Who still wants to pay for Professional vanity?
Tuesday, 26 October, 2010 Leave a comment
My esteemed colleague, Bala Desphande (at Ontonix USA), delivers…as usual! If you want to read the full article here is the link: Risk of using Models in Risk Management – Part 1
I am still amazed how many people, in senior positions within major institutions, still argue for a belief system so dangerously flawed. They are fixated with the ability to predict the future and not a crystal ball in sight!!!
Conventional risk management, of the variety used by the likes of Lehman, involves calculating the probability of the maximum loss a given portfolio can experience over a specified time horizon. Let us unpack this statement for what its worth:
1. We first need to specify a time horizon – fairly simple,
2. We need to compute the return of this portfolio over this time period – any financial website can feed a spreadsheet to do this,
3. Then we need to state the probability that the return (or loss) will be below (or above) a certain value.
Hmm 3. gives me a problem! How much faith should any right-minded person have in a vision of our future based upon an incomplete picture of our immediate past, some mathematical theory and a model to satisfy the belief system. P-l-l-l-ease.