Knowledge Limited for Dummies….Didactics.


Bertrand Russell with Alfred North Whitehead, in the Principia Mathematica aimed to demonstrate that “all pure mathematics follows from purely logical premises and uses only concepts defined in logical terms.” Its goal was to provide a formalized logic for all mathematics, to develop the full structure of mathematics where every premise could be proved from a clear set of initial axioms.

Russell observed of the dense and demanding work, “I used to know of only six people who had read the later parts of the book. Three of those were Poles, subsequently (I believe) liquidated by Hitler. The other three were Texans, subsequently successfully assimilated.” The complex mathematical symbols of the manuscript required it to be written by hand, and its sheer size – when it was finally ready for the publisher, Russell had to hire a panel truck to send it off – made it impossible to copy. Russell recounted that “every time that I went out for a walk I used to be afraid that the house would catch fire and the manuscript get burnt up.”

Momentous though it was, the greatest achievement of Principia Mathematica was realized two decades after its completion when it provided the fodder for the metamathematical enterprises of an Austrian, Kurt Gödel. Although Gödel did face the risk of being liquidated by Hitler (therefore fleeing to the Institute of Advanced Studies at Princeton), he was neither a Pole nor a Texan. In 1931, he wrote a treatise entitled On Formally Undecidable Propositions of Principia Mathematica and Related Systems, which demonstrated that the goal Russell and Whitehead had so single-mindedly pursued was unattainable.

The flavor of Gödel’s basic argument can be captured in the contradictions contained in a schoolboy’s brainteaser. A sheet of paper has the words “The statement on the other side of this paper is true” written on one side and “The statement on the other side of this paper is false” on the reverse. The conflict isn’t resolvable. Or, even more trivially, a statement like; “This statement is unprovable.” You cannot prove the statement is true, because doing so would contradict it. If you prove the statement is false, then that means its converse is true – it is provable – which again is a contradiction.

The key point of contradiction for these two examples is that they are self-referential. This same sort of self-referentiality is the keystone of Gödel’s proof, where he uses statements that imbed other statements within them. This problem did not totally escape Russell and Whitehead. By the end of 1901, Russell had completed the first round of writing Principia Mathematica and thought he was in the homestretch, but was increasingly beset by these sorts of apparently simple-minded contradictions falling in the path of his goal. He wrote that “it seemed unworthy of a grown man to spend his time on such trivialities, but . . . trivial or not, the matter was a challenge.” Attempts to address the challenge extended the development of Principia Mathematica by nearly a decade.

Yet Russell and Whitehead had, after all that effort, missed the central point. Like granite outcroppings piercing through a bed of moss, these apparently trivial contradictions were rooted in the core of mathematics and logic, and were only the most readily manifest examples of a limit to our ability to structure formal mathematical systems. Just four years before Gödel had defined the limits of our ability to conquer the intellectual world of mathematics and logic with the publication of his Undecidability Theorem, the German physicist Werner Heisenberg’s celebrated Uncertainty Principle had delineated the limits of inquiry into the physical world, thereby undoing the efforts of another celebrated intellect, the great mathematician Pierre-Simon Laplace. In the early 1800s Laplace had worked extensively to demonstrate the purely mechanical and predictable nature of planetary motion. He later extended this theory to the interaction of molecules. In the Laplacean view, molecules are just as subject to the laws of physical mechanics as the planets are. In theory, if we knew the position and velocity of each molecule, we could trace its path as it interacted with other molecules, and trace the course of the physical universe at the most fundamental level. Laplace envisioned a world of ever more precise prediction, where the laws of physical mechanics would be able to forecast nature in increasing detail and ever further into the future, a world where “the phenomena of nature can be reduced in the last analysis to actions at a distance between molecule and molecule.”

What Gödel did to the work of Russell and Whitehead, Heisenberg did to Laplace’s concept of causality. The Uncertainty Principle, though broadly applied and draped in metaphysical context, is a well-defined and elegantly simple statement of physical reality – namely, the combined accuracy of a measurement of an electron’s location and its momentum cannot vary far from a fixed value. The reason for this, viewed from the standpoint of classical physics, is that accurately measuring the position of an electron requires illuminating the electron with light of a very short wavelength. But the shorter the wavelength the greater the amount of energy that hits the electron, and the greater the energy hitting the electron the greater the impact on its velocity.

What is true in the subatomic sphere ends up being true – though with rapidly diminishing significance – for the macroscopic. Nothing can be measured with complete precision as to both location and velocity because the act of measuring alters the physical properties. The idea that if we know the present we can calculate the future was proven invalid – not because of a shortcoming in our knowledge of mechanics, but because the premise that we can perfectly know the present was proven wrong. These limits to measurement imply limits to prediction. After all, if we cannot know even the present with complete certainty, we cannot unfailingly predict the future. It was with this in mind that Heisenberg, ecstatic about his yet-to-be-published paper, exclaimed, “I think I have refuted the law of causality.”

The epistemological extrapolation of Heisenberg’s work was that the root of the problem was man – or, more precisely, man’s examination of nature, which inevitably impacts the natural phenomena under examination so that the phenomena cannot be objectively understood. Heisenberg’s principle was not something that was inherent in nature; it came from man’s examination of nature, from man becoming part of the experiment. (So in a way the Uncertainty Principle, like Gödel’s Undecidability Proposition, rested on self-referentiality.) While it did not directly refute Einstein’s assertion against the statistical nature of the predictions of quantum mechanics that “God does not play dice with the universe,” it did show that if there were a law of causality in nature, no one but God would ever be able to apply it. The implications of Heisenberg’s Uncertainty Principle were recognized immediately, and it became a simple metaphor reaching beyond quantum mechanics to the broader world.

This metaphor extends neatly into the world of financial markets. In the purely mechanistic universe of classical physics, we could apply Newtonian laws to project the future course of nature, if only we knew the location and velocity of every particle. In the world of finance, the elementary particles are the financial assets. In a purely mechanistic financial world, if we knew the position each investor has in each asset and the ability and willingness of liquidity providers to take on those assets in the event of a forced liquidation, we would be able to understand the market’s vulnerability. We would have an early-warning system for crises. We would know which firms are subject to a liquidity cycle, and which events might trigger that cycle. We would know which markets are being overrun by speculative traders, and thereby anticipate tactical correlations and shifts in the financial habitat. The randomness of nature and economic cycles might remain beyond our grasp, but the primary cause of market crisis, and the part of market crisis that is of our own making, would be firmly in hand.

