The Future of Everything

December 15, 2014

The butterfly effect and efficient market hypothesis: right for the wrong reasons

Filed under: Economics, World Finance column — Tags: — David @ 11:36 am

“Prediction,” the great physicist Niels Bohr is said to have once observed, “is very difficult. Especially when it concerns the future.” In science and economics, our lack of ability to foresee the future has traditionally been attributed to two theories – the butterfly effect, and the efficient market hypothesis – which have more in common than might appear.

The “butterfly effect” was first coined by the meteorologist Ed Lorenz in a 1972 talk, based on an earlier paper in which he observed that the solutions to a highly simplified weather model were sensitive to initial conditions. When he slightly changed the inputs to the model and ran the simulation, the answer changed completely. This was like running a weather prediction model using slightly different values for today’s weather, and getting wildly divergent forecasts for the weather next week.

[Read rest of latest World Finance column here.]

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