Monday, February 27, 2006

Kids in a Candy Store

Professor James Sheehan has a nice piece over at that pretty much nails the problem with misuse of computer and mathematical models by economists. I've always maintained that a lot of macro people, econometricians and hedge fund managers act like spoiled brats in a candy store.

[Thanks to for the photo.]

Sheehan bases his comments on those of Nassim Nicholas Taleb ("Fooled By Randomness, Random House 2004) and Robert Lucas. He says everyone in hedge funds has read Taleb's book. I hope economists have noticed it, too, because they're just as guilty.

I particularly like this quote:

"What has gone wrong with the development of economics as a science? Answer: There was a bunch of intelligent people who felt compelled to use mathematics just to tell themselves that they were rigorous in their thinking, that theirs was a science. Someone in a great rush decided to introduce mathematical modeling techniques (culprits: Leon Walras, Gerard Debreu, Paul Samuelson) without considering the fact that either the class of mathematics they were using was too restrictive for the class of problems they were dealing with, or that perhaps they should be aware that the precision of the language of mathematics could lead people to believe that they had solutions when in fact they had none…. Indeed the mathematics they dealt with did not work in the real world, possibly because we needed richer classes of processes — and they refused to accept the fact that no mathematics at all was probably better."

I wouldn't go that far. After all, just because the shoe doesn't fit doesn't mean you shouldn't wear shoes. That's the old story of throwing out the baby with the bath water.

And this one paraphrasing an idea from Lucas is nice:

"Nor do [economists] account for the possibility ... that people will incorporate predictable patterns into their expectations, thus canceling out the predictive value of such patterns."

These are what I call "duh" moments. Why don't hedgies, econometricians and macro people see the potential for error? 'Tis a puzzlement. I would guess it's the same addiction as gambling.

Read Sheehan's article here.


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