Lessons from Jean-Philippe Bouchaud

Jean-Philippe Bouchaud is, in Wikipedia's words, "a French physicist" who is "co-founder and chairman of Capital Fund Management (CFM)." The lessons below are sentences from his Nature essay "Economics needs a scientific revolution," his Substack, his papers and book descriptions, and interviews that quote him. — Wikipedia: Jean-Philippe Bouchaud.

On the Critique of Mainstream Economics & Finance

On the failure of economic models: He wrote "Compared to physics, it seems fair to say that the quantitative success of the economic sciences is disappointing. Rockets fly to the moon, energy is extracted from minute changes of atomic mass without major havoc, global positioning satellites help millions of people to find their way home". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008).
On the axioms of classical economics: He wrote "Classical economics is built on very strong assumptions that quickly become axioms: the rationality of economic agents, the invisible hand and market efficiency, etc. An economist once told me, to my bewilderment: These concepts are so strong that they supersede any empirical observation". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008).
On the Efficient Market Hypothesis (EMH) as a "blind alley": He wrote "In my view, EMH is one of the most momentous intellectual blind alley of the XXth century". — Bouchaud's Archive (Substack): Efficient Market Hypothesis: Blind Alley of the 20th Century?.
On the allure of the EMH: Covel's page quotes him "The efficient market hypothesis is not only intellectually enticing, but also very reassuring for individual investors, who can buy stock shares without risking being outsmarted by more savvy investors". — Trend Following: Jean-Philippe Bouchaud, Trend Following Trader and Quant Pioneer (Michael Covel).
On the EMH's inability to explain market phenomena: Scientia's profile says that, as Bouchaud explains, "the efficient market paradigm has difficulty explaining many real-world market phenomena we observe, from short-term microstructure effects to long-term bubbles and crashes". — Scientia: Professor Jean-Philippe Bouchaud, The Inelastic Market Hypothesis.
On the deification of the market: He wrote "As Robert Nelson argued in his book, Economics as Religion, the marketplace has been deified. Physicists, on the other hand, have learned to be suspicious of axioms and models. If empirical observation is incompatible with the model, the model must be trashed or amended, even if it is conceptually beautiful or mathematically convenient". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008).
On the mindset of economics: He argued in his Nature essay about "crucial need to change the mindset of those working in economics and financial engineering". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008)
On the real drivers of price changes: He wrote that the order-driven theory holds that "prices move primarily because people trade, whatever the reason they are trading, and much less because of unexpected news that change the elusive ‘fundamental value’ of assets". — Bouchaud's Archive (Substack): Efficient Market Hypothesis: Blind Alley of the 20th Century?.
On the problem with Black-Scholes: He wrote "Reliance on models based on incorrect axioms has clear and large effects. The Black-Scholes model was invented in 1973 to price options assuming that price changes have a Gaussian distribution, i.e. the probability extreme events is deemed negligible". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008).
On the disconnect between models and reality: Covel's page quotes him "a lot of models used in mathematical finance seem to be more driven by their convenience and the possibility to answer a question with a number, rather than taking the time and thinking about the problem". — Trend Following: Jean-Philippe Bouchaud, Trend Following Trader and Quant Pioneer (Michael Covel).

On the Nature of Financial Markets

On the wildness of free markets: He wrote "In reality, markets are not efficient, humans tend to be over-focused in the short-term and blind in the long-term, and errors get amplified through social pressure and herding, ultimately leading to collective irrationality, panic and crashes. Free markets are wild markets". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008).
On social effects: He wrote "Missing such ubiquitous - in space and across time - social effects is one of the main flaw of classical models, DSGE, efficient markets and the likes". — Bouchaud's Archive (Substack): Markets are becoming less efficient, not more (Jan 2024)
On the dominance of order flow: Scientia's profile says that, if order flow is the main driver of price movements, whether informed or uninformed, in Bouchaud's argument, "the lion’s share of volatility comes not from changes in fundamentals but from trading itself – from the aggregation of heterogeneous investor buying and selling". — Scientia: Professor Jean-Philippe Bouchaud, The Inelastic Market Hypothesis.
On feedback loops: He wrote "interactions and feedback loops can easily explain why anecdotal news may self-amplify into full blown crises". — Bouchaud's Archive (Substack): Markets are becoming less efficient, not more (Jan 2024).
On the square-root law of market impact: The abstract of his paper with Mastromatteo and Toth describes the "epsilon-intelligence" model as a minimal framework to understand "the square-root dependence of the impact of meta-orders on volume in financial markets". — Mastromatteo, Toth and Bouchaud, Agent-based models for latent liquidity and concave price impact (arXiv 1311.6262).
On latent liquidity: The abstract of the paper says that the basic idea is that "most of the daily liquidity is “latent” and furthermore vanishes linearly around the current price, as a consequence of the diffusion of the price itself". — Mastromatteo, Toth and Bouchaud, Agent-based models for latent liquidity and concave price impact (arXiv 1311.6262).
On the persistence of trends: He wrote "The persistence of medium-term Trend Following (or “momentum”) is one of the most scathing indictments of the Efficient Market Hypothesis". — Bouchaud's Archive (Substack): Persistence of Medium-Term Trend Following (Sep 2022).
On the cause of trends: He wrote that, as he argued in the post, "trend following begets trends". — Bouchaud's Archive (Substack): Persistence of Medium-Term Trend Following (Sep 2022).
On the illusion of market efficiency: He wrote "But maybe when averaging over a large crowd of agents, individual errors average out and markets are efficient, as if we were rational?" and "Now, we know that beyond a certain level of interaction, collective behaviour totally decouples from the one that would prevail if individuals acted independently". — Bouchaud's Archive (Substack): Markets are becoming less efficient, not more (Jan 2024).
On mass panics: He wrote "history is strewn with mass panics, fads and trends, bubbles and crashes, booms and busts, crises and upheavals of all sorts". — Bouchaud's Archive (Substack): Markets are becoming less efficient, not more (Jan 2024)

