Monday, April 20, 2009

Re-thinking Risk Management: Why the Mindset Matters More Than the Model

From Knowledge@Wharton:

Forecasting used to be straightforward. Over the years, by the end of the first quarter, managers usually had a fairly reliable sense of how the business was shaping up and whether targets would be met, missed or exceeded. Confidence in quarterly and annual predictions was so high that coming in above or below by even the smallest amount was considered a surprise and set off moves in stock prices. This year, however, things have changed. Companies like Unilever, Union Pacific and Visteon are declining to make any predictions at all for their performance over the months ahead. In other words, all bets are off.

According to company reports, the problem is not that these firms are reluctant to provide a gloomy outlook. Instead, the companies say they just don't know which way the markets will go; it seems the global economy is so shaky that executives have little confidence in their projections. This means that more and more managers are growing unwilling, at least temporarily, to make judgments about the future and then to act on those beliefs. The danger is that these businesses will become paralyzed -- and by extension, the global economy as well.

The fundamental issue, of course, is understanding and managing risk. Any time a merger is considered, a new product concept funded or an investment made, success is never guaranteed. Over the years, business has become increasingly sophisticated in developing tools that can help in this analysis, especially in financial matters. Complex mathematical models were created to analyze potential outcomes and probabilities, based on past performance. Yet, as has been widely reported in the media, many of these same models failed spectacularly to predict or prepare companies for the current global economic crisis, and major efforts are underway on Wall Street to fix these systems....MORE

The problem with models?:

"The map is not the territory"...

-Alfred Korzybski

Some of our prior posts on models:

Obama: Swedish Model Would Be Impossible Here

The Financial Modelers' Manifesto

After the Crash: How Software Models Doomed the Markets

How Models Caused the Credit Crisis
Quants Lose that Old Black (Box) Magic
Finance: "Blame the models"
Climate Models Overheat Antarctica, New Study Finds
Climate modeling to require new breed of supercomputer
Computer Models: Climate scientists call for their own 'Manhattan Project'
Computer Models: " Misuse of Models" and "No model for policymaking"
Climate prediction: No model for success
Climate Models and Modeling
Based on Our Proprietary "What's on T.V." Timing Model...
How many Nobel Laureates Does it Take to Make Change...And: End of the Universe Puts
The New Math (Quant Funds)
Modeling*: The Map is Not the Territory
Inside Wall Street's Black Hole