Title: Honours Finance (Advanced Topics in Finance: Nonlinear Analysis)
1Honours Finance (Advanced Topics in Finance
Nonlinear Analysis)
- Lecture 4 ODEs continuedCoupled ODEs,
nonlinearity and the equilibria of nonlinear
systems
2Recap
- Last lecture we considered coupled differential
equations, where the level of one variable (a
species) depends on itself and another variable - Before considering an economic application of
these, Ill clear up one point concerning complex
solutions to second order ODEs. - Remember that
- a second order linear ODE can be solved by the
characteristic equation method - guess a solution of the form y(t)ert
- substitution converts equation into quadratic in
r - complex solution results when b2-4aclt0
3Recap
- Last week we considered the Volterra
predator-prey system
- This week we consider an application of this to
economics and finance which provides a foundation
for a model of the Dual Price Level Hypothesis. - Non-equilibrium predator-prey cycle matches
non-equilibrium foundation of Fishers
debt-deflation theory - Predator-prey model can be derived from Marx
4A predator-prey cycle in capitalism
- In capitalist, Exchange-Value of work brought to
foreground - Exchange-Value of workersubsistence wage
- Use-Value of worker in background irrelevant to
wage - But Use-Value of worker to capitalist purchaser
of labour-timeability to produce commodities for
sale - Gap between (objective, quantitative) UV and EV
of worker is source of surplus-value (SV) - Analysis presumed labour bought and sold at its
value - cost of production of labour-power
- subsistence wage
- Is labour actually paid its value in practice?
5A predator-prey cycle in capitalism
- Many Marxists (especially internationalists like
Amin, etc.) argue labour paid less than its value - But plenty of hints that Marx believed labour
paid more than its value - the value of the labour-power is equal to the
minimum of wages (1861 I 46) - the minimum wage, alias the value of
labour-power (1861 II 233) - For the time being, necessary labour supposed as
such i.e. that the worker always obtains only
the minimum of wages. (1857 817)
6A predator-prey cycle in capitalism
- No explanation given by Marx, but can be found in
a dialectic of labour - Worker both a commodity (labour-power) and
non-commodity (person) - Capitalism focuses on commodity aspect, pushes
non-commodity aspects into background - Pure commodity--paid subsistence wage only
- Non-commodity--demands share in surplus
- struggle over minimum wage, social wage, etc.
- Wage normally exceeds subsistence subsistence
wage a minimum (when commodity aspect dominant
and worker power minimal)
7A predator-prey cycle in capitalism
- Dialectic of labour puts into perspective a
passage from Marx which is difficult to interpret
for labour is paid less than its value analysts - a rise in the price of labor resulting from
accumulation of capital implies ... accumulation
slackens in consequence of the rise in the price
of labour, because the stimulus of gain is
blunted. The rate of accumulation lessens but
with its lessening, the primary cause of that
lessening vanishes, i.e. the disproportion
between capital and exploitable labour power. The
mechanism of the process of capitalist production
removes the very obstacles that it temporarily
creates. The price of labor falls again to a
level corresponding with the needs of the
self-expansion of capital, whether the level be
below, the same as, or above the one which was
normal before the rise of wages took place...
8A predator-prey cycle in capitalism
- To put it mathematically, the rate of
accumulation is the independent, not the
dependent variable the rate of wages the
dependent, not the independent variable. (Marx
1867, 1954 580-581) - Same passage used by Goodwin (1967) to devise a
predator-prey model of cycles in employment and
income distribution - High wages shareLow rate of accumulationIncrease
in unemploymentDrop in wagesIncrease in
accumulationIncrease in employmentHigh wages
share - Phillips curve part of Marxs logic (wage
change a function of the rate of unemployment) - Goodwin built predator-prey model on this
foundation - Try to work out a model
9A predator-prey cycle in capitalism
- Capital stock determines output
- Level of output determines employment
- Level of employment determines rate of change of
wages - Differential equation of Rate of change of wages
determines wages - Output - Wages determines profits
- Profits determine investment
- Investment determines rate of change of capital
- Capital determines output...
