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

“. . . this is how their enterprise is usually characterized . . .”: one cer-
tainly gets this impression from Bass (1999); likewise, Broad (1992) writes that farmer 
and Packard are “private entrepreneurs using world-class skills in chaos theory to pre-
dict the rise and fall of stocks and bonds.”
149
“Farmer and Packard didn’t use chaos theory . . .”: this section in 
particular is based on an interview with farmer. the closest thing from farmer’s and 
Packard’s days as physicists that was helpful in their early days with the Prediction com-
pany was the work in farmer and Sidorowich (1987), where they present a method for 
making short-term predictions based on a particular algorithmic approximation.
149
“One strategy they used was something called statistical arbitrage 
. . .”: for more on the history of statistical arbitrage, see Bookstaber (2007). ed thorp 
also played a significant role in the early development of the idea; for more on his con-
tribution, see thorp (2004).
150 “. . . a variety of computer programs known as genetic algorithms”: for more on 
genetic algorithms, see, for instance, Mitchell (1998). for Packard’s early contributions, 
see Packard (1988, 1990).
154 “. . . over the firm’s first fifteen years . . .”: More specifically, this person told me 
that the company had a Sharpe ratio of 3.
7. tyranny of the dragon King
159 “Didier Sornette looked at the data again”: the opening story, which plays 
out throughout the chapter, is a dramatization, but the basic details are correct. In late 
summer 1997, Sornette observed a pattern in U.S. financial data that he had previously 
argued could be used to predict financial crashes; he contacted his colleagues olivier 
Ledoit and Anders Johansen and proceeded as described here. the story is told briefly, 
for instance, in chapman (1998) and alluded to in Sornette (2003); further details are 
from an interview and numerous e-mail exchanges with Sornette. More generally, bio-
graphical material on Sornette is based on this interview and on Sornette’s story of how 
he became interested in finance in Sornette (2003). Sornette generously read an earlier 
draft of this chapter and offered helpful comments to improve its clarity and accuracy.
161 “Imagine inflating a balloon”: Sornette offers a very clear account of how criti-
cal phenomena may be used to understand market crashes, including an explanation of 
the mechanisms that lead to self-organization in markets, in Sornette (2003). for more 
on Sornette’s work on critical ruptures, and the application of these ideas to other con-
texts, see also Sornette (2000).
162 “He has also written four books . . .”: these are Sornette (2003), Sornette 
(2000), Malevergne and Sornette (2006), and Saichev et al. (2010).

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Notes 
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245
164 “But by the mid-1960s, the leaders of several western European nations . . .”: the 
definitive history of the european Space Agency, from 1973 through 1987, is to be found 
in Krige et al. (2000).
166 
“This kind of conspiracy is sometimes called self-organization . . .”: 
Self-organization is an old idea, though its modern form originates in the work of 
the 1977 nobel laureate for chemistry, Ilya Prigogine (Glansdorff and Prigogine 1971; 
Prigogine and nicolis 1977). the idea described in the text is more specifically described 
as “self-organized criticality,” which is due to Bak et al. (1987); see also Bak (1996).
167 “Together, they began to think about . . .”: Sauron’s thesis, Sauron (1990), in-
volved constructing a small (physical) model of the earth’s crust using sand, Silly Putty, 
and honey, and then using it to perform experiments on how the crust buckles when 
plates collide. Sauron and Sornette showed that these collisions exhibited a character-
istic fractal pattern. this work is described in davy et al. (1990), Sornette and Sornette 
(1990), Sornette et al. (1990a, b), and Sornette (2000). for more on the history of the 
study of tectonic plates, see oreskes and Le Grand (2003).
168 “The ancient Roman historian Aelian . . .”: Aelian makes these remarks in On