{"id":29315,"date":"2018-01-02T10:57:41","date_gmt":"2018-01-02T15:57:41","guid":{"rendered":"http:\/\/olduvai.ca\/?p=29315"},"modified":"2018-01-02T10:57:41","modified_gmt":"2018-01-02T15:57:41","slug":"why-models-fail","status":"publish","type":"post","link":"https:\/\/olduvai.ca\/?p=29315","title":{"rendered":"Why Models Fail"},"content":{"rendered":"
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Why Models Fail<\/a><\/h3>\n<\/div>\n
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QUESTION:<\/strong> Mr. Armstrong; Did AIG use the Black-Scholes Model and that is what created the crisis again in 2007?<\/p>\n

WJ<\/p>\n

ANSWER:<\/strong> No.\u00a0It\u2019s my understanding that AIG\u00a0developed different models, they\u00a0called a \u201cValue-at-Risk\u00a0Model,\u201d (VaR)<\/strong> which used a binomial-expansion-technique to start valuing their positions. I believe the original model was developed at Moody\u2019s. However, like the Black-Scholes Model<\/strong><\/a>, it too lacked depth. In model development, it is extremely complex.<\/p>\n

Virtually every model created tends to be predominately flat with a minimum of dynamic variables lacking understanding of TIME<\/strong>. Then the testing period lacks the database reflecting all conditions. In the case of\u00a0Black-Scholes, they back-tested only with data to 1971. If I created a model with only data from 2009 forward, then it would be biased to presume a bull market is normal in the stock market.<\/p>\n

The Value at risk (VaR) model is a measure of the risk of investments. It estimates<\/strong> how much a set of investments might lose, given normal market conditions<\/strong>, in a set time period such as a day. VaR is typically used by firms and regulators in the financial industry to gauge the number of assets needed to cover possible losses. It obviously failed in 2007-2009 because once again it was not a \u201cnormal market condition\u201d<\/strong> for it fails utterly to understand CONTAGION<\/strong> when sound assets are sold to raise cash for other assets that collapse. The assumption of the model is its own nemesis.<\/p>\n

For example, if a portfolio of stocks has a one-day 5% VaR of $10 million, this actually means that there is a 5% probability that the portfolio will fall in value by more than $1o million over a one-day period if there is no trading.<\/p>\n

…click on the above link to read the rest of the article…<\/p>\n<\/div>\n<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"

Why Models Fail   QUESTION: Mr. Armstrong; Did AIG use the Black-Scholes Model and that is what created the crisis again in 2007? WJ ANSWER: No.\u00a0It\u2019s my understanding that AIG\u00a0developed different models, they\u00a0called a \u201cValue-at-Risk\u00a0Model,\u201d (VaR) which used a binomial-expansion-technique to start valuing their positions. I believe the original model was developed at Moody\u2019s. However, […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[2],"tags":[5496,3487,4517,5479,17739,9545],"class_list":["post-29315","post","type-post","status-publish","format-standard","hentry","category-economics","tag-armstrong-economics","tag-cycles","tag-economic-models","tag-martin-armstrong","tag-model-failure","tag-models"],"_links":{"self":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts\/29315","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=29315"}],"version-history":[{"count":1,"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts\/29315\/revisions"}],"predecessor-version":[{"id":29316,"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts\/29315\/revisions\/29316"}],"wp:attachment":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=29315"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=29315"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=29315"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}