Complexity that truly is unpredictable

[koganbot]

A 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.

Comments

[dubdobdee.livejournal.com]

john robb also very animated -- usually he talks about warfare rather than economics

(not especially the stuff about unstable systems)

[dubdobdee.livejournal.com]

(i mean NOTE especially)

[koganbot]

He's writing almost in note form. His idea seems to be that somewhat unstable systems are actually more stable than totally stable systems (that can suddenly go down), but that the somewhat unstable systems also need continual counterbalancing or else they suddenly go down as well. (Or is that an entire misreading. My first clause was actually a guess.)

But maybe an airplane isn't a good metaphor for a society.

Here are some assumptions that underly all current activities related to the global financial crises:

--Optimistic long term outcomes. Things are going to get better. Pollyanna mindsets.

--The system, as it is currently configured, is the best possible or the only possible system. Faith in ideology.

--Nation-states, singularly or collectively, are bigger and stronger than the financial/market system. The US is the guardian of this system. 20th Century legacy thinking.

Really? Are these the only three assumptions?

[koganbot]

But do you have any opinion on the actual piece I actually linked?

[dubdobdee.livejournal.com]

(yes but too mazed and busy to write it up yet)

[koganbot]

E.g., as I read down further I see that Robb actually does talk about information cascades and butterfly effects (which, when the effects are big and unexpected, he calls "black swans").