Models. Behaving. Badly.: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life - Hardcover

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EMANUEL DERMAN is Head of Risk at Prisma Capital Partnersand a professor at Columbia University, where he directs theirprogram in financial engineering. He is the author of My Life AsA Quant, one of Business Week's top ten books of the year, inwhich he introduced the quant world to a wide audience.
He was born in South Africa but has lived most of his professionallife in Manhattan in New York City, where he has made contributionsto several fields. He started out as a theoretical physicist, doingresearch on unified theories of elementary particle interactions.At AT&T Bell Laboratories in the 1980s he developed programminglanguages for business modeling. From 1985 to 2002 he worked onWall Street, running quantitative strategies research groups infixed income, equities and risk management, and was appointed amanaging director at Goldman Sachs & Co. in 1997. The financialmodels he developed there, the Black-Derman-Toy interest rate modeland the Derman-Kani local volatility model, have become widely usedindustry standards.
In his 1996 article Model Risk Derman pointed out thedangers that inevitably accompany the use of models, a theme hedeveloped in My Life as a Quant. Among his many awards andhonors, he was named the SunGard/IAFE Financial Engineer of theYear in 2000. He has a PhD in theoretical physics from ColumbiaUniversity and is the author of numerous articles in elementaryparticle physics, computer science, and finance.

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Praise for Models.Behaving.Badly.

"Emanuel Derman has written my kind of book, an elegant combination of memoir, confession, 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

"This is a compelling, accessible, and provocative piece of work that forces us to question many of our assumptions. 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 on his own lifetime experience—ranging from growing up in apartheid South Africa to 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 optimistic—if people choose to listen."
—GILLIAN TETT, author of Fool's Gold

"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, The Life of the Cosmos, and Three Roads to Quantum Gravity

"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, PhD, managing and founding principal, AQR Capital Management

Aus dem Klappentext

Quants, physicists working on Wall Street as quantitative analysts, have been widely blamed for triggering the recent financial crisis with their complex mathematical models. What made these models, employed to minimize financial risk, so dangerous?

In this penetrating, insider's look at the recent economic collapse, Emanuel Derman--former head quant at Goldman Sachs and a former physicist--explains the collision between mathematical modeling and economics that has touched every one of us. Though financial models imitate the style of physics and employ the language of mathematics, there is a fundamental difference between the aims and potential achievements of physics and those of finance. In physics, theories aim for a description of reality; in finance, at best, models can shoot only for a simplistic and very limited approximation of reality.

Derman ranges widely over his first-hand experiences in practice and theory, to explain the financial tangles that have paralyzed the economy. With sharp metaphors and tremendous explanatory power,he conveys the essence of these daunting financial models--The Black Scholes Model, The Efficient Market Model, the Capital Asset Pricing Model, etc--in very human terms.

Derman clearly shows us the intrinsic deficiencies of all models and explains why Wall Street, in its love affair with them, has a blindspot that prevents it from recognizing that finance will never be physics and that it will never be possible to write down a model that encapsulates human behavior.