Nassim Taleb and his coauthors argue that conventional risk-management textbooks don't prepare us for the real world.
You don't have to look back far into history to discover this: No model predicted the 2008 financial crisis.
Black Swan events are almost impossible to predict.
Instead of perpetuating the illusion that we can anticipate the future, risk management should try to reduce the impact of the threats we don't understand.
Managers make six common mistakes when confronting risk: They try to anticipate extreme events, they study the past for guidance, they disregard advice about what not to do, they use standard deviations to measure risk, they fail to recognize that mathematical equivalents can be psychologically different, and they believe there's no room for redundancy when it comes to efficiency.
We don't live in the world for which conventional risk-management textbooks prepare us. No forecasting model predicted the impact of the current economic crisis, and its consequences continue to take establishment economists and business academics by surprise. Moreover, as we all know, the crisis has been compounded by the banks' so-called risk-management models, which increased their exposure to risk instead of limiting it and rendered the global economic system more fragile than ever.
Low-probability, high-impact events that are almost impossible to forecast we call them Black Swan events – are increasingly dominating the environment. Because of the internet and globalization, the world has become a complex system, made up of a tangled web of relationships and other interdependent factors. Complexity not only increases the incidence of Black Swan events but also makes forecasting even ordinary events impossible. All we can predict is that companies that ignore Black Swan events will go under.
Remember that the biggest risk lies within us: We overestimate our abilities and underestimate what can go wrong. The ancients considered hubris the greatest defect, and the gods punished it mercilessly. Look at the number of heroes who faced fatal retribution for their hubris: Achilles and Agamemnon died as a price of their arrogance; Xerxes failed because of his conceit when he attacked Greece; and many generals throughout history have died for not recognizing their limits. Any corporation that doesn't recognize its Achilles' heel is fated to die because of it.
- We think we can manage risk by predicting extreme events.
- We are convinced that studying the past will help us manage risk.
- We don't listen to advice about what we shouldn't do.
- We assume that risk can be measured by standard deviation.
- We don't appreciate that what's mathematically equivalent isn't psychologically so.
- We are taught that efficiency and maximizing shareholder value don't tolerate redundancy.