tag:blogger.com,1999:blog-8817171247555815363.post2854740698645167109..comments2024-03-26T05:57:44.937+00:00Comments on True Economics: 7/5/2014: Simple vs Complex Financial Regulation under Knightian UncertaintyTrueEconomicshttp://www.blogger.com/profile/07350536454228478974noreply@blogger.comBlogger2125tag:blogger.com,1999:blog-8817171247555815363.post-67978371563194188552014-05-09T19:49:55.858+01:002014-05-09T19:49:55.858+01:00The thing that teachers about risk management that...The thing that teachers about risk management that I have always had, have tried to teach us that when you reduce either the 'impact' or 'probability' side of the equation, down close to zero,... you essentially cancel out the risk. <br /><br />Again, plugging the equation into a 'real world' example, as in Ireland. What we do find, before any crisis hit society, was that a lot of people were working diligently to reduce the 'probability' side of the equation. The impact of the crisis in Ireland, although very severe in reality, it relied on a low probability sequence of events to occur,... specifically at a time in Ireland, when the little economy there, was experiencing a 'growth cycle' for the first time in generations (for the first time ever perhaps in the entire history of the new state). <br /><br />I can recall that during the 2000's decade many descendants of Irish men and women who had emigrated to the United States or Great Britain, or elsewhere during the 20th century, would return to Ireland, in order to trace their ancestors and meet distant relations. It was not only a proud time for native Irish citizens, to think that they had 'arrived'. It was a proud time also for the descendants and distant cousins of the Irish, all over the globe. <br /><br />What we really had was a low probability sequence of events, that turned into an absolute misfortune on an impressive scale. <br /><br />But I think, that if we look back again to the theory of 'risk management', what you will remember is that idea of reducing the factor on either side of the equation down to close to zero, and one cancels out the 'risk'. <br /><br />I am not convinced, that there was an awful lot more that the authorities in Ireland should have done, or perhaps could have done to work on the 'probability' side of the equation. But looking at the 'impact' side of the risk equation,... there is a lot of scope of investigation, into what we could have done, on the 'impact' side of it,... that may not have eliminated the risk altogether, but would have greatly, greatly reduced the impact when it did happen, as a result of that awfully low probability catastrophe. Brian O' Hanlonhttps://www.blogger.com/profile/09185216066875647495noreply@blogger.comtag:blogger.com,1999:blog-8817171247555815363.post-31661241369483336372014-05-08T23:55:42.519+01:002014-05-08T23:55:42.519+01:00Boiled down to the most simple level, something th...Boiled down to the most simple level, something that most people do not realize, is that 'risk' is actually a hybrid concept, being comprised of the product of two elements. <br /><br /><br /><br />Risk equals - 'probability' multiplied by 'impact'. <br /><br /><br /><br />Like a lot of things, I guess, the science behind this makes a lot more sense, when we plug it into an example. It is so difficult to resist perhaps, making a reference to the 'impact' of the financial crisis upon society in Ireland. I mean, in the area of risk management theory, it would be hard to find any clearer example of an 'impact'. <br /><br />That is one side of the equation. <br /><br />We are very clear about one side of the equation, so we then need to look at 'probability'. This is the area, which does appear to cause difficulties in practice. Because it appears that a lot of people had underestimated the 'probability' of the risk maturing in Ireland during the crisis in the manner that it did, and having the level of impact that it did. <br /><br />This is very much the point that Marian Finucane might make on Irish radio (often in the context of discussions, where the name 'Morgan Kelly' seems to arise). That is, as Marian would say, if one opened their 'beak' in Ireland, and mentioned that we might be living in a bubble and headed in the 'wrong direction', one would have been subject to much abuse. <br /><br />I could honestly conclude, that I myself, would have been very annoyed by someone who raised doubts about assessment of risks, and probability of negative impacts, before the 'crisis' hit in Ireland in the late 2000's. Even after the crisis had finally hit, and people discussed with me, the fact that it was 'bad',... I would have been reluctant to accept the fact that the risk had matured as badly as it had done, even then. <br /><br />Risk as I mentioned is one of these strange things. <br /><br />It could not be simpler in terms of the equation. It is the pure hybrid of two 'concepts' that most people do understand very well - probability and impact. But when we put them together for some strange reason, we continually manage to underestimate the 'product' of these simple ingredients,... and even after the risk has matured, many of us, still manage somehow to live in complete denial. <br /><br />This was never illustrated in more stark relief perhaps, than in that famous RTE PrimeTime episode, in which Morgan Kelly gave his most 'bleak' assessment of the reality in Ireland in 2008,... and he was in the company of some extremely talented, extremely intelligent people, who refused to see it, when presented so plainly to them. If we honestly believe now in 2014, than many of the rest of us, could have redeemed ourselves any better on that occasion, we'd be very much mistaken I think. B. Brian O' Hanlonhttps://www.blogger.com/profile/09185216066875647495noreply@blogger.com