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Thursday, October 31, 2013

There is a naïve belief that mathematical models can foretell future risks…

The article titled “Well Short of Model Behaviour” written by Brandon Davies (CEO of dRisk.biz) and published in the October 2013 edition of Financial World (www.financialworld.co.uk) provides an excellent description of the development and abject failure of financial risk modelling, as currently practiced. Reading the article is highly recommended.

Mr Davies’ perceptive conclusion is quoted here to pique your interest:

‘There seems to be a naïve belief, often encouraged by risk professionals, that models are a modern crystal ball. They are not. Models can, and do, bring greater insight into risk and its management but, whatever their sophistication, they are simply guides to action – not a substitute for individual expertise or collective responsibility.

Risk management should be based on expertise informed by a variety of models. Whether this fits with the current risk governance process within banks is, however, questionable. Boards, in general, do not understand the limitations of the financial models. It is, therefore, not only the models that need changing; it is also the governance structure in which they sit.’

The GCMG Blog of August 15, 2013 “Complex Systems such as ‘Economic Risk’ demand a new approach to potential modelling”, and the Blog posted on April 22, 2012 “The Art of Predicting Failure” also touch on this subject but from different perspectives.

BarrettWells
info@t3plimited.com