Yes, No, Maybe So

 

*/By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc./*

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We like to think that with our advanced intelligence and our advanced
technologies and techniques that we have created a yes / no world.  Perhaps
that is true for simple problems, but for virtually all problems worthy of a
manager's attention or the analysis of an expert, the answer is almost
always "maybe so".


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Are you sure you don’t have FX exposures?

 

*/By Stephen McPhie, CA
Partner, RSD Solutions Inc./*

/(Repost of blog from May 15, 2012)/

So your company operates only domestically and you are satisfied that all
purchases and sales are in domestic currency.  No need then to spend any
more time thinking about exchange rate volatility.  Are you sure?  How
about your major suppliers?  Or your major customers?  Their currency
exposures could affect you greatly. 

If your supplier gets a lot of inputs from abroad, he may be forced to jack
up his prices to you if the domestic currency weakens.  Or if your sell
inputs to a major customer who sells much of his product abroad, you are
vulnerable to him passing on some or all of his currency exposures to you. 
And of course, if your currency strengthens, you may suddenly be hit by a
flood of cheap imports competing with your products.

So are your risk systems geared up to look at the bigger picture?

Pictures

 

*/By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc./*

*/Follow us on Twitter/* [1]

In the September 6 issue of the Wall Street Journal, Stephen Hawking wrote a
short essay that describes the writing of his bestseller A Brief History of
Time.[1] [2]  It is a very interesting account of how a very unlikely book
became a best seller.  One of the aspects of the book that allowed it to
become so popular is that it explained theoretical physics in a way that most
people could (sort of) understand. 

Part of getting a very mathematical subject understandable to the masses is
to minimize the need for advanced mathematics.  In this article Hawking
makes a comment about this that I find to be very fascinating.  He writes,
"I don`t care much for equations myself.  This is partly because it is
difficult for me to write them down, but mainly because I don`t have an
intuitive feeling for equations.  Instead I think in pictorial terms, …"

There are two things I find fascinating about this statement that are also
relevant to risk management.  The first is that the great physicist Stephen
Hawking does not have an "intuitive feeling" for equations.  The second
is that he thinks in pictorial terms.

How many risk managers are concerned about having an intuitive feeling for
the risk situations they are trying to quantify.  How many risk managers,
particularly the most mathematical trained, are concerned with their
intuitive understanding of a situation?  Furthermore, how many risk managers
think in pictorial terms?  I suspect that many senior executives and Board
members think in pictorial terms.  If it is good enough for Stephen Hawking,
it ought to be good enough for the vast majority of risk managers.

------------------------------------------------------------------------------
[1] [3] Stephen Hawking, Stephen Hawking`s Brief History of a Best Seller,
Wall Street Journal, September 6, 2013

 


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[2] #_ftn1
[3] #_ftnref1

International Development

 

*/By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc./*

*/Twitter/* [1]

I just finished a book on international development by Samir Rihani.  The
title of the book is Complex Systems Theory and Development Practice:
Understanding Non-linear Realities.  It is a very thoughtful and well
written look at the history of international development.  As with most of
my blogs, you are probably wondering what the heck this has to do with risk
management.  There are two things.  The first is that the book takes a look
at international development in the context of complex systems, which of
course is an area of interest to me and an area to which I think much more
interest needs to be paid by the risk management community.   I could of
course write the blog on this point alone. 

However in reading this book a much more significant thought hit me.  In his
book, Dr. Rihani points out the failure of the linear thinking world when it
comes to international development.  He points to the enormous efforts in
terms of resources and time that the IMF, the WTO and the World Bank (to name
just three international organizations involved in international development)
have put into trying to get the undeveloped world out of poverty.  He also
points out the equally (and depressingly) poor results have that have been
achieved.

Dr. Rihani"s thesis of course is that the failure of these august
organizations is to apply one size fits all linear (complicated) thinking to
systems that are inherently complex.  Before I too easily digress into yet
another rant about the need to appreciate and develop complexity thinking, I
believe it is worth a moment's thought to ask how effective major
international organizations such as Basel have been at preventing financial
disruptions.  Is there a parallel with International development?

International development, just like international risk management, basically
began in earnest in the shadow of World War II, although earlier adjustments
began with the Great Depression.  As Dr. Rihani argues, the record in
relieving poverty in the undeveloped world has been abysmal.  Any
corporation with the same track record of results given the resources
allocated to the problem would have been shunned by investors long ago.  But
has the record of cooperation for the purposes of keeping the international
financial system free from excess volatility been any better?

