Models built on calm history

A model fitted to years of moderate outcomes cannot see the one that is not moderate.

• Risk
• Crises and market history

2 ideas that carry it

• FrameworkCrises and market historyFilm

  A rating is a model output, and the model rests on a correlation assumption

  Ask what a rating assumes about defaults happening together before trusting what it says about the pool.

  Any question about 2008, about structured credit, or about why a highly rated instrument lost most of its value.

  From The Big Short · 2015

• LessonRiskLetter located

  Beware of geeks bearing formulas: a model built on calm history cannot see the storm

  Ask what period a model was fitted to, and whether that period contained the event you are worried about.

  Any risk model, stress test or structured product that reports a probability of loss.

  From Berkshire Hathaway's 2008 letter to shareholders · Warren Buffett