Why are some of us so poor at Measuring Risk?
People (we) are generally poor at measuring risk. We have dozens of useful statistical tools at our disposal, we collect lots of data, or in some cases, we pour over data and discuss with our ‘experts’, or we just read the news and form (uninformed) ideas about what is reality. Then in business we make decisions that affect our company and its future. This approach is the norm. Why is this so?
News media needs to sell and attract and it seems to do so with one-liners that grab attention. I find often that those one liners are quite misleading and rarely based on all the facts. Further, even when facts or data are the foundation of an article, basic statistics sometimes ignored.
For example, in the early days of our recent major economic decline, the NY Times (2009) reported that “the American economy is contracting at its steepest pace in 50 years“. Subsequent in the article it was stated that economists are predicting “…the worst of the recession might have passed” due to a recent rise (then in early 2009) in consumer spending.” [1]
One month, one data point, and things are getting better? I think not! It is precisely this inane, unsubstantiated rhetoric that feeds the misinformation pipeline and clouds the already unknowns of risk.
Without a trend (in process control, we sometimes considered at least 5-7 data points in a direction to be a trend), each data point taken by itself is meaningless toward predicting with an certainty what will come next in the chain.
The other salient explanation for why people and businesses are generally poor at measuring risk is the unknown nature of catastrophic risk and our inability to apply systematic tools to that unknown. In reading roundtable proceedings from the Wharton School (2005) I was amazed to learn how accurate some of the comments were from noted experts in the fields of financial policymaking, banking, venture capital, insurance, and asset management. [2] During the roundtable session on financial policymaking, Sir Andrew Crockett offered the opinion that despite making ‘great strides’ in advancing the knowledge about managing risks, the unknown and unknowable present outcomes that simply cannot be predicted and that the statistics change over time. [3]
In the human resources recruiting arena, we often say that past performance is a very good indicator of future success. Not so in the financial risk world. In the opinion of more than one expert at the roundtable, (Crockett for sure) the past is not considered a good predictor of the future. Therefore, I think that critical financial risk exposures plague organizations over and over again simply because of the unknown nature of the most consequential hazards and events.
Apgar (2006) provides us with a number of very useful risk measurement tools. These along with other systematic methods of risk assessment can help businesses more accurately understand at least the known exposures to risk.
References:
[1] Uchitelle, Louis and Andrews, Edmund L., (April 2009). “Economy Decline in Quarter Exceeds Forecast“. NY Times. Retrieved 7-19-10: http://www.nytimes.com/2009/04/30/business/economy/30econ.html
[2] The Wharton School, “Financial Risk Management in Practice: The Known, The Unknown and the Unknowable“. a roundtable summary; Alfred P. Sloan Foundation, Mercer Oliver Wyman Institute 2005, 3-4
[3] Wharton, et al, Ibid
[4] Apgar, David. “Risk Intelligence-Learning to Manage What We Don’t Know“. Harvard Business School Press, Boston 2006
Risk Management | blogadmin July 19, 2010