The first step toward the Laplacean goal of complete knowledge is the advocacy by certain financial market regulators to increase the transparency of positions. Politically, that would be a difficult sell – as would any kind of increase in regulatory control. Practically, it wouldn’t work. Just as the atomic world turned out to be more complex than Laplace conceived, the financial world may be similarly complex and not reducible to a simple causality. The problems with position disclosure are many. Some financial instruments are complex and difficult to price, so it is impossible to measure precisely the risk exposure. Similarly, in hedge positions a slight error in the transmission of one part, or asynchronous pricing of the various legs of the strategy, will grossly misstate the total exposure. Indeed, the problems and inaccuracies in using position information to assess risk are exemplified by the fact that major investment banking firms choose to use summary statistics rather than position-by-position analysis for their firmwide risk management despite having enormous resources and computational power at their disposal.

Perhaps more importantly, position transparency also has implications for the efficient functioning of the financial markets beyond the practical problems involved in its implementation. The problems in the examination of elementary particles in the financial world are the same as in the physical world: Beyond the inherent randomness and complexity of the systems, there are simply limits to what we can know. To say that we do not know something is as much a challenge as it is a statement of the state of our knowledge. If we do not know something, that presumes that either it is not worth knowing or it is something that will be studied and eventually revealed. It is the hubris of man that all things are discoverable. But for all the progress that has been made, perhaps even more exciting than the rolling back of the boundaries of our knowledge is the identification of realms that can never be explored. A sign in Einstein’s Princeton office read, “Not everything that counts can be counted, and not everything that can be counted counts.”

The behavioral analogue to the Uncertainty Principle is obvious. There are many psychological inhibitions that lead people to behave differently when they are observed than when they are not. For traders it is a simple matter of dollars and cents that will lead them to behave differently when their trades are open to scrutiny. Beneficial though it may be for the liquidity demander and the investor, for the liquidity supplier trans- parency is bad. The liquidity supplier does not intend to hold the position for a long time, like the typical liquidity demander might. Like a market maker, the liquidity supplier will come back to the market to sell off the position – ideally when there is another investor who needs liquidity on the other side of the market. If other traders know the liquidity supplier’s positions, they will logically infer that there is a good likelihood these positions shortly will be put into the market. The other traders will be loath to be the first ones on the other side of these trades, or will demand more of a price concession if they do trade, knowing the overhang that remains in the market.

This means that increased transparency will reduce the amount of liquidity provided for any given change in prices. This is by no means a hypothetical argument. Frequently, even in the most liquid markets, broker-dealer market makers (liquidity providers) use brokers to enter their market bids rather than entering the market directly in order to preserve their anonymity.

The more information we extract to divine the behavior of traders and the resulting implications for the markets, the more the traders will alter their behavior. The paradox is that to understand and anticipate market crises, we must know positions, but knowing and acting on positions will itself generate a feedback into the market. This feedback often will reduce liquidity, making our observations less valuable and possibly contributing to a market crisis. Or, in rare instances, the observer/feedback loop could be manipulated to amass fortunes.

One might argue that the physical limits of knowledge asserted by Heisenberg’s Uncertainty Principle are critical for subatomic physics, but perhaps they are really just a curiosity for those dwelling in the macroscopic realm of the financial markets. We cannot measure an electron precisely, but certainly we still can “kind of know” the present, and if so, then we should be able to “pretty much” predict the future. Causality might be approximate, but if we can get it right to within a few wavelengths of light, that still ought to do the trick. The mathematical system may be demonstrably incomplete, and the world might not be pinned down on the fringes, but for all practical purposes the world can be known.

Unfortunately, while “almost” might work for horseshoes and hand grenades, 30 years after Gödel and Heisenberg yet a third limitation of our knowledge was in the wings, a limitation that would close the door on any attempt to block out the implications of microscopic uncertainty on predictability in our macroscopic world. Based on observations made by Edward Lorenz in the early 1960s and popularized by the so-called butterfly effect – the fanciful notion that the beating wings of a butterfly could change the predictions of an otherwise perfect weather forecasting system – this limitation arises because in some important cases immeasurably small errors can compound over time to limit prediction in the larger scale. Half a century after the limits of measurement and thus of physical knowledge were demonstrated by Heisenberg in the world of quantum mechanics, Lorenz piled on a result that showed how microscopic errors could propagate to have a stultifying impact in nonlinear dynamic systems. This limitation could come into the forefront only with the dawning of the computer age, because it is manifested in the subtle errors of computational accuracy.

The essence of the butterfly effect is that small perturbations can have large repercussions in massive, random forces such as weather. Edward Lorenz was testing and tweaking a model of weather dynamics on a rudimentary vacuum-tube computer. The program was based on a small system of simultaneous equations, but seemed to provide an inkling into the variability of weather patterns. At one point in his work, Lorenz decided to examine in more detail one of the solutions he had generated. To save time, rather than starting the run over from the beginning, he picked some intermediate conditions that had been printed out by the computer and used those as the new starting point. The values he typed in were the same as the values held in the original simulation at that point, so the results the simulation generated from that point forward should have been the same as in the original; after all, the computer was doing exactly the same operations. What he found was that as the simulated weather pattern progressed, the results of the new run diverged, first very slightly and then more and more markedly, from those of the first run. After a point, the new path followed a course that appeared totally unrelated to the original one, even though they had started at the same place.

Lorenz at first thought there was a computer glitch, but as he investigated further, he discovered the basis of a limit to knowledge that rivaled that of Heisenberg and Gödel. The problem was that the numbers he had used to restart the simulation had been reentered based on his printout from the earlier run, and the printout rounded the values to three decimal places while the computer carried the values to six decimal places. This rounding, clearly insignificant at first, promulgated a slight error in the next-round results, and this error grew with each new iteration of the program as it moved the simulation of the weather forward in time. The error doubled every four simulated days, so that after a few months the solutions were going their own separate ways. The slightest of changes in the initial conditions had traced out a wholly different pattern of weather.

