ABSTRACT
Chapter 4 introduced Econophysics as a way to break loose from existing financial persuasions, resistances, and Financial Engineering (FE) methods. In particular, an econophysics perspective helps us to move away from assumptions associated with Louis Bachelier’s (1914) random-walk model of stock price behaviour and Gene Fama’s (1970) widely accepted view that markets always behave according to the efficient market hypothesis (EMH). Ideally, our goal should be to create financial markets that are resilient, hence less prone to crashes. For example, interventions to prevent bubble-build-ups and/or lessen their negative impact would be highly desirable. In the following we will refer to these types of interventions as resilience interventions. Leveraging econophysics, we identify conditions leading to herding behaviour (Hirshleifer and Teoh, 2003), which begins with tiny initiating events (Holland, 1995, 2002) and sometimes results in extreme outcomes such as trading volatility, bubble-build-ups and crashes. In Chapter 5 we illustrated how numerous scalability spirals occurred in the 35 years between the invention of the Black-Scholes options-pricing model in 1972 and the 2007 liquidity crisis and the following Great Recession.
