Why Models Can Never Get Things Quite Right
Their downfall is the assumption that the future will be like the past.
Bloomberg, May 4, 2020
New column out about why new events — when something novel occurs for the first time — it tends to “break” models.
What are some events that have never happened before that are happening right now?
• The move toward negative interest rates in the U.S. is blowing up the Federal Reserve’s model of inflation and yield. As the old adage goes, if the Fed can’t model something, it assumes it doesn’t exist.
• The Bureau of Labor Statistics has never had to cope with 20% of the workforce filing for unemployment within a month. That surely wasn’t in any of the calcualtions.
• Value investing, the model championed by Benjamin Graham and Warren Buffett, is in trouble because it didn’t anticipate low inflation, low interest rates and enormous Fed market interventions.
• The model for speculating and hedging in oil has come undone. With two of the world’s biggest producers in a price war, a collapse in demand amid the pandemic and a lack of crude oil storage space, futures prices briefly traded at a negative $40 a barrel last month — meaning those holding oil had to pay to have it taken off their hands.
Full column here.
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I originally published this at Bloomberg, May 4, 2020. All of my Bloomberg columns can be found here and here.
Bloomberg, May 4, 2020
