This book emphasizes what standard texts and research in economics and finance ignore: that there is as yet no evidence from the analysis of real, unmassaged market data to support the notion of Adam Smith's stabilizing Invisible Hand. There is no empirical evidence for stable equilibrium, for a stabilizing hand to provide self-regulation of unregulated markets. This is in stark contrast with the standard model taught in typical economics texts (Mankiw, 2000; Barro, 1997), which forms the basis for the positions of the US Treasury, the European Union, the World Bank, and the IMF, who take the standard theory as their credo (Stiglitz, 2002). Our central thrust is to introduce a new empirically based model of financial market dynamics that prices options correctly and also makes clear the instability of financial markets. Our emphasis is on understanding how markets really behave, not how they hypothetically “should” behave as predicted by completely unrealistic models.

By analyzing financial market data we will develop a new model of the dynamics of market returns with nontrivial volatility. The model allows us to value options in agreement with traders' prices. The concentration is on financial markets because that is where one finds the very best data for a careful empirical analysis. We will also suggest how to analyze other economic price data to find evidence for or against Adam Smith's Invisible Hand. That is, we will explain that the idea of the Invisible Hand is falsifiable. That method is described at the end of Sections 4.9 and 7.5.

Standard economic theory and standard finance theory have entirely different origins and showvery little, if any, theoretical overlap.