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Models.Behaving.Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life Hardcover – October 25, 2011

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Models.Behaving.Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life + My Life as a Quant: Reflections on Physics and Finance + How I Became a Quant: Insights from 25 of Wall Street's Elite
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Editorial Reviews


Review of: Models. Behaving. Badly: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life
Emanuel Derman Free Press 240 pp. $26 (2011)

"Ranging wittily across philosophy, literature and the arcane world of high finance, Derman's argument is a heady mix of physics, economics and memoir" -- NATURE, 2011

“A readable, even eloquent combination of personal history, philosophical musing and honest confession concerning the dangers of relying on numerical models not only on Wall Street but also in is undeniable that Models.Behaving.Badly. itself performs splendidly.” —Burton Malkiel, Wall Street Journal

"An erudite yet pleasantly readable exploration of why financial models failed during the U.S. mortgage meltdown and why modelers must learn to use them more wisely. Derman has distilled a lifetime of reading, research and thinking into these pages, and I read the book twice to see how he pulled the threads together without losing the reader." Bloomberg News

"Ranging wittily across philosophy, literature, and the arcane world of high finance, Derman's argument is a heady mix of physics, economics, and memoir." Nature

“A fascinating cross-disciplinary exploration of how and why financial and scientific models fail…A unique examination of the limits of models and theories in understanding and predicting human behavior, and a nice rejoinder to the equations-can-solve-or-explain-everything crowd.” Kirkus Reviews

Emanuel Derman has written my kind of a book, an elegant combination of memoir, confession, and essay on ethics, philosophy of science and professional practice. He convincingly establishes the difference between model and theory and shows why attempts to model financial markets can never be genuinely scientific. It vindicates those of us who hold that financial modeling is neither practical nor scientific. Exceedingly readable.” —Nassim N. Taleb, author of The Black Swan

"This is a compelling, accessible and provocative piece of work, that forces us to question many of the assumptions that we work with. As Derman explains so clearly, models are not "bad" in themselves; on the contrary, they are crucial for modern society. However, they have been used in a dangerously sloppy and careless way, with sometimes terrible results. Derman explains this clearly, and draws heavily onhis own lifetime experiences - ranging from growing up in appartheid south africa, working in the scientific field and then as a financial engineer on wall street - to provide a moving and fascinating set of illustrations of these principles. The conclusion is unexpectedly otpimistic - if people choose to listen." —Gillian Tett, author of Fool's Gold

"Models. Behaving. Badly. is an engaging and personal meditation on the limitations of our ability to predict the future, especially—but not only—in the context of financial markets. He is not interested in blame or politics, but in the deeper lessons to be drawn from the financial crisis. As a physicist who was also highly placed in the financial world, he explains clearly the difference between prediction and advice, theory and model and knowledge and wisdom." —Lee Smolin, Senior Researcher at Perimeter Institute for Theoretical Physics, author of The Trouble with Physics; Life of the Cosmos, and Three Roads to Quantum Gravity

"If you don't want your models to behave badly, you should study carefully these words of wisdom on the philosophy of quantitative modeling. Emanuel Derman has always been one of the most respected quants on Wall Street.  Now he has proven that he is also one of the most thoughtful. Though, in the sequel he should tell us what happened to the large man over the Sudan!"
—Clifford S. Asness, Ph.D., Managing & Founding Principal AQR Capital Management

“I found this book fascinating. Derman has a skill of mixing the personal with the abstract. You will not find another that takes you from the vagaries of the human eye to the vagaries of the stock market with stops at quantum electrodynmics. It is quite a ride.” —Jeremy Bernstein, author of Quantum Leaps, and Plutonium

"This is a thoughtful book for anyone interested in the overlap between the hard sciences and the soft sciences, from physicists to bankers. But finance academics beware, Professor Derman, with an iron fist in a velvet glove, gives them a good slapping." —Paul Wilmott, co-author "Financial Modelers' Manifesto"

Praise for Emanuel Derman’s My Life as a Quant:

"There are few "gentlemen bankers" left these days. That is why Emanuel Derman's memoirs are so compelling…Derman's wry humour and sense of irony are apparent throughout the book." Financial Times

"That sense of being an intruder in outlaw territory lends an intriguing mood to Derman's My Life as a Quant, a literate and entertaining memoir." BusinessWeek

“Reads like a novel, but tells a lot about brains applied to making money grow.” —Paul A. Samuelson, MIT, Nobel Laureate in Economic Sciences

From the Author

This is an outline of the book:


  • Part I. Models

Chapter 1. A Foolish Consistency
 A personal account of my experiences with models that failed.

