Modelling market behaviour

Life is complicated. It's perhaps for that reason that philosophers have mused about the world for millennia. How do mathematicians deal with this complexity we encounter in the world? They seek to simplify it. By breaking down problems into their constituent parts, they become more tractable and solvable, and something that we might be able to model mathematically. This approach of divide and conquer is a cornerstone of computer science. Complexity can be transformed into simplicity.

Then there is the question of what precisely is a mathematical model? Essentially, we are trying to approximate some sort of behaviour in a way that it can be explained mathematically. Nature abounds in models, whether we are seeking to understand the motion of objects, the growth of populations, the trajectory of planets and so on. Models are never perfect. Earlier this year I attended a brilliant talk by Emanuel Derman (@EmanuelDerman) where he discussed the subject of finance and models, and musing on what he said, was one of the reasons why I wrote this article. In his talk, he explained a lot of the problems associated with models, and one particular sentence, which he said, stuck in my mind:

Read the rest of the post on the Cuemacro blog here