Its somewhat shocking to think about, but the mathematical underpinnings of modern finance have existed since at least 1898 when an obscure french mathematician Louis Bachelier was first getting started on what would become known as random walks.
The two centuries prior to Bachelier witnessed the development of a broad set of theoretical tools for understanding probability and statistics, yet why did it take us until the 1980’s to realize what this meant for financial derivatives?
The fundamental problem is that mathematical formula are hard to visualize for most of us; their true power remains locked behind an abstruse symbology.
Since the 1960’s, computers have unlocked our ability to visualize mathematical concepts. Only a small subset of humanity naturally possess the pure mathematical mind to understand squiggly letters on a page and understand how they actually translate to deep underlying concepts.
On the other hand, visualizations hijack our highly evolved visual senses to implant mathematical thought in our brains, bypassing the traditional barrier that a formula imposes on would be mathematicians.
To understand the nature of the explosion in visualization that has occurred over the last century, we extracted data on the relative word usage of the term “visualization” from Google’s Ngram viewer and plotted it since 1898:
To put it in economic terms, using our visual senses lowers the cost of acquiring mathematical knowledge, thus making it easier to obtain for every individual. Given the high payoffs associated with this knowledge, a shock downward in the barriers to entry should lead to much broader adoption.
One of our favorite visualizations serves as a perfect example of how they can enable understanding: when applied to a correlation matrix, the Minimum Spanning Tree can reduce the complexity of the stock market to a single graph. Even today, few traders and investors explicitly understand the concept of correlation, but they intuitively grasp the idea that stocks can herd together. Financial Network Graphs make the concept visually explicit, thereby implying the deep mathematical relationships at play in the markets.
Hopefully this trend continues. Given the rapid pace of evolution of financial visualization technology the future seems bright on that front. MKTSTK eagerly awaits a more mathematically literate financial market enabled by visualizations.
For more financial visualizations and plenty of quant-minded discussion of financial markets, make sure to check out Quantocracy.
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Categories: Quantitative Trading