Models that failed *  Capitalism and the Great Financial Crisis * Divining the future: models, theories, and intuition * Time causes desire * Disappointment is inevitable * To be disappointed requires time, desire and a model * Living under apartheid * Growing up in "The Movement" * Tat Tvam Asi

Chapter 2. Metaphors, Models and Theories

The various ways we have of understanding the world and predicting its future. Theories tell you what something is. Models tell you merely what something is like. Intuition is a merging of the understander and the understood.

* Language is a tower of metaphors * The hole in the Dirac sea  * Metaphors become real: the discovery of the positron * Absence is a presence * Analytic continuation * Every fact is a theory * Building a model airplane * Why is a model a model? * Why is a theory a theory? * A puzzling case of monocular diplopia * Making the unconscious conscious again

  • Part II. Models Behaving

Chapter 3. The Absolute

An illustration of a theory: Spinoza's Theory of the Emotions

* The Tetragrammaton * The Name of the Name of the Name * The Irreducible Nonmetaphor * Spinoza's Theory of the Emotions * Fiat Money * How to Live in the Realm of the Passions

Chapter 4. The Sublime
Electromagnetism, a perfect theory. The role of intuition.

* The Birds of the Air * The Best Theory in the World * No Logical Path to It
 * Electricity and Magnetism * Their Qualities * Their Quantitative Laws * Ampère's Sympathetic Understanding of the Phenomena * Faraday's Imaginary Lines of Force * Maxwell's Factual Field * The Beasts of the Field

The ultimate goal would be: to grasp that everything in the realm of fact is already theory.
                        Goethe,Maxims and Reflections
  • Part III. Models Behaving Badly

Chapter 5. The Inadequate
The efficient market model: a model and an analogy but NOT a valid theory.

* Financial models are not the physics of markets  * In finance, uncertainty is everywhere * The difference between uncertainty and risk * The Efficient Market Model  * The relation between risk and return * Risk is like pleasure * The Black-Scholes Model * CAPM * Alpha and beta * Why the Efficient Market Model fails * The unbearable futility of modeling

There is nothing so terrible as activity without insight.    
Goethe,Maxims and Reflections

Chapter 6. Breaking The Cycle

How to cope with the inadequacies of models, via ethics and pragmatism.

* The Perfect Cage * The Mysteries of the World * Models That Failed * How to use financial models * Beware of Idolatry * The Financial Modelers' Manifesto * Markets and Morals * Tat Tvam Asi

See all Editorial Reviews

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Product Details

  • Hardcover: 240 pages
  • Publisher: Free Press (October 25, 2011)
  • Language: English
  • ISBN-10: 9781439164983
  • ISBN-13: 978-1439164983
  • ASIN: 1439164983
  • Product Dimensions: 6 x 1.1 x 9 inches
  • Shipping Weight: 14.1 ounces (View shipping rates and policies)
  • Average Customer Review: 2.9 out of 5 stars  See all reviews (48 customer reviews)
  • Amazon Best Sellers Rank: #725,561 in Books (See Top 100 in Books)

More About the Author

EMANUEL DERMAN is Head of Risk at Prisma Capital Partners and a professor at Columbia University, where he directs their program in financial engineering. He is the author of My Life As A Quant, one of Business Week's top ten books of the year, in which he introduced the quant world to a wide audience. His latest book is Models.Behaving.Badly: Why Confusing Illusion with Reality Can Lead to Disasters,On Wall Street and in Life.

He was born in South Africa but has lived most of his professional life in Manhattan in New York City, where he has made contributions to several fields. He started out as a theoretical physicist, doing research on unified theories of elementary particle interactions. At AT&T Bell Laboratories in the 1980s he developed programming languages for business modeling. From 1985 to 2002 he worked on Wall Street, running quantitative strategies research groups in fixed income, equities and risk management, and was appointed a managing director at Goldman Sachs & Co. in 1997. The financial models he developed there, the Black-Derman-Toy interest rate model and the Derman-Kani local volatility model, have become widely used industry standards.

In his 1996 article Model Risk Derman pointed out the dangers that inevitably accompany the use of models, a theme he developed in My Life as a Quant. Among his many awards and honors, he was named the SunGard/IAFE Financial Engineer of the Year in 2000. He has a PhD in theoretical physics from Columbia University and is the author of numerous articles in elementary particle physics, computer science, and finance.

He blogs at
Twitter @emanuelderman

Customer Reviews

Most Helpful Customer Reviews

22 of 25 people found the following review helpful By Nicholas E. Johansen VINE VOICE on January 27, 2012
Format: Hardcover
Here's a quick summary of this review, for those who are short on time: this book lacks focus and I would not recommend it unless you have A LOT of patience. It is a LONG 200 page read.

