]. Physics training, gives a person powerful Key Words: Econophysics, Stistical Finance, mathematical tools, computer savvy, a Physics of Finance facility in manipulating large sets of data, and an intuition for modeling and Broad Area: Physics simplification. Such skills have brought a new order into economics. Sub Area: Econophysics 2 2. What lies in Econophysics? Reliance on models based on incorrect axioms has clear and large effects [2]. The Econophysics is an interdisciplinary research Black-Scholes model assumes that price changes field, applying theories and methods originally have a Gaussian distribution, i.e. the probability developed by physicists in order to solve of extreme events is deemed negligible. problems in economics, usually those including Unwarranted use of this model to hedge the uncertainty or stochastic processes and nonlinear downfall risk on stock markets spiraled into the dynamics. Its application to the study of financial October 1987 crash. Ironically, it is the very use markets has also been termed statistical finance of the crash-free Black-Scholes model that referring to its roots in statistical physics. destabilized the market! In the recent subprime Physics has played an important role in the crisis of 2008 also, the problem lay in part in the development of economic theory through the development of structured financial products that 19th century, and some of the founders of packaged sub-prime risk into seemingly neoclassical economic theory, were originally respectable high-yield investments. The models trained as physicists. used to price them were fundamentally flawed: they underestimated the probability of the multiple borrowers would default on their loans 2.1 Why Econophysics? simultaneously. In other words, these models again neglected the very possibility of a global The quantitative success of the crisis, even as they contributed to triggering one. economic sciences is disappointing when it is Surprisingly, there is no framework in classical compared with that of physics. Its recurrent economics to understand wild markets, even inability to predict and avert crises, including the though their existence is so obvious to the current worldwide credit crunch is obvious? layman. Physicists, on the other hand, has Why is this so? Of course, modeling the madness developed in physics, several models allowing of people is more difficult than the motion of one to understand how small perturbations can planets, as Newton once said. But the goal here lead to wild effects. The theory of complexity, is to describe the behavior of large populations, developed in the physics literature over the last for which statistical regularities should emerge. thirty years, shows that although a system may The crucial difference between physical sciences have an optimum state (such as a state of lowest and economics or financial mathematics is rather energy, for example), it is sometimes so hard to the relative role of concepts, equations and identify that the system in fact never settles empirical data. Classical economics is built on there. This optimal solution is not only elusive, it very strong assumptions that quickly become is also hyper-fragile to small changes in the axioms: the rationality of economic agents, the environment, and therefore often irrelevant to invisible hand and market efficiency, etc. understanding what is going on. There are good Physicists, on the other hand, have learned to be reasons to believe that this complexity paradigm suspicious of axioms and models. If empirical should apply to economic systems in general and observation is incompatible with the model, the financial markets in particular. Simple ideas of model must be trashed or amended, even if it is equilibrium and linearity do not work. We need conceptually beautiful or mathematically to break away from classical economics and convenient. So many accepted ideas have been develop altogether new tools, as attempted in a proven wrong in the history of physics that still patchy and disorganized way by behavioral physicists have grown to be critical and queasy economists and econophysicists. But their fringe about their own models. Unfortunately, such endeavour is not taken seriously by mainstream healthy scientific revolutions have not yet taken economics. hold in economics, where ideas have solidified Thus there is a crucial need to into dogmas. In reality, markets are not efficient, change the mindset of those working in humans tend to be over-focused in the short-term economics and financial engineering. They need and blind in the long-term, and errors get to realize that an overly formal and dogmatic amplified through social pressure and herding, education in the economic sciences and financial ultimately leading to collective irrationality, mathematics is serious part of the problem. In panic and crashes. Free markets are wild sum the Economic curriculums need to include markets. It is foolish to believe that the market more natural science so that it can tackle the real can impose its own self-discipline. world problems more accurately and efficiently. 3 2.2 Historical Development: speculative markets, an activity that is extremely important in fancial markets (1900). In 1938, Econophysics studies were started in the Ettore Majorana pre-sciently outlined both the mid 1990s by several physicists working in the opportunities and pitfalls in applying statistical subfield of statistical mechanics [3-5]. They physics method to socio economic systems. Jan decided to tackle the complex problems posed by Tinbergen, who studied physics with Paul economics, especially by financial markets. Ehrenfest at Leiden University, won the Unsatisfied with the traditional explanations of first Nobel Prize in economics in 1969 for economists, they applied tools and methods from having developed and applied dynamic models physics - first to try to match financial data sets, for the analysis of economic processes. Ingrao and then to explain more general economic and Israel showed that the works of Léon Walras phenomena. With the availability of huge and Vilfredo Pareto on equilibrium economics is, amounts of financial data, starting in the 1980s, in fact, based on the physical concept it became apparent that traditional methods of of mechanical equilibrium. One of the most analysis were insufficient. Standard economic revolutionary development in the theory of methods dealt with homogeneous agents and speculative prices since Bachelier's initial work, equilibrium, while many of the interesting is the Mandelbrot's hypothesis that price changes phenomena in financial markets fundamentally follow a Levy stable distribution rather than a depended on heterogeneous agents and far-from- Gaussian one. A widely accepted belief in equilibrium situations. financial theory is that time series of asset prices The term “econophysics” was coined by H. are unpredictable. Poincare (1854-1912) has Eugene Stanley in the mid 1990s, to describe the pointed the possibility of unpredictability in a. large number of papers written by physicists in nonlinear dynamical system, establishing the the problems of stock and other markets, and foundations of the chaotic behavior. The study of first appeared in a conference on statistical chaos turned out to be a major branch of physics in Calcutta in 1995 and its following theoretical physics. It was only a question of publications. The inaugural meeting on time, how fast these ideas will start to appear in Econophysics was organised 1998 economy. Ironically, Poincare, who did not in Budapest by János Kertész and Imre Kondor. appreciate