Physics Envy
Thanks to Sanjiv Sir’s forward, this note on financial models is one of my best reads till date, on the crucial differences between a Physics based Model and a Financial Model. Why should a financial modeler be extra cautious in whatever he/she does and not carried out away by math jazz is something that is well brought out by the paper by Andrew Lo.
_If Tycho, Kepler, Galileo and Newton had been confronted with such “quasi-periodic” data for the cyclical paths of the planets, it may have taken centuries, not years, of observational data for them to arrive at the same level of understanding of planetary motion that we have today.
Fortunately, as challenging as physics is, much of it apparently does not operate at this level of uncertainty. Unfortunately, financial markets can sometimes operate at an even deeper level of uncertainty, uncertainty that cannot be reduced to any of the preceding levels simply with additional data._
A beautiful way to put things in perspective. It is a MUST read for any financial modeler. One thing is certain You will begin to seriously doubt whatever you have been doing till date as far as financial modeling is concerned . You would definitely wonder at the ways to bridge the gap between Level 4 & Level 5 uncertainty.
What are Level 4 and Level 5 uncertainties ? Here’s the link to find out more about it .