nottheaverageactuary

Actuarial news and views from Cape Town and beyond

Attitudes towards model risk

2 Comments

I found this article, which discusses the different ways in which people view and use models, given the limitations that most models have.

Three general limitations of models are identified in the article: models are only approximations to complex problems and as such may miss some relevant features; sensitivity of results to assumptions cannot in general be validated; and there is a strong reliance on past data, despite the concern being with the future.

People have different attitudes towards using models in light of their limitations. By considering two aspects of attitudes towards models – confidence that we can effectively overcome uncertainties in order to make good decisions, and belief that models have a place in the decision making process – the authors have created a two-by-two matrix, identifying four types of people:
  • Intuitive Decision Makers, who believe that gut instinct and market knowledge are superior to model usage
  • Confident Model Users, who believe that models should be used to optimise decisions
  • Conscientious Modellers, who are very technically accurate, and because of this, uncomfortable with the way uncertain results are used in the decision-making process
  • Uncertainty Avoiders, who believe we are not able to make good decisions under uncertainty

Different attitudes towards using models to overcome uncertainty

As actuarial students, I think we are very much exposed to the Conscientious Modellers spectrum of this matrix. I think it’s possible, especially if we are usually surrounded by like-minded people, to forget that not all stakeholders in the business world will view risk and our ability to handle it in the same way that we do. We may well be confronted by people who fit the stereotypes depicted by each of these quadrants at some point in our careers.

The authors’ view is that all four of the perspectives are needed:

“Conscientious Modellers, possibly to their chagrin, need the operational focus of Confident Model Users (to attract investment in the model), the scenarios imagined by Uncertainty Avoiders (to challenge long-held wisdoms) and the survival instincts of Intuitive Decision Makers (to ensure model use does not lead to commercial disadvantage). At the same time, Conscientious Modellers can use the model to challenge Intuitive Decision Makers, by demonstrating “what you have to believe” for the model to be consistent with intuition. Such a challenge reveals management’s implicit assumptions and enhances accountability.”

I think that none of these four views are optimal individually, and in reality, one needs to be aware of the core ideas behind each of the four perspectives in order to responsibly and effectively use models. However, I think that, especially as actuaries, we should lean towards the right of the matrix (after all, if we don’t believe models have any predictive value, why did we study a course dedicated to them?). I think that ‘Uncertainty Avoiders’ take things too far, and that while it may be good to employ some degree of intuitive decision making, it should still be guided by data and models. I think a balance needs to be struck between the technical awareness of the Conscientious Modellers, who are possibly not pragmatic enough to make tough decisions under uncertainty, and Confident Model Users, who might place too much faith in the results of models.

The authors conclude by saying that communication of model uncertainty needs to be more transparent. They say that currently, admitting to high uncertainty would be seen as unacceptable. However, risks should not be borne only by the technical experts who build and use models, but rather should be openly communicated and shared by other parties in the decision making process.

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2 thoughts on “Attitudes towards model risk

  1. This is a really interesting way to look at how people use models and realise that our view is not unique. I am sorry I did not spot this before the lecture on Tuesday, but it is a very useful thing to keep in mind when communicating model results. I will send the link to Terri (in communications) because I think it will be valuable to her class!

  2. Indeed, it is and will be. These type of stereotypes probably closely align with personality types as well. … And I agree that understanding the affordances and constraints of all four is helpful as it is informed by the fact that one size does not necessarily fit all and that so many variables come into play which may or not not be easily controlled (as we saw with the sub-prime and subsequent crises).

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