Banks Confuse Uncertainty, Risk: Complex Predictive Tools May Have Obscured Meltdown

Article excerpt

WASHINGTON -- Major banks conduct an annual ritual of financial forecasting futility: Their complex risk models consistently flub predictions about the relative values of the dollar and the euro in the coming year, a new analysis finds.

Annual forecasts of currency values from December 2001 to December 2010, which guided banks' investment decisions, missed the mark nine out of 10 times, says psychologist Gerd Gigerenzer of the Max Planck Institute for Human Development in Berlin. Banks incorrectly foretold the fates of the dollar and the euro in the years leading up to, during and after the recent financial crisis.

Gigerenzer described his findings October 4 at "Reckoning with the Risk of Catastrophe," a meeting of scientists trying to devise ways to measure the probability of financial calamities, natural disasters and other catastrophes.

"It's hard to predict currency values worse than the banks did," Gigerenzer said. "Highly paid people produced worthless predictions."

The problem, he asserted, is that most risk modelers don't distinguish risk and uncertainty. …