Financial Modelling: From Stochastics to Chaotics and Back to Stochastics

In this paper we argue that the stochastic paradigm of asset prices has prevented us from understanding market behavior because most of the variance of the variables of economic interest is often attributed to random shocks. One implication of the tests of the Efficient Market Hypothesis is that most of the variation in prices is due to our ignorance of the underlying structure. As an alternative to the stochastic methodology we propose an economic interpretation of the most famous chaotic map called the Lorenz system. We briefly describe the major characteristic of this chaotic system and we also use financial data for its empirical testing.