Practical analysis for investment professionals
07 May 2012

James Montier: More Realistic Financial Models Incorporating Illiquidity and Leverage Are Needed

Opening the CFA Institute 65th Annual Conference in Chicago, behavioral investor James Montier condemned theorists, policymakers, and practitioners for creating the financial crisis with “bad models, bad policies, bad incentives, and bad behavior.” Worse still, Montier contended, nothing much has been learned from the disaster — setting us up for yet another calamity.

Montier began his talk by attacking key financial models. “In finance, we forget we have made abstractions and take the models as if they were reality,” he said. Value at Risk (VaR), a popular measure of downside risk and potential loss, “cuts off the very part of the probability distribution (the extremes) which you most need to worry about.” VaR —  combined with leverage and naïve calculations about volatility based on overly recent data — has escalated institutional risk to the point that it has become systematic risk. “You are introducing an enormous amplifying device into global markets,” he added.

Read more on the Annual Conference blog →

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About the Author(s)
Mark Harrison, CFA

Mark Harrison, CFA, was director of journal publications at CFA Institute, where he supported a suite of member publications, including the Financial Analysts Journal, In Practice summaries, and CFA Digest. He has more than 12 years of investment experience as a portfolio manager and securities analyst. Harrison is a graduate of the University of Oxford.

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