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Complexity that truly is unpredictable
Oct. 6th, 2008 11:10 amA Mountain, Overlooked: How Risk Models Failed Wall St. and Washington
Piece by James G. Rickards in the Washington Post. I know nothing about financial risk models, but assumed that they failed in the current crisis because people were plugging in risk values for subprime mortgages that were based on fantasy without really knowing what the actual risk was. But this article is arguing that even if analysists had known the precise risk of the individual mortage-based securities, the models themselves were flawed and that there is no way to create a model that will accurately predict the risk to the system, except you can be sure that the overall risk is far greater than the sum of the individual risks.
The article is too short, but here are a couple of potent quotes:
Lurking behind the models, however, was a colossal conceptual error: the belief that risk is randomly distributed and that each event has no bearing on the next event in a sequence.
...
Beyond chaos lies complexity that truly is unpredictable and cannot be modeled with even the most powerful computers. Capital markets are an example of such complex dynamic systems.
Piece by James G. Rickards in the Washington Post. I know nothing about financial risk models, but assumed that they failed in the current crisis because people were plugging in risk values for subprime mortgages that were based on fantasy without really knowing what the actual risk was. But this article is arguing that even if analysists had known the precise risk of the individual mortage-based securities, the models themselves were flawed and that there is no way to create a model that will accurately predict the risk to the system, except you can be sure that the overall risk is far greater than the sum of the individual risks.
The article is too short, but here are a couple of potent quotes:
Lurking behind the models, however, was a colossal conceptual error: the belief that risk is randomly distributed and that each event has no bearing on the next event in a sequence.
...
Beyond chaos lies complexity that truly is unpredictable and cannot be modeled with even the most powerful computers. Capital markets are an example of such complex dynamic systems.
