Wall Street’s Game of Risk

A relatively thoughtful piece from The New York Times Magazine on the risk metrics used by Wall Street, especially the now notorious Value at Risk (VaR).  However, it still seems like neither the author nor the risk managers they interviewed really get what Taleb is saying.  Or possibly they’re just not willing to admit the implications of what he’s saying: that market outcomes, especially when investing is focused on the short term, are dominated by so-called “rare” events.  And that the consequence (as one of the managers even says outright), is that a lot of the investment banks don’t really have a business model.

Except, of course, for the fact that they can count on the public coffers if they all arrange to go bankrupt simultaneously.  Better, in this case, to fail in a conventional way along with everyone else, and be bailed out, than to play your own game for the long term, like Warren Buffet, and either succeed unconventionally, or have to take responsibility for your own failures, which are then likely not to take place at the same time industry wide.

We’re playing the same game of fat-tails chicken with Earth’s climate, and that story will eventually have the same ending if we are unable to generalize the lessons of this relatively innocuous financial disaster.

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