- Try to work it out
10A predator-prey cycle in capitalism
- Level of output determines employment
- Differential equation of rate of change of wages
determines wages
- Output - Wages determines profits
- Profits determine investment
- Investment determines capital
- Capital determines output...
- Can you see how to make a predator-prey system
out of this?
11A predator-prey cycle in capitalism
- System state variables are employment rate, and
income distribution (use either w or p) - Goodwin assumed exponential growth of population
(N) and labour productivity (a)
- Work out the differential equations for w and l
as functions of themselves and each other
12A predator-prey cycle in capitalism
This is w
Try same thing for w (its easier!)
13A predator-prey cycle in capitalism
Expand these
The end product is aversion of a predator-prey
model
These cancel
Apply chain rule
14A predator-prey cycle in capitalism
- Negative feedback from wages share to employment
- Positive feedback from employment to wages share
- more complicated than basic predator-prey because
of Phillips curve relation between rate of
change of wages and level of employment - Phillips recap 3 factors which might influence
rate of change of money wages - Level of unemployment (highly nonlinear
relationship) - Rate of change of unemployment
- Rate of change of retail prices when retail
prices are forced up by a very rapid rise in
import prices or agricultural products.
Economica 1958 p. 283-4 - Latter two factors ignored in conventional
treatment of Phillips
15A predator-prey cycle in capitalism
- Functional form for Phillips curve was log-log
- Well use raw linear-exponential form
(derived via a nonlinear regression onPhillipss
raw data)
16A predator-prey cycle in capitalism
- Put this Phillips curve in as the equation for
w(l) in
- Simulation for given values of a and b yields
17A predator-prey cycle in capitalism
- Goodwin/Marx model thus gives same basic cycle as
biological predator-prey, but for wages share
(income distribution) vs employment rather than
fish vs sharks
18A predator-prey cycle in capitalism
- As with biological model, trade cycle model
traces out a limit cycle
- What causes this neither converging nor diverging
behaviour? - Nonlinearity
- Compare to a linear model with cycles
19The importance of being nonlinear
- Characteristic equation is
- General solution is of the form
- If agt0 then cycles get infinitely large with time
- System must break down (Tacoma bridge, Braun
1993 173)
- This bit
- amplifies cycles if agt0
- damps cycles if alt0
20The importance of being nonlinear
- In a linear system
- Forces determining oscillations (the trig
functions) are distinct from forces determining
magnitude of those oscillations (the exponential) - In a nonlinear system
- Oscillation and magnitude are linked
- Magnitude is a function of deviation from
equilibrium - In predator prey system
- near equilibrium, linear term dominates
- far from equilibrium, power term dominates
- balance keeps cycles within check, but away from
equilibrium
21The importance of being nonlinear
- Number of fish
- positive function of number of fish F (linear)
- negative function of F times S (quadratic)
- increasing fishshark numbers means this term
dominates linear population growth term
- Number of sharks
- negative function of number of sharks S (linear)
- positive function of S times F (quadratic)
- increasing fishshark numbers means this term
dominates linear death rate term
22The importance of being nonlinear
- Equilibria of nonlinear systems thus
fundamentally different to those of linear
systems - If equilibrium of linear system is unstable,
whole system is unstable - If equilibrium of nonlinear system is unstable,
whole system can still be stable - If equilibrium of linear system is stable, whole
system is stable and will converge to equilibrium - If equilibrium of nonlinear system is stable,
whole system may be stable or unstable and may or
may not converge to equilibrium
23The importance of being nonlinear
- Three classes of equilibrium for linear systems
- Stable converges for all time (Re(r) lt 0)
- Unstable diverges for all time (Re(r)gt0)
- Marginal instability neither converges nor
diverges (Re(r)0)
24The importance of being nonlinear
- Others neither (limit cycles, etc.)
- Can have mix of stable unstable saddle node
25The importance of being nonlinear
- Nonlinear system can have complicated properties
- stable equilibrium, unstable about equilibrium,
stable at greater displacement, etc...
- To understand system dynamics, have to
- Simulate
- Analyse stability properties of equilibria
(stability analysis/ perturbation theory)
26Stability of nonlinear systems
- Simulation later today...
