Physicists Fix Economics: Ole Peters' Ergodic Hypothesis

In summary, Nature recently published a paper by two physicists that suggests that economics is in a state of crisis because it makes an indiscriminate assumption of ergodicity. While the idea may be novel and interesting, the argument is weak and the reaction by economists has not been kind.
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Nature recently published this piece with another physicist (Ole Peters from the Santa Fe Institute) trying to 'fix' economics:
https://www.nature.com/articles/s41567-019-0732-0
The ergodic hypothesis is a key analytical device of equilibrium statistical mechanics. It underlies the assumption that the time average and the expectation value of an observable are the same. Where it is valid, dynamical descriptions can often be replaced with much simpler probabilistic ones — time is essentially eliminated from the models. The conditions for validity are restrictive, even more so for non-equilibrium systems. Economics typically deals with systems far from equilibrium — specifically with models of growth. It may therefore come as a surprise to learn that the prevailing formulations of economic theory — expected utility theory and its descendants — make an indiscriminate assumption of ergodicity. This is largely because foundational concepts to do with risk and randomness originated in seventeenth-century economics, predating by some 200 years the concept of ergodicity, which arose in nineteenth-century physics. In this Perspective, I argue that by carefully addressing the question of ergodicity, many puzzles besetting the current economic formalism are resolved in a natural and empirically testable way.

With a short paper that, to my reading, just comes up with a toy model of geometric brownian motion with a small positive expectation but high variance, so that ergodicity (defined as a finite time average <> infinite time expectation value) is violated for relativity short time periods. The model is simply a coin toss where you gain 50% on a win and lose 40% on a loss. A finite even number of wins and losses will result in an overall loss, but the large right tail makes the overall expectation positive. He goes on to discuss utility and the St Petersburg paradox

While the media loves these 'outsider fixes economics' stories, this seems really trivial, and understandably the reaction by economists has not been kind, and reveals Peter's argument as largely a straw man

https://static-content.springer.com...x/MediaObjects/41567_2020_1106_MOESM1_ESM.pdf
physicists.png
 
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Is that the paper that says financial success is 95% luck?
 

FAQ: Physicists Fix Economics: Ole Peters' Ergodic Hypothesis

What is the Ergodic Hypothesis and how does it relate to economics?

The Ergodic Hypothesis is a concept in physics that states that a system will eventually visit all possible states over a long enough period of time. In the context of economics, this means that the economy will eventually reach all possible outcomes and therefore can be modeled using a single, average trajectory. Ole Peters' theory suggests that this is not the case and that the economic system is non-ergodic, meaning that it will not visit all possible states and therefore cannot be accurately modeled using a single average trajectory.

How does Ole Peters' theory challenge traditional economic models?

Ole Peters' theory challenges traditional economic models by suggesting that the economy is non-ergodic and therefore cannot be accurately modeled using a single average trajectory. This challenges the idea that the economy will eventually reach equilibrium and that economies can be accurately predicted using mathematical models.

Can you provide an example of how the Ergodic Hypothesis affects real-world economics?

One example of how the Ergodic Hypothesis affects real-world economics is in the concept of risk management. Traditional economic models assume that risk can be managed by diversifying investments and spreading out risk. However, Peters' theory suggests that risk is actually non-ergodic and cannot be accurately predicted or managed using traditional methods.

How can understanding the Ergodic Hypothesis improve economic policies?

Understanding the Ergodic Hypothesis can improve economic policies by challenging traditional economic models and encouraging policymakers to consider alternative methods for predicting and managing the economy. This could lead to more accurate and effective economic policies that take into account the non-ergodic nature of the economy.

What are some potential criticisms of Peters' Ergodic Hypothesis?

Some potential criticisms of Peters' Ergodic Hypothesis include the lack of empirical evidence to support the theory, as well as the complexity of the concept which may make it difficult for policymakers to implement in practical economic policies. Additionally, some may argue that the Ergodic Hypothesis is too radical of a departure from traditional economic models and may be met with resistance from the economic community.

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