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Plight of the Fortune Tellers

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Plight of the Fortune Tellers

Why We Need to Manage Financial Risk Differently

Princeton UP,

15 min read
10 take-aways
Audio & text

What's inside?

A penetrating, skeptical analysis of the weaknesses in financial risk management – with recommendations for repair.

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Editorial Rating

8

Qualities

  • Applicable

Recommendation

Reading this book is like reading the prophecies of Cassandra, whose fate was to speak the truth to the unbelieving. In the wake of the fiscal crisis, no one can question the observation that the practice of financial risk management has serious flaws. Business journalist Riccardo Rebonato’s discussion of why and how financial institutions misunderstand and mismanage risk provides valuable insights. He works to make his ideas accessible beyond the narrow circles of financial economists and quantitative risk managers. He uses no equations in the text, and his few graphs are clear and accessible. He states his case against excess reliance on statistical methods in plain language. getAbstract believes that his analysis should interest any manager or regulator whose responsibilities include oversight of finance.

Summary

Confused Risk Managers

Financial risk managers are dangerously confused. They believe in the possibility of estimating risk with extreme precision and they think that exact, quantitative metrics provide enough information to make the right decisions about risk. This is not true, and the consequences of their confusion could endanger the entire financial system – even the so-called “real economy.” Risk managers analyze risk using a misleading approach to probability.

The problem is that financial risk managers calculate the probability of complex, uncertain events as if they were calculating the probability of a flipped coin coming up tails. Yet, probability exists in several forms and ignoring that fact leads people to reach the kinds of decisions that human beings are actually ill equipped to make. The more accurate approach would be to think of some kinds of probabilities as if they were beliefs or to regard them as the implications of previous decisions. Instead, contemporary risk management focuses on low-probability, high-impact events, like natural catastrophes.

The development of new financial instruments and markets has benefited the economy. Such instruments...

About the Author

Riccardo Rebonato is global head of market risk, quantitative research and quantitative analysis at the Royal Bank of Scotland. He is visiting lecturer in mathematical finance at the University of Oxford and adjunct professor at the Tanaka Business School, Imperial College London.

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