The Failure of Risk Management: Why It's Broken and How to Fix It

Cover......Page 1
Title Page......Page 5
Copyright......Page 6
Contents......Page 9
About the Author......Page 13
Preface......Page 15
Acknowledgments......Page 19
Part One An Introduction to the Crisis......Page 21
 Chapter 1 Healthy Skepticism for Risk Management......Page 23
  A “Common Mode Failure”......Page 25
  Key Definitions: Risk Management and Some Related Terms......Page 28
  What Failure Means......Page 34
  Scope and Objectives of This Book......Page 37
  A Short and Entirely‐Too‐Superficial History of Risk......Page 41
  Current State of Risk Management in the Organization......Page 45
  Current Risks and How They Are Assessed......Page 46
 Chapter 3 How Do We Know What Works?......Page 55
  Anecdote: The Risk of Outsourcing Drug Manufacturing......Page 56
  Why It\'s Hard to Know What Works......Page 60
  An Assessment of Self‐Assessments......Page 64
  Potential Objective Evaluations of Risk Management......Page 68
  What We May Find......Page 77
 Chapter 4 Getting Started: A Simple Straw Man Quantitative Model......Page 81
  A Simple One‐for‐One Substitution......Page 83
  The Expert as the Instrument......Page 84
  A Quick Overview of “Uncertainty Math”......Page 87
  Establishing Risk Tolerance......Page 92
  Supporting the Decision: A Return on Mitigation......Page 93
  Making the Straw Man Better......Page 95
Part Two Why It\'s Broken......Page 99
 Chapter 5 The “Four Horsemen” of Risk Management: Some (Mostly) Sincere Attempts to Prevent an Apocalypse......Page 101
  Actuaries......Page 103
  War Quants: How World War II Changed Risk Analysis Forever......Page 106
  Economists......Page 110
  Management Consulting: How a Power Tie and a Good Pitch Changed Risk Management......Page 116
  Comparing the Horsemen......Page 123
  Major Risk Management Problems to Be Addressed......Page 125
 Chapter 6 An Ivory Tower of Babel: Fixing the Confusion about Risk......Page 129
  The Frank Knight Definition......Page 131
  Knight\'s Influence in Finance and Project Management......Page 134
  A Construction Engineering Definition......Page 138
  Risk as Expected Loss......Page 139
  Defining Risk Tolerance......Page 141
  Defining Probability......Page 148
  Enriching the Lexicon......Page 151
 Chapter 7 The Limits of Expert Knowledge: Why We Don\'t Know What We Think We Know about Uncertainty......Page 155
  The Right Stuff: How a Group of Psychologists Might Save Risk Analysis......Page 157
  Mental Math: Why We Shouldn\'t Trust the Numbers in Our Heads......Page 159
  “Catastrophic” Overconfidence......Page 162
  The Mind of “Aces”: Possible Causes and Consequences of Overconfidence......Page 170
  Inconsistencies and Artifacts: What Shouldn\'t Matter Does......Page 175
  Answers to Calibration Tests......Page 180
 Chapter 8 Worse Than Useless: The Most Popular Risk Assessment Method and Why It Doesn\'t Work......Page 183
  A Few Examples of Scores and Matrices......Page 184
  Does That Come in “Medium”?: Why Ambiguity Does Not Offset Uncertainty......Page 190
  Unintended Effects of Scales: What You Don\'t Know Can Hurt You......Page 193
  Different but Similar‐Sounding Methods and Similar but Different‐Sounding Methods......Page 203
 Chapter 9 Bears, Swans and Other Obstacles to Improved Risk Management......Page 213
  Algorithm Aversion and a Key Fallacy......Page 214
  Algorithms versus Experts: Generalizing the Findings......Page 218
  A Note about Black Swans......Page 223
  Major Mathematical Misconceptions......Page 229
  We\'re Special: The Belief That Risk Analysis Might Work, but Not Here......Page 237
 Chapter 10 Where Even the Quants Go Wrong: Common and Fundamental Errors in Quantitative Models......Page 243
  A Survey of Analysts Using Monte Carlos......Page 244
  The Risk Paradox......Page 248
  Financial Models and the Shape of Disaster: Why Normal Isn\'t So Normal......Page 256
  Following Your Inner Cow: The Problem with Correlations......Page 263
  The Measurement Inversion......Page 268
  Is Monte Carlo Too Complicated?......Page 270
Part Three How to Fix It......Page 275
 Chapter 11 Starting with What Works......Page 277
  Speak the Language......Page 279
  Getting Your Probabilities Calibrated......Page 286
  Using Data for Initial Benchmarks......Page 292
  Checking the Substitution......Page 300
  Simple Risk Management......Page 305
 Chapter 12 Improving the Model......Page 313
  Empirical Inputs......Page 314
  Adding Detail to the Model......Page 325
  Advanced Methods for Improving Expert\'s Subjective Estimates......Page 332
  Other Monte Carlo Tools......Page 335
  Self‐Examinations for Modelers......Page 337
 Chapter 13 The Risk Community: Intra‐ and Extra‐organizational Issues of Risk Management......Page 343
  Getting Organized......Page 344
  Managing the Model......Page 347
  Incentives for a Calibrated Culture......Page 351
  Extraorganizational Issues: Solutions beyond Your Office Building......Page 357
  Practical Observations from Trustmark......Page 359
  Final Thoughts on Quantitative Models and Better Decisions......Page 361
Additional Calibration Tests and Answers......Page 365
Index......Page 377
EULA......Page 387