Aikman,D.
Galesic,M.
Gigerenzer,G.
Kapadia,S.
Katsikopoulos,K.V.
Kothiyal,A.
Murphy,E.
Neumann,T.

Distinguishing between risk and uncertainty, this paper draws on the psychological literature on\nheuristics to consider whether and when simpler approaches may outperform more complex\nmethods for modelling and regulating the financial system. We find that: (i) simple methods can\nsometimes dominate more complex modelling approaches for calculating banks' capital\nrequirements, especially if limited data are available for estimating models or the underlying risks\nare characterised by fat-tailed distributions; (ii) simple indicators often outperformed more\ncomplex metrics in predicting individual bank failure during the global financial crisis; and (iii) when\ncombining information from different indicators to predict bank failure, 'fast-and-frugal' decision\ntrees can perform comparably to standard, but more information-intensive, regression techniques,\nwhile being simpler and easier to communicate.

Aikman, D., Galesic, M., Gigerenzer, G., Kapadia, S., Katsikopoulos, K., Kothiyal, A., Murphy, E., & Neumann, T. (2014). Taking uncertainty seriously: Simplicity versus complexity in financial regulation (Financial Stability Paper / Bank of England No. 28). London: Bank of England. (Full text)

Publication year	2014
Document type:	Book
Publication status:	Published
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