Monday, April 5, 2010

Economists need their own uncertainty principle : Nature News

Economists need their own uncertainty principle : Nature News
Andrew Lo and Mark Mueller of the Sloan School of Management at the Massachusetts Institute of Technology, in Cambridge, suggest that what economists grappling with uncertainty need is a proper taxonomy of risk — not unlike, as it turns out, Rumsfeld's infamous classification. In this way, they state, risk assessment in economics can be united with the way uncertainties are handled in the natural sciences. It may then become clearer where conventional economic theory is a reliable guide to planning and forecasting, and where its predictive value fails.
They call for more support of postgraduate economic training to create a cadre of better informed practitioners, who are more alert to the limitations of the current economic models, such as those used to calculate expected daily returns on investments in a 'business-as-usual' market. They point out the dangers of devolving business management decisions to financial analysts who have become accustomed to thinking that their models capture all there is to say about economic risk. But to truly eliminate the ruinous false confidence engendered by the clever, physics-aping maths of economic theory, why not make it standard practice to teach everyone who studies economics at any level that their models apply only to specific and highly restricted varieties of uncertainty?
The original paper(draft) of Lo and Mueller can be downloaded from http://arxiv.org/abs/1003.2688


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