Why Simple Models Are Better Than Complex In Finance, Climate, Coronadoom & More

Why Simple Models Are Better Than Complex In Finance, Climate, Coronadoom & More

Right after yesterday’s post on (again) why rationalism and reason fail as philosophies, and on their severe limitations, I read an article profiling Gerd Gigerenzer and his “simple rules”.

It repeats a lot of what I said in simpler language. This does not surprise me, as I draw upon Gigerenzer in Uncertainty, especially on people thinking what models are. He never uses the term Deadly Sin of Reification, but it’s there in between the words.

Here’s the succinct summary from the author of the piece:

There is a big difference between risk and uncertainty. You are dealing with risk when you know all the alternatives, outcomes and their probabilities. You are dealing with uncertainty when you don’t know all the alternatives, outcomes or their probabilities.

Like I said yesterday, in artificial situations like homework problems where the logic (which I called L) is specified in complete rigor, it is possible to calculate both probability and the best decision. The recognition that these are not the same must still be there, of course.

But reality when it is complex, as defined below, cannot be specified in anything like complete rigor. When people think they have is when the commit the Deadly Sin of Reification.

The mistakes rationalists and champions of reason make is to suppose that every problem is completely, or well enough, specified in rigor, so that they answers they supply are the “right” and “obvious” ones. This is why they label deviations from these right and obvious ones as “irrational”. This is why they seek theories why this supposed irrationality exists.

Gigerenzer also recognizes this. See if this doesn’t sound familiar: “The problem with complex models is not calculations – computers can do that pretty well and fast. The problem is that they would demand that you make estimations. And that’s where things go wrong.”

And this:

One of Gigerenzer’s favorite examples is the modern portfolio theory, pioneered by Harry Markowitz back in the 1950s. Markowitz offered a mathematical framework to design your portfolio so you can maximise your returns for any given level of risk. His theory was elegant, is taught in finance courses in universities across the world, has finance professors swear by it, and won him a Nobel prize in 1990.

Someone else who understands the limitations of this approach, but in a different and more limited way, is Nassim Taleb.

Simplified, Taleb recognized the rigor in the old models, like from Markowitz, was in their insistence on normality. All the models were correct given the assumptions they made. Just as all the theories of Q followers are also correct given the assumptions they make.

Taleb’s solution was to widen the expanse of models to consider beyond normals. This is why he’s always on about “fat” or “heavy” tails. He uses models which assign more probability to events that are rarer than in normal models.

But he never went as far as Gigerenzer. Taleb, just like the older crew, also commits the Deadly Sin of Reification when he insists those heavy tails are real. The events themselves are real as can be. The probability never is.

Models which allow for greater variability do better than normality based ones in Finance. But they are, like all models, reifications. This is not bad in itself. It’s only a sin when the model is taken as reality.

Taleb might have suspected his models were “the” truth because he personally made a bundle. But it’s more likely he made money by having better intuition, better rules of thumb, about the markets he was meddling in. There is no substitute for experience.

None of this is to infer that models cannot be useful, or even excellent. They surely can. Like I always say, casinos make fortunes from terrific, well verified, but still reified, models. It is a model that says the probability of snake eyes is 1/36. A damned good model. But a model nonetheless when applied to the actual craps table. The dice will do what they do because of various causes, not because of probability or a model.

The Deadly Sin of Reification can be (and usually is) made at craps tables, but there it is at best a venial sin. It becomes mortal with the growth of complexity.

Anything involving groups of people involves complexity. Finance markets, global cooling, the spread of disease, politics, war and the like. It is there that experts sin. Not by creating models, which (I repeat) can be of some use. It is when experts insist their model is the model, or the only model. It is when they insist their decision is not just the right one, but the only possible decision.

It is when experts (or their blind fans) scream “Denier!” when their reification is questioned.

Perhaps the best definition of (midwit) expert is he who believes his model is reality. This is why we need to rescue ourselves from experts.

Finance Addendum The almost exception to this Finance. If all the majority traders are using the same suite of models, regardless whether this is known to them all, then the more these models capture the “model universe”, the less reification there is.

