Moshe Levy – Microscopic Simulation of Financial Markets
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Microscopic Simulation (MS) uses a computer to represent and keep track of individual (“microscopic”) elements in order to investigate complex systems which are analytically intractable.
Most models in economics and finance assume that investors are rational. However, experimental studies reveal systematic deviations from rational behavior. How can we determine the effect of investors’ deviations from rational behavior on asset prices and market dynamics? By using Microscopic Simulation, a methodology originally developed by physicists for the investigation of complex systems, the authors are able to relax classical assumptions about investor behavior and to model it as empirically and experimentally observed. This rounded and judicious introduction to the application of MS in finance and economics reveals that many of the empirically-observed “puzzles” in finance can be explained by investors’ quasi-rationality.
Researchers use the book because it models heterogeneous investors, a group that has proven difficult to model. Being able to predict how people will invest and setting asset prices accordingly is inherently appealing, and the combination of computing power and statistical mechanics in this book makes such modeling possible. Because many finance researchers have backgrounds in physics, the material here is accessible.
Emphasizes investor behavior in determining asset prices and market dynamics
Introduces Microscopic Simulation within a simplified framework
Offers ways to model deviations from rational decision-making