Can of Worms

By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
www.RSDsolutions.com
info@RSDsolutions.com

The Economist really put one out there two weeks ago.  On its website, the well known British based newspaper had the audacity to ask “Should MBA students care about their professor’s research?”  http://www.economist.com/node/16291542?story_id=16291542

Before I fall into this lake of quicksand a few disclosures are in order.  Although I do research I am not the most prolific referred published academic on the face of the planet.  To be frank, for the field of finance the bar to get into a top journal is so far adrift from the practice of finance that it seems nonsensical to attempt to publish.  (I am sure that will make me popular with the editors of the Journal of Finance.)  Also in the interest of full disclosure you should know that I teach ERM, as well as Derivatives (and a variety of other finance courses) in a variety of business school programs.  Oh, by the way, I also win teaching awards … funny.

In my opinion my field of finance (under which risk management generally falls) suffers from a major case of physics envy.  For a long time B-School professors were thought to be the weak link of the academic food chain.  Research was traditionally based on anecdotal evidence.  That all changed with the construction of financial price databases.  Finance was the field to lead business academics to scientific respectability with quantifiable studies.  Ever since, the academic field of finance has become addicted to quantification to the almost total exclusion of all else. 

My background is actually in physics, and indeed it was the ability to use my physics training that led to my changeover to finance.  However my adopted field has gone way too far – in my opinion.  In finance and risk management we need to realize that not everything can or should be quantified.  Some of the greatest problems do not have numbers attached (or they might have numbers but not enough to get the desired level of statistical significance required for publication.)

The irony of the importance placed on publication is that little if none of the academic literature is, or could be, read by the vast majority of practitioners.  Even the practitioner publications in finance have become too mathematically sophisticated to be read by practitioners, with the exception of the few who might have advanced degrees in math or physics. 

The irony of the Economist article is that even fewer MBA students have any hope of understanding the concepts that are put forth in the top finance journals.  How many MBA students (not specialized Financial Mathematics students) have a background in stochastic calculus, or econometric techniques such as generalized method of moments which are the minimum entrance requirements for understanding current research?

I understand the argument that you do not need to understand the math if the research has useful conclusions.  My counterargument is that the vast majority of top level research has math as the end point and any practical applications are simple a happy accident of the research.  Think I am out of it?  Then send me a note telling me a piece of academic research in the last 5 years that has made a difference in your operations.  (I am sure that there are useful research articles, but unfortunately it takes a long time for them to bubble up and attract attention as they are generally not considered to be sexy enough for the top journals.)

Qualitative risk management and enterprise risk management in particular are relatively new fields of academia.  (Yes, I know that insurance studies, as well as the study of derivatives have been around since business schools have been popular.)  Therefore there might be a hope that risk management does not fall into the trap of worshiping the academic quant gods.

Follow-up of “The Fantods of Risk: Essays on Risk Management” Part 3

Two Quotes (Well, Ok Three)

by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
www.RSDsolutions.com

In a previous blog I reviewed H. Felix Kloman’s book “Fantods of Risk:  Essays on Risk Management”, published by Seawrack Press, 2008.  The Amazon link is:
http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_1?ie=UTF8&s=books&qid=1276378958&sr=8-1

As a follow-up to my review, I thought I would post a couple of thoughts that Kloman’s book produced in my own little brain.  I hope you find these blogs interesting so that you will be inspired to go get Kloman’s book.  The field of risk management needs more people to know about Felix Kloman, his writing and his books.

In this blog I want to focus on two different quotes of others that Kloman uses in his book.

“I’ve come to the conclusion that there is nothing good that doesn’t have bad consequences and nothing bad that doesn’t have good consequences.”
Pete Seeger
The second quote is:

“We cannot legislate for the unknown consequences of consequences of consequences.”
Isaiah Berlin

Now, the question to ask yourself is:  “when was the last time you read a book that quoted both Pete Seeger and Isaiah Berlin?”  That is what makes this collection of essays so interesting and useful for the risk manager.

For those in the risk community who think this is stretching it, Kloman also quotes the well known academic risk textbook writer Carol Alexander,

“Quantification will never be a substitute for good risk management”. 
Carol Alexander
There, hopefully that makes everybody happy.  (Probably not, but then again is the goal of risk management to make everybody happy all of the time?)

Follow-up of “The Fantods of Risk: Essays on Risk Management” Part 2

Riskipedia


by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.

In a previous blog I reviewed H. Felix Kloman’s book “Fantods of Risk:  Essays on Risk Management”, published by Seawrack Press, 2008.  The Amazon link is http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_1?ie=UTF8&s=books&qid=1276378958&sr=8-1

As a follow-up to my review, I thought I would post a couple of thoughts that Kloman’s book produced in my own little brain.  I hope you find these blogs interesting so that you will be inspired to go get Kloman’s book.  The field of risk management needs more people to know about Felix Kloman, his writing and his books.

