Accuracy and Precision in Finance

9 Pages Posted: 3 Dec 2015

See all articles by Manfred Gilli

Manfred Gilli

University of Geneva - Research Center for Statistics; Swiss Finance Institute

Enrico Schumann

Independent

Date Written: September 30, 2015

Abstract

Modern finance, both theoretical and practical, makes extensive use of mathematical reasoning and modelling. But this reliance on exact methods comes with unfortunate side effects: numerical precision is emphasised, but without an equal insistence on empirical accuracy; methods that do not offer numerical precision are shunned from the beginning. This is most severe in those fields of finance in which theories build on optimisation. We argue that precision in modelling is only useful up to a certain level; we can do with approximations and low precision as long as models are sufficiently accurate for the purpose at hand. We illustrate this view through a concrete example: selecting financial portfolios with so-called heuristic methods. Heuristics provide only approximations to an optimisation model's solution, but we show that their precision is sufficient for all practical purposes. In compensation for their lack of precision, heuristics allow researchers to solve more-accurate models.

Keywords: heuristics, portfolio optimisation, model validation, model risk

Suggested Citation

Gilli, Manfred and Schumann, Enrico, Accuracy and Precision in Finance (September 30, 2015). Available at SSRN: https://ssrn.com/abstract=2698114 or http://dx.doi.org/10.2139/ssrn.2698114

Manfred Gilli

University of Geneva - Research Center for Statistics ( email )

Geneva
Switzerland
+41223798222 (Phone)
+41223798299 (Fax)

HOME PAGE: http://www.unige.ch/ses/metri/gilli/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Enrico Schumann (Contact Author)

Independent ( email )

No Address Available
United States

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