It’s Not Blue!

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Steven Johnson, in his book “Where Good Ideas Come From”[1], outlines the academic work of Charlan Nemeth, a Berkeley psychology professor. 

 

Dr. Nemeth would show research subjects a colored card – for example a blue card – and ask them to free-associate on the color card they had seen.  When shown the card by themselves, the answers were fairly predictable.  However when shown the colored card in a group where there was a research plant who would deliberately talk about the card in erroneous terms (It’s not blue, that card is green!), the responses from the other research subjects were much more nuanced and varied.  Dr. Nemeth’s conclusion was that “… deliberately introducing noise into the decision making process ends up making more original connections than the groups that had been given only pure information.” 

 

I believe that there is a lesson here for risk management departments.  As I have argued in many different blogs – both explicitly and implicitly – risk management departments suffer from group-think.  More specifically they suffer from model and mathematical group-think.  I have argued for introducing sociologists (who are mainly qualitative, not quantitative in focus), and for eclectic modeling and thinking.  Risk management in striving to become a rigorous discipline has perhaps become too dogmatic and pure.  Perhaps, as Dr. Nemeth’s work shows, it is time to contaminate the field a bit with impure thoughts as to make newer and more efficient connections. 

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[1] Follow the link for more on this:  http://tinyurl.com/3cl7rrcPublish

 

The Psychology of Motivation: What motivates you determines your risk management focus

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

My colleague, Rick Nason has recently done a series of blogs on “Models “and on occasion peers into the world of algorithm based risk management.  While these risk management techniques (processes?) have their place there is, as a supporter of behavioral economics,  a greater force at work determining your approach to risk management and in turn, the way you handle and quantify risk.  This greater force is looked at by Ms. Heidi Grant Halvorson, a motivational psychologist who believes that it is how we think about the goals we pursue that determines our views and management of risk.

 

When we pursue a goal we make many decisions along the way and according to Ms. Halvorson we make our decisions based on either what we might lose or what we might gain.  In other words we may have a prevention focus or a promotion focus.  Sadly, it is pointed out that the prevention focus, while helping your organization (or you personally) in the short term, in the longer term it will be those following a promotion focus that will come out on top.  For the “promotion motivation is about getting ahead, maximizing your potential, and reaping the rewards” and “never missing an opportunity for a win, even when doing so means taking a leap of faith”. 

 

With this in mind, what is your “focus”?  How do you feel it impacts your risk management strategy and just as importantly, the road to achieving your goals?

 

For more on Heidi Grant Halvorson’s thoughts click on the link:  http://tinyurl.com/3ne63df

Models - Part 4

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

In the initial blog in this four part series about models, I talked about how models were a balancing act.  In the first blog I discussed how models were a balancing act between being too general (and useless), and too specific (and also useless).  In the second blog I inferred that models were a balancing act between hiding things and not hiding things.  In the third blog I implied there needed to be a balance between information provided by models and the actions taken by managers.  (OK, that is a bit of a stretch, but I think you get my point.)

 

In this last blog for the series I would like to bring up the balance between keeping a model static and adapting it to changing conditions.  A model that is constantly changing (through time) will not provide much guidance or comfort, as it will not be capable of being tested under different conditions.  Likewise a model that never changes to account for developments in knowledge or industry practice will also not be of much use. 

 

The upshot of all of this talk about models and balance is that using models is really tough!  Too often regulators, managers, and other stakeholders believe that if the right model is selected that all will be great.  That is far from the truth and the reason why we need to get back to an emphasis on managing and less of an emphasis on modeling. 

 

Do you take exchange rate views?

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

I recently attended a financial conference.  Near the end was a panel of 3 economists who each gave their views on the economy. Always an interesting session as economists usually give polished, well conceived and authoritative sounding presentations.  The last question they were asked, an old favourite, was what they expected the US dollar / Canadian dollar exchange rate to be in one year’s time.  One economist thought the Loonie (Canadian dollar) would be weaker, one thought it would be stronger and the third thought it would be about the same.  Usually you might expect 6 different answers from 3 economists but in this case, the question only allowed for 3 possibilities and we got them all.  Each economist backed up his forecast with very sound reasoning and was very convincing.

 

In discussing foreign currency risk with potential clients, we are often told that banks have great expertise and provide very good views on currencies and so they follow their bank’s advice and manage their hedging strategies accordingly.  Do you take a view in managing your company’s foreign currency exposures, either your own or that of your bank or trusted advisor? 

 

Two of the economists at the conference work for banks and the third for a highly respected institution.  Each economist at the conference backed up his forecast with very sound reasoning and was very convincing but 2 of them will be wrong and the only correct one will be only correct directionally.

 

As of today, each forecast outcome is possible but only one will happen – to some unknown extent.  It depends on many factors, including a number in process at present as well as “known and unknown unknowns” and psychology. 

 

So in identifying, quantifying and managing your foreign currency risks, the lesson is that you should not include your view as a significant factor in the equation.  We have seen many companies that do this and regret it sooner or later.

Models - Part 3

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

What exactly do models do?  They tell us about part of a system (acknowledging – since you did read my previous blog – that they hide stuff).  But what do models actually do?  What actions do they perform?

 

Of course models do not act.  Hopefully however they cause someone to act, since risk management is not a spectator sport.

 

Do you act based upon your models, or does your risk management department hope the models themselves take care of the issues and seize the opportunities by themselves?  Which is it?  Is risk modeling the be all and end all of risk management?  Is there a disconnect between the people who build the models and the people who need to act based upon the models? 

 

Wow – if only models could actually do more.