Emanuel Derman

The first (1990) paper on valuing quanto options

The author tries to justify a career spent in financial modeling

Ihr iPad funktioniert, weil irgendjemand die Maxwellschen Gleichungen und die Grundlagen der Quanten-Physik verstanden hat - und dieser irgendjemand kann etwas bauen, das tut, was Sie wollen, wenn sie einen Knopf drücken. Quants benutzen die gleiche Art von Mathematik um Optionen und Märkte zu beschreiben. Es sieht genauso aus, aber es basiert auf einer ganz vagen Analogie, die behauptet Aktienkurse verhielten sich wie die Diffusion von Dampf. Es ist keine Beschreibung der Wirklichkeit.“

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Models Behaving Badly: The English Original

The good days are here once again for models of the physical world: after a drought of almost fifty years, physicists at CERN have discovered what seems to be the long-awaited Higgs boson. But we are living through a period of bad days for models of the social world, where I am using the word ‘model’ in the sense of Gilbert and Sullivan’s Major-General Stanley in The Pirates of Penzance, who sang: “I am the very model of a modern Major-General.”

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The full English version will be on www.faz.net too.

All characters appearing in this work are fictitious. Any resemblance to real persons, living or dead, is purely coincidental.

Derman is not enamoured with the growing field of behavioural finance, which he fears has become a plaything for policy-makers, because it is not comprehensive enough to exist as a stand-alone theory to explain financial markets. As long as markets have existed, models to explain them have failed.

“Part of me wanted to believe that human beings are part of nature and eventually people can understand people. But as soon as someone gets a model of human behaviour, people will change their behaviour as a consequence.”

Derman says: “Your iPad works because someone understands Maxwell’s equations and quantum electrodynamics, and they can build something that does what you want when you hit a button. They use the same kind of math to describe options and markets.

“It looks the same but it’s based on a vague analogy which says stock prices behave like smoke diffusions, it’s not a description of reality. Whereas for Newton’s laws or Maxwell’s equations, that’s the way the world is.”

Writing books on finance is one thing; reading them is another.

So I discovered when I invited Satyajit Das and Emanuel Derman to discuss their reading in the wake of the crisis that killed off Lehman Brothers Holdings Inc. (LEHMQ)

What do quantum theory, Schopenhauer, Goethe, and Spinoza have to teach us about the economic disaster of 2007-8?

With “Models Behaving Badly” he offers a readable, even eloquent combination of personal history, philosophical musing and honest confession concerning the dangers of relying on numerical models not only on Wall Street but also in life.

… it is undeniable that “Models Behaving Badly” itself performs splendidly. Bringing ethics into his analysis, Mr. Derman has no patience for coddling the folly of individuals and institutions who over-rely on faulty models and then seek to escape the consequences.

Some smart people at BNN asking good questions.

The Globe and Mail: Mr. Derman was in Toronto discussing his new book, Models. Behaving. Badly: Why Confusing Illusion With Reality Can Lead to Disaster, on Wall Street and in Life.

David Magee interviews Emanuel Derman on IBTimes.tv

The Daily Ticker: It’s a question of confidence in funding, not just confidence in models