It’s nice to see one’s thoughts echoed by others who are much better known and established— even to the point of the same words and phrases used to categorize and clarify a universal problem and possible approaches to understanding and solutions. This book was just published:
Models.Behaving.Badly by Emanuel Derman (Why Confusing Illusion With Reality Can Lead To Disaster, On Wall Street And In Life)
In the HME group, in the HIMMS, and in the HFMA group we’ve had several discussions on this topic in various forms –that of inappropriate models. This book is a delightful read and provides insight into the current economics problems along with interesting history and insight into model building.
Emanuel Derman started as a physicist delving into much the same work as Richard Feynman, then he switched to working with economist Fischer Black at Goldman Sachs.
This book wanders from South African Apartheid in the 1960s as viewed from the eyes of a jewish child to Spinoza’s theories on emotion to Classic and Quantum physics to Fischer Black developing derivatives on Wall Street. What they all have in common is attempts to create models of reality.
Emanuel separates the definitions of theories and models, models being analogies or metaphors to real life and as such requiring a priori observation for their existence. Theories, on the other hand, spring full blown from observation and intuition to stand on their own merits—to be proven or disproven. Models are not as powerful as theories, and it requires ‘intimate knowledge’ of a subject for intuition to develop a theory.