For the most part, the empirical tools used by physicists working in finance are theoretical data grubbing techniques that search for exploitable correlations in historical data. For example, if there is an asset price that is correlated with an observable variable, hopefully with a lag, then price movements can be predicted – the higher the correlation the better the prediction – and used to make profit or hedge against risk. But as the Lucas critique points out, relying on these correlations can be dangerous since they can change when people try to exploit them.
(Curated by Dennis Moore. Read the complete article here)
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