Intrigued by his chance observation, Lorenz wrote an article entitled “Deterministic Nonperiodic Flow,” which stated that “nonperiodic solutions are ordinarily unstable with respect to small modifications, so that slightly differing initial states can evolve into considerably different states.” Translation: Long-range weather forecasting is worthless. For his application in the narrow scientific discipline of weather prediction, this meant that no matter how precise the starting measurements of weather conditions, there was a limit after which the residual imprecision would lead to unpredictable results, so that “long-range forecasting of specific weather conditions would be impossible.” And since this occurred in a very simple laboratory model of weather dynamics, it could only be worse in the more complex equations that would be needed to properly reflect the weather. Lorenz discovered the principle that would emerge over time into the field of chaos theory, where a deterministic system generated with simple nonlinear dynamics unravels into an unrepeated and apparently random path.

The simplicity of the dynamic system Lorenz had used suggests a far-reaching result: Because we cannot measure without some error (harking back to Heisenberg), for many dynamic systems our forecast errors will grow to the point that even an approximation will be out of our hands. We can run a purely mechanistic system that is designed with well-defined and apparently well-behaved equations, and it will move over time in ways that cannot be predicted and, indeed, that appear to be random. This gets us to Santa Fe.

The principal conceptual thread running through the Santa Fe research asks how apparently simple systems, like that discovered by Lorenz, can produce rich and complex results. Its method of analysis in some respects runs in the opposite direction of the usual path of scientific inquiry. Rather than taking the complexity of the world and distilling simplifying truths from it, the Santa Fe Institute builds a virtual world governed by simple equations that when unleashed explode into results that generate unexpected levels of complexity.

In economics and finance, institute’s agenda was to create artificial markets with traders and investors who followed simple and reasonable rules of behavior and to see what would happen. Some of the traders built into the model were trend followers, others bought or sold based on the difference between the market price and perceived value, and yet others traded at random times in response to liquidity needs. The simulations then printed out the paths of prices for the various market instruments. Qualitatively, these paths displayed all the richness and variation we observe in actual markets, replete with occasional bubbles and crashes. The exercises did not produce positive results for predicting or explaining market behavior, but they did illustrate that it is not hard to create a market that looks on the surface an awful lot like a real one, and to do so with actors who are following very simple rules. The mantra is that simple systems can give rise to complex, even unpredictable dynamics, an interesting converse to the point that much of the complexity of our world can – with suitable assumptions – be made to appear simple, summarized with concise physical laws and equations.

The systems explored by Lorenz were deterministic. They were governed definitively and exclusively by a set of equations where the value in every period could be unambiguously and precisely determined based on the values of the previous period. And the systems were not very complex. By contrast, whatever the set of equations are that might be divined to govern the financial world, they are not simple and, furthermore, they are not deterministic. There are random shocks from political and economic events and from the shifting preferences and attitudes of the actors. If we cannot hope to know the course of the deterministic systems like fluid mechanics, then no level of detail will allow us to forecast the long-term course of the financial world, buffeted as it is by the vagaries of the economy and the whims of psychology.

Reductionism of Numerical Complexity: A Wittgensteinian Excursion


Wittgenstein’s criticism of Russell’s logicist foundation of mathematics contained in (Remarks on the Foundation of Mathematics) consists in saying that it is not the formalized version of mathematical deduction which vouches for the validity of the intuitive version but conversely.

If someone tries to shew that mathematics is not logic, what is he trying to shew? He is surely trying to say something like: If tables, chairs, cupboards, etc. are swathed in enough paper, certainly they will look spherical in the end.

He is not trying to shew that it is impossible that, for every mathematical proof, a Russellian proof can be constructed which (somehow) ‘corresponds’ to it, but rather that the acceptance of such a correspondence does not lean on logic.

Taking up Wittgenstein’s criticism, Hao Wang (Computation, Logic, Philosophy) discusses the view that mathematics “is” axiomatic set theory as one of several possible answers to the question “What is mathematics?”. Wang points out that this view is epistemologically worthless, at least as far as the task of understanding the feature of cognition guiding is concerned:

Mathematics is axiomatic set theory. In a definite sense, all mathematics can be derived from axiomatic set theory. [ . . . ] There are several objections to this identification. [ . . . ] This view leaves unexplained why, of all the possible consequences of set theory, we select only those which happen to be our mathematics today, and why certain mathematical concepts are more interesting than others. It does not help to give us an intuitive grasp of mathematics such as that possessed by a powerful mathematician. By burying, e.g., the individuality of natural numbers, it seeks to explain the more basic and the clearer by the more obscure. It is a little analogous to asserting that all physical objects, such as tables, chairs, etc., are spherical if we swathe them with enough stuff.

Reductionism is an age-old project; a close forerunner of its incarnation in set theory was the arithmetization program of the 19th century. It is interesting that one of its prominent representatives, Richard Dedekind (Essays on the Theory of Numbers), exhibited a quite distanced attitude towards a consequent carrying out of the program:

It appears as something self-evident and not new that every theorem of algebra and higher analysis, no matter how remote, can be expressed as a theorem about natural numbers [ . . . ] But I see nothing meritorious [ . . . ] in actually performing this wearisome circumlocution and insisting on the use and recognition of no other than rational numbers.

Perec wrote a detective novel without using the letter ‘e’ (La disparition, English A void), thus proving not only that such an enormous enterprise is indeed possible but also that formal constraints sometimes have great aesthetic appeal. The translation of mathematical propositions into a poorer linguistic framework can easily be compared with such painful lipogrammatical exercises. In principle all logical connectives can be simulated in a framework exclusively using Sheffer’s stroke, and all cuts (in Gentzen’s sense) can be eliminated; one can do without common language at all in mathematics and formalize everything and so on: in principle, one could leave out a whole lot of things. However, in doing so one would depart from the true way of thinking employed by the mathematician (who really uses “and” and “not” and cuts and who does not reduce many things to formal systems). Obviously, it is the proof theorist as a working mathematician who is interested in things like the reduction to Sheffer’s stroke since they allow for more concise proofs by induction in the analysis of a logical calculus. Hence this proof theorist has much the same motives as a mathematician working on other problems who avoids a completely formalized treatment of these problems since he is not interested in the proof-theoretical aspect.

