Models Behaving Badly

Physicists are looking for the “God particle.” Could its discovery affect investments?

The scientists at the CERN Institute are huddling over the results of some supercollider experiments. They show a tantalizing bulge in the curves that has a “one-in-a-thousand” chance of being random. That is, there’s a very good chance that the scientists have found evidence of the Higgs Boson, a long-predicted but never-observed key to the Standard Model of physics.

The Standard Model is a set of physical theories that combines the forces of gravity, electromagnetism, weak, and strong nuclear interactions. The Higgs Boson is a key to this theory, because according to the model, it explains why fundamental particles have mass. It’s the only particle predicted by the Standard Model that hasn’t yet been discovered.

In finance there is no standard model, no broadly accepted theory that purports to explain why markets behave the way they do. Instead, we have rational expectations and efficient markets, behavioral finance, Austrian economics, Keynesian and neo-Keynesian models, and a host of micro-applications, like public choice theory and the theory of the firm. But there is no overarching framework that holds them all together, no “one ring” that binds them.

In part, that’s because finance describes people’s economic behavior, and people are funny subjects. They generate feedback effects that can counteract a model’s carefully quantified predictions. But similar problems vexed physicists 100 years ago. It took them 70 years to formulate the Standard Model, and it is now being challenged by the elusive “God particle.”

Someday we may devise a Standard Model of finance. In the meantime, we’ll just have to keep searching.

Douglas R. Tengdin, CFA
Chief Investment Officer
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