Saturday, December 06, 2008
I just heard a man - well, a financial 'expert' - say something like, 'If you do not understand risk, do not invest in the stock market.' Ahem, well, excuse me. Let us be clear - over the past twenty years no 'expert', no financial journalist, no broker, no politician, no trader and, above all, not a single banker has shown the slightest understanding of risk. Of all the astounding revelations that have emerged from this crisis, none is more staggering that the continued deployment by the banks of a mathematical system called Value at Risk. This involves some very sophisticated mathematics designed to console. Some grand fromage at Goldmans or wherever would daily be told that his 'value at risk' was x, he would smile and calmy spend the day drinking camomile tea and thinking he was a master of the universe. But VAR is nothing more than the bell curve in a fancy suit. The bell curve is useless in assessing complex system. Almost everybody outside the financial system has known this for years. But people in the City were too stupid and too impatient to read academic papers and they sat back with their VAR report thinking everything would happen inside the bell curve and anything that didn't couldn't possibly matter. What real statisticians and scientists know and what should be the lesson that sinks in from this crisis - but it won't - is that catastrophe will happen, it will happen sooner than you think and its impact will be worse than you expect. Get used to it, guys - but you won't.
Posted by Bryan Appleyard at 8:08 am