A nice article from Emanuel Derman who tries to justify a career spent in financial modeling. The title of the article is Apologia Pro Vita Sua which means “a defense of one’s life” and is the title of a book by John Newman.
First the superb modelling manifesto:
∼ I will remember that I didn’t make the world, and it doesn’t satisfy my equations.
∼ Though I will use models boldly to estimate value, I will not be overly impressed by mathematics.
∼ I will never sacrifice reality for elegance without explaining why I have done so.
∼ Nor will I give the people who use my model false comfort about its accuracy. Instead, I will make explicit its assumptions and oversights.
∼ I understand that my work may have enormous effects on society and the economy, many of them beyond
Unfortunately it is the opposite which has ruled the modelling world. Here is my version:
∼ I will not just remember but tell others that I made the world, and everything in the world can be narrowed to equations.
∼ Though I will use models to show value in even non-valuable things ofcourse overly using mathematics to look sophisticated and avoid questions. The idea is to confuse as much as possible.
∼ Reality is usually ugly which can be transformed into elegant models without feeling the former.
∼ I will exclude all assumptions and limitations and arrogantly dismiss any questions asked. All praise of course would be welcome.
∼ My work will transform the economy and if economy is transformed, society will be happy as well.
∼ Soon the world will see the value of financial modelling and modellers will be seen as individuals having top 1% intellectual quotient the world..
I mean one could add many more to it on salaries, inequality, etc etc…
Anyways, Derman says financial engg is a interdisciplinary field. I actually don’t like the word engineering associated with finance at all. Earlier it added credibility to the field. Now it just connotes some kind of jugglery:
Financial engineering is an interdisciplinary field devoted to the art of applying mathematical models to help make decisions about the risk and return of investments. True engineering, the mechanical or electrical kind, is based on reliable science or reliable heuristics. Unfortunately, no matter what academics, economists, or banks tell you, there is no truly reliable financial science beneath financial engineering. By using variables such as volatility and liquidity that are crude but quantitative proxies for complex human behaviors, financial models attempt to describe the ripples on a vast and ill-understood sea of ephemeral human passions. Such models are roughly reliable only as long as the sea stays calm. When it does not, when crowds panic, anything can happen.
Models, therefore, are useful but intrinsically fallible. They are constructed by humans, with a simple, direct purpose related to trading and sales. Humans, however, came about through a complex process for no explicit purpose that we understand. (I hope that both atheists and believers can agree on the validity of the previous sentence.) To confuse a model with the world of humans is a form of idolatry—and dangerous.
One should always remember the words of late Prof. Ostrom
We are fallible humans studying fallible human behavior within institutional structures constructed by other fallible humans. We should not act as if we know for certain how to achieve sustainable development. We can, however, recognize our growing capabilities and those of the individuals we study to experiment with rules, learn from the experiments, and, if the broader institutional and cultural milieu facilitates, gradually improve outcomes so they are sustainable over time.
A useful defense from Prof. Derman. However, it is a bit too late..
These efforts should have been made more aggressively earlier. The crisis has not just been about firms failing but about all kinds of corrupt practices followed by the street. And one things has followed other. Finance is all over the place as of now…