The Misbehavior Of Markets
Benoit Mandelbrot, mathematician and father of the fractal, a self-similar pattern that appears the same regardless of the observer’s viewpoint, has consistently challenged the accepted norm, and his book, The Misbehavior of Markets, follows suit.
Mandelbrot begins by introducing the people and ideas that shaped modern financial theory into what exists today, providing the roots for the Efficient Market Hypothesis, Modern Portfolio Theory, and the Capital Asset Pricing Model, all of which, he contests, rest on unstable ground.
More than simply claiming that each of the methodologies fails to predict market fluctuations, Mandelbrot describes concrete examples of when estimated volatility paled in comparison to the actual market’s rises and falls. He argues that by assuming price movements are independent of one another and normally distributed across the bell curve, current models are fundamentally flawed and underestimate the likelihood of crises.
Mandelbrot further expands on his revolutionary idea, the fractal, and asserts that the notion should be applied to modern financial frameworks. He demonstrates how scaling factors cause various assets to deviate drastically from the mean, long-term dependence creates ties between past events and future performance, and both act together to cause real markets to fluctuate in unexpected, yet predictable ways. Mandelbrot concludes with a proposal that modern financiers adopt a multifractal model, which allows one to compare price variations across time while considering the pace of volatility in the market.
The book rests on the viewpoint that the current models are not simply underperforming, but rather, their underlying assumptions set them up to fail. Mandelbrot consistently asserts that investors need an accurate predictor of estimable volatility and an appropriate correction factor tied to the actual, not theoretical, behavior of the markets. In the end, Mandelbrot hopes that “readers of this book … will forsake, at least for a moment, the practical details of why” and “emerge from the book’s pages with a greater fundamental understanding of how financial markets work.”
Introduction of Author: Described by peers as a “maverick in science,” Benoit Mandelbrot has spent his multigenerational academic and industrial career paving paths between disconnected fields. His pursuits, even those of his elementary school days, have sought to simplify and explain the world around him in ways similar to Isaac Newton; yet, his revolutionary viewpoints and methodologies better resemble those of Nicolaus Copernicus.
Mandelbrot was born in 1924 in Warsaw, Poland, but immigrated to France at the age of eleven. After his undergraduate study at École Polytechnique, he earned a master’s degree in aeronautics from Caltech and a Ph.D. in mathematical sciences from the University of Paris. In 1958, he joined a newly formed team of enlightened thinkers at a New York industrial laboratory, IBM Research, where he would begin his work developing models and frameworks that would alter many diverse fields across the scientific landscape.
Titans Brief written by Taylor Arnold (taylorarnold11@gmail.com). The full brief can be found on the Titans website.
