Future of Finance

Finance theory continues to develop beyond the traditional academic precincts of rational expectations and efficient markets, with the latest innovations coming from psychology, neuroscience and biology.

J. Doyne Farmer is making his mark by thinking outside the box as well. Farmer is a professor of mathematics at the University of Oxford and a director of the program on complexity economics at the Institute for New Economic Thinking. Additionally, he is an external professor at the Santa Fe Institute, a private, nonprofit research organization. But Farmer was originally trained as a physicist. In the 1980s he worked at the Los Alamos National Laboratory, home of the Manhattan Project, where scientific luminaries like J. Robert Oppenheimer and Richard Feynman once plied their trade. At Los Alamos Farmer founded the Complex Systems Group in the theoretical division.

In 1991, he co-founded the Prediction Company, a quantitative trading firm about which University of Chicago professor and architect of the Efficient Market Hypothesis Eugene Fama said: “Prediction Company’s chance of success is not zero, but close to it.” The firm would prove Fama wrong, however, and was purchased by Swiss banking giant UBS in 2005.

At the Santa Fe Institute, Farmer is looking for laws in financial markets that can help explain what drives the stability and performance of the banking system.

Over his career Farmer has collaborated with prominent academics such as MIT Sloan School of Management finance professor Andrew Lo — whose Adaptive Markets Hypothesis attempts to reconcile Fama’s hypothesis with the realities of human behavior through the application of evolutionary biology — and Yale University economics professor John Geanakoplos, a noted contributor to the general equilibrium branch of economics.

Currently, Farmer is working on a different method of understanding market behavior: agent-based modeling — simulations of financial market participation by investors.

This work requires gathering and coding an enormous amount of data and creating a library of information of sorts from which to simulate interactions of agents in financial markets. Farmer’s background in dynamical systems theory, time-series prediction and chaos theory coupled with his newer work with complex systems and financial economics has aided him in his effort to simulate and analyze the individual actions of and interactions between agents on a marketwide basis.

Farmer is also the scientific coordinator of CRISIS, a large-scale European Union project to build an agent-based model of the banking system and the real economy.