“Patriot Missile Failure”
http://ta.twi.tudelft.nl/nw/users/vuik/wi211/disasters.html

In this case I’m using a simulation to study theoretical models of optimal portfolio choice. No data, just equations for the system’s dynamics. I’ve done the Merton model and now have a model by Wachter with mean reverting Sharpe ratios working. I started with these as they have analytic solutions. I’m now moving into behaviour finance models such as prospect theory for which analytic solutions can be very difficult.

Over short time periods matching the analytic models is no problem, but with a few hundred time steps tiny errors build up and things in the simulation deviate from the analytic solutions… which is bad news for us as we want to use this to understand the analytic models.

Nevertheless, I think it’s still valid to question whether analytic models which are so sensitive when simulated are good models of real behaviour over extended time periods.

In our particular case we are interested in prospect theory and in this theory we usually consider relatively passive investors who rebalance their portfolio about once a year. In this case simulating 30 years is no problem at all and the solutions at each point in time don’t need to be all that accurate. But for other models, simulating the behaviour can be problematic.