Author: Edgar E. Peters
Length: 222 pages
Reading time: 24 hours
Reading rating: 8 (1=very hard, 10=very easy)
Overall rating: 3 (1=average, 4=outstanding)
Reviewed by Robert F. Mulligan
Special to the Asheville Citizen-Times
Edgar Peters is chief investment strategist at PanAgora Asset Management and author of Chaos and Order in the Capital Markets and Fractal Market Analysis. In his newest book, he explores the relationships among complexity, uncertainty, risk, and reward, with a view toward understanding how markets operate, why they sometimes break down, and how to take advantage of market regularities to earn extraordinary profits.
This well-written book offers a broad, philosophical look at how market economies self-organize into complex and sometimes chaotic systems. It offers deeper understanding about the economy and market processes, but readers hoping to learn secrets of stock picking or get-rich strategies will be disappointed.
Self-organizing systems, patterns which emerge spontaneously from the actions of independent and uncoordinated individuals, result when individuals respond to one another. Adam Smith recognized this principle when he described the coordination of productive activity in a free market as the working of an invisible hand.
A key insight is the contrast between planned economies governed by totalitarian political systems, and the market economy of a capitalist society. Planned economies attempt to insulate their citizens from uncertainty and risk, but can succeed only to a limited extent. Investment in a planned economy should offer a guaranteed return, but things do not always go according to plan. Often, planned economies suffer greater impact from uncertainty and risk because they lack the flexibility and freedom of a market economy. Peters notes that uncertainty and risk go along with freedom of choice, and are necessary preconditions for competition and innovation, two things a planned economy attempts to do without.
Peters praises the Austrian school of economics, in part, for its recognition of the diversity and uniqueness of market participants. Investors are not all alike – each has a unique and subjective combination of time horizon and risk tolerance. In contrast, mainstream and Keynesian economics ignore differences among individual agents by assuming, for simplicity, that everyone is identical. The diversity of individual goals and actions enables entrepreneurs to create profit opportunities by better satisfying individual wants. The Austrian school views knowledge as subjective, and unique to the individual who acts on that knowledge. Far from consisting of identical agents, the real economy consists of perfectly unique agents who react differently in response to the same information.
In financial markets, investors compete to employ capital in the most productive manner, and to provide liquidity to whoever is willing and able to pay the most. The market has no mind of its own, but rewards investors who succeed in this competition. Joseph Schumpeter's model of creative destruction is invoked to describe the business cycle. The Great Depression and the Asian financial crisis led to market reforms which laid the foundation for future prosperity. Although it is still too early to know the final outcome, hopefully the same will turn out to be true for the recent accounting scandals which have deepened the current recession.
Complexity, Risk, and Financial Markets presents a coherent overview of how local randomness, existing at the level of diverse and independent individuals, interacts to form the global structure of a market economy, which is stable and yet continuously in flux.
Robert F. Mulligan is assistant professor of economics in the Department of Business Computer Information Systems and Economics of the College of Business at Western Carolina University. His research interests are monetary economics and constitutional political economy. For previously reviewed books, visit our web site at www.wcu.edu/cob/bookreviews.