There might be quite similar reasons for the interest of some set theorists in expressing usual mathematical constructions exclusively with the expressive means of ZF (i.e., in terms of ∈). But beyond this, is there any philosophical interpretation of such a reduction? In the last analysis, mathematicians always transform (and that means: change) their objects of study in order to make them accessible to certain mathematical treatments. If one considers a mathematical concept as a tool, one does not only use it in a way different from the one in which it would be used if it were considered as an object; moreover, in semiotical representation of it, it is given a form which is different in both cases. In this sense, the proof theorist has to “change” the mathematical proof (which is his or her object of study to be treated with mathematical tools). When stating that something is used as object or as tool, we have always to ask: in which situation, or: by whom.

A second observation is that the translation of propositional formulæ in terms of Sheffer’s stroke in general yields quite complicated new formulæ. What is “simple” here is the particularly small number of symbols needed; but neither the semantics becomes clearer (p|q means “not both p and q”; cognitively, this looks more complex than “p and q” and so on), nor are the formulæ you get “short”. What is looked for in this case, hence, is a reduction of numerical complexity, while the primitive basis attained by the reduction cognitively looks less “natural” than the original situation (or, as Peirce expressed it, “the consciousness in the determined cognition is more lively than in the cognition which determines it”); similarly in the case of cut elimination. In contrast to this, many philosophers are convinced that the primitive basis of operating with sets constitutes really a “natural” basis of mathematical thinking, i.e., such operations are seen as the “standard bricks” of which this thinking is actually made – while no one will reasonably claim that expressions of the type p|q play a similar role for propositional logic. And yet: reduction to set theory does not really have the task of “explanation”. It is true, one thus reduces propositions about “complex” objects to propositions about “simple” objects; the propositions themselves, however, thus become in general more complex. Couched in Fregean terms, one can perhaps more easily grasp their denotation (since the denotation of a proposition is its truth value) but not their meaning. A more involved conceptual framework, however, might lead to simpler propositions (and in most cases has actually just been introduced in order to do so). A parallel argument concerns deductions: in its totality, a deduction becomes more complex (and less intelligible) by a decomposition into elementary steps.

Now, it will be subject to discussion whether in the case of some set operations it is admissible at all to claim that they are basic for thinking (which is certainly true in the case of the connectives of propositional logic). It is perfectly possible that the common sense which organizes the acceptance of certain operations as a natural basis relies on something different, not having the character of some eternal laws of thought: it relies on training.

Is it possible to observe that a surface is coloured red and blue; and not to observe that it is red? Imagine a kind of colour adjective were used for things that are half red and half blue: they are said to be ‘bu’. Now might not someone to be trained to observe whether something is bu; and not to observe whether it is also red? Such a man would then only know how to report: “bu” or “not bu”. And from the first report we could draw the conclusion that the thing was partly red.

ε-calculus and Hilbert’s Contentual Number Theory: Proselytizing Intuitionism. Thought of the Day 67.0


Hilbert came to reject Russell’s logicist solution to the consistency problem for arithmetic, mainly for the reason that the axiom of reducibility cannot be accepted as a purely logical axiom. He concluded that the aim of reducing set theory, and with it the usual methods of analysis, to logic, has not been achieved today and maybe cannot be achieved at all. At the same time, Brouwer’s intuitionist mathematics gained currency. In particular, Hilbert’s former student Hermann Weyl converted to intuitionism.

According to Hilbert, there is a privileged part of mathematics, contentual elementary number theory, which relies only on a “purely intuitive basis of concrete signs.” Whereas the operating with abstract concepts was considered “inadequate and uncertain,” there is a realm of extra-logical discrete objects, which exist intuitively as immediate experience before all thought. If logical inference is to be certain, then these objects must be capable of being completely surveyed in all their parts, and their presentation, their difference, their succession (like the objects themselves) must exist for us immediately, intuitively, as something which cannot be reduced to something else.

The objects in questions are signs, both numerals and the signs that make up formulas a formal proofs. The domain of contentual number theory consists in the finitary numerals, i.e., sequences of strokes. These have no meaning, i.e., they do not stand for abstract objects, but they can be operated on (e.g., concatenated) and compared. Knowledge of their properties and relations is intuitive and unmediated by logical inference. Contentual number theory developed this way is secure, according to Hilbert: no contradictions can arise simply because there is no logical structure in the propositions of contentual number theory. The intuitive-contentual operations with signs form the basis of Hilbert’s meta-mathematics. Just as contentual number theory operates with sequences of strokes, so meta-mathematics operates with sequences of symbols (formulas, proofs). Formulas and proofs can be syntactically manipulated, and the properties and relationships of formulas and proofs are similarly based in a logic-free intuitive capacity which guarantees certainty of knowledge about formulas and proofs arrived at by such syntactic operations. Mathematics itself, however, operates with abstract concepts, e.g., quantifiers, sets, functions, and uses logical inference based on principles such as mathematical induction or the principle of the excluded middle. These “concept-formations” and modes of reasoning had been criticized by Brouwer and others on grounds that they presuppose infinite totalities as given, or that they involve impredicative definitions. Hilbert’s aim was to justify their use. To this end, he pointed out that they can be formalized in axiomatic systems (such as that of Principia or those developed by Hilbert himself), and mathematical propositions and proofs thus turn into formulas and derivations from axioms according to strictly circumscribed rules of derivation. Mathematics, to Hilbert, “becomes an inventory of provable formulas.” In this way the proofs of mathematics are subject to metamathematical, contentual investigation. The goal of Hilbert is then to give a contentual, meta-mathematical proof that there can be no derivation of a contradiction, i.e., no formal derivation of a formula A and of its negation ¬A.