Does your organization have a Riskipedia?  What the heck is a “Riskipedia”?  Well Kloman has hit upon the idea of a Riskipedia as a resource and mechanism for all employees (and perhaps stakeholders) of an organization to input their views on risk assessment in the organization.

Such a transparent self-analysis and reporting of risk assessments would definitely increase the transparency and relevance of risk monitoring in the organization.  It would also dramatically help develop a risk culture within an organization. 

The idea of a Riskipedia has some other precedents.  For instance McKinsey (as well as other consulting companies) go to great lengths to create a database of consulting projects that future consultants can use as learning templates as they develop ideas for similar situations and assignments.  Having such a database greatly aids in efficiency and institutionalizes and synergizes knowledge.  (Great Scott!  That last sentence sounds like something out of one of my MBA classes – sorry about that.)

How would your organization use a Riskipedia?  Would it be useful?  Would it be allowed?  (Is transparency something your organizations talks about but rarely practices?)  Who would be the most frequent users and / or contributors?  Would its use increase or decrease with time?  Would it make the organization less risky?  (Whatever that means.)  Fun questions and a neat idea.

Follow-up of “The Fantods of Risk: Essays on Risk Management” Part 1

Part 1:  Three Unsolved Problems 

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

In a previous blog I reviewed H. Felix Kloman’s book “Fantods of Risk:  Essays on Risk Management”, published by Seawrack Press, 2008.  The Amazon link is http://www.amazon.com/Fantods-Risk-H-Felix-Kloman/dp/1436302269/ref=sr_1_1?ie=UTF8&s=books&qid=1276378958&sr=8-1

As a follow-up to my review, I thought I would post a couple of thoughts that Kloman’s book produced in my own little brain.  I hope you find these blogs interesting so that you will be inspired to go get Kloman’s book.  The field of risk management needs more people to know about Felix Kloman, his writing and his books.

In this blog I would like to point out Kloman’s “three problems that remain unsolved”.  Before I get to his three problems, what would you answer if asked what three problems of risk management were that remained unsolved? 

If you are like most risk managers, you would probably have a hard time limiting your list to just three problems of importance that you thought remained unsolved.  Probably within your own organization you can come up with at least 10 risk problems that you believe are core and that you would give your eye-teeth to have solved. 

Perhaps it is ironic that as risk managers we are trained to think of problems.  Perhaps the title of CRO should be more aptly named Chief Worrier and Problem Spotter.  However that leads into the first unsolved problem that Kloman states (they are on page 101 if you are following along).  Paraphrasing, Kloman states that the first unsolved problem of risk management is that of “seeing risk as a negative result”.  I suspect that many risk managers (without the experience and insight of Kloman) are now scratching their heads and saying “Huh?!?!?  How in heck can that be an unsolved problem of risk management, much less a major unsolved problem?”  Next time you use a mathematical model that incorporates standard deviation or variance, then you might be able to see the disconnect.

I will never forget the first time I went to a risk conference sponsored by an auditing organization.  I was one of the few people in attendance who had never conducted an audit.  However I was reasonably confident in my knowledge of risk.  I found out real quick that I was real stupid, or else I had entered the wrong conference!  How the auditors thought about and acted on risk was dramatically different from my views.  Later I learned the insurance risk masters thought very different yet again.  Likewise one of my best friends is an expert in workplace safety and a “risk-expert” as well.  He and I have a difficult time conversing on risk issues since we speak the same words, but they seem to have very different meanings!  This brings up Kloman’s second unsolved problem of risk management – namely that risk is limited to specific areas of expertise.  Taking the liberty to expand on his idea, I take this as a call to develop more universal standards and concepts of risk that can be used and applied across disciplines.  (You might interpret Kloman’s view of this concept very differently than I did.)

When asked what you organization’s risk unit’s objective is, the responses will likely vary widely within any given organization.  Different managers (from outside the risk unit) will have their own responses, with the likely theme that the risk unit is the “Department of No!”  If you ask the risk unit what it believes its goals and objectives are, you are also likely to get a range of responses.  This brings us to Kloman’s third unsolved problem of risk management which is that the goal of risk management is too restricted.  More accurately Kloman states that the goal of risk management has become “corrupted” on “improving shareholder value”.  I will let you read Kloman’s response to this problem (I have to admit that I am not sure that I am in 100% agreement with him on this point). 

I asked you at the start of this blog what you thought were the three greatest unsolved problems in risk management.  Now the interesting question is this:  did you have the same problems as Kloman?