Finding new models

In today’s FT:

Organic mechanics

By Clive Cookson, Gillian Tett and Chris Cook

What do you call a financier in search of the iron laws of human behaviour? Answer: someone with a bad case of “physics envy”.

That is the peculiar psychological disorder diagnosed by Andrew Lo, a professor of financial engineering, as afflicting bankers and economists. Symptoms include a desperate search for the predictive certainty that comes from the hard sciences.

Continue reading (excellent and stimulating article).

3 Responses to Finding new models

  1. Andrea says:

    It’s not just “physics envy”. Often its a case of “old habits die hard”…

    Lots of physics majors and grad students get fed up with their field and become traders or economics grad students, bringing with them their frame of mind.

    Though technically I guess its still a case of “physics envy”, but on the part of the recruiters and adcoms…

  2. Andrea says:

    Wow talk about mixed metaphors:

    “From an individual firm’s perspective, these strategies looked like sensible attempts to purge risk through diversification: more eggs are being placed in the basket,” says Mr Haldane.

    err… maybe you meant “The eggs were being spread into more baskets?”

  3. Dave Parker says:

    It’s not just financiers either: the same can be said of most of the economics profession. The last couple of years should alone show us that economic modelling tends to offer as much predictive power as a bucket of goat entrails – probably rather less, indeed, since entrails tend to obey the law of gravity, unlike economists’ complacent warblings.

    And it’s carried into economic history, where we’re invited to get worked up about putative centuries-old fraction-of-a-percent changes in TFP when we don’t even know output or employment levels to within 5% or 10% (as for capital, forget it!). We don’t even have an authoritative figure for current-price US GDP a century ago, but no worries, here’s some 1990 G-K $ estimates for Africa in Roman times instead.

    The history tends at least to be approached that bit more empirically, but there’s the same assumption that if we don’t know, we’re just not trying hard enough, or maybe we just don’t need to know that bit. So instead of The Theory, we get blind faith in The Data, usually data that someone cobbled together from a handful of partial observations, a heap of proxies or dummies and some more-or-less plausible coefficients (or better still, a model!) to tie the ensuing mess together.

    Now don’t get me wrong, I love the data thing too. Our orders of magnitude offer valuable insights that blanket qualitative assertions don’t. But to imagine we’ve anything more than broad (and broadly improving) estimates even well into the last century is the equivalent of divining the future from the last few years’ Nasdaq quotes.

    There are limits to our knowledge. Unfortunately there seems to be no limit to our imagining we know what we can’t, or that the unknowns can be somehow reduced to not really mattering. There’s a lot we do know about the past, but to imagine that that’s enough to support every minute calculation is to impoverish a rich and complex landscape extending far beyond our numbers.

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