On Econophysics and the Physicist's Approach

On letting the data speak: Covel's page quotes him "It is really more of a physics approach, to let the data speak. Very often, many economic theories – such as the principle of efficient markets – seem to be more inspired by some kind of underlying political agenda than a strict understanding of what is going on in the markets". — Trend Following: Jean-Philippe Bouchaud, Trend Following Trader and Quant Pioneer (Michael Covel).
On the importance of empirical data: The description of his book Trades, Quotes and Prices states that "All discussions are firmly rooted in the empirical behaviour of real stocks, and all models are calibrated and evaluated using recent data from Nasdaq". — Google Books: Trades, Quotes and Prices (Bouchaud, Bonart, Donier, Gould).
On the value of simple models: The abstract of the paper says "we study various alternative specifications of the model, for example allowing limit orders to react to the order flow, or changing the execution protocols". — Mastromatteo, Toth and Bouchaud, Agent-based models for latent liquidity and concave price impact (arXiv 1311.6262).
On the physicist's mindset: He wrote "physicists have grown to be critical and queasy about their own models". — Bouchaud, Economics needs a scientific revolution (arXiv 0810.5306; Nature, Oct 2008).
On the limits of rationality: He wrote that, as he argued in his previous post, "faced with complex problems, rational agents cannot compute the optimal solution nor learn the optimal strategy, but go for “satisficing” solutions". — Bouchaud's Archive (Substack): Markets are becoming less efficient, not more (Jan 2024).
On interdisciplinary work: Wikipedia lists among his papers "From statistical physics to social sciences: the pitfalls of multi-disciplinarity". — Wikipedia: Jean-Philippe Bouchaud.

On Risk Management and "Fat Tails"

On the underestimation of risk: The description of Theory of Financial Risk and Derivative Pricing states "Classical theories, however, are based on simplified assumptions and lead to a systematic (and sometimes dramatic) underestimation of real risks". — Bouchaud and Potters, Theory of Financial Risk and Derivative Pricing (Cambridge University Press).
On the nature of randomness: The notes for his Trend Following Radio interview list among the topics "Benign randomness vs. wild randomness" and "Accepting uncertainty". — Trend Following Radio, Ep. 242: Jean-Philippe Bouchaud (Michael Covel).
On the importance of "rare events": The book's description says "Starting from the detailed analysis of market data, one can take into account more faithfully the real behaviour of financial markets (in particular the ‘rare events’) for asset allocation, derivative pricing and hedging, and risk control". — Bouchaud and Potters, Theory of Financial Risk and Derivative Pricing (Cambridge University Press).
On accepting uncertainty: The notes for his Trend Following Radio interview list this topic: "Differences between physicists and economists". — Trend Following Radio, Ep. 242: Jean-Philippe Bouchaud (Michael Covel).
On risk control as a primary concern: The book's description begins "Risk control and derivative pricing have become of major concern to financial institutions". — Bouchaud and Potters, Theory of Financial Risk and Derivative Pricing (Cambridge University Press).

On Trading and Strategy

On trend-following as a robust anomaly: He wrote "The persistence of medium-term Trend Following (or “momentum”) is one of the most scathing indictments of the Efficient Market Hypothesis" and "Backtests over 220 years show that the trend effect has always been there, with a strength that has not substantially changed over time". — Bouchaud's Archive (Substack): Persistence of Medium-Term Trend Following (Sep 2022).
On the psychology of trend following: He wrote "FOMO is so strongly engrained in human psyche that is is hard to see how trend following behaviour could ever go away". — Bouchaud's Archive (Substack): Persistence of Medium-Term Trend Following (Sep 2022).
On the performance of trend following: He wrote "A disciplined, diversified implementation of trend following strategies is as good, in the long run, as buying and holding the S&P index". — Bouchaud's Archive (Substack): Persistence of Medium-Term Trend Following (Sep 2022).
On the skew of trend following: He wrote "A little bonus is that trend following is positively skewed whereas stock indexes are negatively skewed". — Bouchaud's Archive (Substack): Persistence of Medium-Term Trend Following (Sep 2022)
On why trend followers lose more often than they gain: In their paper, he and Marc Potters wrote that "the fraction of winning trades is in fact a measure of the ratio of the holding periods of winning trades to that of losing trades". — Potters and Bouchaud, Trend followers lose more often than they gain (Wilmott).
On market impact as a cost: He and his co-authors wrote "To these traders, price impact is tantamount to a cost, because the impact of their earlier trades makes the price of their subsequent trades worse on average". — Bouchaud et al., The Inelastic Market Hypothesis: A Microstructural Interpretation (arXiv 2108.00242).
On publishing research: He told Risk "I think in the last 20 years or so we have gained much more by publishing papers than we have lost, from the point of view of hiring, the quality of the work inside the company and the spirit". — Risk Awards 2018 interview: Buy-side quant of the year Jean-Philippe Bouchaud (CFM).
On agent-based modeling for macroeconomics: He told Risk "Agent-based modelling has been used a lot on traffic jams, for example, or epidemics, but not enough in macroeconomics". — Risk Awards 2018 interview: Buy-side quant of the year Jean-Philippe Bouchaud (CFM).

Learn more:

Lessons from Jean-Philippe Bouchaud

On the Critique of Mainstream Economics & Finance

On the Nature of Financial Markets

On Econophysics and the Physicist's Approach

On Risk Management and "Fat Tails"

On Trading and Strategy

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