Financiers and financial institutions – banks and the like – use mathematical models to guide them. I have mistrusted these on principle since they seem about as likely as perpetual motion. However, I assumed that they were so complex and so mathematically sophisticated that on the one hand the authors had ended by fooling themselves and on the other I would be quite unable to follow what they had done. Several have received Nobel prizes for their efforts. So I was interested in an article in The Economist dealing with models as part of a special section on banking. The one tool that was described in detail, namely Value At Risk, proved to be not just wrong but wholly misconceived. I have checked on the Internet and found similar accounts of VAR there. Other investment tools certainly have not worked and the result has been the credit crunch. I wonder how many of those also have been naive, illogical and fundamentally flawed.
Feb 2009