The Perils of Simplifying Risk To a Single Number

A few weeks back we discussed the perspective that the economic meltdown could be viewed as a global computer crash. In the NYTimes magazine, Joe Nocera writes in much more depth about one aspect of the over-reliance on computer models in the ongoing unpleasantness: the use of a single number to assess risk. Reader theodp writes: "Relying on Value at Risk (VaR) and other mathematical models to manage risk was a no-brainer for the Wall Street crowd, at least until it became obvious that the risks taken by the largest banks and investment firms were so excessive and foolhardy that they threatened to bring down the financial system itself. Nocera explores the age-old debate between those who assert that the best decisions are based on quantification and numbers, and those who base their decisions on more subjective degrees of belief about the uncertain future. Reliance on models created a 'false sense of security among senior managers and watchdogs,' argues Nassim Nicholas Taleb, who likens VaR to 'an air bag that works all the time, except when you have a car accident.'"

Comments

Second attempt.

[khasim]

http://www.nytimes.com/2009/01/04/magazine/04risk-t.html?pagewanted=all

Re:Math?

[Alpha830RulZ]

Tell me the meaningful service the stock market provides

1) the stock market makes it possible to invest in companies at fractional rates, allowing capital to flow from small pools (you and me) to companies who seek investment capital. Without the stock market, only large investors could invest in companies, which would make it more difficult for enterpreneurs to raise funds.

2) The stock market provides liquidity for those investors who have new information about companies, and therefore want to get rid of their investment. The market makes it possible to sell. Again, this makes people more willing to provide investment funds, because of the existance of an exit strategy/mechanism.

This does not change the fact that most of the participants are lying thieving bastards, and that regulation is needed. That said, though, stock markets are an essential mechanism for the distribution of saved wealth to productive uses for that wealth, and are close to as important as money itself for allowing the economies of the world to function.