Credit models get even more complicated

By Felix Salmon
August 10, 2009
This is the kind of thing which makes Nassim Taleb tear his hair out. The 32-page, equation-filled IMF paper on new developments in credit risk modelling (which, yes, spends a lot of time on Gaussian copulas) seems to accept as an article of faith that the problem with credit risk models was that they weren't sophisticated and complicated enough.

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This is the kind of thing which makes Nassim Taleb tear his hair out. The 32-page, equation-filled IMF paper on new developments in credit risk modelling (which, yes, spends a lot of time on Gaussian copulas) seems to accept as an article of faith that the problem with credit risk models was that they weren’t sophisticated and complicated enough.

One thing I’m quite sure of: the kind of equations being flung around in this paper are not going to be intuitively understood by underpaid regulators. This could then constitute a good test of any new regulatory regime: will the regulators roll over and say “oh well you’re very clever we’re sure you know what you’re doing”, or will they slap down any attempt to use these newfangled models to persuade regulators that everything’s perfectly safe? I do hope it’s the latter.

Update: A reader finds a classic quote on page 19 of the paper:

With sufficient detailed information, it is possible to design an optimal algorithm that generates contagion in the network and, therefore, correlation and multiple defaults, following the failure of one or more firms to honor its liabilities.

Yes, people still believe in “optimal algorithms”, even now, even after all we’ve been through.

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