Hilbert and Bernays developed the ε-calculus as their definitive formalism for axiom systems for arithmetic and analysis, and the so-called ε-substitution method as the preferred approach to giving consistency proofs. Briefly, the ε-calculus is a formalism that includes ε as a term-forming operator. If A(x) is a formula, then εxA(x) is a term, which intuitively stands for a witness for A(x). In a logical formalism containing the ε-operator, the quantifiers can be defined by: ∃x A(x) ≡ A(εxA(x)) and ∀x A(x) ≡ A(εx¬A(x)). The only additional axiom necessary is the so-called “transfinite axiom,” A(t) → A(εxA(x)). Based on this idea, Hilbert and his collaborators developed axiomatizations of number theory and analysis. Consistency proofs for these systems were then given using the ε-substitution method. The idea of this method is, roughly, that the ε-terms εxA(x) occurring in a formal proof are replaced by actual numerals, resulting in a quantifier-free proof. Suppose we had a (suitably normalized) derivation of 0 = 1 that contains only one ε-term εxA(x). Replace all occurrences of εxA(x) by 0. The instances of the transfinite axiom then are all of the form A(t) → A(0). Since no other ε-terms occur in the proof, A(t) and A(0) are basic numerical formulas without quantifiers and, we may assume, also without free variables. So they can be evaluated by finitary calculation. If all such instances turn out to be true numerical formulas, we are done. If not, this must be because A(t) is true for some t, and A(0) is false. Then replace εxA(x) instead by n, where n is the numerical value of the term t. The resulting proof is then seen to be a derivation of 0 = 1 from true, purely numerical formulas using only modus ponens, and this is impossible. Indeed, the procedure works with only slight modifications even in the presence of the induction axiom, which in the ε-calculus takes the form of a least number principle: A(t) → εxA(x) ≤ t, which intuitively requires εxA(x) to be the least witness for A(x).

Fundamental Theorem of Asset Pricing: Tautological Meeting of Mathematical Martingale and Financial Arbitrage by the Measure of Probability.


The Fundamental Theorem of Asset Pricing (FTAP hereafter) has two broad tenets, viz.

1. A market admits no arbitrage, if and only if, the market has a martingale measure.

2. Every contingent claim can be hedged, if and only if, the martingale measure is unique.

The FTAP is a theorem of mathematics, and the use of the term ‘measure’ in its statement places the FTAP within the theory of probability formulated by Andrei Kolmogorov (Foundations of the Theory of Probability) in 1933. Kolmogorov’s work took place in a context captured by Bertrand Russell, who observed that

It is important to realise the fundamental position of probability in science. . . . As to what is meant by probability, opinions differ.

In the 1920s the idea of randomness, as distinct from a lack of information, was becoming substantive in the physical sciences because of the emergence of the Copenhagen Interpretation of quantum mechanics. In the social sciences, Frank Knight argued that uncertainty was the only source of profit and the concept was pervading John Maynard Keynes’ economics (Robert Skidelsky Keynes the return of the master).

Two mathematical theories of probability had become ascendant by the late 1920s. Richard von Mises (brother of the Austrian economist Ludwig) attempted to lay down the axioms of classical probability within a framework of Empiricism, the ‘frequentist’ or ‘objective’ approach. To counter–balance von Mises, the Italian actuary Bruno de Finetti presented a more Pragmatic approach, characterised by his claim that “Probability does not exist” because it was only an expression of the observer’s view of the world. This ‘subjectivist’ approach was closely related to the less well-known position taken by the Pragmatist Frank Ramsey who developed an argument against Keynes’ Realist interpretation of probability presented in the Treatise on Probability.

Kolmogorov addressed the trichotomy of mathematical probability by generalising so that Realist, Empiricist and Pragmatist probabilities were all examples of ‘measures’ satisfying certain axioms. In doing this, a random variable became a function while an expectation was an integral: probability became a branch of Analysis, not Statistics. Von Mises criticised Kolmogorov’s generalised framework as un-necessarily complex. About a decade and a half back, the physicist Edwin Jaynes (Probability Theory The Logic Of Science) champions Leonard Savage’s subjectivist Bayesianism as having a “deeper conceptual foundation which allows it to be extended to a wider class of applications, required by current problems of science”.

The objections to measure theoretic probability for empirical scientists can be accounted for as a lack of physicality. Frequentist probability is based on the act of counting; subjectivist probability is based on a flow of information, which, following Claude Shannon, is now an observable entity in Empirical science. Measure theoretic probability is based on abstract mathematical objects unrelated to sensible phenomena. However, the generality of Kolmogorov’s approach made it flexible enough to handle problems that emerged in physics and engineering during the Second World War and his approach became widely accepted after 1950 because it was practically more useful.

In the context of the first statement of the FTAP, a ‘martingale measure’ is a probability measure, usually labelled Q, such that the (real, rather than nominal) price of an asset today, X0, is the expectation, using the martingale measure, of its (real) price in the future, XT. Formally,

X0 = EQ XT

The abstract probability distribution Q is defined so that this equality exists, not on any empirical information of historical prices or subjective judgement of future prices. The only condition placed on the relationship that the martingale measure has with the ‘natural’, or ‘physical’, probability measures usually assigned the label P, is that they agree on what is possible.

The term ‘martingale’ in this context derives from doubling strategies in gambling and it was introduced into mathematics by Jean Ville in a development of von Mises’ work. The idea that asset prices have the martingale property was first proposed by Benoit Mandelbrot in response to an early formulation of Eugene Fama’s Efficient Market Hypothesis (EMH), the two concepts being combined by Fama. For Mandelbrot and Fama the key consequence of prices being martingales was that the current price was independent of the future price and technical analysis would not prove profitable in the long run. In developing the EMH there was no discussion on the nature of the probability under which assets are martingales, and it is often assumed that the expectation is calculated under the natural measure. While the FTAP employs modern terminology in the context of value-neutrality, the idea of equating a current price with a future, uncertain, has ethical ramifications.

The other technical term in the first statement of the FTAP, arbitrage, has long been used in financial mathematics. Liber Abaci Fibonacci (Laurence Sigler Fibonaccis Liber Abaci) discusses ‘Barter of Merchandise and Similar Things’, 20 arms of cloth are worth 3 Pisan pounds and 42 rolls of cotton are similarly worth 5 Pisan pounds; it is sought how many rolls of cotton will be had for 50 arms of cloth. In this case there are three commodities, arms of cloth, rolls of cotton and Pisan pounds, and Fibonacci solves the problem by having Pisan pounds ‘arbitrate’, or ‘mediate’ as Aristotle might say, between the other two commodities.

