behavioral economics

Risk ≠ Uncertainty – Why all people, companies & governments are losing value faster in the era of VUCA

BLUF (Bottom Line Upfront) – A whole new approach is necessary in theory and practise and in my opinion, what we are working on is based on #heuristics and #evolutionary thinking (Heuristic Computing & Evolutionary Computing)

Risk is a weapon of mass destruction used by businesses and governments to blame a complex mathematical and statistical tools when things go wrong to protect their jobs, nothing more nothing less. Risk as a subject should not be taught or practised except when you play monopoly at home (in case you miss dinner)!

Very good and blunt work by Jon Danielsson Director of the ESRC funded Systemic Risk Centre, London School of Economics on risks and why it’s all fallacy and fantasy and actually change behaviours of participants based on risk data mining and models created

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Let’s begin with some data points;

  1. 2, the total number of AAA companies in Fortune 500, down 97% from 1980s
  2. Over-reliance on models one lesson of the sub-prime crisis ($12 Trillion according to the US GAO)
  3. One AI based fund ran over 40 Trillion trading desk scenarios to pick 1 or 2 and in less than two years shut down. They are not alone. Every financial company investing in AI/ML is based on the magic bullet approach and according to SPIVA data (active vs. passive investing) between 75% to 90% of all actively traded funds underperform!

It is clear in the world of #VUCA (Volatility, Uncertainty, Complexity & Ambiguity) a term developed by the US Army post the Cold War was to define the challenges in the real world. That is why we really need to re-visit Risk ≠ Uncertainty and understand why as people, professionals, companies and governments are all being #unbundled and have little or poor responses to Uncertainty.

The Bank of England in our opinion is a real pioneer in the financial world and looking at Uncertainty with brilliant minds like Gerd Gigerenzer.  Based III to Basel IV and vs a simple approach that does not require 1,000 pages of models, math, statistics and theory, rather fast and frugal heuristics to arrive quickly at a similar view of the banking efficiency and resilience.

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Gerd Gigerenzer said Risk ≠ Uncertainty. This is simple, clear and not understood. All people, companies and governments are all modelled around Risk, based on its definition in theory and practise is flawed by design.

A brilliant and defining book written 1921 by Frank Knight titled “Risk, Uncertainty and Profit” pioneered uncertainty vs. risk and summing up his brilliant insights.

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Business decisions;

  • situations which are far too unique, for any sort of statistical tabulation to have any value for guidance.

 

  • The conception of an objectively measurable probability or chance is simply inapplicable.

 

  • estimate the value or validity or dependability of our opinions and estimates, … same form us a probability judgment;

 

  • A ratio, expressed by a proper fraction. But in fact, it appears to be meaningless and fatally misleading to speak of the probability, in an objective sense, that a judgment is correct.

 

His conclusion was “In the society which we have described with both uncertainty and progress absent, there would be no motive for lending or borrowing value funds for the purchase of productive agencies”. In other words, the companies and entrepreneurs and governments that encourage and are designed for uncertainty will adapt and profit, while the ones designed around risk will fail with uncertainty.

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Summary from this great work is;

The key conclusion is that;

  1. nature does not select for maximum efficiency, but for a balance between the two opposing poles of efficiency and resilience.

2.Because both are indispensable for long-term sustainability and health,

1.the healthiest flow systems are those that are closest to an optimal balance between these two opposing pulls.

2.Conversely, an excess of either attribute leads to systemic instability.

3.Too much efficiency leads to brittleness ( caused by too little diversity and                       connectivity)

4. too much resilience leads to stagnation (latter by too much diversity and                           connectivity).

Summing up. The time for a whole new approach and that is what is most exciting. Everyone will be unbundled.

 

Signed

#Homo-Heuristicus | Evolutionary Architect  

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