Emanuel Derman’s Apologia Pro Vita Sua
Why, if I’m so aware of the powers and dangers of modeling, do I still earn my living doing mathematical modeling? How am I to explain myself?
It’s not an easy question, and I’m happy to see that my friend Emanuel Derman has addressed this a couple of weeks ago in an essay published by the Journal of Derivatives, of all places (h/t Chris Wiggins). Its title is Apologia Pro Vita Sua, which means “in defense of one’s life.” Please read it – as usual, Derman has a beautiful way with words.
Before going into the details of his reasoning, I’d like to say that any honest attempt at trying to answer this question by someone intrigues and attracts me to them – what is more threatening and interesting that examining your life for its flaws? Never mind publishing it for all to see and to critique.
Emanuel starts his essay by listing off the current flaws in finance better than any Occupier I’ve ever met:
After giving some background about himself and setting up the above question of justifying oneself as a modeler, Derman reveals himself to be a Blakean, by which he means that “part of our job on earth is to perceptively reveal the way the world really works”.
And how does the world work? According to Norman Mailer, anyway, it’s an enormous ego contest – we humans struggle to compete and to be seen as writers, scientists, and, evidently, financial engineers.
It’s not completely spelled out but I understand his drift to be that the corruption and crony capitalism we are seeing around us in the financial system is understandable from that perspective – possibly even obvious. As an individual player inside this system, I naturally compete in various ways with the people around me, to try to win, however I define that word.
On the one hand you can think of the above argument as weak, along the lines of “because everybody else is doing it.” On the other hand, you could also frame it as understanding the inevitable consequences of having a system which allows for corruption, which has built-in bad incentives.
From this perspective you can’t simply ask people not to be assholes or not to use lobbyists to get laws passed for their benefit. You need to actually change the incentive system itself.
Derman’s second line of defense is that the current system isn’t ideal but he uses his experience to carefully explain the dangers of modeling to his students, thereby training a generation not to trust too deeply in the idea of financial engineering as a science:
Unfortunately, no matter what academics, economists, or banks tell you, there is no truly reliable financial science beneath financial engineering. By using variables such as volatility and liquidity that are crude but quantitative proxies for complex human behaviors, financial models attempt to describe the ripples on a vast and ill-understood sea of ephemeral human passions. Such models are roughly reliable only as long as the sea stays calm. When it does not, when crowds panic, anything can happen.
Finally, he quotes the Modelers’ Hippocratic Oath, which I have blogged about multiple times and I still love:
Although I agree that people are by nature tunnel visioned when it comes to success and that we need to set up good systems with appropriate incentives, I personally justify my career more along the lines of Derman’s second argument.
Namely, I want there to be someone present in the world of mathematical modeling that can represent the skeptic, that can be on-hand to remind people that it’s important to consider the repercussions of how we set up a given model and how we use its results, especially if it touches a massive number of people and has a large effect on their lives.
If everyone like me leaves, because they don’t want to get their hands dirty worrying about how the models are wielded, then all we’d have left are people who don’t think about these things or don’t care about these things.
Plus I’m a huge nerd and I like technical challenges and problem solving. That’s along the lines of “I do it because it’s fun and it pays the rent,” probably not philosophically convincing but in reality pretty important.
A few days ago I was interviewed by a Japanese newspaper about my work with Occupy. One of the questions they asked me is if I’d ever work in finance again. My answer was, I don’t know. It depends on what my job would be and how my work would be used.
After all, I don’t think finance should go away entirely, I just want it to be set up well so it works, it acts as a service for people in the world; I’d like to see finance add value rather than extract. I could imagine working in finance (although I can’t imagine anyone hiring me) if my job were to model value to people struggling to save for their retirement, for example.
This vision is very much in line with Derman’s Postscript where he describes what he wants to see:
Finance, or at least the core of it, is regarded as an essential service, like the police, the courts, and
the firemen, and is regulated and compensated appropriately. Corporations, whose purpose is relatively straightforward, should be more constrained than individuals, who are mysterious with possibility.
People should be treated as adults, free to take risks and bound to suffer the consequent benefits and disadvantages. As the late Anna Schwartz wrote in a 2008 interview about the Fed, “Everything works much better when wrong decisions are punished and good decisions make you rich.”
No one should have golden parachutes, but everyone should have tin ones.