According to the Millennium Project the biggest
global challenges facing humanity are those illustrated in the image
above. The image conveys a holistic message which some of us already
appreciate: everything is connected with everything else. The economy
isn't indicated explicitly in the above image but, evidently, it's
there, just as the industry, commerce, finance, religions, etc. Indeed a
very complex scenario. The point is not to list everything but to
merely point out that we live in a highly interconnected and dynamic
world. We of course agree with the above picture.
As we have repeatedly pointed out in our previous articles, under similar circumstances:
- it is impossible to make predictions - in fact, even the current economic crisis (of planetary proportions) has not been forecast
- only very rough estimates can be attempted
- there is no such thing as precision
- it is impossible to isolate "cause-effect" statements as everything is linked
- optimization is unjustified - one should seek acceptable solutions, not pursue perfection
The well known Principle of Incompatibility states in
fact that "high precision is incompatible with high complexity".
However, this fundamental principle, which applies to all facets of
human existence, as well as in Nature, goes unnoticed. Neglecting the
Principle of Incompatibility constitutes a tacit and embarrassing
admission of ignorance. One such example is that of ratings. While the
concept of rating lies at the very heart of our economy, and, from a
point of view of principle, it is a necessary concept and tool,
something is terribly wrong. A rating, as we know, measures the
Probability of Default (PoD). Ratings are stratified according to
classes. One example of such classes are shown below:
Class PoD
1 =<0.05%
2 0.05% - 0.1%
3 0.1% - 0.2%
4 0.2% - 0.4%
5 0.4% - 0.7%
6 0.7% - 1.0%
etc.
A rating affects the way stocks of a given company
are traded - this is precisely its function. What is shocking in the
above numbers, however, is the precision. A PoD of 0.11% puts a company
in class 3, while a 0.99 in class 2. How can this be so? Isn't the
world supposed to be a highly complex system? Clearly, if even a crisis
of planetary proportions cannot be forecast, it not only points to high
complexity (see the Principle of Incompatibility) but it also says a
lot about all the Business Intelligence technology that is used in
economics, finance, or management and decision making. So, where does
all this precision in ratings come from? From a parallel virtual
universe of equations and numbers in which everything is possible but
which, unfortunately, does not map well onto reality. But the
understanding of the real universe cannot be based on a parallel virtual
universe which is incorrect.
The above example of PoD stratification reflects very
little understanding of Nature and of its mechanisms. In fact, economic
crises of global proportions suddenly happen. As Aristotle wrote in
his Nikomachean Ethics: an educated mind is distinguished by the fact
that it is content with that degree of accuracy which the nature of
things permits, and by the fact that it does not seek exactness where
only approximation is possible.
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