Extended finite similitude and dimensional analysis for scaling

Abstract

Abstract The theory of scaling called finite similitude does not involve dimensional analysis and is founded on a transport-equation approach that is applicable to all of classical physics. It features a countable infinite number of similitude rules and has recently been extended to other types of governing equations (e.g., differential, variational) by the introduction of a scaling space $$\Omega _{\beta }$$ Ω β , within which all physical quantities are deemed dependent on a single dimensional parameter $$\beta $$ β . The theory is presently limited to physical applications but the focus of this paper is its extension to other quantitative-based theories such as finance. This is achieved by connecting it to an extended form of dimensional analysis, where changes in any quantity can be associated with curves projected onto a dimensional Lie group. It is shown in the paper how differential similitude identities arising out of the finite similitude theory are universal in the sense they can be formed and applied to any quantitative-based theory. In order to illustrate its applicability outside physics the Black-Scholes equation for option valuation in finance is considered since this equation is recognised to be similar in form to an equation from thermal physics. It is demonstrated that the theory of finite similitude can be applied to the Black-Scholes equation and more widely can be used to assess observed size effects in portfolio performance.