... a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics; and I went more and more on the rules.
- Use mathematics as a shorthand language, rather than as a engine of inquiry
- Keep to them till you have done.
- Translate into English.
- Then illustrate by examples that are important in real life
- Burn the mathematics.
- If you can’t succeed in 4, burn 3. This last I did often.
Even though he was speaking more than a century ago, Marshall provides useful advice from one of the great economist of all time. All models, including econometric ones with empirical results, should be able to be translated into plain English. There should be a simple narrative associated with the model and there should be examples that others can use to explain or describe the results. If you cannot tell an effective narrative using the model, then go back to the model and try again.
The magic in models is their ability to compact a lot of information in statements where there should be limited ambiguity. It is a shorthand language that can provide concise intuition about a specific problem. The magic of narrative in translating this concise representation into useful stories that can explain the existing environment and tell us something about what may happen in the future. Narratives don’t have to be compact or use a shorthand language. Narratives are the descriptive real world examples and need to be truthful. A model that cannot lead to a truthful narrative that represents the facts fails.
There are useful models in finance, but there are also ones that steer us in the wrong direction because they do not fit reality. A key job of the investment professional is knowing which ones work and which ones are suspect.