Geometry of Financial Markets - Towards Information Theory Model of Markets

Edward Piotrowski () and Jan Sladkowski ()

Departmental Working Papers from University of Bialtystok, Department of Theoretical Physics

Abstract: Most of parameters used to describe states and dynamics of financial market depend on proportions of the appropriate variables rather than on their actual values. Therefore, projective geometry seems to be the correct language to describe the theater of financial activities. We suppose that the object of interest of agents, called here baskets, form a vector space over the reals. A portfolio is defined as an equivalence class of baskets containing assets in the same proportions. Therefore portfolios form a projective space. Cross ratios, being invariants of projective maps, form key structures in the proposed model. Quotation with respect to an asset X (i.e. in units of X) are given by linear maps. Among various types of metrics that have financial interpretation, the min-max metrics on the space of quotations can be introduced. This metrics has an interesting interpretation in terms of rates of return. It can be generalized so that to incorporate a new numerical parameter (called temperature) that describes agent's lack of knowledge about the state of the market. In a dual way, a metrics on the space of market quotation is defined. In addition, one can define an interesting metric structure on the space of portfolios/quotation that is invariant with respect to hyperbolic (Lorentz) symmetries of the space of portfolios. The introduced formalism opens new interesting and possibly fruitful fields of research.

New Economics Papers: this item is included in nep-cba, nep-fin, nep-fmk and nep-knm
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Related works:
Journal Article: Geometry of financial markets—Towards information theory model of markets (2007)
Working Paper: Geometry of Financial Markets -- Towards Information Theory Model of Markets (2006)
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