As a cross-disciplinary individual (I studied Finance and English in college), this type of "crossover" book intrigues me. A mashup of philosophy, physics and finance, Models Behaving Badly is, at the very least, a very unique book. Indeed, I've never quite read anything like it. While centered around the markets -- and the idea that most of the models used to describe them are garbage -- Derman supports his points with quotes from Goethe, discussions on Maxwell's electromagnetic theory and anecdotes about his own youth as a Jewish boy in the era of South African apartheid. The fields that are of interest to me, likewise, are eclectic, and I think that most of the stuff I was taught in undergraduate Finance was wholly useless. I mention these facts simply because I feel as if I am precisely the demographic Derman targeted with this book.

And, unfortunately, he missed the mark.

The reason is simple: he never reconciles the three disciplines into any sort of coherent argument. On a broad level, he uses each separate field to show that theories are reflective of reality, whereas models are merely an approximation. He never, however, goes beyond this generalization and provides a good reason WHY he's talking about the philosophy/physics (other than, presumably, that they interest him). I have no doubt that Derman is an intelligent guy; his prose is generally decent and he clearly knows a lot about the markets as well as physics. Unfortunately, there is NO reason to have the physics (and, to a lesser extent, the philosophy) in this book.
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70 of 86 people found the following review helpful By Suez on December 26, 2011
Format: Hardcover
This book got me excited. Then, just as the economic models I teach,it became a disappointment. It's refreshing to start something that's different -- that isn't Michael Lewis. But this book quickly became tedious -- a self-promoting reflection of pieces of the author's life, a not-detailed-enough (you can't get much out of it if you don't already know it) and yet too-detailed (pages and pages) review of philosophy and physics, and very shallow comments about economic and financial models. It's also unfortunate that no one caught the error in defining a CDO, which is a collateralized debt obligation, not a collateralized "default" obligation. Mistakes such as this compromise the author's credibility. Don't buy this book. Spend your money on Daniel Kahneman's Thinking Fast and Slow -- it's fascinating and gives you the real meat of why economic and financial models behave badly.
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18 of 21 people found the following review helpful By A. Menon on December 24, 2011
Format: Hardcover Verified Purchase
Emanuel Derman is a very prominent former financial modeller who trained as a physicist. Models Behaving Badly is a combination of personal philosophy, practical reality and ethical retrospective. Each focus is readable and there is much personal experience shared which makes the book very personal, but the contents never really come together particularly well.

The book has three sections, Models, Models Behaving, and Models Behaving Badly. The author starts with a description of his childhood, describing how experience affects perspective, how people are not generally not objective about themselves. He discusses his youth in South African apartheid. The author spends a lot of time philosophizing about the nature of reality and the differences between physical theories and theories about human behaviour. He discusses Spinoza and the residualizing of human motivation to Pain, Pleasure and Desire. The author then discusses what I think most readers assumed what the book was about, financial models. In particular the failures of the Efficient Market Hypotheses and the non stationary behaviour of people and the recursiveness that prevents a theory of human behaviour to be possible. The book ends with a dissappointment in the lack of consequence faced by financial services despite the recession we are currently faced with.

I unfortunately learned very little from this book other than substance about the author's life. This is not because the book does not offer information, but rather because it only has a very light history of science discussion and shallow analysis of financial modelling failure.
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10 of 11 people found the following review helpful By Olly Buxton on February 22, 2012
Format: Kindle Edition
Emanuel Derman is a "quant" of illustrious pedigree: not only a 20-year veteran of Goldman Sachs (say what you like about the Vampire Squid but over the last couple of decades Goldman's financial analysts have consistently been the smartest guys in the room), but also a close colleague of nobel laureate Fischer Black, co-inventor with Myron Scholes of the (in)famous Black Scholes option pricing model.

Given that the motion before the house concerns misbehaving financial models you might expect some fairly keen insights on this topic: It has already been well documented that Black Scholes doesn't work awfully well when the market is in a state of extreme stress - that is, precisely when you want it working awfully well. In fact, in those situations Black Scholes can create havoc, and memorably did during the Russian Crisis of 1998, during which Myron Scholes' pioneering hedge fund Long Term Capital Management catastrophically failed.

But this isn't Emanuel Derman's interest: the specific inadequacy of Black-Scholes (that it assumes that market events occur in isolation of each other and are therefore arranged according to a "normal" probability distribution) rates barely a mention. Derman's view is that reliance on *any* financial model will end in tears, simply because models are poor metaphors which are not grounded in the same reality as the sciences whose language they mimic.


Benoit Mandelbrot, whose excellent book The (Mis)Behaviour of Markets clearly outlines the "tail risk" inadequacy of Black Scholes, recognises that it is the market, not the model, that tends to misbehave. A model can't be blamed for failing to work when misapplied.
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