Seeing Tomorrow, II

Book review of Dembo & Freeman’s “Seeing Tomorrow: Rewriting the Rules of Risk”

In chapter 1, the authors give more details about the Soros / Reichmann deal gone wrong which they hinted at in the introduction.   It seems the reason for the deal was that Reichmann camp considered only one possible risk event (one that would be a windfall for them), got fixated on that and wouldn’t budge in the negotiations.  They (inadvertently?) preferred to risk losing the whole deal rather than giving up a small portion of the profit.

Demob & Freeman writes that the way to think about risk not to consider one possible event, but to look at several different possible outcomes, explore how each event will make use react .

The chapter then very lightly mentions considerations about risk. That we all have different views of risk, that what is attractive to one is repellent to another, that risks have positive and negative aspects, that doing nothing can be risky as well. 

The one interesting notion I hadn’t come across before stood out briefly:

“an acceptable risk one day might appear a foolish gamble on the next day.” 

But after further reflection, this is very common in hindsight, when events that we weren’t able to consider during decision time unfold.

The second half of the chapter consist of continuing remarks about flawed and outdated approaches to risk management, examples of failures in managing risk: Orange County, the very biggest banks, etc.   They also picked up on Peter Bernstein’s notion on whether modern man has replaced his earlier superstitions of the fates and the gods with new superstitions about the magic of statistics and quantifications of risk.

The topic then shifts to the idea of sharing the risk, with a story about a group of women involved in charity, who without realising it, bought futures contracts on grains. 

They reveal a little more about their soon-to-be-explained  framework, by noting that risk sharing (distributing the risk) is an important concept of the framework.

The last few paragraphs of the chapter – oddly - begin sounding like a marketing brochure on reinsurance. Words like catastrophe reinsurance, catastrophe insurance bonds, pure risk, packaging of business risk and so on are spoken about (with a bit of a hint of glee?)  Some of the final paragraphs in this chapter may be more opaque  for readers not yet familiar with insurance terms as they are used without definition.

A review of chapter 2 will come next.

Seeing Tomorrow, I

Book review of Dembo and Freeman’s “Seeing Tomorrow: Rewriting the Rules of Risk”.

There is something breath-taking about the title of this book. The audacious title,  the equally audacious subtitle, and even the painting on the cover remind me of Peter Bernstein’s risk management opus, “Against the Gods”, a book that made Bernstein to risk management what Carl Sagan was to cosmology: a modern-day Prometheus who brought the fascinating story of a scientific discipline to the  understanding of mortals.

However, at just the second page of the Introduction, I was startled by a prosaic admission: “Even as this book was in preparation, one of the authors, who sold a house in 1994, watched in dismay as property prices…defied expectations and rose to new heights” -- weren’t these blokes going to teach us to see ‘tomorrow’?

Anyway, as with so many risk management books, this one  opens with an example of risk-taking gone wrong.  The authors pick on someone as big as they can get: George Soros, the man who broke the Bank of England. 

Apparently, naive George often makes the mistake of looking at the past to predict the future. “It is no use looking over our shoulder and assuming that we can find all there is we need to know”, says Dembo and Freeman.   Quite true, but quite unconvincing since the man you pick is several times wealthier than you and prides himself as being a philosopher of some calibre.  I do not quite think the circumstances and the mistake are quite as simple as what the book relayed.

Modern man, say the authors, is faced with far too many choices, and they have written the book to rewrite the rules of risk, calling approaches to risk ‘outmoded’ and ‘flawed’. 

They bring up a pausing image of what we all go through each time we come to a fork in the road and have to make a choice:

“…we are faced with a single, unique decision that will probably not be repeated or will only be repeated a few times. We need to make that decision despite the uncertainty the future brings, and we need to make it now.”

Do I buy this house? Do I take this job? Should I get this insurance? Should I sell these shares now?

The book is about a new risk-taking framework which the authors introduce to make use of a risk concept they call  ‘Regret.’  D&F say this framework is ‘no different’ from the system they use ‘to help the world’s most sophisticated banks manage their risks.’ The framework is focused on the future, with the past taking a backseat (though not ignored).

Towards the end of the Introduction, there is a brief excursion on the etymology of the word ‘speculator’.  Anyone familiar with  Benjamin Graham’s or Warren Buffet’s writings know what pejorative connotations the word ‘speculator’ can bring.  Everyone coming from reading Graham will want to be known as ‘investors’ and not ‘speculators'.’

D&F gives us an etymology of the word that might change our minds. ‘Speculator’ comes from the Latin ‘specula’ which refer to watchtowers ringing the boundaries of the Roman Empire. 

When guards in the watchtowers see danger coming (barbarian hordes, for example), they would send signal to the next specula, which in turn sends a signal to the next one, until the signal reaches Rome, which dispatches its legions.

A speculator was someone who ‘tries to see dangers in the future and acts on them.’

More in the next post.

Risk and Uncertainty

The Institute of Risk Management’s “A Risk Management Standard” defines risk as the combination of the probability of an event and its consequences.

A risk is connected to an event, its probability, and its consequences.

An event that has no probability of happening does not pose a risk.  There is no risk that your project team will be kidnapped by aliens tomorrow.

An event that has a 100% chance of happening should not be treated as a risk.  If you do not pay your employees, do not place in your risk register that “my employees might not want to work without pay.”

If the event has no consequences for you, it is not a risk.  The collapse of the Nigerian stock market may affects thousands of people, but of no consequence to you (presuming you have no investments there).

If the event (if it occurred) has a positive impact on you, you can take advantage of that by treating it as a risk.