Ignoring the Black Swan

An article in this week’s edition of The New York Times Magazine entitled “Risk Mismanagement” provided a view into the use of statistical models in the world’s largest financial institutions to understand risk.  Value at Risk (“VaR”) models are the focus of the article and are criticized for not predicting rare, catastrophic events (known as Black Swans) such as the financial crisis that we have experienced.  

At the height of the bubble, there was so much money to be made that any firm that pulled back because it was nervous about risk would forsake huge short-term gains and lose out to less cautious rivals. The fact that VaR didn’t measure the possibility of an extreme event was a blessing to the executives.  It made black swans all the easier to ignore.  All the incentives — profits, compensation, glory, even job security — went in the direction of taking on more and more risk, even if you half suspected it would end badly. 

While the VaR models are not perfect, they should not shoulder the blame for the mismanagement of risk.  The mismangement of risk was driven by short-term decision making and pure greed.The New York Times Magazine


About Wheelhouse Advisors
Wheelhouse Advisors LLC is the publisher of The ERM Current™, an online publication and blog dedicated to providing the latest updates on current trends in Enterprise Risk Management & Control. Wheelhouse Advisors provides cost-effective Enterprise Risk Management & Control solutions to both large and mid-size corporations. To learn more about Wheelhouse Advisors, please visit our web site at www.WheelhouseAdvisors.com.

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