A flaw in the model...that defines how the world works

The authors of this paper claim that modeling financial markets based on probability theory is a severe systematic mistake that led to the global financial crisis. They argue that the crisis was not just the result of risk managers using outdated financial data, but that the employed efficiency mode...

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Bibliographic Details
Published in:Policy File 2010
Main Authors: Bieta, Volker, Milde, Hellmuth, Weber, Nadine
Format: Report
Language:English
Subjects:
Banking/Finance
Economic policy
Globalization
Management of crises
The World Bank
Online Access:Request full text
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Summary:The authors of this paper claim that modeling financial markets based on probability theory is a severe systematic mistake that led to the global financial crisis. They argue that the crisis was not just the result of risk managers using outdated financial data, but that the employed efficiency model--also referred to as the stochastic model--is basically flawed. In an exemplary way, the analysis proves that this model is unable to account for interactions between market participants, neglects strategic interdependences, and hence leads to erroneous solutions. The central message is that the existing efficiency model should be replaced by an approach using agent-based scenario analysis.