Nonlinear Pricing: Theory and Applications

Nonlinear Pricing: Theory and Applications

by Christopher T. May, May

In a totally new way of looking at financial economics, Nonlinear Pricing abandons the traditional assumptions of equilibrium in economics and randomness in a time-series. These shortcomings are becoming increasingly awkward given a superior technological infrastructure and advances in mathematics and the sciences. Despite these advances and their empirical proof,

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In a totally new way of looking at financial economics, Nonlinear Pricing abandons the traditional assumptions of equilibrium in economics and randomness in a time-series. These shortcomings are becoming increasingly awkward given a superior technological infrastructure and advances in mathematics and the sciences. Despite these advances and their empirical proof, much remains confused or muddled. In this groundbreaking new book, leading hedge fund manager Christopher T. May explores the nature and role of nonlinearity, an inherent part of everyday reality, and illustrates a profit-making strategy. One of the many striking applications of nonlinear technology in recent years, nonlinear pricing uses cutting-edge technology to identify and exploit patterns hidden within the seemingly helter-skelter rise and fall of daily stock prices. Nonlinear Pricing sheds much needed light on the principles behind this innovative view of reality and provides clear explanations of how it is employed to predict-at least partially-the unpredictable. Beginning with an incisive introduction to the topic, May presents the roots of nonlinearity through the examples of calendrics, geometry, and music. He then illustrates the application and integration of various nonlinear technologies, including genetic algorithms, fuzzy logic, fractal imaging, and nonlinear dynamics, to such essentials as trading strategies, asset allocation, risk management, and derivative pricing and hedging. Along with practical methodologies and a wealth of real-world examples, this comprehensive resource contains a glossary of terms, a bibliography, and in-depth information on:
* Fractal analysis-power law distributions, fractional Brownian motion, and their relationships
* The Hurst Exponent-the KAOS screen and its practical implementation
* Resonance-time domain versus frequency domain, Brownian motion, and the Gaussian distribution
* Advanced concepts-Soros's Reflexivity, nonequilibrium economics, kernel of theoretical nonlinear pricing, May's Law, resolution and resonance
Written by one of the few practitioners using this breakthrough methodology to trade the markets successfully, Nonlinear Pricing fills an important niche in investment literature. It is a must read for anyone seeking to understand-and capitalize on-twenty-first century financial economics.

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Editorial Reviews

From the Publisher
"A lively and intriguing book from a writer who can range from Zento mathematics."-Adam Smith, author of The Money Game and PaperMoney

"Nonlinear Pricing is an eminently readable book which I foundsatisfied both the theorist and the practitioner in me. For thetheorist, there are new insights into the relationship betweencomplexity and the markets. For the practitioner, there arepractical ideas on how to fashion investment strategies. I highlyrecommend Nonlinear Pricing to all students of the markets."-EdgarE. Peters, Chief Investment Strategist, PanAgora Asset Management;author, Chaos and Order in the Capital Markets

"Nonlinear Pricing goes further than any book I am aware of indrawing a connection between the real world of economics and thenew ideas about economics coming from the science of self-organizedsystems. Written in a lively, informal style, this is a wonderfulread for those of us who have been wondering whether anyoneunderstands anything at all about how markets work."-Lee Smolin,PhD, Department of Physics, Pennsylvania State University

"Required reading for the enlightened financial professional.Enjoyable for the intelligent investor. A dash of physics,bite-sized pieces of nonlinear concepts, and a broth of hands-onexperience make this a cookbook for the modern trader."-Richard E.Morley, Potts Medal recipient and founder of the BreakfastClub

"A real eye-opener-Nonlinear Pricing explains a complex subject ineasy terms and makes the reader aware of the many opportunitiesoffered by this new technology." -Richard Olsen, founder, Olsen andAssociates, Zurich

"I, of course, think highly of this book as it credits Dance of theMoney Bees with inventing 'swarm theory', now a discipline incomputer science. There are many other splendid insights." -JohnTrain, author and President of the Montrose Fund

"An extraordinary tour d'horizon, this book challenges conventionalthinking about finance, investing, and much else besides. Brimmingwith ideas and eye-opening connections, it makes a powerful casefor our need to understand the extent to which nonlinearity shapesour lives." -Andrew Freeman, Managing Editor, Financial Services,The Economist Intelligence Unit; co-author, Seeing Tomorrow:Rewriting the Rules of Risk

