Top 10 Risk Analytics

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I’m often asked for my “top 10” risk measures, and it happened again just the other day.  The trouble is that a top 10 list is often interpreted as  “No. 10 does matter all that much” and “I really only care about No. 1.”  We love top 10 lists because they provide a linear answer, and our brains love to think linearly.  We really like it when someone tells us what the single most important answer is to whatever we’re trying to solve.  One of the tenets of this blog is that risk analysis, market behavior and economics are not linear systems and that thinking about them linearly is inappropriate and dangerous.

I’ll give examples from two very different non-linear systems: sports and piloting an airplane.  What is the single most important factor in having a winning baseball team?  Surely it’s pitching, because without an A team in the bullpen, good hitters on the opposing team will dominate.  But what about having your own set of sluggers?  Surely the answer is having quality hitters at the plate so you score more runs.  Wait – what about fielding and hustle and smart base running?  Baseball, like all sports, is a complex dynamic system and there is no answer to “what is the most important attribute.”  Of course, that doesn’t stop the sports announcers from attempting to present it that way.  The amount of debate among experts about the most important factor is in itself a pretty good sign that you’re dealing with a complex system.  Similarly, what is the most important thing for a pilot to monitor while flying?  Should she most closely monitor Altitude?  Air speed?  Weather conditions?  Flaps?? Fuel?? The answer is obvious: all of the above, plus some!  I, for one, would never get on a plane whose pilot was only concerned with a “the top 10 things to keep track of.”

So I hope you agree that I’m not dodging the question when I write that the very idea of a “top 10” list of risk analytics is the wrong thing to look for.   Still, some people press the issue and ask me “if you could only have one risk analytic, what would it be?”  My answer, which is not tongue in cheek nor glib nor snarky, is simply “if I could only have one risk analytic, I would not manage the portfolio.”  Just like I hope the pilot would answer “If I could only have one instrument on my airplane, I would not fly it.

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Darwin Day 2011

Today is Darwin Day — the 202 anniversary of Darwin’s birth on February 12, 1809. Theodosius Dobzhansky (try saying that three times), a Ukrainian American biologist, is credited with saying that “nothing in biology makes sense except in the light of evolution.”  I think it’s fair to extend that well past biology – natural selection applies to a great many different systems including of course, economics.

Eric Beinhocker chose to entitle his groundbreaking book “The Origin of Wealth,” a clear echo of Darwin’s masterpiece “The Origin of Species.”  Actually, Beinhocker’s full title is “The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics.”   Not everything he writes about is directly related to evolution, but evolution plays a central role in the explanation of how the economy works.  Daniel Dennett – one of the greatest philosophers of our time – has described evolution as a method for “creating design without a designer.”  That sums up why evolution is so important: it shapes the participants into ‘better’ and ‘better’ designs as the environment around them changes.

When I started this blog and I created my reading list I included Beinhocker’s book and added “Everyone in the world should read this book.”  I really do mean that.  It’s not just that his book is well written and a joy to read.  It’s also that the contents are just that important. Read more of this post

A Childish View of Risk

Figure 1: Teenagers are missing part of their brains. Click the image for full size.

As a parent of three – my kids are 14, 11 and 9 – I try to teach my children how to make better choices.  It’s easy to just tell them “do this” or “don’t do that.”  Sometimes they even listen.  But what I really try to do it have them understand what’s behind the decision – what makes one activity safe and another dangerous.  For those readers who don’t have children, this is much harder than it sounds.  When I say something like “don’t you think that was a dangerous thing to do?” my children’s first reaction is usually something like “but Dad – Nothing bad happened!”  Their justification for taking a risk is that they didn’t get hurt.  “See – I’m OK.”  Read more of this post