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

Primordial Seeds 
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relationship of these variables to the individuals who make up the 
economy. In 1947, Samuelson published a book based on his disserta-
tion at Harvard, called Foundations of Economic Analysis.
Samuelson’s book was groundbreaking in a way that Bachelier’s the-
sis never could have been. When Bachelier was studying, economics 
was only barely a professional discipline. In the nineteenth century, it 
was basically a subfield of political philosophy. numbers played little 
role until the 1880s, and even then they entered only because some 
philosophers became interested in measuring the world’s economies 
to better compare them. When Bachelier wrote his thesis, there was es-
sentially no field of economics to revolutionize — and of the few econ-
omists there were, virtually none would have been able to understand 
and appreciate the mathematics Bachelier used.
over the next forty years, economics matured as a science. early 
attempts to measure economic quantities gave way to more sophisti-
cated tools for relating different economic quantities to one another
— in part because of the work of Irving fisher, the first American 
economist and another student of Gibbs’s at Yale. for the first decades 
of the twentieth century, research in economics was sporadic, with 
some mild support from european governments during World War I, 
as the needs of war pushed governments to try to enact policies that 
would increase production. But the discipline fully came into its own 
only during the early 1930s, with the onset of the depression. Political 
leaders across europe and the United States came to believe that some-
thing had gone terribly wrong with the world’s economy and sought 
expert advice on how to fix it. Suddenly, funding for research spiked, 
leading to a large number of university and government positions. 
Samuelson arrived at Harvard on the crest of this new wave of inter-
est, and when his book was published, there was a large community 
of researchers who were at least partially equipped to understand its 
significance. Samuelson’s book and a subsequent textbook, which has 
since gone on to become the best-selling economics book of all time, 
helped others to appreciate what Bachelier had accomplished nearly 
half a century earlier.
In modern parlance, what Bachelier provided in his thesis was a model 

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for how market prices change with time, what we would now call the 
random walk model. the term model made its way into economics 
during the 1930s, with the work of another physicist turned economist, 
Jan tinbergen. (Samuelson was the second nobelist in economics; 
tinbergen was the first.) the term was already being used in physics, 
to refer to something just shy of a full physical theory. A theory, at least 
as it is usually thought of in physics, is an attempt to completely and 
accurately describe some feature of the world. A model, meanwhile, is 
a kind of simplified picture of how a physical process or system works. 
this was more or less how tinbergen used the term in economics, too, 
although his models were designed specifically to devise ways of pre-
dicting relationships between economic variables, such as the relation-
ship between interest rates and inflation or between different wages 
at a single firm and the overall productivity of that firm. (tinbergen 
famously argued that a company would become less productive if the 
income of the highest-paid employee was more than five times the in-
come of the lowest-paid employee — a rule of thumb largely forgotten 
today.) Unlike in physics, where one often works with full-blown theo-
ries, mathematical economics deals almost exclusively with models.
By the time the cootner book was published in 1964, the idea that 
market prices follow a random walk was well entrenched, and many 
economists recognized that Bachelier was responsible for it. But the 
random walk model wasn’t the punch line of Bachelier’s thesis. He 
thought of it as preliminary work in the service of his real goal, which 
was developing a model for pricing options. An option is a kind of 
derivative that gives the person who owns the option the right to buy 
(or sometimes sell) a specific security, such as a stock or bond, at a 
predetermined price (called the strike price), at some future time (the 
expiration date). When you buy an option, you don’t buy the underly-
ing stock directly. You buy the right to trade that stock at some point 
in the future, but at a price that you agree to in the present. So the price 
of an option should correspond to the value of the right to buy some-
thing at some time in the future.
even in 1900, it was obvious to anyone interested in trading that 
the value of an option had to have something to do with the value of 
the underlying security, and it also had to have something to do with 
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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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