Models.Behaving.Badly.: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life - Softcover

Derman, Emanuel

Softcover

ISBN 10: 1439164991 ISBN 13: 9781439164990

Publisher: Free Press, 2012

Synopsis

Now in paperback, “a compelling, accessible, and provocative piece of work that forces us to question many of our assumptions” (Gillian Tett, author of Fool’s Gold).

Quants, physicists working on Wall Street as quantitative analysts, have been widely blamed for triggering financial crises with their complex mathematical models. Their formulas were meant to allow Wall Street to prosper without risk. But in this penetrating insider’s look at the recent economic collapse, Emanuel Derman—former head quant at Goldman Sachs—explains the collision between mathematical modeling and economics and what makes financial models so dangerous. Though such models imitate the style of physics and employ the language of mathematics, theories in physics aim for a description of reality—but in finance, models can shoot only for a very limited approximation of reality. Derman uses his firsthand experience in financial theory and practice to explain the complicated tangles that have paralyzed the economy. Models.Behaving.Badly. exposes Wall Street’s love affair with models, and shows us why nobody will ever be able to write a model that can encapsulate human behavior.

About this title

From the Author

This is an outline of the book:
Models.Behaving.Badly

• Part I. Models

Chapter 1. A Foolish Consistency
 A personal account of my experiences with models that failed.

Models that failed *  Capitalism and the Great Financial Crisis * Divining the future: models, theories, and intuition * Time causes desire * Disappointment is inevitable * To be disappointed requires time, desire and a model * Living under apartheid * Growing up in "The Movement" * Tat Tvam Asi
Chapter 2. Metaphors, Models and Theories

The various ways we have of understanding the world and predicting its future. Theories tell you what something is. Models tell you merely what something is like. Intuition is a merging of the understander and the understood.

* Language is a tower of metaphors * The hole in the Dirac sea  * Metaphors become real: the discovery of the positron * Absence is a presence * Analytic continuation * Every fact is a theory * Building a model airplane * Why is a model a model? * Why is a theory a theory? * A puzzling case of monocular diplopia * Making the unconscious conscious again

• Part II. Models Behaving

Chapter 3. The Absolute
An illustration of a theory: Spinoza's Theory of the Emotions

* The Tetragrammaton * The Name of the Name of the Name * The Irreducible Nonmetaphor * Spinoza's Theory of the Emotions * Fiat Money * How to Live in the Realm of the Passions
Chapter 4. The Sublime
Electromagnetism, a perfect theory. The role of intuition.

* The Birds of the Air * The Best Theory in the World * No Logical Path to It  * Electricity and Magnetism * Their Qualities * Their Quantitative Laws * Ampère's Sympathetic Understanding of the Phenomena * Faraday's Imaginary Lines of Force * Maxwell's Factual Field * The Beasts of the Field

The ultimate goal would be: to grasp that everything in the realm of fact is already theory.                         Goethe,Maxims and Reflections

• Part III. Models Behaving Badly

Chapter 5. The Inadequate
The efficient market model: a model and an analogy but NOT a valid theory.

* Financial models are not the physics of markets  * In finance, uncertainty is everywhere * The difference between uncertainty and risk * The Efficient Market Model  * The relation between risk and return * Risk is like pleasure * The Black-Scholes Model * CAPM * Alpha and beta * Why the Efficient Market Model fails * The unbearable futility of modeling

There is nothing so terrible as activity without insight.        
Goethe,Maxims and Reflections


Chapter 6. Breaking The Cycle
How to cope with the inadequacies of models, via ethics and pragmatism.

* The Perfect Cage * The Mysteries of the World * Models That Failed * How to use financial models * Beware of Idolatry * The Financial Modelers' Manifesto * Markets and Morals * Tat Tvam Asi

From the Inside Flap

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.
 
 
Emanuel Derman is a professor at Columbia University, director of the university's program in financial engineering, and a principal at Prisma Capital Partners. He was formerly a quant and  managing director at Goldman Sachs, and the author of many widely used financial models.  He lives in New York City.

Edition details

• Publisher: Free Press
• Publication date: 2012
• ISBN 10: 1439164991
• ISBN 13: 9781439164990
• Binding: Paperback
• Language: English
• Number of pages: 240