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Models. Behaving. Badly.

Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life

Models. Behaving. Badly. by Emanuel Derman
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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.

Wiley; October 2011
240 pages; ISBN 9781119944690
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Title: Models. Behaving. Badly.
Author: Emanuel Derman
 
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