- How to analyse the stability of a nonlinear
equilibrium? - Linearise system about its equilibrium
- Properties of complete nonlinear system will
match those of linearised version about
equilibrium point (but not far from it) - Can thus
- identify equilibria of nonlinear system
- characterise near equilibrium behaviour by
behaviour of linear counterpart
27Stability of nonlinear systems
28Stability of nonlinear systems
- With multiple equilibria, can have complicated
landscape of dynamic system - Knowledge of equilbria can give qualitative
portrait of system dynamics
29Stability of nonlinear systems
- So how to linearise a nonlinear system?
- Take Taylor expansion about equilibrium point
- Convert complicated nonlinear system into
polynomial - Drop all but first two terms
- First is a constant
- Second is another constant times vector of
variables - Application of basic calculus property
- any nonlinear function can be converted into
polynomial approximation (unless function not
continuous) - if function continuous on an interval a,b then
its value at b can be estimated from its value at
a and polynomials derived from its first order
and higher differentials
30Stability of nonlinear systems
- Consider cos(x)
- Set a0
- Cos(x) continuous for all x, so set bx (any
value) - Then what we get is...
- Lets look at this visually
31Stability of nonlinear systems
- To apply this to system of ODEs, have to
- convert into set of first order ODEs
- Apply matrix version of Taylor partial
differentiation
32Taylor Series
- Taylor Series are a delightful example of the
application of the basic rules of mathematics - what have we got that we dont want?
- A complex equation (sin, cos, exponential, log,
etc.) that we cant easily numerically estimate - what do we want that we can put in?
- something simple--like a polynomial
- keep it balanced
- So the basic question is can we estimate a
difficult function using something simple like a
polynomial? - The answer is lets just assume the answer is
yes and see what falls out - and unlike economists, keep it balanced!
33Taylor Series
- So we start with the assumption that we can
represent a complex function, say f(x), as a
polynomial
- Since all the powers of x are a known quantity,
the only problem now is working out what the
coefficients might be - So how about mapping them to the differential of
the function - since we can easily (in most cases) derive the
differential of a function (unlike integration,
which is normally difficult and usually cant be
done) - starting with the first differential
34Taylor Series
- Now for the second differential
- And in general for the nth derivative
- Finally we start to narrow down the coefficients
- Again we take the easy route lets substitute in
a value we know - If we use the value of f at zero, then its known
as a Maclaurin series if any other value, its
called a Taylor series (Brook Taylor rediscovered
the method in 1715)
35Taylor Series
- Using the value of f at zero
36Taylor Series
- So the general rule is that the coefficient of
the nth power of x in the polynomial expansion
for a function is the nth derivative of the
function, evaluated at zero, divided by n
factorial
- So the Taylor series for a function is simply
- Try this for a few well-known functions
- Can you see a problem for some other functions?
37Taylor Series
- Obviously we cant substitute in the value of
these functions at zero, because they dont have
any value (colloquially, 1/0 is infinity, the log
of zero is minus infinity) - Instead we have to choose a point at which there
is a known value (this raises the issue known as
the radius of convergence, but we wont worry
about this here) - Call this point a. Then we have the series
- Exactly the same logic applies to working out
this more general Taylor series - The unknowns are the coefficients, and we use
differentiation to work out possible values. - Cutting a long story short,...
38Taylor Series
- The (fairly obvious) end result is that the
constant a takes the place of 0 in the previous
expansion
- The nth coefficient in the polynomial expansion
for f about the point a is the nth derivative of
f evaluated at a, divided by n factorial
39Taylor Series
- The differentials of ln are
- We can substitute to give, in complete detail
40Taylor Series
- Try this using a1, at which point ln(1)0
41Taylor Series
- This works for xgt0 (since ln of a negative number
is not defined) but it doesnt converge very
well (for reasons we wont go into). Points other
than 1 converge somewhat better.
42Taylor Series
- So why are we bothering with all this stuff?
