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I'm not sure you can get to the financial crisis without faulty models. Risk models, especially on packaged securities, are crucial to setting ratings as a prox
by tomkarlo 14y ago
I'm not sure you can get to the financial crisis without faulty models. Risk models, especially on packaged securities, are crucial to setting ratings as a proxy for risk. Those ratings are key to determining pricing, maximum leverage, and which portfolios can buy them.
If the models had been more accurate - for example, if they had more properly reflected the way that the value of a bundle of mortgages will suddenly lose value as housing prices decline - banks would not have been able to pile up such huge risks and high leverage.
You can only justify things like 30X leverage if you believe the securities in question have essentially no risk - because at that leverage, a 3% loss in value means you're wiped out.
- pdonis 14y agoI'm not sure you can get to the financial crisis without faulty models. Sure you can. The root cause of the crisis was people gaming the system. There are many ways to game the system; faulty models are only one of them.
- tomkarlo 14y agoOkay, but all routes to that gaming - at least at the institutional level - ran through being able to do it without it impacting credit ratings. Credit ratings and security pricing are very dependent on statistical models for risk, in particular correlation and downside outcomes.
- pdonis 14y agoall routes to that gaming All routes to that particular method of gaming. There are other methods.