One of the best recent books about financial markets is [amazon_link id=”1861977654″ target=”_blank” ]The (Mis)Behaviour of Markets[/amazon_link] by Benoit Mandelbrot with Richard Hudson. The book attacks the conventional modelling of financial markets based on the statistical theory derived originally from Bachelier. Instead, Mandelbrot presents pretty compelling evidence that fractal mathematics is a far sounder basis for the analysis of financial markets. (See more on fractals on Mandelbrot’s website for his class at Yale.) This makes natural systems such as the weather or the oceans apt metaphors for the patterns of price movements – in Mandelbrot’s words they are, like turbulence at sea, “a complicated pattern of churning eddies and torrents, all interrelated.” (p227, Profile paperback edition) It is possible to describe general regularities common to all fractal systems such as the scaling, long term dependence etc – but impossible to make specific forecasts. Except to say that markets are far, far riskier than we had grown used to thinking.

Contemplating this morning the renewed implosion of trust that the global banks have for each other – reflected in them not wanting to lend some of their number any money at all overnight – it occurred to me that the situation is even worse than just turbulent. We have the turbulence of a massive storm at sea washing over institutional structures (banks, corporate treasuries) simply not designed to withstand the scale of the buffeting. Time to hide under the duvet for the holidays?

[amazon_image id=”1861977654″ link=”true” target=”_blank” size=”medium” ]The (mis)Behaviour of Markets: A Fractal View of Risk, Ruin and Reward[/amazon_image]