Financial heat machine

TL;DR

This paper models financial markets using thermodynamics, proposing a financial Carnot cycle where crises are essential stages, challenging traditional views and suggesting crises are integral to market functioning.

Contribution

It introduces a thermodynamic framework for financial markets, including a financial Carnot cycle and a novel interpretation of crises as necessary phases.

Findings

Financial crises are crucial stages in the financial cycle.

The model suggests markets can operate like a heat machine with cycles.

Crises play a role similar to cooling in the Carnot cycle.

Abstract

We consider dynamics of financial markets as dynamics of expectations and discuss such a dynamics from the point of view of phenomenological thermodynamics. We describe a financial Carnot cycle and the financial analogue of a heat machine. We see, that while in physics a perpetuum mobile is absolutely impossible, in economics such mobile may exist under some conditions. Our thermodynamical model for the financial market induces a rather unusual interpretation of the role of financial crises. In contrast to the common point of view, in our model financial crises play a crucial role in functioning of the modern financial market. This is an important (concluding) stage of any financial cycle that is analogous to the stage of cooling in the ordinary Carnot cycle. A financial cycle could not be completed without such a stage as well as the ordinary Carnot cycle. Thus, in spite its destructive (at the first sight) consequences the stage or financial crises is as well important as the stage of "boiling of the financial market" ("heating of expectations")