Conventional risk management…a waste of money!?

Apologies to any hardcore risk managers who are offended that I even pose such a question…PLEASE read on and (I hope) you will understand why I pose the question. I make no apology for “recycling” extracts from earlier blog items to TRY to convey a supremely important message:

A recent item referred to a Report by US National Academies/NRC & Fed. Reserve Bank of NY and I wanted to revisit this from my summary:

Two particularly illuminating questions about priorities in risk management emerge from the report. First, how much money is spent on studying systemic risk as compared with that spent on conventional risk management in individual firms? Second, how expensive is a systemic-risk event to a national or global economy (examples being the stock market crash of 1987, or the turmoil of 1998 associated with the Russian loan default, and the subsequent collapse of the hedge fund Long-Term Capital Management)? The answer to the first question is “comparatively very little”; to the second, “hugely expensive”.

“We can’t solve problems by using the same kind of thinking we used when we created them” Einstein

We knew about this threat and did little about it. Now, some may say post-crisis others mid-recession, we are STILL failing to address the underlying issues. Preferring to waste even more time and money on ad hoc or ill-considered regulations. That is one of the reasons why we, at Ontonix, believe that we offer genuine solutions to the underlying problem of assessing the complexity and robustness of system(s).

Institutions are under pressure like never before and it will only get worse because they are more intent upon defending the indefensible and to fight to retain power and wealth…worryingly reminiscent of the words of Dr Joseph Tainter referring to The Collapse of Complex Societies:

Complex societies collapse because, when some stress comes, those societies have become too inflexible to respond. In retrospect, this can seem mystifying. Why didn’t these societies just re-tool in less complex ways? The answer Tainter gives is the simplest one: When societies fail to respond to reduced circumstances through orderly downsizing, it isn’t because they don’t want to, it’s because they can’t.

buiding-collapse In such systems, there is no way to make things a little bit simpler – the whole edifice becomes a huge, interlocking system not readily amenable to change. Tainter doesn’t regard the sudden de-coherence of these societies as either a tragedy or a mistake—”[U]nder a situation of declining marginal returns collapse may be the most appropriate response”, to use his pitiless phrase. Furthermore, even when moderate adjustments could be made, they tend to be resisted, because any simplification discomfits elites.

When the value of complexity turns negative, a society plagued by an inability to react remains as complex as ever, right up to the moment where it becomes suddenly and dramatically simpler, which is to say right up to the moment of collapse. Collapse is simply the last remaining method of simplification.

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Benoit Mandelbrot: The “heretics” are taking over the asylum

Benoît Mandelbrot at the EPFL, on the 14h of M...

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Thankfully the times have changed and, much as they have resisted, institutions are finally getting the message that they can no longer get away with marginalising or burying the theories and other creative contribution of passionate and capable individuals whose work draws conclusions that challenge the very basis of their power and wealth.

Issues that were once buried or “swept under the carpet” are having to be dealt with because thinking citizens have the means to communicate (like never before) with like-minded individuals. Questions have been and will continue to be asked and for as long as Government; Church; Corporation; Financial institutions, are shown to be so deeply flawed and refuse to embrace transparency they are contributing to their own downfall.

So, unless I am a complete idiot(!) the message in this – 11 min – interview is that the whole basis of “efficient market theory” and, therefore dirty big chunks of time and money associated with modelling risk, were obtained by what can only be described as a massive deception? Well, if we are talking about deliberately and knowingly ignoring the the impact of infrequent (random) major “events” – Black Swans – on the basis that the truth was too inconvenient then what other conclusion can there be?

When it comes to interview style he ain’t no firebrand like Nassim Taleb but then again neither was the late Peter L Bernstein. But both men possess the wisdom and presence of another era with enormous relevance for NOW. NOT rebels and NOT heretics.

Benoit Mandelbrot on Risk, Efficient Markets, and Bachelier

Pt 1: In a fascinating in-depth interview with John Authers, investment editor, 85-year old mathematician Benoit Mandelbrot discusses his now 40-year old groundbreaking critique of the “efficient markets” hypothesis and why new theories on price movement discontinuities are needed after the credit crunch. Benoit Mandelbrot is an emeritus professor of mathematics at Yale University.

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