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.'"

Re:Minmaxing ftw!

[sugarman]

Now why did anyone think this would be different when real money is involved, and thus the incentive to abuse the rules way higher?

Perhaps because those in the "roleplayer" and "policy wonk" sets have almost no-overlap?

While I'm all for using simulations in systems work, thinking the econ crisis is similar to the time your party killed an Ancient Red Dragon and then bought Greyhawk with the loot probably isn't too helpful.

Re:Liberal economics, Adam Smith, etc

[ultranova]

The difference with physics is that when physicists start saying "assuming that this body is of negligible mass and at non-relativistic speeds" they don't end their exposé with "thus we have a solution to the three body problem for three super massive black holes at 0.999 c"

But if we could repeal the physical regulations, so the three black holes would be free to contract amongst themselves how they wish to move without being burdened by nanny physics, we would have that solution !

Re:Not an Either/Or Situation

[Paul Rose]

Commonly used analogy in derivative trading: "Picking up nickels in front of a steamroller" (sometimes bulldozer).
Modest returns, low rate of failure, but really messy when you do fail...

Even a complex number?

[noidentity]

The Perils of Simplifying Risk To a Single Number

Even if it's a complex number? Or would that make it too imaginary?

Re:Gladwell's "Blowing Up"

[Chris Burke]

Personally I think the most surprising thing is that the risk factor for simplifying risk to a single number is 70%.