Within neo-classical economics, the Law of One Price was developed in a series of papers between 1954 and 1964 by Kenneth Arrow, Gérard Debreu and Lionel MacKenzie in the context of general equilibrium, in particular the introduction of the Arrow Security, which, employing the Law of One Price, could be used to price any asset. It was on this principle that Black and Scholes believed the value of the warrants could be deduced by employing a hedging portfolio, in introducing their work with the statement that “it should not be possible to make sure profits” they were invoking the arbitrage argument, which had an eight hundred year history. In the context of the FTAP, ‘an arbitrage’ has developed into the ability to formulate a trading strategy such that the probability, under a natural or martingale measure, of a loss is zero, but the probability of a positive profit is not.

To understand the connection between the financial concept of arbitrage and the mathematical idea of a martingale measure, consider the most basic case of a single asset whose current price, X0, can take on one of two (present) values, XTD < XTU, at time T > 0, in the future. In this case an arbitrage would exist if X0 ≤ XTD < XTU: buying the asset now, at a price that is less than or equal to the future pay-offs, would lead to a possible profit at the end of the period, with the guarantee of no loss. Similarly, if XTD < XTU ≤ X0, short selling the asset now, and buying it back would also lead to an arbitrage. So, for there to be no arbitrage opportunities we require that

XTD < X0 < XTU

This implies that there is a number, 0 < q < 1, such that

X0 = XTD + q(XTU − XTD)

= qXTU + (1−q)XTD

The price now, X0, lies between the future prices, XTU and XTD, in the ratio q : (1 − q) and represents some sort of ‘average’. The first statement of the FTAP can be interpreted simply as “the price of an asset must lie between its maximum and minimum possible (real) future price”.

If X0 < XTD ≤ XTU we have that q < 0 whereas if XTD ≤ XTU < X0 then q > 1, and in both cases q does not represent a probability measure which by Kolmogorov’s axioms, must lie between 0 and 1. In either of these cases an arbitrage exists and a trader can make a riskless profit, the market involves ‘turpe lucrum’. This account gives an insight as to why James Bernoulli, in his moral approach to probability, considered situations where probabilities did not sum to 1, he was considering problems that were pathological not because they failed the rules of arithmetic but because they were unfair. It follows that if there are no arbitrage opportunities then quantity q can be seen as representing the ‘probability’ that the XTU price will materialise in the future. Formally

X0 = qXTU + (1−q) XTD ≡ EQ XT

The connection between the financial concept of arbitrage and the mathematical object of a martingale is essentially a tautology: both statements mean that the price today of an asset must lie between its future minimum and maximum possible value. This first statement of the FTAP was anticipated by Frank Ramsey when he defined ‘probability’ in the Pragmatic sense of ‘a degree of belief’ and argues that measuring ‘degrees of belief’ is through betting odds. On this basis he formulates some axioms of probability, including that a probability must lie between 0 and 1. He then goes on to say that

These are the laws of probability, …If anyone’s mental condition violated these laws, his choice would depend on the precise form in which the options were offered him, which would be absurd. He could have a book made against him by a cunning better and would then stand to lose in any event.

This is a Pragmatic argument that identifies the absence of the martingale measure with the existence of arbitrage and today this forms the basis of the standard argument as to why arbitrages do not exist: if they did the, other market participants would bankrupt the agent who was mis-pricing the asset. This has become known in philosophy as the ‘Dutch Book’ argument and as a consequence of the fact/value dichotomy this is often presented as a ‘matter of fact’. However, ignoring the fact/value dichotomy, the Dutch book argument is an alternative of the ‘Golden Rule’– “Do to others as you would have them do to you.”– it is infused with the moral concepts of fairness and reciprocity (Jeffrey Wattles The Golden Rule).

FTAP is the ethical concept of Justice, capturing the social norms of reciprocity and fairness. This is significant in the context of Granovetter’s discussion of embeddedness in economics. It is conventional to assume that mainstream economic theory is ‘undersocialised’: agents are rational calculators seeking to maximise an objective function. The argument presented here is that a central theorem in contemporary economics, the FTAP, is deeply embedded in social norms, despite being presented as an undersocialised mathematical object. This embeddedness is a consequence of the origins of mathematical probability being in the ethical analysis of commercial contracts: the feudal shackles are still binding this most modern of economic theories.

Ramsey goes on to make an important point

Having any definite degree of belief implies a certain measure of consistency, namely willingness to bet on a given proposition at the same odds for any stake, the stakes being measured in terms of ultimate values. Having degrees of belief obeying the laws of probability implies a further measure of consistency, namely such a consistency between the odds acceptable on different propositions as shall prevent a book being made against you.

Ramsey is arguing that an agent needs to employ the same measure in pricing all assets in a market, and this is the key result in contemporary derivative pricing. Having identified the martingale measure on the basis of a ‘primal’ asset, it is then applied across the market, in particular to derivatives on the primal asset but the well-known result that if two assets offer different ‘market prices of risk’, an arbitrage exists. This explains why the market-price of risk appears in the Radon-Nikodym derivative and the Capital Market Line, it enforces Ramsey’s consistency in pricing. The second statement of the FTAP is concerned with incomplete markets, which appear in relation to Arrow-Debreu prices. In mathematics, in the special case that there are as many, or more, assets in a market as there are possible future, uncertain, states, a unique pricing vector can be deduced for the market because of Cramer’s Rule. If the elements of the pricing vector satisfy the axioms of probability, specifically each element is positive and they all sum to one, then the market precludes arbitrage opportunities. This is the case covered by the first statement of the FTAP. In the more realistic situation that there are more possible future states than assets, the market can still be arbitrage free but the pricing vector, the martingale measure, might not be unique. The agent can still be consistent in selecting which particular martingale measure they choose to use, but another agent might choose a different measure, such that the two do not agree on a price. In the context of the Law of One Price, this means that we cannot hedge, replicate or cover, a position in the market, such that the portfolio is riskless. The significance of the second statement of the FTAP is that it tells us that in the sensible world of imperfect knowledge and transaction costs, a model within the framework of the FTAP cannot give a precise price. When faced with incompleteness in markets, agents need alternative ways to price assets and behavioural techniques have come to dominate financial theory. This feature was realised in The Port Royal Logic when it recognised the role of transaction costs in lotteries.

Frege-Russell and Mathematical Identity

Frege considered it a principal task of his logical reform of arithmetic to provide absolutely determinate identity conditions for the objects of that science, i.e. for numbers. Referring to the contemporary situation in this discipline he writes:

How I propose to improve upon it can be no more than indicated in the present work. With numbers … it is a matter of fixing the sense of an identity.

