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Financial Models Must Be Clean and Simple

The complex financial models that got us into this mess too often mask human nature behind false limitations of risk

Whirring away at the center of the mortgage meltdown that prompted the current crisis were those theoretical constructs known as financial models. As bankers sliced and securitized mortgages, traders and investors relied on the models to calculate the bundled loans’ values and risks?risks they failed to predict.

What went wrong? As modelers, we see the fantasy of perfection as the fatal flaw seducing both developers and users. The invisible worm of financial modeling is a dark love of theoretical elegance and excessive precision.…

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