Derman’s Latest

There are things to quibble with, but I’m generally an Emanuel Derman fan. He’s one of the original physicists who became a “quant” for Goldman Sachs, and now has turned commentator about the virtues and perils of modeling. Specifically, he’s very good at explaining the role of math in forecasting capital markets.

Derman’s new book is pithy and well wrought—an easy one to knock out during the holidays.

I find folks in the finance field tend to treat data as “facts” sans the caveat that numbers are a kind of semiotics—representations; a step removed from reality and not reality as such. It’s one of the reasons, among many, I think it’s worth occasionally taking a look at current thinking in physics—which really starkly reveals what mathematics can and can’t do in terms of explaining the world. Physics is a place where imagination and creative thinking intersect with the rigid logic of math—it’s a style of thought much better suited to how to think about capital markets as opposed to rote statistics and engineering.

Said differently, how many times this year (or any year, really) have we seen some bulge bracket firm tell us how the world is going to work based on some ironclad multifactor regression model…only to see the world simply do something else? There’s a chasm of difference between math’s ability to quantify and categorize the world in order to better understand it, and the ability for math to say what happens next. One of the great next debates in financial theory will be about the prevalent illusion of validity tied to faith in numbers.

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