- Paperback: 240 pages
- Publisher: Free Press (July 24, 2012)
- Language: English
- ISBN-10: 1439164991
- ISBN-13: 978-1439164990
- Product Dimensions: 5.5 x 0.6 x 8.4 inches
- Shipping Weight: 8.8 ounces (View shipping rates and policies)
- Average Customer Review: 52 customer reviews
- Amazon Best Sellers Rank: #842,350 in Books (See Top 100 in Books)
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Models.Behaving.Badly.: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life Paperback – July 24, 2012
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"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"
""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"
"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"
"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." --GillianTett, author of "Fool's Gold"
"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"
"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"
"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 life....it is undeniable that "Models.Behaving.Badly." itself performs splendidly." --Burton Malkiel, "Wall Street Journal"
"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"
About the Author
Emanuel Derman is a professor at Columbia University and Director of the university’s program in financial engineering. Until his retirement in 2002, he spent sixteen years at Goldman Sachs as a quant.
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After nearly 20 years in finance, there's definitely some value to the book's position, and the hypothesis posited by the author has been observed by this reader. The need for subjective analysis of financial models inherently limits their "scientific" predictive power.
In general, the premise of the book is sound and somewhat interesting. The challenge in representing this book is that the position it espouses could have been articulated in about half the pages, and in a more straightforward way. Instead, the book rambles, jumps and challenges the reader to extract the author's hypothesis.
Having chosen his title, he has an obligation to explain what a model is. He begins by saying what it is not. It is not a theory, and it is not fact. A model is a metaphor, a simplified representation of reality, necessary when reality itself is too multifaceted to easily grasp. The value of the model depends on how well it represents those aspects of reality in which the user is interested. A model airplane, his example, is useful because it looks like a real airplane and has similar aerodynamics. The kid who makes a model airplane knows full well that it is much smaller and the internal structure and is nothing like a real airplane. For the kids purpose, that doesn't matter.
A theory represents reality. A theory that has been proven is the fact. The Pythagorean theorem is a fact, as our Newton's laws of gravity, Maxwell's laws of electricity and magnetism, and so on. One of the valuable parts of the book is a short history of science in the realm of electricity and magnetism. Derman, whose professional training was in physics and spent half of his career doing it, elegantly and succinctly takes the reader through the groundbreaking theorems describing these phenomena, electricity and magnetism, which can only be examined indirectly - through their effects rather than the thing in itself.
Derman was raised in Jewish neighborhoods of South Africa. His account of his childhood is fascinating, evoking in this reader a nostalgia for the kind of community that every kid should be lucky enough to have. It was a community of caring people, intellectual challenge, social involvement, and a vast amount of adventure. His description of his own involvement with apartheid seemed a little bit formulaic; what can you say? For a far better treatment of South Africa of that era, by a woman whose father led the Jewish opposition to apartheid, read "Into the Cannibals Pot" by Ilana Mercer.
There is a pretty good exegesis on the various names for God in the Hebrew language, and the two, three, and four levels of circumlocution used by the most devout to avoid saying the name of God. He somehow equates God with a theory rather than a model. To that I would not say yes or no, simply "Huh?" He then goes into philosophy with Baruch Spinoza. What he finds to be incredibly deep looks to me like navel gazing.
And at last we get into the world of finance and find not very much, at least not compared to so many other recent books such as the Black Swan, How Markets Fail, Money and Power, Boomerang and many, many others. He talks at extremes. He gives very simple, high school level descriptions of securities such as stocks and bonds, then maybe a collegiate description of derivatives, and then jumps into Black Scholes models. Is unbalanced, and fundamentally not very useful. The take-home messages are quite simple. Your hedge fund manager is not earning his 20 percent if he is making money in a rising market. No model works all the time; you should not give up your intuition and trust totally in models. Making money in the stock market is hard work. And other platitudes.
Lastly, Derman is not very sanguine about the current course of events. He considers the bailout of Wall Street an outrage, and does not sound very bullish on the future of the long-standing alliance between capitalism and democracy.