Wednesday, 3 July 2013

Things That Cannot Be Modeled Shouldn't be Modeled

 

Ludwig Wittgenstein sustained that "what cannot be debated should not be debated". We say that what cannot be modeled should not be modeled. Otherwise one faces making massive investments with no tangible return. Based on our current understanding of physics and using our contemporary mathematics certain things are "impossible to model". Therefore, we should not spend time and precious resources on modeling them. What are these things? The list is evidently interminable but we could mention, for example, the following:
  • Human nature
  • Feelings, emotions, states of mind, perceptions (love, hatred, fear, anger, happiness, sorrow, vengeance, treason, danger)
  • Conscience
  • Good
  • Evil
Risk belongs to the above list. Risk is a subjective reflection of the (subjective) perception of danger and, at the same time, it hides an attempt to predict the future. In fact, risk is not a physical quantity. It doesn't exist in Nature. There are no non-negotiable laws of risk (like the law of gravity for example) that hold everywhere in the Universe and that may be verified on experimental grounds. The concept of risk is flawed. It is an imaginary, intangible and non-physical concept.

But why is the concept of risk flawed?  As mentioned, the concept of risk materializes the desire to predict the future.  Man has come up with many intangible and non-physical concepts. Such concepts may be easily spotted – it is extremely difficult to reach consensus even when a definition has to be established. In the case of risk there isn’t a universally accepted definition. Some theorists define risk as an “expected after-the-fact level of regret”. But how do you measure that? One of the best “definitions” of risk we have found is: risk is exposure to uncertainty. But since the matter which fills our Universe behaves based on the principles of quantum mechanics - fact that ultimately propagates also to the macro scale – it means that the Universe and all that fills it is non-deterministic in character. Therefore, uncertainty is ubiquitous and affects everything to a lesser or greater extent. The economy – in which the concept of risk plays a central role - is probably the best example of a non-deterministic environment, impregnated with irrational human behaviour, in which one is constantly and from every possible direction exposed to uncertainty. But if everything is exposed to some form of uncertainty and all of the time, then, according to the above definition, everything is always at risk. In effect, if everything is constantly at risk, because everything is exposed to uncertainty, then the concept of risk itself is also redundant (it is like adding to everyone's address that he is an inhabitant of the planet Earth).

Nature taxes heavily any attempt to violate its laws. Predicting the future via mathematical models, or any other means, is impossible. Acting based on the results of such models (i.e models that don't follow Nature's laws) is, consequently, increasingly dangerous as the prediction horizon is extended as well as the degree of sophistication of the model that is used to perpetrate the crime. The concept of risk reflects the unhealthy desire to predict the future using sophisticated mathematics but this doesn’t hide the substance. The uneducated public may find comforting the fact that exotic mathematics is used to predict the value of stocks or real-estate, or to establish the Probability of Default of a company. However, any statements along these lines are nothing more than obscure high-tech camouflage of the same old and futile attempt to predict the future. The future is always under construction.