The relation between finance and physics

“The true logic of this world is in the calculus of probabilities” – James Clerk Maxwell First I should make the disclaimer that I am graduated in finance and my interest in physics is due to a book I’ve read last summer on quantum physics (“Absolutely Small : How Quantum Theory Explains Our Everyday World” by Michael D. Fayer– strongly recommend it, by the way). Recently I’ve had the chance to listen a lecture by Prof. Jim Al-Khalili (by the way he has a book translated in Bulgarian - Paradox: The Nine Greatest Enigmas in Science) and also have found the Feynman Lectures on Physics (still missing Volume 2, however), which are greatly inspirational! The idea to look for a link between finance and a pure science as physics lies in the characteristics that both share – the probabilistic nature. Probability is the way to deal with uncertainty no matter where – in nature or in finance. In a way, successful investing is a probabilistic activity. It is the probability that makes both finance and physics very exciting but it seems to me in finance people tend to neglect this probabilistic nature. One of the common concepts is the Brownian motion. In finance we have the geometric Brownian motion model for price changes developed by Samuelson who rediscovered the work of the French mathematician Bachelier. When simulating stock prices we use two major components: drift (expected return) which is the deterministic component and volatility, which is the random shock component. In physics, as Feynman writes that the most precise description of nature must be in terms of probabilities. For instance, the probability plays an important role in the specification of a position of a particle in describing the structure of atoms. Hence, the way of looking at atom is as a nucleus surrounded by electron cloud (which is essentially probability cloud) – this is the atomic orbital model.