The Physics of Wall Street: a brief History of Predicting the Unpredictable

Swimming Upstream 
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grounds that the stock market is composed of people, not quarks or 
pulleys. Physics is fine for billiard balls and inclined planes, even for 
space travel and nuclear reactors, but as newton said, it cannot predict 
the madness of men. this kind of criticism draws heavily on ideas 
from a field known as behavioral economics, which attempts to under-
stand economics by drawing on psychology and sociology. from this 
point of view, markets are all about the foibles of human beings — they 
cannot be reduced to the formulas of physics and mathematics. for 
this reason alone, osborne’s argument is historically interesting, and 
I think telling. It shows that mathematical modeling of financial mar-
kets is not only consistent with thinking about markets in terms of the 
psychology of investors, but that the best mathematical models will 
be ones that, like osborne’s and unlike Bachelier’s, take psychology 
into account. of course, osborne’s psychology was primitive, even by 
the standards of 1959. (the Weber-fechner law was already a century 
old when osborne applied it, and much subsequent research had been 
conducted on how human subjects register change.) Modern econom-
ics can draw on far more sophisticated theories of psychology than the 
Weber-fechner law, and later in the book we will see some examples 
where it has. But bringing in new insights from psychology and related 
fields only strengthens our ability to use mathematics to reliably model 
financial markets, by guiding us to make more realistic assumptions 
and by helping us identify situations where the current crop of models 
might be expected to fail.
osborne was accustomed to working with the very finest physicists of 
his day, and he could not be cowed by authority. If he worked out the 
solution to a problem, or if he believed he understood something, he 
argued his case forcefully. In early 1946, for instance, osborne became 
interested in relativity theory. to learn as much about the theory as 
he could, he picked up a book by einstein, The Meaning of Relativity, 
in which einstein offered an argument about how much dark matter 
could exist in the universe. dark matter — literally, stuff in the uni-
verse that doesn’t seem to emit or reflect light, which means that we 
can’t see it directly — was first discovered in the 1930s, by its effects on 

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the rotation of galaxies. devotees of popular physics know that today, 
dark matter is one of the most puzzling mysteries in all of cosmol-
ogy. observations of other galaxies suggest that the vast majority of 
the matter in the universe is unobservable, something that is not ex-
plained by any of our best physical theories.
einstein proposed a simple way of figuring out the lower bound for 
the total amount of dark matter in the universe. He argued that the 
density of dark matter in the universe as a whole was at least as much 
as the density within a galaxy (or rather, a group of galaxies known as 
a cluster). osborne decided he didn’t buy the argument. for one, ein-
stein seemed to be making a series of bad assumptions. Worse still, the 
best evidence that anyone had in 1946 showed that most dark matter 
was restricted to certain parts of a galaxy, with basically no dark matter 
in empty space (this still seems to be true). So if anything, you should 
expect the density of dark matter to be higher in a galaxy than in space 
as a whole.
By 1946, most people, if they disagreed with an argument of ein-
stein’s pertaining to relativity and astrophysics, would assume they had 
misunderstood something. einstein was already a cultural icon. But 
osborne took no heed of such things. When he understood some-
thing, he understood it, and no amount of reputation or authority 
could intimidate him. So osborne wrote einstein a letter in which he 
very politely suggested that einstein’s argument didn’t make any sense. 
einstein replied by restating his argument from the book. So osborne 
wrote again. einstein conceded that his argument was problematic but 
thought the conclusion remained sound, and so he offered another 
argument. once again, osborne refuted it. At the end of a half-dozen-
letter correspondence, it was clear that einstein was unconvinced by 
osborne. But it was equally clear to osborne that einstein’s argument 
in the book failed, and that he didn’t have any other good arguments 
up his sleeve.
*
osborne approached his work in economics in the same spirit. 
Unconcerned about his lack of background in economics or finance, 
* I think most physicists today, if they read the letters, would say that osborne got the better 
of the exchange.
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t h e p h y s i c s o f wa l l s t r e e t

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