This is close to the artificial situation where the events are described in complete rigor. And it is why markets work well—most of the time. But there’s always that event that was outside the view of the models that proves that complete rigor is not to be had. The Deadly Sin of Reification steals your money.

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  1. Sheri

    I have a doctor who commits the Deadly Sin of Reification plus bases all of his arguments on “his patients”. Being a very brittle type 1 diabetic, I understand risk versus uncertainty, probability, statistical outcomes (generally used to lie to and terrify diabetics) and why one must buy the actual research to find out what the study REALLY said. Yes, the simple models work best and I live that. Computers are not gods nor life savers in all or perhaps even many instances. So I’m with Briggs all the way on this model stuff. If you live your life with people quoting statistics at you and trying to get you to believe doom or gloom if you don’t do things their way, you learn or you die. More and more people are probably going to die, because thinking is forbidden and the “science” is propaganda and sales pitches. Sad, but not surprising. I am so glad I became diabetic BEFORE the science became GOD and the sales pitches were meant to terrify and depress patients.

    There is a commercial where the female “doctor” (how do I know she has an MD????) says “You can’t argue with clinical proof”. I CAN AND I DO. Everyone should and they should demand the full study and other studies of a product or “cure”. So take that, Ms. MD.

    As for finance, I have only on thing to say: GameStop.

  2. Sheri

    Speaking of the Deadly Sin of Reification and of human insanity, I read this today: “The NSC is calling on President Biden to commit to a zero roadway deaths by 2050 policy, which includes new rules like making even hands-free use of phones illegal while driving, lowering speed limits, and initiating a three-tier driver’s license system for new drivers.”

    I’m sure there’s a model that shows how we can use highways and still have zero deaths, in spite of snow, rain, etc. and reality getting in the way. Heck, the self-driving cars ran into other cars and even killed people. We live in the Matrix all right.

  3. Sussibar

    In the linked article, the sentence immediately preceding “The problem with complex models is not calculations…” is spot on, too!

    “The comparison [Gigerenzer] is interested in making is that a *simple rule in a complex world can outperform a complex rule in an artificially simplified world.*”

    A few others:
    “A quote attributed to Einstein captures that imbalance well. It goes like this: the intuitive mind is a sacred gift and the rational mind is a faithful servant. We have created a society that honors the servant and has forgotten the gift.

    In the days since Einstein, we seem to be honoring the servant with even greater fervour, thanks to the exponentially growing power of two weapons he holds in his hands: data, and the ability to process it. And, our memory hasn’t gotten any better, when we have to remember the gift. That tendency has serious implications for business leaders and policy makers.”

    “[Gigerenzer] said, “We need to dare to think for ourselves, instead of anxiously adapting to our environment . We have in western world fewer and fewer people who are willing to take responsibility, to make decisions on their own and the tendency of the management to delegate to consulting firms which is often a waste of time and money…. There is a lot defensive decision in society and unwillingness to take responsibility, and the fear of one’s own common sense.”

  4. John B()

    Apparently you weren’t paying attention:
    Ad on TV says “You can’t argue with clinical proof” but then says in small print it’s not FDA evaluated.
    (even if it were FDA evaluated …) I’d argue too
    Also love the list of side effects including “… may cause death”
    Life … may result in death

    From one of the boxed paragraphs:
    “…universities across the world…” shouldn’t it be around the world?
    Sounds like a flat Earth turn of phrase

  5. Somewhere, in the dusty old cobwebs of my mind, I am reminded of: Books don’t cover everything, think for yourself and own up to your mistakes, be respectful of your elders, for they have lived through stuff that you have not, and especially, there are no stupid questions but there are stupid answers.

  6. Jim Fedako

    In my experience, simple models contain the very same assumptions that end up being built into complex ones. So complex models end up being more complex, but are no more real than simple ones.

  7. Our challenge IMO is to improve in the area of successfully distributing effective conservative social contagions. The liberals are more successful than conservatives in this realm. Both weak (or simple) and complex ties or communications are effective. Example- BLM was cemented by the deaths of Michael Brown and George Floyd, regardless of how one sees their death or the cause. These deaths were used to connect and mobilize people for a cause. Reason and rational perspective were not part of the process. Sure there are other factors, but conservatives experience difficulties using this phenomenon to our advantage,

  8. helpmespock

    In craps, the dice indeed do what they do based on the causes rather than what the model says.

