Abstract
In this paper we argue that the stochastic paradigm of asset prices has prevented us from understanding market behavior because most of the variance of the variables of economic interest is often attributed to random shocks. One implication of the tests of the Efficient Market Hypothesis is that most of the variation in prices is due to our ignorance of the underlying structure. As an alternative to the stochastic methodology we propose an economic interpretation of the most famous chaotic map called the Lorenz system. We briefly describe the major characteristic of this chaotic system and we also use financial data for its empirical testing.
We are thankful to Henry Wen-herng King, Dimitrios Bouroudzoglou and Raffaella Cremonesi for extensive computations. An earlier version of mis paper was presented at the European Working Group on Financial Modelling, June 1–3, 1995 at the University of Bergamo, ITALY. We are very grateful to Professor Marida Bertocchi for the invitation to participate and to two anonymous referees for constructive criticisms.
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© 1996 Physica-Verlag Heidelberg
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Malliaris, A.G., Stein, J.L. (1996). Financial Modelling: From Stochastics to Chaotics and Back to Stochastics. In: Bertocchi, M., Cavalli, E., Komlósi, S. (eds) Modelling Techniques for Financial Markets and Bank Management. Contributions to Management Science. Physica-Verlag HD. https://doi.org/10.1007/978-3-642-51730-3_1
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DOI: https://doi.org/10.1007/978-3-642-51730-3_1
Publisher Name: Physica-Verlag HD
Print ISBN: 978-3-7908-0928-2
Online ISBN: 978-3-642-51730-3
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