Emanuel Derman – Models Behaving Badly

As someone who has disagreed for years with the application of modern portfolio theory’s equilibrium models, it is a breath of fresh air to see someone else brandish this sword so well…

If you have ever tried to find criticism of modern financial economic models, you will know how difficult this actually is, so please note this link to Emanuel Derman’s blog and his recent post, The perils of pragmamorphism and a few quotes from that post.  

The Efficient Market Model that has gone so badly awry compares stock prices to smoke diffusing through a room, and models them with the physics of diffusion. But those are flawed analogies, not theory or fact.

“The invisible worm at the heart of economics has been its dark secret love of inappropriate scientific elegance and scientism…. A model may be entrancing but no matter how hard you try, you will not be able to breath true life into it. To confuse a limited flawed model with a theory is to embrace a future disaster driven by the belief that humans obey mathematical rules.”

“Economists think that matter is simple and that people can modeled similarly.”