"Nonlinear Pricing: Theory & Application by Christopher T. Maymakes nice reading even for people like me who are not economists.This is an ambitious book as it presents economics starting fromfundamental physics. It deserves a large readership." -IlyaPrigogine, 1977 Nobel Laureate, Chemistry; author, The End ofCertainty; and the world's foremost non-equilibrium scientist

Les Clewlow
This book is best digested in small morsels as the content is very rich and varied. It is not a book on the implementation of non-linear methods, as the title might imply. It is a personal view on how relatively new techniques such as chaos, fractals, genetic algorithms, and fuzzy logic, and their connections to modern finance can be understood.

The author, who has many years trading experience, proposes the total replacement of the classical approaches with these new non-linear methods. Maybe he took this iconoclastic approach because of his perception of how deep-rooted the resistance is to the introductions of these new techniques. Perhaps, deep down, he believes just as much that progress lies with the refinement of the classical methodologies.

In either case, the book is targeted at the non-technical reader and many of the qualitative explanations of technical concepts -- one might argue -- are misleading. In defence of the author I suggest that the primary aim of the book is to communicate the potential significance of the concepts to a very general audience. The scope of the book is enormous. Chapter one sets the scene and style -- sketching the problems that the author sees with the standard approaches and indicating where he feels the solutions lie. Chapter two looks at the historical development the linear and non-linear approaches. By the time we reach chapter three we begin to have our imagination stretched with examples drawn from many disciplines -- astrophysics, music, evolution and quantum physics. Fractal analysis and the Hurst exponent are discussed in the next two chapters in particular with reference to the KAOS screen on Bloomberg that the author helped to develop. In the remaining chapters, we are made to work hard, as we are taken on a fascinating exploration of many other new tools and techniques. Genetic algorithms and fuzzy logic are dealt with in some detail, as are the relationships between models and reality. Insights are drawn from physics, biology and computation.

In summary, if you approach this book with an open mind, it is worth the effort. There are hidden gems for everyone her
—School of Finance and Economics, University of Technology, Sydney Financial Options Research Centre, Warwick Business School Lacima Consultants Ltd.

Thomas Stridsman
Above all, market analysis books should explain. They should be well-balanced tomes that bring readers forward in understanding the topic at an even pace, with as few confusing digressions as possible. If an author's mission is to cover all subject matter exhaustively simply to show the world he's mastered his subject, it's his editor's obligation to prevent him from doing so.

In Nonlinear Pricing, Christopher T. May does an excellent job of describing the philosophical and historical aspects of this new paradigm in financial theory. He argues well the point that it is sure to conquer the analytical world in the coming decades. He thoroughly describes how his approach fits into a new world order of chaos and complexity theory that is more likely to impact our lives as our computers become faster and computer power more readily available.

Unfortunately, May does too good a job, which results in a book too long, with too much "base covering." The journalistic expression "kill your darlings," which suggests that as soon as the writer thinks he has nailed it, he has probably overdone it, is apropos here. This one book comprises the foundations for many more. As it is, all the gunpowder is used up for one big blast instead of for several smaller ones that could have made a larger impact.

Another disappointment is the misleading title; the book holds far more theory than application. Indeed, it presents only two practical examples: one on the Deutsche mark and one on the components of the S&P 500 index. Further, both studies were performed on too little data, leaving the robustness of the results suspect.

Nonetheless, this book is a long-awaited contribution to the goal of finding practical uses for nonlinear models that for years scientists have argued explain the world far better than our worn and torn linear tools. Despite its drawbacks, Nonlinear Pricing is a must read for all traders who have ever tried (or would like to try) to understand this very intricate topic. For nothing else, after reading May's well-targeted, if ill-executed, effort, you'll be more prepared to avoid the shameless hucksters who use terms such as "chaos" and "nonlinear" as buzz words to make a cheap buck.
—Trading Systems Advisor

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Product Details

Publication date:
Wiley Trading Series, #65
Product dimensions:
6.36(w) x 9.36(h) x 1.20(d)

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