Computer Models

Al Gore has argued that computer models can be trusted to make long-term forecasts, because Wall Street has been using such models for years.  From the New York Times:

In fact, most Wall Street computer models radically underestimated the risk of the complex mortgage securities, they said. That is partly because the level of financial distress is “the equivalent of the 100-year flood,” in the words of Leslie Rahl, the president of Capital Market Risk Advisors, a consulting firm.

But she and others say there is more to it: The people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough.

Top bankers couldn’t simply ignore the computer models, because after the last round of big financial losses, regulators now require them to monitor their risk positions. Indeed, if the models say a firm’s risk has increased, the firm must either reduce its bets or set aside more capital as a cushion in case things go wrong.

In other words, the computer is supposed to monitor the temperature of the party and drain the punch bowl as things get hot. And just as drunken revelers may want to put the thermostat in the freezer, Wall Street executives had lots of incentives to make sure their risk systems didn’t see much risk.

“There was a willful designing of the systems to measure the risks in a certain way that would not necessarily pick up all the right risks,” said Gregg Berman, the co-head of the risk-management group at RiskMetrics, a software company spun out of JPMorgan. “They wanted to keep their capital base as stable as possible so that the limits they imposed on their trading desks and portfolio managers would be stable.”

Tweaking model assumptions to get the answer you want from them?  Unheard of!

5 thoughts on “Computer Models”

  1. Al Gore has argued that computer models can be trusted to make long-term forecasts, because Wall Street has been using such models for years – where has he argued this?


    Models ‘key to climate forecasts’

    By Dr Vicky Pope
    UK Met Office’s Hadley Centre

    “The only way to predict the day-to-day weather and changes to the climate over longer timescales is to use computer models.”

    “Now, current state-of-the-art climate models include fully interactive clouds, oceans, land surfaces and aerosols, etc. Some models are starting to include detailed chemistry and the carbon cycle.”

    “Much longer predictions are run, typically reproducing the last 150 years and predicting the next 100 to 1,000 years”

    This is what the Hadley Center claims but their rants don’t include the recent cooling or they gloss over it. It may take several cold dark winters to have them back to square one scratching their posteriors. But by then many people will be suffering from lack of energy supplies and costs and Congress will be in the deep shit dumpster.

    McCain needs a wheel alinement as he still supports the Cap and Trade proposal and wants to include AlGore in his cabinet. What a nut job. I think I’m going into hibernation for the next 4 years.

  3. Four words – Long Term Capital Management. This was a company that boasted two Nobel Laureates on the payroll with supercomputers to analyse investment opportunities, that almost brought down the financial system in 1998. I actually believe in the ability of computers to help us figure really complex things out, but they are only as good as the data they are fed, and these climate models are not factoring in anything like enough variables to get useful data out. I’m sure I read something on RealClimate that said that 12 variables are used in calculating their models. Even if they break these down into smaller subsets of related data, this isn’t anything like enough to get an accurate assessment of something as complex as climate.

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