- About the Lecture
-
About the Lecture
In this talk Andrew Lo addresses the problem of finding the right level of abstraction with which to think about economic phenomena. He compares economics to physics, with some surprising results.
For at least several decades economics theorists have assumed that the highest level of abstraction is the best. Lo argues that this assumption has stemmed from what he calls "physics envy": the enviable ability to explain a huge range of phenomena with a small number of rules or laws.
Admittedly physics envy has led to the development of many useful ideas, including utility theory, game theory, and general equilibrium theory, among others. These have been real successes; however Lo takes up the argument recently made by some observers that the recent fiscal crisis is evidence that economics is by the nature of its subject matter not reducible to a small number of general laws.
The possibility that a certain level of abstraction can be inappropriate for a given material raises the question of how to know what level is right where. Lo addresses this issue with a distinction originally made in the 1920's between risk and uncertainty which has been further developed into the Ellsberg Paradox. Both terms refer to unknowns, but in this formulation, "risk" refers to the category of unknown that is governed by defined probabilities. You do not know whether a flipped coin will land heads or tails, but you do know, with certainty, that the odds of either outcome is 50- 50. “Uncertainty" refers to unknowns in which the odds of a given outcome are not known and even cannot be known, such as the odds of running into an old friend you have not seen for years on the street tomorrow.
Recently Lo and physicist Mark T. Mueller developed this polarity into a spectrum of types or kinds of unknowns. These run from well- defined cases like the coin toss, through types in which, while the odds of a given outcome are unknown now, it is pretty clear how to go about making them known, to unknowns that are so complex that there is no way to even begin to get a handle on them, to cases that are a confusing mixture of all three. Lo demonstrates an instrument developed by researchers that allows managers and analysts to assess what kind of unknowns they are dealing with at any given time, and therefore to get a sense of what level of abstraction might reasonably be expected to be useful for that particular material.
In response to a question, Lo observed that the highest rewards seem to flow to people who deal successfully with the most profound levels of unknowns. He concluded by speculating that people with a very high level of self-confidence might be able to use his instrument to pick the most intractable unknowns facing society. If they pick right, and then manage those unknowns successfully, they should do well.Related Videos
-
The Evolution of Financial Technology
Stewart Myers, Myron Scholes, Robert Merton, John Cox and Stephen Ross
January 28, 2011
-
The Future of Finance
Robert Merton
January 28, 2011
-
The Economic Meltdown: What Have We Learned, if Anything?
Paul Krugman
February 5, 2010
-
- About the Speaker
-
About the Speaker
Andrew Lo
Harris & Harris Group Professor of Finance, MIT Sloan School of Management Director, MIT Laboratory for Financial Engineering
Andrew Lo’s research interests include the empirical validation and implementation of financial asset pricing models; the pricing of options and other derivative securities; financial engineering and risk management; trading technology and market microstructure; statistics, econometrics, and stochastic processes; computer algorithms and numerical methods; financial visualization; nonlinear models of stock and bond returns; hedge-fund risk and return dynamics and risk transparency; and, most recently, evolutionary and neurobiological models of individual risk preferences and financial markets.
He has published numerous articles in finance and economics journals, and is a co-author of The Econometrics of Financial Markets and A Non-Random Walk Down Wall Street, and author of Hedge Funds: An Analytic Perspective. He is currently an associate editor of the Financial Analysts Journal, the Journal of Portfolio Management, the Journal of Computational Finance, and Statistica Sinica.
Lo is a former governor of the Boston Stock Exchange, and currently a research associate of the National Bureau of Economic Research, a member of the NASD's Economic Advisory Board, and founder and chief scientific officer of AlphaSimplex Group, LLC, a quantitative investment management company based in Cambridge, Massachusetts.
Lo received his Ph.D. in economics from Harvard University in 1984, and taught at the University of Pennsylvania's Wharton School 1984 to 1988. - About the Host
-
About the Host
MIT Sloan School of Management
The MIT Sloan School of Management, based in Cambridge, Massachusetts, is one of the world’s leading business schools — conducting cutting-edge research and providing management education to top students from more than 60 countries. The School is part of MIT’s rich intellectual tradition of education and research.
MIT Sloan began in 1914 as engineering administration curriculum in the MIT Department of Economics and Statistics. The scope and depth of this educational focus have grown steadily in response to advances in the theory and practice of management to today’s broad-based management school.
A program offering a master’s degree in management was established in 1925. The world’s first university-based executive education program — the MIT Sloan Fellows — was created in 1931 under the sponsorship of Alfred P. Sloan, Jr., an 1895 MIT graduate who was then chairman of General Motors. A MIT Sloan Foundation grant established the MIT School of Industrial Management in 1952 with a charge of educating the “ideal manager.”
Video Player
Warning: Physics Envy May be Hazardous to Your Wealth
- Andrew Lo
- June 5, 2010
- Running Time: 57:18