Frege makes the following critically important assumption : identity is a general logical concept, which is not specific to mathematics. Frege says:

It is not only among numbers that the relationship of identity is found. From which it seems to follow that we ought not to define it specially for the case of numbers. We should expect the concept of identity to have been fixed first, and that then from it together with the concept of number it must be possible to deduce when numbers are identical with one another, without there being need for this purpose of a special definition of numerical identity as well.

In a different place Frege says clearly that this concept of identity is absolutely stable across all possible domains and contexts:

Identity is a relation given to us in such a specific form that it is inconceivable that various forms of it should occur.

Frege’s definition of natural number, as modified in Russell (Bertrand Russell – Principles of Mathematics) later became standard. Intuitively the number 3 is what all collections consisting of three members (trios) share in common. Now instead of looking for a common form, essence or type of trios let us simply consider all such things together. According to Frege and Russell the collection (class, set) of all trios just is the number 3. Similarly for other numbers. Isn’t this construction circular? Frege and Russell provide the following argument which they claim allows us to avoid circularity here: given two different collections we may learn whether or not they have the same number of members without knowing this number and even without the notion of number itself. It is sufficient to find a one-one correspondence between members of two given collections. If there is such a correspondence, the two collections comprise the same number of members, or to avoid any reference to numbers we can say that the two collections are equivalent. This equivalence is Humean. Let us define natural numbers as equivalence classes under this relation. This definition reduces the question of identity of numbers to that of identity of classes. This latter question is settled through the axiomatization of set theory in a logical calculus with identity. Thus Frege’s project is realized: it has been seen how the logical concept of identity applies to numbers. In an axiomatic setting “identities” in Quine’s sense (that is, identity conditions) of mathematical objects are provided by an axiom schema of the form

∀x ∀y (x=y ↔ ___ )

called the Identity Schema (IS). This does not resolve the identity problem though because any given system of axioms, generally speaking, has multiple models. The case of isomorphic models is similar to that of equal numbers or coincident points (naively construed): there are good reasons to think of isomorphic models as one and there is also good reason to think of them as many. So the paradox of mathematical “doubles” reappears. It is a highly non-trivial fact that different models of Peano arithmetic, ZF, and other important axiomatic systems are not necessarily isomorphic. Thus logical analysis à la Frege-Russell certainly clarifies the mathematical concepts involved but it does not settle the identity issue as Frege believed it did. In the recent philosophy of mathematics literature the problem of the identity of mathematical objects is usually considered in the logical setting just mentioned: either as the problem of the non-uniqueness of the models of a given axiomatic system or as the problem of how to fill in the Identity Schema. At the first glance the Frege-Russell proposal concerning the identity issue in mathematics seems judicious and innocent (and it certainly does not depend upon the rest of their logicist project): to stick to a certain logical discipline in speaking about identity (everywhere and in particular in mathematics).

To Err or Not? Neo-Kantianism’s Logical Flaw. Note Quote.

According to Bertrand Russell, the sense in which every object is ‘one’ is a very shadowy sense because it is applicable to everything alike. However, Russell argues, the sense in which a class may be said to have one member is quite precise. “A class u has one member when u is not null, and ‘x and y are us’ implies ‘x is identical with y’.” In this case the one-ness is a property of a class and Russell calls this class a unit-class. Thus, Russell claims further, the number ‘one’ is not to be asserted of terms but of classes having one member in the above-defined sense. The same distinction between the different uses of ‘one’ was also made by Frege and Couturat. Frege says that the sense in which every object is ‘one’ is very imprecise, that is, every single object possesses this property. However, Frege argues that when one speaks of ‘the number one’, one indicates by means of the definite article a definite and unique object of scientific study. In his reply to Poincaré’s critique of the logicist programme, Couturat says that the confusion which exists in Poincaré’s mind arises from the double meaning of the word for ‘one’, that is, it is used both as a name of a number and as an indefinite article:

To sum up, it is not enough to conceive any one object to conceive the number one, nor to think of two objects together to have by that alone the idea of the number two.

According to Couturat, from the fact that the proposition “x and y are the elements of the class u” contains the symbols x and y one should not conclude that the number two is implied in this proposition. As a result, from the viewpoint of Russell, Couturat and Frege, the neo-Kantians are making here an elementary logical mistake. This awakens an interesting question. Why the neo-Kantians did not notice the mistake they had made? The answer is not that they would not have been aware of the opinion of the logicists. Both Cohn and Cassirer discuss the above-mentioned passage in Russell’s Principles. However, although Cohn and Cassirer were familiar with the distinction presented by Russell, it did not convince them. In Cohn’s view, Russell’s unit-class does not define ‘one’ but ‘only one’. As Cohn sees it, ‘only one’ means the limitation of a class to one object. Thus Russell’s ‘unit-class’ already presupposes that an object is seen as a unit. As a result, Russell’s definition of ‘one’ is unsuccessful since it already presupposes the number ‘one’. Cassirer, too, refers to Russell’s explanation, according to which it is naturally incontestable that every member of a class is in some sense one, but, Cassirer says, it does not follow from this that the concept of ‘one’ is presupposed. Cassirer mentions also Russell’s explanation according to which the meaning of the assertion that a class u possesses ‘one’ member is determined by the fact that this class is not null and that if x and y are u, then x is identical with y. According to Cassirer, the logical function of number is here not so much deduced as rather described by a technical circumlocution. Cassirer argues that in order to comprehend Russell’s explanation it is necessary that the term x is understood as identical with itself, and at the same time it is related to another term y and the former is judged as agreeing with or differing from the latter. In Cassirer’s view, if this process of positing and differentiation is accepted, then all that has been done will be to presuppose the number in the sense of the theory of ordinal number.

