Innovation Blog

The (Mis)Behavior of Financial Markets:

Benoit Mandelbrot –We  Should Have Heeded Him

By Shlomo Maital

      “Clouds are not spheres, mountains are not cones, coastlines are not circles, and bark is not smooth, nor does lightning travel in a straight line.”

—     B. Mandelbrot,  The Fractal Geometry of Nature

 Benoit Mandelbrot, pioneering mathematician, passed away on Oct. 14 at age 85.  He was an innovative thinker who should have been more closely heeded.   Mandelbrot is known for the invention of fractals – visual representation of ‘odd’ events.   He liked to visualize fractals by using cauliflower – each floret is composed of smaller florets, composed of smaller florets,  and so on – a true fractal.

    His math had a deep cautionary implication.  For years, we economics professors taught ‘efficient markets theory’, which theorized that in capital markets, all known relevant information is immediately embodied in the price of assets, meaning that whatever motion there is in such prices must be Brownian, or random.  This became the so-called random walk theory.   Scholars like Scholes, Merton, and others won Nobel Prizes for work based on efficient markets.  Mandelbrot, in contrast, cautioned that America’s financial system “is too complex to work” and warned of what Nassim Nicholas Taleb calls “Black Swans” (rare events, unpredictable, that destroy everything).   His wonderful 2004 book The (Mis)Behavior of Markets debunked the efficient markets theory, and had it been heeded, would have helped prevent the catastrophe of 2007-9.   Capital market returns do not follow a bell curve (normal distribution), he stressed, those who use this assumption as the basis of their risk management will end up in deep trouble. And they did.

    Mandelbrot spent 30 years at IBM, as a researcher, before entering academic life.  Even though he did very pure research at IBM, nonetheless he did live among people who lived in the real world.  I believe this had a strong influence on his work.   He was a maverick, radical innovator, unconventional writer, tackled anything and everything that interested him.      

     Mandelbrot was Jewish, of Polish-Lithuanian origin; his family fled to America in 1936, foreseeing the rise of the Nazis.  Sometimes, such a history makes those who survive it risk averse and overly cautious. For Mandelbrot, it did not.  He took risks.   His life is a model for all those who seek to innovate in the realm of ideas.  His credo:  Pursue your passion, research and write about whatever interests you, damn the critics, look for the big picture, and, attack sacred-cow assumptions with powerful intellect.