Financial Simulation Modeling in Excel

NEW FRONTIERS OF ECONOPHYSICS

One new frontier in simulation modeling is the interface between the natural sciences and markets. Financial modelers have long looked to the sciences for ideas on how to model financial phenomena. The Black-Scholes Model itself is based on a heat-diffusion equation. However, as new questions arise, financial modelers look to different fields for inspiration on how to best model markets.

One of the more prominent names in this field is Didier Sornette, a professor at ETH Zurich. He previously held an academic position as a geophysicist and has dedicated some of his research work to exploring econophysics: applying models built originally for physics that may have applications in finance of economics. One application that has gained some following is that of a “regime change,” that sudden events like the bursting of asset bubbles are like earthquakes. There is a build-up of pressure and then there is a sudden movement. After the bubble or earthquake, the strain is gone and the asset or seismic activity would be expected to follow a different pattern. Along these lines, in a recent paper in the Journal of Economic Behavior & Organization titled “Bubble Diagnosis and Prediction of the 2005–2007 and 2008–2009 Chinese Stock Market Bubbles,” the authors claim to have predicted the date of two crashes with 80 percent probability within one month of the highest closing price.

The tool that this research team believes has the ability to reveal the date of a ...