Mainstream economics’ failure to predict the 2008 crash undermined the profession’s public credibility. There’s a new game in town that financial risk guru, Rick Bookstaber, has faith in. He shares his belief.
Her Majesty Queen Elizabeth spoke possibly for the entire country when she famously expressed her disbelief in how the economics profession failed to see the banking crash a decade ago. Others did predict it but went unheeded. And while a repeat is oft predicted, there remains no way to see it coming. There may, however be something on the horizon.
Nearly 15 years before the events of 2008, “one of Wall Street’s rocket scientists,” Rick Bookstaber, first encountered an emergent approach to behaviour modelling that had promise. In 1993 Bookstaber – then head of risk management at Morgan Stanley – was introduced to so-called agent-based modelling at a conference in Santa Fe. He maintains that agent-based modelling provides something closer to the reality in financial markets than anything coming out of existing modelling approaches.
The approach, now commonly applied in traffic management design, resonated with his observations of the car crash that was the 1987 financial crisis: “Once I saw agent based modelling it really struck a chord for me because I had been in the middle of the 1987 crisis. I was doing portfolio insurance and I saw the process and the dynamic as it occurred.
“I realised people don’t optimise. There are different people doing different things, they came into the market with different time frames. It was much more the way a traffic flow turns into a traffic jam.”
He continued to be aware that “something was missing with standard methods.”
He says he “played around building little agent based models, using C programming,” before letting it go. But he continued to be aware that “something was missing with standard methods.” His realisation of the potential power in agent based modelling to reveal the vulnerabilities in a market was at least part of Bookstaber’s rise to guru status in market risk management.