Here's a quick summary of this review, for those who are short on time: this book lacks focus and I would not recommend it unless you have A LOT of patience. It is a LONG 200 page read.
As a cross-disciplinary individual (I studied Finance and English in college), this type of "crossover" book intrigues me. A mashup of philosophy, physics and finance, Models Behaving Badly is, at the very least, a very unique book. Indeed, I've never quite read anything like it. While centered around the markets -- and the idea that most of the models used to describe them are garbage -- Derman supports his points with quotes from Goethe, discussions on Maxwell's electromagnetic theory and anecdotes about his own youth as a Jewish boy in the era of South African apartheid. The fields that are of interest to me, likewise, are eclectic, and I think that most of the stuff I was taught in undergraduate Finance was wholly useless. I mention these facts simply because I feel as if I am precisely the demographic Derman targeted with this book.
And, unfortunately, he missed the mark.
The reason is simple: he never reconciles the three disciplines into any sort of coherent argument. On a broad level, he uses each separate field to show that theories are reflective of reality, whereas models are merely an approximation. He never, however, goes beyond this generalization and provides a good reason WHY he's talking about the philosophy/physics (other than, presumably, that they interest him). I have no doubt that Derman is an intelligent guy; his prose is generally decent and he clearly knows a lot about the markets as well as physics. Unfortunately, there is NO reason to have the physics (and, to a lesser extent, the philosophy) in this book. His examples are impossible to follow unless you're a physicist or engineer, and the discussion is way too technical for non-scientists to understand. Worse, the discussion is pointless, as it does not relate back to the core thesis of the book, which revolves around CAPITAL MARKETS. I get that there are theories in science, and that they are generally indisputable tenants of reality. However, it is unnecessary and BORING to devolve into a 30+ page discussion about the intricacies of electromagnetic theory.
The philosophy was sometimes interesting, at least, but again, it was only tenuously linked to the core point of capital markets. It's interesting when he brings up the idea of life being "negative" and sleep/death being "positive" (or something akin to this), but it's out of place. If, after reading the previous sentence, you're wondering "Surely he relates that back SOMEHOW," then I have news for you: he doesn't. It's just kind of hanging out there. Interesting point, but completely irrelevant to his main topic of discussion.
The philosophy/biographical/physics sections should have been edited down into a single chapter as a SUPPORT to his main point: that bad models caused the market meltdown. His main point is good -- and, for what it's worth, I think he's right on -- but he spends WAY too much time getting there, and not enough time discussing capital markets. If you even get that far -- the section entitled Models. Behaving. Badly., where he finally gets to the point of the book, is located about 50 pages from the end. And it is brutally difficult to get there.
Oh, and then when he finally does get there, in the first part of that section he refers to a CDO as a collateralized default obligation -- which kind of makes me wonder how accurate his physics diagrams etc. were. To make matters worse, if you're not a Finance major or investment professional, this section -- like the physics one -- is going to make very little sense to you. Be prepared for lots of technical terms and jargon and definitions that assume familiarity with certain concepts. If you didn't know what the CAPM, Efficient Market Hypothesis or Sharpe Ratio were before reading this book, I doubt Derman will help shed much light on these topics.
I gave this book 3 stars because at points, when it does come together, it's fascinating -- and I believe that his core thesis (that financial models are crap) is dead-on, not to mention refreshing. Unfortunately,the rest of the text is dry, usually pointless and meandering without a clear purpose. If this had been 100 pages and focused more upon investing/finance, I think this would be a 4 - 4.5 star book. As it stands, I can only offer my recommendation to people who have experience in Finance/markets, or to those with TONS of patience and the will to look up a lot of concepts on Investopedia.