Sunday, May 29, 2011

Modeling a Financial Nonlinear Phase Transition

A disclaimer. Before you (or I) go any further with this, an upfront and blanket disclaimer.

This is not a real, true, serious modeling effort.

It is not even a true gedanken-experiment (German for "mental experiment," or mental walk-through.)

If anything, this is a little warm-up exercise. An attempt to stretch and flex some "modeling muscles" that have not been used for a couple of years. (And in good cause, I might add - I've just completed a book, see Unveiling: The Inner Journey.

Writing that book fulfilled a private passion that had taken sixteen years to come to completion; the last two years were nearly full-time spent on writing and rewriting, editing and re-editing, proofing and re-proofing, plus a great deal of reference-checking, index-building, and related activities. But even the cover art is now done (or it will be soon), and I am deeply drawn back to another passion - that of modeling complex, nonlinear systems. Especially systems that tend to go "boom!"

Such is the case with the financial meltdown of 2008-2009. I'm listening (once again) to Suzanne McGee's Chasing Goldman Sachs. I stopped the CD somewhere around Chapter 4, when she was describing how highly-leveraged buyouts climbed to an increasing crescendo. We knew, of course, that the collapse was coming. Could this be described as a phase transition?



Modeling Financial Meltdown as a Phase Transition


The financial system described by McGee in Chasing Goldman Sachs
has an increasing number of institutions - both private-equity and hedge funds on the one side, and companies being purchased on the other side, together with the institutions that enable these transactions - involved in buyouts. The frequency became so great, along with the number of repeated sales of certain companies, that it became clear that this was no buy-and-reformulate strategy. As McGee plainly states, "These were flips." And the increase in activity was reaching frenetic proportions.

So - again firmly caveating; this is simply a warm-up exercise; this is "play" - not a real serious attempt at modeling - could we model this as a phase transition?

If so, the first and most important question is the one that I posited in a recent posting, namely Modeling Nonlinear Systems: What is x?

That will be the subject of the next posting.

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