Gustavo Ballvé on December 2nd, 2011
Food for thought, Home, Mental models, Portfolio Management, Risk management, Science

Less than 24h after publishing our rant on Economic models (it’s the first story there), we get John Kay’s brilliant piece in our inbox – “A wise man knows one thing – the limits of his knowledge” – courtesy of the Financial Times. It is the ultimate summary of the many dangers of modelling in general, not just in economics – among which dangers we count over-complicating things, but most importantly over-estimating a model’s value as predictive/forecasting tool. In fact, as the article argues and as we’ve seen countless times, we tend to over-estimate models even in their ability to analyze the past, especially if one is asking the wrong questions. And since we’re taking a turn to the more conceptual in this post, we cite a few quotes and allegories by Taleb and a long article on Edge.org by Emanuel Derman, himself a former quant trader at Goldman Sachs.

“Nothing substitutes for thinking”, as Munger and Buffett have said, and someone has also said that “not everything that counts can be counted, and not everything that can be counted counts.”

Taleb’s book “The Bed of Procrustes” is full of aphorisms, allegories, metaphors and whatnots. In a sense his entire body of work is about the dangers of false empiricism & science, and poor knowledge of, well, everything. And yet we select below just a few aphorisms that apply to this case.

“Suckers problems: when the map does not correspond to the territory, there is a certain category of fool, the overeducated, the academic, the journalist, the newspaper reader, the mechanistic scientist, the pseudo-empiricist, those endowed with what I call epistemic arrogance, this wonderful ability to discount what they did not see, the unobserved who enter a state of denial, imagining the territory as fitting his map.”

Other quick Taleb quips:

“They think that intelligence is about noticing things that are relevant (detecting patterns); in a complex world, intelligence consists in ignoring things that are irrelevant (avoiding false patterns).”

“Randomness is indistinguishable from complicated, undetected, and undetectable order; but order itself is indistinguishable from artful randomness.”

“To bankrupt a fool, give him information.” — Absolutely fantastic!

Finally, the long article on Edge.org (it is rather redundant to use the word “long” before mentioning an article on Edge.org). Emanuel Derman was the Head of the Quantitative Strategies Group, in the Equities Division of Goldman Sachs. If tempted to distill the article into two paragraphs, they would be:

“Theories deal with the world on its own terms, absolutely. Models are metaphors, relative descriptions of the object of their attention that compare it to something similar already better understood via theories. Models are reductions in dimensionality that always simplify and sweep dirt under the rug. Theories tell you what something is. Models tell you merely what something is partially like.”

and

“Given that finance’s best tools are shaky models, the best strategy is to use models as little as possible, and to replicate making as little assumptions as you can.” — This particular sentence is in the last part of the text, section 9, and immediately after this quote Mr. Derman lists a few great tips for those of us who have to use models – in summary: make it simple, don’t over-reach, and most of all don’t idolize neither the model nor the process of modelling.

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