Monday, September 22, 2008

 

Power Law-- A New Gabaix Paper

Xavier Gabaix has a new paper, "Power Laws in Economics and Finance" that surveys research on when and why variables such as city size or executive pay follow the power law distribution. One gets a power law distribution if a city's relative population (its population relative to the average city) grows proportionally to its relative population except for a small absolute increase that gives small cities a bit of an advantage. Even writing that first step is tricky, alas, and I don't think I'll be able to understand well enough to do research in the area. The reason the power law is useful seems to be that when it applies, the same laws are at work for big values and little values of variables, so, for example, one wouldn't need a special theory of stock price plunges-- it would just be a chance occurrence from the same distribution as small price declines.

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