{"id":1958791,"date":"2014-03-31T11:29:21","date_gmt":"2014-03-31T05:59:21","guid":{"rendered":"http:\/\/stockviz.biz\/index.php\/?p=1958791"},"modified":"2014-09-09T12:32:20","modified_gmt":"2014-09-09T07:02:20","slug":"models-dont-lie-incorrect-assumptions","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2014\/03\/31\/models-dont-lie-incorrect-assumptions\/","title":{"rendered":"Models don’t lie, incorrect assumptions do"},"content":{"rendered":"

\"Snarl\"<\/a><\/p>\n

An engineer, a physicist and an economist are stranded on a deserted island with nothing to eat. A crate containing many cans of soup washes ashore and the three ponder how to open the cans.
\nEngineer:<\/strong> Let\u2019s climb that tree and drop the cans on the rocks.
\nPhysicist:<\/strong> Let\u2019s heat each can over our campfire until the increase in internal
\npressure causes it to open.
\nEconomist:<\/strong> Let\u2019s assume we have a can opener. <\/p>\n

In a recent paper titled Chameleons: The Misuse of Theoretical Models in Finance and Economics<\/em> Paul Pfleiderer of Stanford University lays out how some models, built on assumptions with dubious connections to the real world, end up being used to inform policy and other decision making. He terms these models “Chameleons.”<\/p>\n

Notice how similar these two abstracts are:<\/p>\n

\nTo establish that high bank leverage<\/strong> is the natural (distortion-free) result of intermediation focused on liquid-claim production, the model rules out agency problems, deposit insurance, taxes, and all other distortionary factors. By positing these idealized conditions, the model obviously ignores some important determinants of bank capital structure in the real world. However, in contrast to the MM framework \u2013 and generalizations that include only leverage-related distortions \u2013 it allows a meaningful role for banks as producers of liquidity<\/strong> and shows clearly<\/strong> that, if one extends the MM model to take that role into account, it is optimal for banks to have high leverage<\/strong>.\n<\/div>\n

– “Why High Leverage is Optimal for Banks” by Harry DeAngelo and Ren\u00e9 Stulz.<\/p>\n

\nTo establish that high intake of alcohol<\/strong> is the natural (distortion free) result of human liquid-drink consumption, the model rules out liver disease, DUIs, health benefits, spousal abuse, job loss and all other distortionary factors. By positing these idealized conditions, the model obviously ignores some important determinants of human alcohol consumption in the real world. However, in contrast to the alcohol neutral framework – and generalizations that include only overconsumption-related distortions \u2013 it allows a meaningful role for humans as producers of that pleasant \u201cbuzz\u201d one gets by consuming alcohol<\/strong>, and shows clearly that if one extends the alcohol neutral model to take that role into account, it is optimal for humans to be drinking all of their waking hours<\/strong>.\n<\/div>\n

– “Why High Alcohol Consumption is Optimal for Humans” by Bacardi and Mondavi \ud83d\ude09<\/p>\n

These are a good illustration that one can generally develop a theoretical model to produce any result within a wide range. <\/p>\n

Read the whole thing at your leisure: Chameleons: The Misuse of Theoretical Models in Finance and Economics<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

An engineer, a physicist and an economist are stranded on a deserted island with nothing to eat. A crate containing many cans of soup washes ashore and the three ponder how to open the cans. Engineer: Let\u2019s climb that tree and drop the cans on the rocks. Physicist: Let\u2019s heat each can over our campfire … <\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3471,9],"tags":[2761],"class_list":["post-1958791","post","type-post","status-publish","format-standard","hentry","category-investing-insight","category-your-money","tag-quant","entry"],"_links":{"self":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/posts\/1958791","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/comments?post=1958791"}],"version-history":[{"count":0,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/posts\/1958791\/revisions"}],"wp:attachment":[{"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/media?parent=1958791"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/categories?post=1958791"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/stockviz.biz\/index.php\/wp-json\/wp\/v2\/tags?post=1958791"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}