The (mis)Behavior Of Markets

Benoit Mandelbrot's latest book treads old paths in new shoes. For those familiar with his original work on fractals, much of what is written here is a retread. By now we should know that many natural phenomena scale as fractals, that recursion is one way to envelop history, and that variation is mainly what is predictable. All that and more was popularized a long time ago in Godel, Escher, Bach which demonstrated fractals as art. But today's people have long forgotten hippies and the counter-culture, which embraced those "trippy" themes. Thus, the need for this book; another tour of the land which is neither concrete nor stable.

The (mis)Behavior of Markets is getting mixed reviews. For example, Gene Epstein dismisses the book,

Mr. Epstein is a very conservative man, as I understand him through his writings in Barron's. He seems to be believe the truths of ultra-capitalism, including the calculable nature of markets (using neo-classical tools). So, I wouldn't expect him to treasure Mandelbrot's latest work, which attacks the priests in charge of the capitalist temple as well as their theology. (What else could you expect from a born Frenchman?) Among the dogmas undermined by the fractal view of markets are these:

1. the Efficient Market Hypothesis (indexing)

2. Black-Sholes option valuation

3. the "value" theory of stocks

4. Buy and Hold

5. Crashes are exceptional

In chapter 12, Mandelbrot lays out the Ten Commandments of Fractology - he calls them the "Ten Heresies" -

1. Markets are turbulent

2. Markets are very, very risky

3. Market "timing" matters greatly

4. Prices often leap, not glide

5. In markets, time is flexible

6. Markets in all places and ages work alike

7. Markets are inherently uncertain, and Bubbles are inevitable

8. Markets are deceptive

9. Forecasting prices may be perilous, but you can estimate the odds of future volatility

10. In financial markets, the idea of "value" has limited value

Mandelbrot makes several hits on the economic priesthood, which he shows to be slow to allow expression (publication) of new and different ideas, and reluctant to give up whatever face they've become accustomed to. Thus, the recently defended Black-Sholes options pricing formula, and its inclusion in corporate accounting standards, even though its inventor now says its is inaccurate. What Mandelbrot doesn't say loudly - maybe he is too academic or polite for it - is that the economics and financial professions have their thumbs, and maybe all 10 fingers, in the pie. Financial ideas such as the "Efficient Market Hypothesis" are taught and worshipped at almost all MBA schools. Mutual fund companies make millions - even hundreds of millions - selling you on the ideas of INDEXING, BUY & HOLD and the like. You are told the "market timing" is disastrous, and to ignore the fact that most great fortunes were made by lucky market timing. So, if you get my drift, the financial professions are most interested in, GEE WHIZ!, themselves. They spend millions to tell you every day that you need them to guide you through the shoals to safe harbor. Don't do it yourself. Don't notice that the millions spent on advertising come from, Surprise!, YOU. ('Fools and their money are soon parted.')

I give Mandelbrot FOUR STARS for his effort. (I didn't give him 5 stars, because there is a bit too much repetition and self-congratulation in the book.) I think anyone who is not familiar with his work at a professional level, and who invests in markets, should go out and buy this book. Better yet, by hook or crook, READ IT! (Sorry, this one is not coming to Hollywood anytime soon.) I think the ideas are very well explained. I found it an easy read, and informative of the basic concepts he is trying to get across. I found the formulas included in the Notes especially instructive.

This book will NOT help you or me make a million dollars. However, it should encourage you to reassess how and when to invest money. After reading it, you should shut your eyes and ears to those TV commercials promising an easy trip to future rewards. You might even reconsider the nature and basis of (ultra-)capitalism. But, if you "smoked something" long ago, you may have already done that.