Being Rational About Risk
Leonard Mlodinow—physicist at Caltech and author of The Drunkard’s Walk, a highly-praised book looking at randomness and our inability to take it into account—has an interview in The New York Times about understanding risk. Some choice quotes:
I find that predicting the course of our lives is like predicting the weather. You might be able to predict your future in the short term, but the longer you look ahead, the less likely you are to be correct.
I don’t think complex situations like [the current financial crisis] can be predicted. There are too many uncontrollable or unmeasurable factors. Afterwards, of course, it will appear that some people had gotten it just right: since there are many people making many predictions, no doubt some of them will get it right, if only by chance. But that doesn’t mean that, if not for some unforeseen random turn, things wouldn’t have gone the other way. […]
In some sense this idea is encapsulated in the cliché that “hindsight is always 20/20,” but people often behave as if the adage weren’t true. In government, for example, a “should-have-known-it” blame game is played after every tragedy.
As someone who has taken risks in life I find it a comfort to know that even a coin weighted toward failure will sometimes land on success. Or, as I.B.M. pioneer Thomas Watson said, “If you want to succeed, double your failure rate.”
I haven’t had a chance to watch it, but in May 2008 Mlodinow spoke for the Authors@Google series.
3 Comments
I think it is fine to mention the inherent unpredictability of very complex systems like the weather, but I get a nagging doubt when the argument is used to support the idea that the current financial crisis could not have been foreseen.
I would go so far as to say that I *fundamentally* disagree with Nassim Nicholas Taleb’s Black Swan theory when applied to recent economic events. For example, Chuck Prince, ex-CEO of Citigroup is often cited (by Fortune magazine among others) as being ‘one of the people who didn’t foresee the credit crisis’. However back as early as January 2007, he publically remarked that “As long as the music is playing, we have to keep dancing”.
To use the example of predicting the weather, lets say if you have a straight week of sunny days, would it be reasonable to say that umbrellas are no longer necessary? Chuck and quite a few other economists may not have foreseen the scale of the crisis, but they knew the credit boom was unsustainable and that a bust would surely follow the boom as sure as a thunderstorm follows a week of sunshine.
At the time though, there was little that they could do individually to persuade enough people to influence the outcome. When the outcome arrived of course, everyone ran for cover and said that it ‘was an unforeseeable black swan event’, and that throughout the entire week, no-one needed their umbrellas so they were all burned last Thursday and how could anyone have predicted rain this week and been taken seriously?
To top it off, after the crash happened some of the people ‘taken by surprise’ (and who may even have profited significantly from the bubble) even had the gall to say that those that did correctly predict the turn of events probably just ‘got lucky’, and it might just as well have not rained today, or tomorrow or the next day. In fact, it might never have rained again, perhaps. Perhaps.
This is not randomness at all, and its not about blame. It is about good old fashioned risk management — something that industries outside banking have been doing *for decades*. The problem is that when the regulator is invited to the party too, they’re not going to be thinking about a rainy day.
While reading Mlodinow’s article, and in fact any article about statistics, there is always one idea that comes to mind. Statistics can tell you the odds of what ‘a plane’ crashing are, but it can never tell you which plane it will be. Same with the lottery. Same with cancer.
What about the people who are on the plane when the heavy turbulence hit and thought to themselves, “the odds are this plane won’t crash” and they happened to be in the one plane that did crash? Statistics be damned. Someone has to be ‘that person’. The one who gets hit be lightening. Who wins the lottery.
The only answer a rational individual can give is, “that’s life, it’s a weird, random jumble of atoms bumping into each other and sometimes the illusion that you call your self happens to be in the wrong place at the wrong time and has to experience the consequences.”
I would argue though that there seems to be something missing. With the infinite number of the possibilities that could happen, and the very limited number that actually do happen, one has to ask, where did all those other scenarios disappear too?
[…] Mlodinow, the author of “The Drunkard’s Walk: How Randomness Rules Our Lives” (via). Same story again. We are emotional beings who often make decisions based on intuitions which are […]