Financial Models

The aim of financial models

  • Models are used to rank securities by value
  • Models are used to interpolate from liquid prices to illiquid ones
  • Models transform intuitive linear quantities into nonlinear dollar values

The right way to use models

  • Avoid too much axiomatization
  • Good models are vulgar in a sophisticated way
  • Start with a model and overlay it with common sense and experience
  • Know what’s assumed and what has been removed
  • Think of models as Gedanken Experiments
  • Beware of idolatry
It takes intuition to discover theories. Intuition may sound casual but it results from intimate knowledge acquired by careful observation and painstaking effort.
When you struggle with a field of inquiry for a long time and you eventually master and incorporate not only its formalism but its content,, you can make use of it to build things one level higher.
Intuition is a merging of the understander with the understood. It is the deepest kind of knowledge.
– Excerpt taken from “Metaphors, Models & Theories” by Emanuel Derman
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