- The bad news to work out stability properties,
we have to linearise a nonlinear system of ODEs
in vicinity of (non-trivial, hence not zero)
equilibrium point - More bad news we have to apply the matrix
equivalent of a Taylor series, which means powers
of matrices, etc. - The good news since were trying to linearise
the system, all were interested in are the first
two terms - The first matrix of constants, which since its
based on the equilibrium point of the system will
be a matrix of zeros - The second matrix of constants, which simply
involves the first differentials of the system
and multiplies the vector of variables - More bad news the first differential is an array
of differentials
43Taylor Series
- Consider the predator-prey model
- Where x0 is the prey and x1 the predator
- This can be put in the form of a function
- Where both x and f are vectors
- It sounds messy, but all it means is that x has
two values (x0 and x1) and f has two values
- So the first differential is actually an array
of partial differentials f0 against x0, f0
against x1, f1 against x0, f1 against x1. Its a
matrix known as the Jacobian.
44Taylor series
- The Jacobian of the predator-prey model is thus
- We use this to linearise the system in the
vicinity of its equilibrium, to work out the
stability properties of the equilibrium. As with
the simple Taylor expansion about a point, the
vector version is
45Stability of equilibria of nonlinear systems
- What we do is
- choose a so that its an equilibrium point. The
f(a) will be 0. - Define a variable z(t) as the deviation of the
current position x(t) from the equilibrium a. - Then this vector version of a truncated Taylor
expansion becomes
- Since a is the equilibrium point of the full
nonlinear system, f(a) is 0. So the equation
collapses to
- Where f(x)a is a matrix of constants, found by
evaluating the Jacobian of f at the equilibrium
point a. Now, just as for the linear systems we
studied initially, the stability of this system
depends on whether the real part of its
eigenvalues exceed zero.
46Stability of equilibria of nonlinear systems
- Trying this with the predator prey model, the
Jacobian was
- The non-trivial equilibrium point was
- Feeding this into the Jacobian gives us the
matrix
47Stability of equilibria of nonlinear systems
stable?
- Same old story
- presume a solution of the form z(t)eltv.
- Rework equation, calling Jacobian A for the moment
- And as with the linear problems, the non-trivial
solutions to this require that the determinant of
the matrix lI-A equals zero.
48Stability of equilibria of nonlinear systems
For this to be zero we need the roots
And this isnt a bad place to give a reminder
about complex numbers
49Complex numbers
- These are numbers which have a real component (as
youre used to) and a component multiplied by the
square root of minus one - They were invented because without them, many
quadratics did not have a solution--like the one
were looking at now. - The reason they matter to us in dynamic analysis
is because they have the effect of generating
cycles in mathematical models of real systems - The reason they do this is because there is a
very exact correspondence between exponentials,
complex numbers, and the trigonometric functions
sin and cos. - This can be proven (dont ask me now!) but it can
also be shown by using a Taylor series expansion
50Complex numbers
- We can expand ex around x0 because it has a
value there (e0 1) - But we use xiq where i is the square root of
minus one
- If you separate out the real (all terms without
i) and imaginary (all terms with i), you find one
is cos(q) and the other is i times sin(q)
51Complex numbers
- So from a Taylor expansion alone we know that
- And at a higher level this equation can be proven
- So a complex root to a polynomial can be
factored
- The cos and sin bits mean that this solution
generates cycles - The magnitude of the real bit (a) tells us
whether the cycles explode (agt0) or contract
(alt0) with time
52Stability of nonlinear systems
- Consider basic predator-prey model again
- Non-trivial equilibrium is
- Is this stable? Consider the point
- Treat (c/d, a/b) as the point about which the
equation is converted into a polynomial - like 0 in expansion of cos(x) about 0
- Then putting x0F,x1S, we have
53Stability of nonlinear systems
- Now define z(t) to be the difference between the
current position x(t) and the equilibrium x(0)
(which in this model occurs when x0c/d,x1a/b),
where z(t) is a small distance. Then
- Now we can expand f(x) using the Taylor
expansion. Set x(0) as the beginning of the
interval (equivalent to 0 in the expansion for
cos)
54Stability of nonlinear systems
- This is the linear bit of the Taylor expansion
(so all coefficients are constants)
- This is zero, since dx/dt0 at x(0) where F and S
are at equilibrium values of c/d and a/b
- This is the bit with powers of 2 and above of x,
which can be ignored in the vicinity of x(0) when
squared and above amounts are very small
55Stability of nonlinear systems
- A visual explanation might help here
Taylor expansion forx(t) around equilibiumpoint
x(0)
If this goes to zero as t goesto infinity, then
the systemis stable.
