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Financial Modelers’ Manifesto

A proposal calling for greater fiscal and risk-management responsibilities

What is the Financial Modelers’ Manifesto?

The Financial Modelers’ Manifesto is a proposal calling for greater fiscal and risk-management responsibilities in the wake of the housing market collapse and subsequent financial crisis of 2007-2008. It was created by two financial engineers – Paul Wilmott and Emanuel Derman.

 

Financial Modelers’ Manifesto

 

In the past, both Derman and Wilmott have written extensively about financial models and human error. Both noted in separate articles that as financial tools develop and change, so, too, do the ways that individuals respond to them.

The pair suggests that individuals, with the constant growth and evolution of financial technology and modeling, begin to lose sight of the reality that every model contains inherent flaws. Instead, as new models emerge, people tend to believe the latest model is without flaws. This belief affects peoples’ percepton to the exent that they actually tend to lose the ability to spot flaws in the newest model.

 

Before the Financial Modelers’ Manifesto

In 2000, Paul Wilmott wrote about the increased levels of math in finance and the simultaneous decrease in common sense. He stated, “Unfortunately, as the mathematics of finance reaches higher levels, so the level of common sense seems to drop. There have been some well-publicized cases of large losses sustained by companies because of their lack of understanding of financial instruments…”.

Emanuel Derman also wrote about people and their assumptions regarding financial solutions. He observed, regarding financial modeling, “There are always implicit assumptions behind a model and its solution method. But human beings have limited foresight and great imagination, so that, inevitably, a model will be used in ways its creator never intended. This is especially true in trading environments…but it’s also a matter of principle: you just cannot foresee everything. So, even a “correct” model, “correctly” solved, can lead to problems. The more complex the model, the greater this possibility.”

Both Wilmott and Derman were touching on the aspects of finance and modeling that they would collectively expound upon in the Financial Modelers’ Manifesto.

 

The Modeler’s Hippocratic Oath

Among the various sections included in the manifesto is the Modelers’ Hippocratic Oath. Traditionally, a Hippocratic oath is taken by physicians. It is, essentially, a vow that they will aim to do no harm and to uphold the best interests of their patients and others involved in scenarios they must deal with.

In the Financial Modelers Manifesto, Wilmott and Derman outline a Hippocratic Oath that they encourage financial professionals to adhere to as a guide to help prevent the sometimes-grievous misunderstandings and mishaps that can occur. The Modelers’ Hippocratic Oath reads as follows:

  • “I will remember that I didn’t make the world, and it doesn’t satisfy my equations.”
  • “Though I will use models boldly to estimate value, I will not be overly impressed by mathematics.”
  • “I will never sacrifice reality for elegance without explaining why I have done so.”
  • “Nor will I give the people who use my model false comfort about its accuracy. Instead, I will make explicit its assumptions and oversights.”
  • “I understand that my work may have enormous effects on society and the economy, many of them beyond my comprehension.”

 

Final Word

The Financial Modelers’ Manifesto is an important document because it clearly expresses the key ideas that Wilmott and Durman wrote about throughout their professional lives: that every model contains inherent flaws, can be misused or misunderstood, and that people are likely to misconstrue what such models forecast.

The document is also important because it asks financial modelers and professionals to adhere to a code of conduct designed to combat the tendency of people to overly rely on, misuse, or misconstrue the interpretation of financial models.

 

More Resources

Thank you for reading CFI’s guide to the Financial Modeler’s Manifesto. CFI is the offical provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • Best Practices in Financial Modeling
  • Business Ethics
  • Moral Hazard
  • Financial Modeling Templates Course

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