The neo-Kantian critique cannot be explained away as a mere logical error. The real reason why they did not accept the distinction is that to accept it would be to accept at least part of the logicist programme. As Warren Goldfarb has pointed out, Poincaré’s argument will be logically in error only if one simultaneously accepts the analysis of notions ‘in no case’ and ‘a class with one object’ that was first made available through modern mathematical logic. In other words, the logicists claim that the appearance of circularity is eliminated when one distinguishes uses of numerical expressions that can be replaced by purely quantificational devices from the full-blooded uses of such expressions that the formal definition is meant to underwrite. Hence the notions ‘in no case’ and ‘a class with one object’ do not presuppose any number theory if one simultaneously accepts the analysis which first-order quantificational logic provides for them. Poincaré does not accept this analysis, and, as result, he can bring the charge of petitio principii.

Like Poincaré, the neo-Kantians were not ready to accept Russell’s analysis of the expression ‘a class with one object’. As they see it, although the notion ‘a class with one object’ does not presuppose the number ‘one’ if one accepts the logicist definition of number, it will presuppose it if one advocates a neo-Kantian theory of number. According to Cassirer, the concept of number is the first and truest expression of rational method in general. Later Cassirer added that number is not merely a product of pure thought but its very prototype and source. It not only originates from the pure regularities of thought but designates the primary and original act to which these regularities ultimately go back. In Natorp’s view, number is the purest and simplest product of thought. Natorp claims that the first precondition for the logical understanding of number is the insight that number has nothing to do with the existing things but that number is only concerned with the pure regularities of thought. Natorp connects number to the fundamental logical function of quantity. In his view, the quantitative function of thought is produced when multiplicity is singled out from the fundamental relation between unity and multiplicity. Moreover, multiplicity is a plurality of distinguishable elements. Plurality, in turn, is necessarily a plurality of unities. Thus unity in the sense of numerical oneness is the unavoidable starting-point, the indispensable foundation of every quantitative positing of pure thought. According to Natorp, the quantitative positing of thought proceeds in three steps. First, pure thought posits something as one. What is posited as one is not important (it can be the world, an atom, and so on). It is only something to which the thought attaches the character of oneness. Second, the positing of the one can be repeated in the sense that while the one remains posited, we can posit always another in comparison with it. This is the way in which we attain plurality. Third and last, we collect the individual positings into a whole, that is, to a new unity in the sense of a unity of several. In this way we attain a definite plurality, that is, “so much” as distinguished from an indefinite set. In other words, one and one and one, and so forth, are here joined to new mental unities (duality, triplicity, and so forth).

According to Cohn, the natural numbers are the most abstract objects possible. Everything thinkable can be an object, and every object has two elements: the thinking-form and the objectivity. The thinking-form belongs to every object, and Cohn calls it “positing”. It can be described by saying that every object is identical with itself. This formal definiteness of an object has nothing to do with the determination of an object with regard to content. Since the thinking-form belongs to every object in the same way, it alone is not enough to form any specific object. The particularity of any individual object, or as Cohn puts it, the objectivity of any individual object, is something new and foreign when compared to the thinking-form of the object. In other words, Cohn argues that the necessary elements of every object are the thinking-form, and the objectivity. As a result, natural numbers are objects which have the thinking-form of identity and the minimum of objectivity, that is, the form of identity must be thought to be filled with something in some way or other. Moreover, Cohn says that his theory of natural numbers presupposes the possibility of arbitrary object-formation, that is, the possibility to construct arbitrarily many objects. On the basis of these two logical presuppositions, Cohn says that we are able to form arbitrarily many objects which are all equal with each other. According to Cohn, all of these objects can be described by the same symbol 1, and after this operation the fundamental equation 1 = 1 can be presented. Cohn says that the two separate symbols 1 in the equation signify different unities and the sign of equality means only that in any arithmetical relation any arbitrary unity can be replaced with any other unity. Moreover, Cohn says that we can collect an arbitrary number of objects into an aggregate, that is, into a new object. This is expressed by the repeated use of the word ‘and’. In arithmetic the combination of unities into a new unity has the form: 1 + 1 + 1 and so on (when ‘and’ is replaced by ‘+’). The most simple combination (1 + 1) can be described as 2, the following one (1 + 1 + 1) as 3, and so on. Thus a new number can always be attained by adding a new unity.

Whitehead’s Ontologization of the Quantum Field Theory (QFT)

The art of progress is to preserve order amid change, and to preserve change amid order.

— Alfred North Whitehead, Process and Reality, 1929.


After his attempt to complete the set-theoretic foundations of mathematics in collaboration with Russell, Whitehead’s venture into the natural sciences made him realise that the traditional timeless ontology of substances, and not in the least their static set-theoretic underpinning, does not suit natural phenomena. Instead, he claims, it is processes and their relationships which should underpin our understanding of those phenomena. Whiteheadian quantum ontology is essentially an ontologization of the structure of orthodox relativistic quantum field theory, stripped of any anthropocentric formulations. This means that mentality is no longer reserved for human beings and higher creatures. Does Whitehead’s ontology contain an inconsistency due to the fact that the principle of separateness of all realized regions will generally not be satisfied in his causally local and separable ontology? This would be true if his metaphysics were traced back only to the theory of relativity, if one did not take into account that his ideas originate from a psycho-philosophical discussion, that his theory of prehension connects all occasions of the contemporary world, and that the concrescence process selects positive prehensions. If one concluded that, then either the causal independence of simultaneous occasions or the distinctness of their concrescence processes would have to be abandoned in order to secure the separateness of all realized regions, and one would have to answer the questions: What does causality mean?

Causality is merely the way in which each instance of freedom takes into account the previous instances, as each of our experience refers back through memory to our own past and through perception to the world’s past.” According to quantum thinking and process philosophy there is no backward-in-time causation. “The basic properties of relativistic quantum theory emerge […] from a logically simple model of reality. In this model there is a fundamental creative process by discrete steps. Each step is a creative act or event. Each event is associated with a definitive spacetime location. The fundamental process is not local in character, but it generates local spacetime patterns that have mathematical forms amenable to scientific studies. According to Charles Hartshorne,

The mutual independence of contemporaries constitutes their freedom. Without this independence, what happens anywhere would immediately condition what happens anywhere else. However, this would be fatal to freedom only if the sole alternative to mutual independence were mutual dependence. And this is not a necessary, it is even a possible, interpretation of Bell’s result. What happens here now may condition what happens somewhere else without measurable temporal lapse, although what happens at somewhere else does not condition what happens here, still retains its freedom since […] no set of conditions can be fully determinative of the resulting actuality.