A Review of the book , “Escape from Model Land” in The WSJ explains the limits of models in determining policy.

 My Life as a Quant was written decades ago about an academic with a Phd in math and physics hired by a hedge fund to construct risk models.  He warned his new employers about the limits and assumptions of models and how they were inappropriate for the task they sought to apply, but they paid him far more than he could ever earn in academia so he delivered.

In Black Swan Nassim Taleb warned of the faith placed in risk models

In 1998 Long Term Capital Management (LTCM) collapsed from an over reliance on risk models – even with two Nobel Prize winning economists in the company- it was the biggest bailout on Wall Street until 2008

My summary of LTCM was “the replacement of a philosophical understanding of risk with delusional mathematical models”.

I have seen complicated models I could not begin to understand used to justify some of the dumbest fucking investments I could imagine.  Wealth management professionals fall prey to this lunacy.

In The Tyranny of Reason Yuval Levin warned of the dangers of applying the logic of hard science to social realms.   Even when applied to pandemics and climate change there are tradeoffs that exceed the reach of scientific certainty.

IMO one of the reasons it is so common to see economists weighing in on climate change is their understanding of the limits of elegant models as a harbinger of scientific truth. Another is their understanding of tradeoffs.

Models seek to represent the real world, but they live outside it. Indeed, they exist in their own “wonderful place,” what Ms. Thompson dubs “Model Land.” In Model Land, the assumptions of a model are considered “literally true,” enabling expansive exploration and ambitious predictions. The problem is that Model Land is easy to enter but difficult to escape. Having built “a beautiful internally consistent model,” Ms. Thompson writes, it can be “emotionally difficult to acknowledge that the initial assumptions on which the whole thing is built are literally not true.”

We may be inclined to regard models as objective expressions of truth, yet they are deliberately constructed interpretations, imbued with the values and viewpoints of the modelers—primarily, as Ms. Thompson notes, well-educated, middle-class individuals.

“Science cannot tell us how to value things,” Ms. Thompson says. “The idea of ‘following the science’ is meaningless.”

print