Sadder but wiser

The more you do, the more mistakes you are likely to make. Only those who sit on their hands are not infallible. Even wicked corporations hold such approach dear! The more we experience, the more nasty situations life puts us through, the opportunities to learn we receive. Lucky those who do not need to draw conclusions from their own missteps and wise those who intently observe fellow people’s slip-ups, analyse them and take precautions not to repeat them.

It all commences in childhood. I remember well when my mother warned me not to put a finger into a burning flame on a gas stove. Obviously, I refused to listen to her and burnt my finger. Lesson learnt – keep fingers away from flames. Alternatively, the lesson learnt could be to listen what you parents say. With hindsight, coming back to choices made by me when I was a teenager or a student, I recognise my parents were usually right (I have never admitted it to them, as such statement would have all appearances of asking for continual advice) and often ask myself what they would advise me in a specific situation, how would they react if I told them about my crazy idea or what they would rebuke me over. By the way, I recall now a training delivered by a coach who claimed parents in Poland do not support their children ingenious ideas, but do their utmost to discourage their offspring from pursuing their ambitions, especially the dicey ones.

I also wonder what can prompt humans to give up on silly activities that might severely harm them? Would throwing up all contents of one’s bowels prompt a binge drinker to become more restraint with alcohol, or would they need to commit a crime or lose a job to get the eye-opener? Would causing an accident persuade a fan of fast driving to stick to speed limits? Or would a severe fine be helpful enough? What else, except for unwanted pregnancy or contracting an illness, would convince a person who indulges in occasional sex to hold their horses? How heavy shortage of money would urge a reckless shopper to think twice before spending money on stuff they don’t need?

I strive to look at other people’s and mine mistakes. Watching humans stumble but not necessarily fall fills me with confidence that cool-headed approach to life pays off. Holding back before making hasty decisions, minding the consequences, putting oneself in someone else’s shoes and trying to guess their perception of a situation, these all make up precious guidance how to become wiser and avoiding the side effect of being sadder.

Lastly, I ponder upon circumstances which can throw an individual off their sanity. The one which instantly is brought to mind is falling in love, a state compared to mild intoxication, when sound judgement is said to be turned off or at best impaired. But symptoms of falling in love and impact on a daily life or an infatuated person changes with time. A teenager in love behaves different than a human in their mid-thirties. And I put it down to benefit of learning from mistakes made by many people.

Expect a break from blogging the next weekend. I am heading west for a short, or maybe longer road trip. This will be not just a sightseeing trip, but also an opportunity to be on my own (oddly enough, this is now something I am longing for) and to think things over, to return happier, but wiser.

Against the Gods

Got the book by Peter Bernstein as one of farewell gifts when leaving the employer in late July. I pledge it has taken me a while to read it from cover to cover. The book, although worthwhile, is not actually immensely gripping and anything but breath-taking, albeit I realise I might not be the perfect target reader.

The content of the book revolves around manifold dimensions of risk and its presence in humans’ lives. Uncertainty regarding what the future holds has kept humans company since origins of the mankind, however centuries passed by before this uncertainty was quantified and gave rise to the concept of risk.

Uncertainty of future outcomes is an indispensable part of life, however sources of it are a matter judgement. You can put down future events to luck, fate, God’s hands or to mathematical probability. Depending on how you approach uncertainty, you may handle it in several ways. If you believe what lies ahead can only hinge upon luck, fate or God, you can only sit on your hands and wait for what future brings. However, if you put faith in existence of any rational root, presence of likelihood, you can harness tools to manage risks you come across. The concepts of risk management evolved with time, as people began to give credence that they need not to solely rely or luck, faith and Gods. Thanks to this risk could be quantified and thus ready to be handled…

The book, among many concepts highlights some that are pivotal in understanding economics on every-day level and deserve to be mentioned here…

1. Insurance is the price to pay for taking away uncertainty. Insurance premium as a matter of principle must be higher than probability of adverse event against you insure taking place. It is not only about an insurer’s profit. The case is that a humans are usually risk-averse and prefer a small, but certain loss (insurance premium) to a small probability of a big loss.

2. The bigger the sample, the more likely it is to reflect reality. The nature generally follows normal distribution. The two sentences above are clichés, however they can be employed to manage population. As the author argues, in the past there were concepts that birth regulation should ensure that only most intelligent, clever, beautiful people should proliferate to make the society in next generations more valuable… In practice, without any regulations, it works the other way round, namely the underclass have more children…

3. Volatility and uncertainty are highly correlated. Oddly enough, markets are placid when risk tolerance is high, but when market participants turn risk-averse, price fluctuations intensify…

4. Derivatives itself are not evil, but they are one of useful in risk management. It has to be noted the book was written long before 2008…

5. Although the concept that decision-makers act rationally underlies many economic theories, practice reveals the perfect world does not exist; the prospect theory justifies why this happens. In effect, people’s choices can easily be affected by their perception of the situation, which in turn can be easily manipulated…

6. Carrot, contrary to many theorem, works better than stick. Truth be told, I forgot why exactly, but maybe if this thread is left unsaid, it will prompt somebody to reach for the book…

If I were to recommend the book for reading, I would be in two minds. It definitely deserves credit for interdisciplinary character. It makes several references to religion, psychology, sociology, philosophy, mathematics, statistic and history. It actually is a handbook of risk management history, putting stuff risk managers deal with every day into historical perspective. It rather broadens horizons than introduces new concepts.

