Understanding Risk - Risk explained to a sixteen year old

By Girish Menon

Risk is the consequence one has to suffer when the outcome of an event is not what you expected or have invested in.

For e.g. as a GCSE student you have invested in getting the grades required by the sixth form college that you wish to go to.

The GCSE exam therefore is the event.

From an individual's point of view this event has only two possible outcome viz. you get the grades or you don't.

Your investment is time, money and effort in order to get the desired outcome.

The risk is what you will have lost when despite all your investment you did not get the desired grades and hence you are not able to do what you had wanted to do.

From a mathematical point of view since there are only two possible outcomes one could say that the probability of either outcome is 0.5.

Your investment with spending time studying, taking tuitions, buying books.... are to lower the probability to failure to as low a figure as possible.

Can you lower the probability of failure to 0? Yes, by invoking the ceteris paribus assumption. If all 'other factors' that affect a student's ability to take an exam are constant, then a student who has studied all the topics and solved past papers will not fail.

Else, some or all the 'other factors' may conspire to bring about a result that the student may not desire. It is impossible to list all the 'other factors' and hence one is unable to control them. Hence, the exam performance of even a hitherto good student remains uncertain.

If the above example, with only two possible outcomes, shows the uncertainty and unpredictability  in the exam results of a diligent student then one shudders to think about other events where all the outcomes possible cannot be identified.

Let's move to study the English Premier League. Here, each team plays 38 matches and each match can have only three outcomes. When one considers picking a winner  of the league one could look at the teams, the manager etc. But, 'other factors' such as injury to key players, the referee...... may scupper the best laid plans.

When one looks at investing in the shares of a company one may study its books of accounts. Assuming that these books are accurate, this information may be inadequate because it is information from the past and the firm which made a huge killing last season may now be facing turbulent conditions of which you an outside investor maybe unaware of. The 'other factors' that may impinge on a firm's performance will include the behaviour of the staff inside the firm, behaviour of other firms, the government's policies and even global events.

Yet, as a risk underwriter one has to take into account all of these factors, quantify each factor based on its importance and likelihood of happening and then estimate the risk of failure. The key thing to remember is that the quantitative value that you have given each factor is at best only a rough estimate and could be wrong. Which is why every risk underwriter follows Keynes' dictum, 'When the facts change, I change my mind'. George Soros, the celebrated investor, has been rumoured to say no to an investment decision that he may have approved only a few hours ago.

Even if Keynes and Soros may have changed their minds on receipt of new information I am willing to bet that their investment record will show many wrong decisions.

So if the risk in investment decisions itself cannot be accurately predicted imagine the dilemma a politician makes when he decides to take his nation to war.

Hence the best way sportsmen, businessmen and politicians overcome the uncertainty of decision making is by posturing. Pretending that you are the best and everything is within your control. They hope that this will scare away the challengers and doubters and victory becomes a self fulfilling prophecy. Alas! It unfortunately does not work every time either. 

(The author is a lecturer in economics.)

What good luck to miss out on a £64m lottery win

 

If we find it hard to believe winning millions might not be so great after all, we just don't have a good enough imagination

• • Julian Baggini
  • guardian.co.uk, Thursday 6 December 2012 17.05 GMT
   

'If I fantasise about winning the lottery, it doesn’t take long before all sorts of worrisome potential consequences occur to me.' Photograph: Danny Lawson/PA

 

What would you do if you discovered that you were the owner of the lottery ticket that won £64m, but you didn't claim it in time?

It would be nice to think you were big enough simply to be pleased that you had become the country's biggest philanthropist of the year by mistake, since at 11pm on Wednesday night, the unclaimed prize was handed over to charity. But I think most of us would be haunted by thoughts of what might have been for the rest of our lives.

Perhaps, but you don't need to have just missed out on a fortune to have dreams of "maybe … ". Life is full of what-ifs, many of which could easily have been realities, had just a few things been different.

Bitter regret is the consequence of being more confident than we should be about where those alternative paths would have led us. The truth is that we will never know. What looks like good fortune can easily turn out to be an incredible stroke of bad luck and vice versa. Albert Camus got in a car going back to Paris instead of getting the train, only to be killed in a fatal road crash. Then there are the passengers who were running late the day of the London bombings of July 2005 and missed the tube or train journey that would have killed them.

If we find it hard to believe that winning millions might not be so lucky after all, we just don't have a good enough imagination. If I fantasise about winning the lottery, it doesn't take long before all sorts of worrisome potential consequences occur to me. I think about how I might spread the love, and worry that it would take away the incentive for someone to work at what might really give them satisfaction; or that they might spend the cash on things like cosmetic surgery or drugs that are no good for them in the long run. Meanwhile, of course, I trust myself to spend wisely, unaware of all the ways in which I too might screw up my life by making bad choices.

The point is not to convince ourselves that wealth brings misery, which is just an idea the rest of us cling on to make ourselves feel better. It's simply that we don't know what would happen in any given case, and so we should not mourn for an alternative future (or past), the outcome of which is mysterious.

If we really do want to turn our near-miss into a positive, then we should take it as a lesson about how fickle fate is. We often don't notice how many of the things that have gone right for us depended on chance events that could have been otherwise. If I think about my choice of university and subject, or meeting my business and life partners, things that set the course of my life, it is frightening how easily none of them could have happened at all.

My greatest consolation would come from an article I researched several years ago, in which I chased up seven members of two rock bands that had very nearly, but not quite, made the big time. For one, it probably came down to no more than a technical hiccup, meaning Simon Bates never played their single on the then biggest radio show in the country. All accepted that it would have been great to have broken through, although one was convinced it would have killed him, so seduced was he by the rock'n'roll life. But all had made their peace with their near misses and could see now that what really mattered was continuing to do what they loved. I thought I had written a great piece, but it never got used. Another "nearly" moment.

We can't control whether we are rewarded for our endeavours, with cash or recognition. It is not up to us how much cash or time we get on Earth, but it is down to us how we spend it.