Okay, I cannot resist.  I am back to complexity again.  I believe there are
parallels between risk management, Basel, Sarbannes Oxley, Dodd Frank, and
the similar well-meaning actions of agencies cooperating to enhance
international development.  Both ignore complexity in favour of complicated
thinking.  Both have less than efficient results.  Which community will
wake up to the fact first that it's not complicated?


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College Football

 

*/By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc./*

*/Twitter [1]/*

College football is back baby!   I love college football – much more than
watching the pros play – which I also enjoy.  But there is a difference to
the college game.  First off it is kids playing (although I realize that to
their face I would call few of them kids.) 

Everyone can be unpredictable, but kids in particular.  When you are in
college you have a million things running through your life, of which
football is undoubtedly a big part – but it is only part.   With the pros
they also have many things running through their heads, but many of them are
football connected.  That makes their job is some sense much easier and much
more predictable.

Secondly in college football, the level of experience and expertise is not
there.  Also there is greater disparity between the best and the worst. 

Finally (for this list anyway) there is a greater role for passion.  In the
pros, it is a profession.  In college football I still believe (perhaps
willingly naively) that it is a passion for the big majority of players. 
Passion brings ebbs and flows.  Passion means that on any given Saturday
that any team can beat any other team provided the passion is present. 
Passion means that the human element (both individually and collectively as a
team) is always present and a factor.

For these reasons (and many others) college football is filled with
unpredictability, with crushing losses and unthinkable upsets.  The
unexpected becomes expected.  It means beauty and ugliness.  It implies
that the full range of outcomes, and then some, are able to happen.  It is
risk management played out to a conclusion within approximately 3 hours. 

Gotta love it baby!


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Thinking Templates

 

*/By Rick Nason, PhD, CFA/*
Partner, RSD Solutions Inc.


I am currently in the middle of marking exams for a MBA course I teach on
Quantitative Decision Making.  In this course, as in all of my courses, I
strive to convince students that knowledge is a commodity and learning how to
think is more important.  In part to walk the talk, I allow my students to
have open book exams and to use a computer on the exam.  This of course
means that they can use computer software packages etc.

In preparation for the exam, many students will create answer templates for
the types of questions that they expect me to ask.  Some students go so far
as to seek out commercially available packages.  I am all in favour of this,
since in the process of doing so the students are probably doing a better job
of studying than they would if they were attempting to memorize a textbook (a
deadbrain exercise in and of itself).

The problem arises however with students who blindly follow their
templates.  Rarely in life does a problem conform exactly to whatever
template you might construct, and in the case of my exams that is also
generally true.  However students are more confident in the ability of their
template than they are in their ability to think.  Or perhaps they are too
lazy to think and thus rely on the template.  Either way it generally does
not end well.  Templates do not think.  Furthermore, any problem that is
solvable by a template is probably not worthy of the attention of someone
with a graduate degree such as an MBA.

In risk management we also tend to rely on templates.  (Anyone seen a risk
audit template?)  In regulation we are almost totally reliant on templates
– although bureaucrats would never label their proclamations as such.  As
with the students writing my exams who rely on a template, risk practitioners
and companies (and regulators) that rely on templates see outcomes that are
rarely satisfactory.  Templates do not think.  The real world rarely
conforms to a template except in the most simplistic of situations.

I realize that many consultants rely on templates – they generally have
fancier names for them.  Many consultants market themselves on the strength
of their template(s).  But again, templates do not think.  Templates do not
adapt.  Templates do not create paradigm shifts.  Templates do not see
unique opportunities.  Instead templates are static, backward looking,
unthinking processes that time and reality quickly pass by.

Now if only there was a foolproof template for marking.

Perfect

 

*/By Rick Nason, PhD, CFA
Partner, RSD Solutions Inc/*

What if everything was always perfect with a company?  In other words, what
if a company never made a mistake, never had a debacle, and never made the
front page of the business news for all of the wrong reasons?  Furthermore,
what if projections were very clear that this good fortune would continue
indefinitely into the future?   Such a company is obviously fictitious, but
would our fictitious company still need a risk management unit?

Those who argue that risk management is solely to take care of downside risk
would clearly answer no – the company would not need a risk management
unit.

Those who subscribe to the idea that risk is maximizing the probability and
magnitude of good risk events happening, while also managing so as to
minimize the probability and severity of bad risk events would argue yes.

Just because a company does not suffer downside risk does not mean that it is
perfect.  If anything it probably means that the company is stale and far
from maximizing opportunities.  In fact, it is likely that a company that
never experiences downside risk is a company most in need of a competent risk
management unit.