    Youtube “Cleveland dice sliding” to see an example where the shooter controls the dice to get the exact number he wants.

    This is why the casino is always after you to “Hit the back wall” when shooting craps.

  9. Johnno

    But they need all that complexity to surround and help bury the very simple bullshit that’s spitting out the results.

    COVIDCHANGERACISM models and big government works just like one big Rube Goldberg machine where you need all kinds of contraptions and gadgets and wazoos in order to simply blow a horn and drop a clown on a whoopee cushion at the end of it.

    And after building all that, the whole thing tends to halt halfway through whenever one domino falls too short of the next one. A problem often solved by buying and adding more dominoes on the taxpayer’s dime.

    Then it won’t be long until dominoes are declared racist because the white man invented black tiles with coloured dots simply to knock them down one after another.

    So if math is racist then it stands to follow that all models are racist and the government should stop using them and we can go back to other multicultural norms of soothsaying by reading the entrails of animals to predict the future.

  10. Milton Hathaway

    The Gigerenzer article talks about heuristics, which to my mind is a different beast than a model, which doesn’t seem to fall on the continuum between simple and complex models. Heuristics seems to be more about saving effort (lazy thinking, if you will); even a very simple model with one input could require a lot of effort to acquire the data. I’d almost call a heuristic a purposeful ‘un-model’.


    Could the vast majority of our current problems be attributed to an over-reliance on heuristics?

  11. Jan Van Betsuni

    Briggs writes: “But reality when it is complex, as defined below, cannot be specified in anything like complete rigor. When people think they have is when the(y) commit the Deadly Sin of Reification.” This very concept was captured by Alfred Korzybski in his 1931 paper titled: “A Non-Aristotelian System and Its Necessity for Rigour in Mathematics and Physics”. Wherein Korzybski ||’remarked that “the map is not the territory” and that “the word is not the thing”, encapsulating his view that an abstraction derived from something, or a reaction to it, is not the thing itself.’|| quoting from: https://en.wikipedia.org/wiki/Map%E2%80%93territory_relation

    Korzybski’s “The map is not the territory” is an elegant way of conveying the idea that models are only attempts to “map” reality – but that reality cannot be wholly simplified into a model (or a map) (particularly where there is potential uncertainty which cannot be represented inside the model.)

    My take on the very interesting topic of heuristics is that it comprises those intuitional faculties which are always engaged in sifting out complexity in order to derive an “Occam’s Razor” explanation. Somehow we can sense a strong likelihood that any glaring complexity is more apt to be ‘noise’ and less apt to be ‘signal’. Occam’s Razor can itself yield erroneous conclusions ~ just as following our heuristics “gut” can lead us astray – but these true insights are not lazy substitutes for deep thought. Sometimes applying brute force (say by algorithmic data crunching) is just wasted (and unproductive) mental energy and factor spinning.

  12. Briggs


    Heuristics are models, albeit simple ones.

  13. LR

    Most of my fellow economists insist that they believe their models are merely useful. I don’t buy it. Most of them are reification sin committers.

  14. awildgoose

    The best models are those built on decades of rigorously collected and compiled empirical data.

    The models for cellular phone radio wave propagation were built in this fashion.

    This is why our miracle cellular network works as well as it does in so many varied environs.

  15. Forbes

    Taleb made a load of money in the ’87 market crash–a 23 SD event, something that can’t happen (probability of once in a million years, or more) according to orthodox finance. He understood–by market experience–that significant pricing anomalies regularly occur due to bouts and cycles of fear/panic and euphoria/exultation. He simply looked to opportunistically capture these pricing anomalies–in derivative (options, futures) securities.

    Orthodox finance says these pricing anomalies shouldn’t exist–that they will be arbitraged away. This is also a result of finance utilizing the homo economicus/rational man assumption. One favorite aphorism is that markets can be wrong (move against you) longer than you can stay liquid/solvent. Such real world experience can’t be explained by orthodox finance.

    Taleb (merely) discovered Yogi Berra’s wisdom: The theory should work in practice, in practice it doesn’t work in theory.

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