Mandelbrot's novel "The Misbehavior of Markets" is truly a hidden gem. The deeper into the book I went, the more it spoke directly to my darkest intuiMandelbrot's novel "The Misbehavior of Markets" is truly a hidden gem. The deeper into the book I went, the more it spoke directly to my darkest intuitions. I actually started to get the feeling that no one else has actually bothered to read the book cover to cover.. all of his wealth of knowledge felt as if it was almost becoming my little secret. Indeed even the jacket reviews are not very convincing. Paraphrasing the Financial Times "[a famous math guy wrote a book.. Math!!]" and the Sunday Telegraph "[founder of fractal geometry, father of chaos theory.. one intelligent dude]" I sincerely doubt their respective reviewers read it, and I can certainly understand why no one was rushing out to pick up a copy after reading their generic enthusiasm.

At its core the book is (a) Mandelbrot's presentation of "modern" financial theory (b) why and how that body of tools is not a complete failure, but because I discovered fractal geometry back in the 1960s it actually sort of is a complete and utter failure and (c) how the market can be better approximated using fractal patterns and analysis. To keep this review incredibly straightforward, "modern" financial theory (EMH, CAPM, Black Scholes) is built on extensions and patchwork of academic work that is based on faulty assumptions. The idea that prices change are independent and move according to a random walk is bullshit. Price changes are not smooth and stocks exhibit long term dependence. At it's fundamental core the market is fractal, not Euclidean, as are many phenomena in real life. Therefore, price changes should be more closely approximated (ie: financial models) by power laws as opposed to a normal Gaussian bell curve distribution.

As a result: when financial engineers (ie: smart math and science people who go into fields which have no redeeming societal value such as high frequency trading) futilely try to map the financial future as a precise science to profit an extra fraction of a penny in a fraction of a second with less variability, because these nerds use formulas of "modern" finance.. And because everyone seems content with keeping the basic foundation of the formulas for the foreseeable future since the math is easy and the approximations "good enough".. the market will likely continue to exhibit higher volatility than they expect. Risk will be higher than confidence dictates.. bubbles will continue to form, and pop with alarming regularity.. and anomalies, and general market misbehavior will remain an innate part of our understanding of finance and economics....more