Models

This article analyzes the methodology of modeling in the physical sciences and in finance. Whereas hobbyists' models aim for realistic resemblance to the object of the model, physics models aim for accurate divination. Financial models, the article argues, can at best aim to extrapolate or inte...

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Bibliographic Details
Published in:Financial analysts journal 2009-01, Vol.65 (1), p.28-33
Main Author: Derman, Emanuel
Format: Article
Language:English
Subjects:
Apartments
Finance
Financial modeling
Financial models
Financial research
Financial securities
Global Financial Crisis
Liquids
Market prices
Mathematical models
Model airplanes
Modeling
Partial differential equations
Physicists
Physics
Securities markets
Security prices
Stochastic models
Stock prices
Valuation
Yield to maturity
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Summary:This article analyzes the methodology of modeling in the physical sciences and in finance. Whereas hobbyists' models aim for realistic resemblance to the object of the model, physics models aim for accurate divination. Financial models, the article argues, can at best aim to extrapolate or interpolate from the known prices of liquid securities to the unknown values of illiquid ones. Financial models are therefore best regarded as a collection of mathematically consistent, parallel "thought universes," each of which will always be far too simple to resemble the real financial world, but whose exploration as a whole can nevertheless provide valuable insight. [PUBLICATION ABSTRACT]
ISSN:0015-198X
1938-3312
DOI:10.2469/faj.v65.n1.5