Models. Behaving. Badly.
Quants, physicists working on Wall Street as quantitative analysts, have been widely blamed for triggering the recent financial crisis with their complex mathematical models. What made these models, employed to minimize financial risk, so dangerous?
In this penetrating, insider's look at the recent economic collapse, Emanuel Derman--former head quant at Goldman Sachs and a former physicist--explains the collision between mathematical modeling and economics that has touched every one of us. Though financial models imitate the style of physics and employ the language of mathematics, there is a fundamental difference between the aims and potential achievements of physics and those of finance. In physics, theories aim for a description of reality; in finance, at best, models can shoot only for a simplistic and very limited approximation of reality
Derman ranges widely over his first-hand experiences in practice and theory, to explain the financial tangles that have paralyzed the economy. With sharp metaphors and tremendous explanatory power,he conveys the essence of these daunting financial models--The Black Scholes Model, The Efficient Market Model, the Capital Asset Pricing Model, etc--in very human terms.
Derman clearly shows us the intrinsic deficiencies of all models and explains why Wall Street, in its love affair with them, has a blindspot that prevents it from recognizing that finance will never be physics and that it will never be possible to write down a model that encapsulates human behavior.
- 240 pages
- Free Press (July 24, 2012)
I found this book fascinating. Derman has a skill of mixing the personal with the abstract. You will not find another that takes you from the vagaries of the human eye to the vagaries of the stock market with stops at quantum electrodynmics. It is quite a ride.Jeremy Bernstein, author of Quantum Leaps, and Plutonium
This is a thoughtful book for anyone interested in the overlap between the hard sciences and the soft sciences, from physicists to bankers. But finance academics beware, Professor Derman, with an iron fist in a velvet glove, gives them a good slapping.Paul Wilmott, co-author "Financial Modelers' Manifesto"
Models. Behaving. Badly. is an engaging and personal meditation on the limitations of our ability to predict the future, especially—but not only—in the context of financial markets. He is not interested in blame or politics, but in the deeper lessons to be drawn from the financial crisis. As a physicist who was also highly placed in the financial world, he explains clearly the difference between prediction and advice, theory and model and knowledge and wisdom.Lee Smolin, Senior Researcher at Perimeter Institute for Theoretical Physics, author of The Trouble with Physics; Life of the Co
If you don't want your models to behave badly, you should study carefully these words of wisdom on the philosophy of quantitative modeling. Emanuel Derman has always been one of the most respected quants on Wall Street. Now he has proven that he is also one of the most thoughtful. Though, in the sequel he should tell us what happened to the large man over the Sudan!Clifford S. Asness, Ph.D., Managing & Founding Principal AQR Capital Management