Tuesday, June 11, 2013

Complex stability

Recent research from the University of Southampton shows a mechanism that self-stabilizes complex systems – such as the Earth’s environment. When the system and its participants are affected, a control system emerges to stabilize the environment. This has implications for many different systems including the financial markets and large companies.

If the financial system is akin to a self equilibrating complex system, that would mean that it is more likely to mend itself after shocks. This means that there is a strong mean reversion in asset prices after shocks. This will challenge the assumption that asset prices follow random walk and this may cast doubts on the efficient market hypothesis. Similarly, predictions of the demise of large and complex companies are premature as unknown mechanisms appear to sustain them and their participants even though most do not demonstrate competitive advantages outside monopoly power.

In general, it appears that the higher the complexity of a system, the more likely that it nourishes self-equilibrating control systems that kick in after shocks. Complexity could be a valuable survival trait for inefficient and naturally unstable systems.