Monday, August 8, 2011

Models - Part 1

Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

  

On a warm summer afternoon of a long weekend, models for some strange reason popped into my head.  I am in the midst of doing researching for my book on complexity, and thus it may be natural that models, and “concepts of models” are swimming around that thing that is on my shoulders.  A lot has been written about models (in fact I have written a lot about models – both in their praise and in their condemnation), but I think it is always healthy to resurface a few ideas that have not been thought about in a while.  Thus this four part blog series on models.  Unfortunately I understand a very high proportion of the science jokes on “The Big Bang Theory” and thus I am of course talking about mathematical models and not runway models – which of course would be a much more interesting topic, but not all that germane to risk management.

 

Richard Levins, the mathematical ecologist (according to Wikipedia) is claimed to have said “ models tend to be so general that they cannot make predictions about particular systems, or so detailed that they merely rephrase what is already known about a system.”  (This quote is from Ants at Work: How an Insect Society us Organized, by Deborah Gordon, Free Press, 1999)

 

I believe that the same could be said about our risk models, and finance models in general.  They are so vague to be useless, or so detailed that they simply replicate the past (and are subsequently useless for the current or future contexts).

 

Models should be a balancing act, and one dimension of that balancing should be between the general and the specific.  Where do the models that you use lie on this spectrum?  Or were they models that were handed down from a regulator or a textbook, or even worse, a committee?

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