Faulty Models — Nassim Taleb
An excellent reminder from Nassim Taleb on the use of faulty models:
…We’re better off with no model than with a defective model, something people understand intuitively, but they tend to forget when they don’t have “skin in the game.” If you are a passenger on a plane and the pilot tells you he has a faulty map, you get off the plane; you don’t stay and say “well, there is nothing better.” But in economics, particularly finance, they keep teaching these models on grounds that “there is nothing better,” causing harmful risk-taking. Why? Because the professors don’t bear the harm of the models.
The good news is that those models that miss rare events also break down when one introduces a higher layer of uncertainty into them, called “parameter uncertainty”. This gives us a fault detection mechanism. What goes out of the window? The entire discipline of modern finance and portfolio theory…
Still curious? Check out My Life as a Quant: Reflections on Physics and Finance and The Black Swan.
What to read next?
Book Recommendations from Nassim Taleb
How to Prevent Other Financial Crises
The Predictability of Unpredictability