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

particular had reservations: dale Jorgenson, one of Harvard’s two rep-
resentatives on the Boskin commission and an expert on the index 
number problem. Malaney’s project covered exactly the same ground 
that the Boskin commission was supposed to investigate. She had de-
veloped an elegant mathematical framework for addressing precisely 
the problem they were tasked with. And so, when she learned of his 
appointment, Malaney arranged a meeting with him. excited, she de-
scribed her work to him, showing how gauge theory could be applied 
to this important problem. Jorgenson replied by throwing her out of 
his office. “You have nothing,” he told her.
At the time, Malaney was discouraged, but she didn’t give up. So 
what if she couldn’t convince Jorgenson on her first try? Maskin liked 
the ideas and would advise the thesis. In the long run, the work would 
speak for itself. But then, as Malaney prepared to apply for jobs, this 
vision of the future began to dissolve. during the jobs meeting, it be-
came clear that Jorgenson’s resistance to Malaney’s project ran deep. 
Several months later, when the Boskin commission released its find-
ings, the reasons for his resistance would become clear.
It took years for Malaney to convince Weinstein to take economics se-
riously. She tried everything: pointing to famous economists, explain-
ing their most influential theories, describing important experimental 
results. But Weinstein was resistant. the mathematics, he was con-
vinced, was too simple; the subject matter, too complex. economics 
was a worthless pursuit, a pseudo science. finally, on the verge of giv-
ing up, Malaney tried one last tack. She gave Weinstein a challenge, a 
problem whose solution was equivalent to a classic result in economics 
known as coase’s theorem.
ronald coase was a British economist who spent most of his career 
in the United States, at the University of chicago. He was interested 
in something he called “social cost.” Imagine you are the local sheriff 
in an agricultural community. two of your constituents come to you, 
asking you to help them settle an ongoing dispute. one of them is a 
rancher, raising cattle. the other, the rancher’s neighbor, farms soy-
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A New Manhattan Project 
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beans. the dispute concerns the rancher’s cattle, which have a habit 
of wandering over to the farmer’s land and destroying his crop. Mat-
ters have recently become especially difficult because the farmer has 
learned that the rancher wants to add more cattle to his herd, and the 
farmer is concerned that the problem will get worse. What should you 
do?
When coase tried to formalize an answer to social cost problems 
like this one, he came to a striking conclusion. It doesn’t matter what 
the sheriff does, at least from a long-term perspective, as long as three 
conditions are met: the damages involved must be adequately quanti-
fied, some well-defined notion of property must be instituted, and bar-
gaining must be free. to see why this would be, consider what would 
happen if the sheriff told the rancher he could have as many cattle 
as he liked, but that he had to pay for all of the damage his herd in-
flicted. In essence, the rancher has incurred an additional cost to rais-
ing cows. depending on how much damage gets done, and how much 
soybeans are worth, it may well make sense for the rancher to keep 
adding head to his herd even while paying the farmer for the soybeans 
that keep getting destroyed. If the rancher really is paying the value of 
the soybeans, the farmer shouldn’t care whether the revenue comes 
from selling the soybeans himself or from the rancher’s compensation
— in fact, he might as well think of the rancher as a customer buy-
ing whatever soybeans the cattle destroy. Ultimately, the rancher and 
farmer will reach an agreement about how many cattle the rancher 
will own based on what is maximally profitable for both parties. But 
what if the sheriff makes some other choice? If the farmer has to pay 
the rancher to keep his cattle from destroying the farmer’s crops, one 
would expect the exact same bargaining to occur. coase’s theorem says 
that the endpoint will always be the same: both parties will agree on an 
arrangement that is maximally profitable for everyone.
When Malaney gave Weinstein this problem, Weinstein took it se-
riously. Making some simple mathematical assumptions, similar to 
the ones coase made, Weinstein soon saw his way to a solution — just 
the solution, in fact, that coase had arrived at. But this, Weinstein 
thought, was a surprise. At least in this case, it seemed as though the 
mathematics was working in the right sort of way, and indeed, it led 

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to what seemed to be a deeply counterintuitive result that nonethe-
less bore weight. the process felt surprisingly similar to using math-
ematics in physics: one makes some simplifying assumptions and then 
uses mathematics to gain insights into a problem that would have oth-
erwise remained intractable. Most importantly, if someone had told 
Weinstein about coase’s theorem before he had worked on it himself, 
he would likely have thought that the solution was politically driven, a 
thinly veiled case for less government intervention, shrouded in math-
ematics to give the appearance of rigor. But now he saw that matters 
were not so simple.
His interest piqued, Weinstein began looking for other cases where 
mathematics was used to reach counterintuitive results in econom-
ics. He uncovered several examples. the Black-Scholes equation was 
one, since it makes use of fairly sophisticated mathematics to get at 
the heart of what it means to produce and trade an option. Another 
was Arrow’s theorem, a famous result in social choice theory that es-
sentially proves that if you have a group of people trying to choose 
between three or more options, there is no voting system that can turn 
the ranked preferences of all of the individuals in the community into 
a fair community-wide ranking.
Weinstein realized that his criticisms of economics had been mis-
placed. Mathematics, he now believed, could be used productively to 
understand economic problems. It was an exhilarating realization, 
because it meant that someone with some mathematical acumen and 
a background in physics stood a chance at making progress on prob-
lems in economics. Soon, instead of looking for cases where math-
ematics had been put to productive use in economics, Weinstein and 
Malaney started looking for cases where it hadn’t been put to use — at 
least, not yet. together, they happened on the index number problem. 
the mathematics underlying the cPI is astoundingly simple, given the 
profound difficulties associated with assigning a number to something 
so complicated as the value of money to a consumer. It was a perfect 
place to start.
Weyl’s essential innovation, conceptually speaking, was to find a 
mathematical theory for comparing otherwise incomparable quanti-
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