In this second installation of The Model Thinker, I will talk about seven uses of models.
The author uses the REDCAPE acronym to illustrate these seven uses which I will illustrate here for folks interested in their personal finances :
a) Reason – To identify conditions and deduce logical implications
One of the best illustrations of this usage is Ray Dalio’s Big Debt Crises he showcases one way to look at how accumulating foreign debt can lead to a depression later on. A detailed discussion of this model, unfortunately, cannot be done on a blog. We do know that taking on a lot of foreign debt can led to tragedy later on.
b) Explain – To provide testable explanations for empirical phenomenon
I attempted to explain the underperformance of a REIT portfolio due to an investor’s preference for REITs run by ‘good’ sponsors using quantitative backtesting. This racked up a lot more unhappiness than