Farnam Street helps you make better decisions, innovate, and avoid stupidity.

With over 350,000 monthly readers and more than 88,000 subscribers to our popular weekly digest, we've become an online intellectual hub.

Economists’ Hubris – The Case of Risk Management

Very interesting.

In this, the third paper in the Economists’ Hubris series, we highlight the shortcomings of academic thought in developing models that can be used by financial institutions to institute effective enterprise-wide risk management systems and policies. We find that pretty much all of the models fail when put under intense scientific examinations and that we still have a long way to go before we can develop models that can indeed be effective. However, we find that irrespective of the models used, the simple fact that the current IT and operational infrastructures of banking institutions does not allow the management to obtain a holistic view of risk and the silos they sit within means that instituting an effective enterprise-wide risk management system is as of today nothing more than a panacea. The main worry is that it is not only academics who fail to realize this fact, practitioners also believe that these models work even without having a holistic view of the risks within their organizations. In fact, we can state that this is the first paper in which we highlight not only the hubris exhibited by economists but also the hubris of practitioners who still believe that they are able to accurately measure and manage the risk of the institutions they manage, monitor, or regulate.

Link