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June 1, 2009 from Forbes – “Information technology experts didn’t cause the current economic downturn, but they certainly made it worse. The creation of incredibly complex risk models on Wall Street by pedigreed quantitative analysts, or quants, and the almost total reliance by trading houses on those models turned what could have been just another housing bubble into a global disaster…
Some people realized those equations had serious flaws from the beginning. But when things are going well people ignore those risks and make money while they can. These computers had a role in convincing people everything was OK. And obviously the top management in firms can’t understand these equations. They’re very complex. There are lots of variables, lots of equations, and they assumed they were OK. In the end, it gave them a very false sense of confidence…”
180 View – I think the bigger problem with the “models on Wall Street” was not the complex equations but in the underlying assumptions. There is also the greed factor that will find a way to make the models and statistics work in a favourable way. The same lessons should be applied to any organization’s forecast or ROI calculation. You need to validate the assumptions. You also need to be wary if the person who did the forecast or ROI had something to gain by it.
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