Chaos Theory on Financial Forecasting Essay Example | Topics and Well Written Essays - 2000 words

Chaos Theory on Financial Forecasting - Essay Example According to the chaos theorists, chaos has two most important attributes which are both necessary for existence of a chaotic system but not sufficient; one, extreme sensitivity to its initial conditions (Ruelle, 2001:37-9), and two, complicated patterns of nonlinear relationships in it which are not truly random (James, 2003:123-6). The first attribute can be described in a way that as time progresses in a continuous chaotic system, the parameters are so distinctly determined that to reach (or to predict) a certain desired point, knowledge of the initial starting point of system gains extreme importance. A meteorologist named Edward Lorenz, who was trying to predict, first observed this factor weather conditions by using a computer simulation. He noticed that he made simple decimal mistakes that lead extreme distinct results as outcome (Lorenz, 1963:1-25). This was actually a hotspot in chaos theory history, which leaded scientists to think about fallacies made in the past by the us e of word "negligible". The other attribute maintains the properties of relationships among the parameters in a system. Today we know that without complex no linearity, the system will usually be predictable and will not be oversensitive on initial conditions as it depends on non-linear scenarios. Some common misunderstanding among daily use of the word "chaos" mainly appears because of its literal meaning as lack of order. Contrary to this misnomer, in most cases systems that show a pattern of deterministic chaos are quite reared and even predictable on short time scales. Solution paths to chaotic systems are basically deterministic in their nature. Chaos theory generally assumes that, if complex interrelations among the particles of a system are known, then future movement of system is predictable. Regarding this property of chaotic systems, it is now possible or will be possible to find solutions to some problems in science that can't be solved before because of their complex nature. 2. Chaos Theory in Economics Throughout the development of economic theory, from Ancient Greek Philosophers to Today's sophisticated theorists; many different ideas shaped the evolution of economics. Although the assumptions, progress and results acquired are different, almost any theory has the same base point showing economics' as a unitary environment. The unitary term comes from the aspect of economy as being an entity that consists of sub-entities. These units are mainly the consumers and producers taking decisions to survive in the ecosystem of economics. It is an obvious fact that the decisions of particular objects in this system lead the way to the general movement of system. This nature of economics is the key feature that embraces Chaos Theory and economics, in the way that; Chaos Theory tries to explain, how does the behavior of small particles effects each other and the system as a whole and economics as being a social science that struggles with problems