Take the risk from a VAR model, and divide the outcome by some factor S(g) where g is the distribution of expected outcomes. The psychological data would allow an exact parameterization of S(g) where human cognitive biases cause a decrease in estimated risk that is roughly proportional to expected gain.

I know this sort of approach isn’t ideal from an objective, scientific perspective…we want our model to only include mechanistic elements of a system. But if I’m a regulator and I don’t have the resources to dissect a company’s risk model in detail, I might do better to evaluate their model using know statistical properties of how humans bias their perceptions.

These human properties wouldn’t change from model to model, even if the model varied wildly, and regulators would deal with enough cases that they could set up their modeler model so that it would be accurate on average with a particular variance.

Scientific method is hard in any discipline and it has an ethical component. There’s an “easy way out” aspect to the failures. Ultimately, I believe, the failures of the discipline were failures, quite literally, of discipline.

IF you promote the group people enough and not those who question, when you get to the top everyone is doing fancy formulas that say nothing but look good and most are very good at being team players and no longer see the outliers as those people who questioned them are now gone.

Please put up with the way I am going to get to my point:

Human math even a basic concept of 1+1=2 is wrong — it usually equals 3 (until modern society where it can still be two) or in the case of Twins or Trips 4 or 5, etc. Stats then gets to fill in where math fails here, but it often fails to look at the outliers and question why they are there — norms are looked at and we are taught to drop everything else.

While I cannot comment on VaR, I can comment on both formulas and why the US loves them based on the math stats statement above. It is based on our love of teams both in the work place and in sports, and not the individual. While I cannot prove this at this time for this post, my gut says this is why America likes teams because you get the norm or group consensus raising everyone up and not the individual. Those who say something different or give another view are pushed to the side and often are not listen to, as they are no longer a team player. These groups then find the math to prove their point and the larger the formula the more they get promoted because it shows what everyone is looking for in the group and for those they have to present to. Those who do not use formulas as much are not considered team players and tend to like to look at the outliers that need to be questioned and investigated. As they are not the group norm, these people do not get promoted and eventually find a new job or field. IF you promote the group people enough and not those who do not question, when you get to the top everyone is doing fancy formulas that say nothing but look good and most are very good at being team players so they no longer see the outliers as those people who questioned them are now gone. Not that everyone knows their Real Colors or what Real Colors is as registered program, but I would suggest that most of the people who do not do well in groups today or do not get promoted are the Greens (6% of pop. of which only 40% are female) who rely on facts and not numbers because they know numbers lie yet these were your thinkers prior to the computers who run today’s great math formulas and print the pretty charts. This team idea then gets reinforced with the idea it is not politically correct or polite to question the norm.

As your article says and a couple of other posts, basically, those who are not team players (math formula gurus) get left behind. I will add, these Greens for lack of a better description, will eventually find a new field or often drift from field to field until they start their own business or give up. For those who did not know, this starts in college as the student drifts looking for a field they can finally say yes to without upsetting the Prof by constantly questioning and looking for other ways to do things without formulas. Usually they land in history or they accumulate enough credits in college to have many degrees, but never graduate. In the 1600 – 1800s, they would have been encouraged more and considered a great thinking mind by joining societies just to debate ideas and write papers on them without being a Prof — if they came from the right social class or had a patron. Today’s Universities have started this problem of conformity and formulas for grades and eventually pay in the work place. Teams and formulas unfortunately, do not lend well to honest Socratic teaching/questioning, discussion, philosophy or the running of businesses in general.

An Income Statement and its Balance Sheet ought to reflect a real history. There is no excuse for it not to be doing so in a computer age. Isn’t the real problem here that large central banks, an experiment that is less than 30 years old, is a proven failure?

The only way that you will build a model that reflects the complexity of the real work is collecting data using a double-entry book-keeping framework of rules that supports a deep cost accounting. “Capital,” after all, is a potential return on the “cash-value in trade” where cash value is decided using data from actual marketplace trades.

If one is counting gambling bets as having “cash-value” then such a model will always be inaccurate and volatile simply because its data is incorrect in terms of what “capital” is. Where cash value in trade is a real factor in a model, capital is a potential value in exchange for the real value.

The only time you will know the real value of a bet on future conditions is when it succeeds or fails.

What is happening with banks gambling with dollars in place of chips is that the bank has no way of measuring the probability of real-gains [losses] from betting without the deep-cost accounting. If the bank had the deep-cost-accounting capability, transactions that are a gambling bet will not post because a wager has no “present cash-value in trade,” hence it will have no balancing “capital-potential in exchange.”

There will be no solution to this melt-down until we recognize the need for a fair and impartial control-language, which double-entry book-keeping had been until about 1980.

Financial modeling of risk that skips the proper book-keeping framework of rules is now and always will be a bad joke played on the greater culture.

Last musing: We’ve already become a sort of large interconnected brain with the help of the communication services and devices. Would the ultimate evolution be one single brain, integrated with synthetic new thinking modules that we create ourselves? Would we let this happen, or is our individuality and survival instinct too strong?

Help us, oh great and good god of finance to continue to find ways, ethical or otherwise, to serve our desire for money, regardless of outcomes for those who are not us.

It is a world that I don’t want to live in. When did this happen, and who will stand up against it? I guess that part of the answer is the pledge signing failure at Harvard Business School, by those who don’t have any believe in the common good!!! Eliot wrote about this outcome.