GLOBAL ASSOCIATION OF RISK PROFESSIONALS 27 MARCH/APRIL 07 ISSUE 35 Critique #1 By Aaron Brown Most people don’t think about risk. If it’s not raining, they don’t carry umbrellas. They get in their cars without walk- ing around to check the tires and for hidden obstructions. When things run smoothly, they focus attention elsewhere. “If it ain’t broke, don’t fix it,” is their motto. When things do go wrong, it’s “who could have imagined…?” Other people always carry umbrellas, don’t drive for fear of accidents and worry no matter how well things are going. They’re not thinking about risk either. They’re mere- ly obsessing about bad things. In the movie For Love of the Game, actor J. K. Simmons’s character chides actor Kevin Costner’s character for being late. Kevin’s character responds, “In 19 years, have I ever not showed?” J. K.’s character has the unarguable answer of worrywarts, “Well, that’s true of everyone until the first time they don’t show.” The first kind of person sometimes slips into the risk management profession and manages the appearance of risk. The second kind sometimes slips in and minimizes risk. But both are opposed to the goals of the profession: transparent reporting of risk and aggressive support for calculated risk taking. Reasoning from Big and Small We have two methods for investigating risk. First is analy- sis of historical disasters: market crashes, hedge fund blow- ups, financial institution scandals, etc. Second is analysis of common events — for example, using the distribution of daily price movements to predict future movements. Nassim Taleb’s new book, The Black Swan, attacks both of these methods. Taleb argues that historical analysis of rare events is poisoned by the narrative fallacy and that reasoning from everyday experience is an inverse problem. Risk managers rely on ineffective and illogical techniques.That's one of the main claims Nassim Nicholas Taleb makes in his controversial new book, The Black Swan. Specifically,Taleb argues that quants focus on statistical projection from common, ordinary events when unexpected, low-probabilty, high-impact events are what determine most profit and loss. He claims that when quants do consider the tails of the distribution, they overestimate the chance of past shocks repeating and ignore the possibility of unprecedented events. Do his criticisms make sense or are they off base? The following multifaceted article comprises a pair of book reviews (one authored by Aaron Brown and another written by Philippe Jorion), an in-depth interview with Mr.Taleb and a note from the author that further explains his views on risk management. Book Review/ Author Interview Cover Story: Part 2 The Black Swan:The Impact of the Highly Improbable Author: Nassim Nicholas Taleb Publisher: Random House ISBN: 978-1-4000-6351-2