Risk, economic and financial complexity
Risk, Economy, and Finance
The application and use of complexity methods to economic systems, the financial industry and capital markets provides us with an enhanced perspective of the dynamics of the diffusion of risk across distinct market agents. Within a complexity framework, risk can be regarded as a variable of relative quantity - akin to fitness within biological systems - where measurement and quantification is dependent on the structure and evolution of the interactions among market agents. Therefore, methods from Complexity can address the weaknesses arising from the endogenous and static nature of risk management systems and prudential frameworks - where risk is quantified, compartmentalised, and managed in isolation. Such a narrow approach played a significant role in the emergence of financial and economic crises.
One can reasonably argue that key concepts associated with Complexity, such as evolution, adaptation and the interconnection of the agents within a system can be found within early stages of classical economics, albeit in an unstructured manner.
For example, Adam Smith’s early writings, “The Theory of Moral Sentiments”, can be viewed as an early attempt to deal with two fundamental elements of Complexity science: Firstly, the fact that the fitness (or ‘utility’ in Smith’s work) of a ’thing’ is not solely the result of its intrinsic property, but of how these ’things’ are arranged together. Secondly, how individual, ‘selfish’, actions by the agents may lead to the stability of a system (the idea of the ‘invisible hand’ in Smith’s work). Fast forward a few centuries, Schumpeter states that “The Special Nature of Economic Laws’ are ‘much less stable than are the laws of any physical science. If one were to imagine Schumpter’s having the same tools and language as of the present day, it would not be too far-fetched to envision him using terms such as ‘self organised criticality’, ‘percolation’ and ‘punctuated equilibrium’ to such Special Nature.
Within the Centre for Complexity Science, our research focus is to apply and make use of complexity methods to economic systems in a dialogical manner to more traditional economic and finance methods and literature. This essentially means that we focus our research on identifying and explaining the evolutionary dynamics of economic and financial systems through distinct methods and approaches that can work together and co-exist with other traditional approaches without the need for establishing a hierarchy of these approaches, single optimum methods or a ‘synthesis of ideas’.
Following Gould’s philosophical approach of the Non-Overlappping Magisteria, we cast our net to cover the empirical aspects of the economic and financial systems, namely ‘how these are organised and evolve’, and ‘why do they work in this way’. In this way, we regard ideological, political and moral aspects of these systems to be the domain of economics and finance magisteria.