The book can be, however, an excellent read for economic laymen. It is written in a clear language and might help one familiarise with concepts I dwelled on during my studies. It should be much more interesting for somebody coming across some economic theories for the first time than to me… As for the drawback, I see one evident – it was written long before the onset of the 2008 - ??? financial crisis (its author died in June 2009, aged 90) and fails to incorporate lesson to economic reasoning learnt from the crisis in terms of risk management.

Next week’s break from blogging will be sponsored by my ‘duty’ to be off for most of the weekend…

Taking chances

I was a first-year student, when, during a class in basic microeconomics, I first encountered the topic of risk from economic perspective.

Have you even tried to put in words what actually risk is?

In economics and finance, one has to distinguish between risk and uncertainty. The former must be measurable, the latter is not quantifiable. If the risk is measurable, it should be possible to estimate probability that a specific scenario materialises. In life we usually face uncertainty – hardly ever it is possible to make an educated guess on how probable it is that a choice we are making will prove right.

Those who have even learnt business English should have come across several verbs that go together with the noun ‘risk’. You can: accept, analyse, avoid, estimate, hedge, manage, measure, minimise, mitigate, quantify, run, take, tolerate, understand a risk; share it and divide it. Something can carry or pose a risk, something can be put at risk. ‘Risk’ as a verb and adjective ‘risky’ might come in useful quite frequently.

Economic theory distinguishes between pure and speculative risk. In the case of the former you might lose, or not, but you cannot win. Pure risk can be transferred to another party, willing to take such risk, this happens when you buy an insurance policy. In the case of the latter there might be one more outcome – you might also win. Modern financial engineering has devised many tools used to manage risks, transfer them between entities and “reliably” quantify it. When misused, those tool can result in worldwide financial meltdowns…

Economists have come up with a concept that different people have different tolerance of risk. Some are eager to take it, some avoid it, some are indifferent to it. As scholars claim, most individuals prefer not to take risks and make do with certainty equivalents. Most of us would rather take out an insurance, pay a fixed premium and reduce our exposure to a specific risk, many people do not fancy investing their money on volatile stock exchange and put them into bank deposits, on which they can earn lower, but “safe” income.

But what determines an attitude to risk a specific person has? Genes? Upbringing? Entourage? Education and awareness? Experience gained in life? Job and challenges it poses?

Why in different realms of life people have a totally different tolerance of risk? Some people drive like lunatics and risk their and other people’s lives but would never put their savings on the stock exchange. Others are not afraid to run up debts in form of mortgage loans for decades, but avoid taking professional decisions that entail responsibility.

Does eagerness to take risks influence the job one should take up? What should be the profile of an employee who works, like me, in risk management? (Incidentally, I recently heard in the risk division there’s no place for people with below-average IQ!) Surely they should have competence to assess and analyse risk, but how about the tolerance of various types of risks their employer would be exposed to, depending on their decisions? Of course, they are paid for taking care of someone else’s business, so private preferences should not matter at all. Once I triggered peals of laughter at work when I commented on potential highly speculative financing for a junk public company: “I wouldn’t put the bank’s money at such risk as my own”.

Financial institutions have their risk managers (who should be well paid ;-)), but human beings should be able to cope with uncertainty in everyday lives. Almost every time we take an important decision, the outcome is a mystery. Choice of path of education – whether you choose the right studies might impinge on your future self-fulfilment. Choice of a spouse – will influence your happiness. Both aforementioned decisions will also affect your financial standing, as well as the choice of career path.

Such decisions surely involve a bit of stress, as each even-tempered person should think twice, weigh in pros and cons, analyse what can go wrong. This can result in paralysis by analysis, but done prudently might help avoid mistakes, which in life are inescapable anyway. When choosing to study at SGH, I was not sure if this would be good for many; with time fortuitous decision proved right. When I got an internship in credit risk department I was not sure whether I would find my way there, but soon settled down very quickly and well there. Again a leap into the dark proved a good decision. I feel when one day I’ll pop the question I will have doubts whether this woman would really be the one I want to spend the rest of my day with.

It is probably the saddest point of this post. These days nothing lasts forever, promises are broken easily and without remorse. Is my observation, that people no longer hold stability as dear as they used to in the past, right? I recently witnessed a marriage breaking up just because one of the spouses found a few years younger, sexually attractive partner. After a few months the new couple have shaken off the short-lived affection and came to a conclusion that together they cannot face everyday hardships and actually they do not fit each other. Guess how one of the spouses, who left the family for a fleeting adventure, the other, cheated-on spouse and their children felt… Now they are back a family and are trying to pick up the pieces of the broken-up marriage and start a new life. But I know how the ex-lover of the spouse feels and oddly enough that person currently appears to be the most hurt, deceived and disillusioned.

For sake of clarity, I do mention the sex of the unfaithful spouse, just not to spread stereotypes – both women and men cheat on their partners… Also for the sake of clarity I am not the aggrieved hero of the story. But there were times when I found flirting with older (in their 20s and 30s) women in relationships exciting (then I have grown out of this silly sort of entertainment). But except for realising those were childish games it occurred to me that if a woman dumps her boyfriend for me, one day she might be capable of doing the same with me for another guy.

There is not just the fear that someone might hurt me, what worries me is that I may inadvertently break a promise given to someone. One day my common sense might tell me to take a path which will give me some stability, but will not be the most preferable, but some time later I might feel the temptation to try my foregone luck. Life is full of wasted chances, but is it worth taking a chance, heedless of consequences?

And you can speak about any risk here? Only uncertainty is left…