x(0)
This distance is z(t)
- So question whether equilibrium is stable reduces
to whether A.z grows with time or shrinks to
zero. - In a matrix Taylor expansion, A is the partial
differentials of f evaluated at x(0) (as
constants in cos expansion are evaluated at x0)
56Stability of nonlinear systems
Where f0 is the function for the first variable
(F), etc., and it is evaluated at the equilibrium
point (c/d)
- So we now define a new linear function
- And if this is stable then the equilibrium x(0)
is stable
57Stability of nonlinear systems
- What is A for our example of a predator-prey
system?
58Stability of nonlinear systems
59Stability of nonlinear systems
- Is this system stable? Analyse it using a guess
(ansatz) of
For this to have a non-trivialsolution, the
determinant ofthe matrix must be zero
60Stability of nonlinear systems
- The determinant is a quadratic in l
Oh oh complex numbers again!
So substituting this value for l backinto our
solution for z(t)
61Stability of nonlinear systems
- This generates cycles, but no convergence
- for convergence, the real part of l must be less
than zero, so that elt gt1, and thus elt0 as t - for divergence, the real part of l gt0, so that
elt is less than one, and thus elt as t. - Here the real part of l is zero, so the system
neither converges nor diverges
62Stability of nonlinear systems
- This explains closed limit cycle behaviour of
Goodwin model - Many other behaviours possible for nonlinear
model - Technique works in vicinity of equilibrium, but
doesnt tell you anything about behaviour away
from equilibrium - To characterise overall stability of nonlinear
system, techniques used which explore parameter
space - How stable is system for varying values of
constants, different initial conditions? - Lyapunov exponents (large-scale eigenvalue
analysis), etc. - Can also simulate, as shown earlier
- Combination of two needed to fully characterise
system - Cant provide analytic solution
63Simulation
- Numerical simulation of analytically insoluble
ODEs/PDEs relies upon - Approximation methods
- simplest Euler method
- more complex (and accurate) Runge-Kutta algorithm
- based on Taylor-style logic
- next value of function can be estimated from
current value plus derivatives evaluated at
current value - b-shadowing hypothesis for chaotic systems
- Despite sensitive dependence on initial
conditions, simulation can be guaranteed to
shadow an actual trajectory of a system, though
not the one intended to be simulated
64Simulation
- Two broad classes of simulation tools
- Top down
- system specified as
- set of ODEs/PDEs
- system of flowcharts
- Bottom up
- characteristics of agents in such a system
described in computer program - environment of system constructed as experience
space for agents - system run as virtual world
65Simulation
- Top Down programs
- ODE/PDE approach
- Mathematica, Mathcad, Maple, Matlab
- Flowchart approach
- Matlab/Simulink, Vissim, IThink, Vensim
- Bottom up programs
- Few commercial versions as yet (SimCity?)
- Many research programs, some public domain
Swarm, Terra, Ecolab - Illustration of both top down approaches for
predator-prey model
66Simulation
- Using Mathcad
- (1) Derive equations
- (2) Convert into vector form
- (3) Provide initial values run simulation
function
Number of pointsto store
Time range
67Simulation
- (5) Run simulations with varying parameters many
times for phase space analysis (Lyapunov, etc.),
production of phase portraits...
68Simulation
- Flowchart method
- (1) Express equations as integrals rather than
differentials (integration more numerically
robust) - (No need to solve reduced form of equations, as
with Goodwin model)
- (2) Build model using flowchart symbols for
numerical operators
- (3) Run simulation dynamically
69Simulation
- A completedflowchart model looks like this
- And a simulation run gives results like
70Simulation
71Next Week
- Derive a model of the Dual Price Level
Hypothesis - Simulate it and discuss results