Peter Bernstein – The Expert on Risk – Video from McKinsey

McKinsey Quarterly: Peter L. Bernstein on Risk Video

Download 2009-2-23 McKinsey Qtrly The Heart of Risk

What is risk management all about anyway? We use the words as though everybody understands what we are talking about. But life is not that simple.

Risk means more things can happen than will happen—which is a fancy way of saying we do not know what is going to happen. If we do not know what is going to happen, some surprises will be damaging, but others will make us wealthier than we had anticipated. For anyone wrestling with the task of managing risk, it’s important to understand both the potential losses and the potential gains. As we’ll see, if more risk managers had thoroughly assessed the former, the current financial crisis might never have come to pass.

In today’s world, mathematical analysis has become the fashionable method for managing risks. This has been most obvious on Wall Street, where the so-called Quants, many of them with PhDs in math or theoretical physics, used their arcane modeling skills to conjure profitable trading models and new products. Non-Quants were often afraid of these new techniques, but liked the profits they produced and shied away from debating whether or not they were reliable.

In fact, math can only take us part way toward managing risk. What it cannot manage is what is at the heart of risk: the unknown. With a mathematical approach alone, the risk manager risks never correctly defining the problem and never asking the right questions. Let me say the same thing from another perspective: risk management really means attempting to optimize outcomes under conditions in which the full range of outcomes might be unknown. Numbers will be a frail reed in such an environment.

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