Monday, July 7, 2008

How Models Caused the Credit Crisis

In addition to big numbers and fast computers we are also into models* [ahem -ed].
From's Market Movers:

...As Wolfgang Münchau says in today's FT:

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation.

This is true, even if you don't buy Münchau's assertion that the real cause of the crisis was New Keynesianism and the dynamic stochastic general equilibrium model in particular. I would rather place the blame at the acceptance of models in general. Gillian Tett explains:

This decade, financiers have invented so many brilliantly clever mathematical tools to repackage risk that the industry has slipped, almost unthinkingly, into an assumption that "credit" is a collection of abstract equations, stripped from any human context....MORE

Some of our recent posts on models and modeling, climate and financial:

Quants Lose that Old Black (Box) Magic
Finance: "Blame the models"
Climate Models Overheat Antarctica, New Study Finds
Climate modeling to require new breed of supercomputer
Computer Models: Climate scientists call for their own 'Manhattan Project'
Computer Models: " Misuse of Models" and "No model for policymaking"
Climate prediction: No model for success
Climate Models and Modeling
Based on Our Proprietary "What's on T.V." Timing Model...
How many Nobel Laureates Does it Take to Make Change...And: End of the Universe Puts
The New Math (Quant Funds)
Modeling*: The Map is Not the Territory
Inside Wall Street's Black Hole

That gets you back to the end of February.