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30 September 2006

The trouble with risk management models



The purpose of the present blog entry is to
beg the question of whether the concept of
risk management has any ethical business
existing. In a subsequent entry I hope
either to have concluded that it does, or
alternatively, to play Devil's Advocate,
using the putative legitimacy of
risk management
as a justification for setting up certain
other metaphorical (or perhaps institutional) straw men
and proceeding to knock them down instead.



First, let's seek a working definition
of 'risk management.' First, I hope readers
(if any) will understand that at this
particular moment I'm at home, not at the library,
so I'm working more from memory than from
reference books, let alone jacking in.



'Risk' (in the 'management' sense) appears
to my untrained readings in finance to be
simply a fancy way of saying 'uncertainty.'
'Risk management' seems to be a catch-all term
for a number of mysterious arts. The purpose
of this attempt at an essay is to explore
the question of whether the divers arts of
risk management include any 'dark' arts.



Here are some apparent schools of risk
management I have heard rumors about:



orthodox upsidism
is built around the assumption that
someone who has 'insured' against
all 'downside risks' has achieved,
if not a 'risk free' life,
a 'risk free' portfolio.



orthodox efficientism
rejects upsidism, holding that
some risks are 'non-diversifiable,'
somehow implying that 'risk' has a greatest
lower bound. Efficientism seeks
to use certain tools of applied
mathematics (called 'hulls')
to systematically hunt
down this lower bound
(or 'frontier' as they call it)
as if it were
an asymptote. This activity is
referred to as the pursuit of
efficiency.



intolerance of moral hazard,
as might be guessed, is where the
student of risk management finds
that Hobbesianism rears its ugly head.
Essentially, the inherently corrupt
nature of human nature is the only
real barrier to the effortless superefficiency
(as defined above) inherent in simply
'letting do,' specifically letting the so-called
'invisible hand' do whatever it wants,
and (importantly) always on its terms.

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