Daily Speculations
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James Sogi
Philosopher, Juris Doctor, surfer, trader, investor, musician, black belt, sailor, semi-centenarian. He lives on the mountain in Kona, Hawaii, with his family. |
10/30/2005
Bernanke's Models and Their Limits, by Jim Sogi
As Doc Rock has said, "The best model is just a guide."
Quantitative analysts take note. The apparent certainty of quantitative models can lead to erroneous interpretation and implementation of trading strategies based on the models. LTCM is the poster child of this pitfall.
Discretion and good judgment are still required in financial and other matters of human involvement and decision making due to its historical existence. The financial time series models that are robust enough to be financially meaningful do not give sufficient micro structural guidance for specific entries and exits. Models giving micro structural cues require infrastructure beyond the average retail participant.
Quantitative models answer the big question: up or down? When reduced to its basic element, financial analysis need answer only one question: up or down? In life there is only one big question: right or wrong? Recession or inflation? Questions of exactly when, how much are best left to discretion. Given a framework and direction, the human mind is quite sophisticated in deciphering discretionary questions of fine shaded complexities.
The big questions are often left unanswered, both in the markets and in life. Default is peril. Witness Libby, Ebbers, Koz, Fastow, LTCM. Loss of a moral compass leaves the ship adrift without a rudder despite the most precise quantitative models. Quantitative studies abrogation of the relationship between the ethical and moral judgments and the statistical is peril. A moral element must be factored into financial decisions as they impact human conditions. Good judgment is necessary for success in markets and life.
c
Jim Sogi, May 2005
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