The driving force called risk
Peter Bernstein takes us through an intriguing journey about risk, through
his book, Against the Gods: The Remarkable Story of Risk. He uses anecdotes
from the past to hint that risk is the driving force behind modern thought and
action. The introduction points out the importance of risk analysis, especially
quantitative, to the development of modern civilisation. This explains the emphasis
on milestones in the evolution of mathematics.
Bernstein begins with the proposition that modern thinking began when man abandoned
the belief that events are due to the whims of gods and embraced the notion
that we are active, independent agents who can manage risks. In ancient Greece,
the logic a mans destiny sways with the whims of gods, prevailed
over experimentation, and the use of letters for numbers inhibited mans
ability to calculate.
But by the 13th century, new mental tools were in place:
the Hindu-Arabic numbering system, algebra, accounting, and other necessary
equipment for the first insights into the laws of chance.
Bernstein begins with the proposition
that modern thinking began when man abandoned the belief that events are
due to the whims of gods and embraced the notion that we are active,
independent agents who can manage risks
Bernstein introduces Pascal, Graunt, Halley, Statuaria studies,
and Lloyds of London, which are the first steps towards economics, a subjective
look at the concept of utility, the law of large numbers (increased confidence
in analysis with increased instances), Gauss (and although the point is obvious,
Gaussian distribution, we never quite get there), and Galton and normal distribution.
Hes at his best while talking about promotional realms, looking at the
short- and long-term activities of stock markets, taking a brief detour of the
Victorian studies of economics, statistics and reliability, comparing Knight
and Keynes, and game theory as applied to chance, stock portfolios, psychological
factors in risk choice, the irrationality of investors, and derivative financial
||Against The Gods: The Remarkable Story of Risk
||Peter L Bernstein
||John Wiley & Sons, Inc.
Among the human tendencies documented by Kahneman and Tversky
are extrapolation from small and unreliable samples, giving greater weight to
catastrophic outcomes than their low probabilities warrant (the Three Mile Island
effect), loss aversion, and mental accounting. Loss aversion refers to our tendency,
when faced with an option between a certain loss and an uncertain gamble, to
gamble unless the odds are strongly against us; embezzlers will recognise this,
as will many investors who avoid selling at a loss in the hope that continuing
the gamble will extricate them. Mental accounting refers to the tendency to
sort decisions into compartments rather than consider the overall position.
Bernstein gives an example of mental accounting, in which, he remarks that the
practice of buying dividend-paying stocks so that one can avoid dipping
into capital selling stockto pay for lifes necessities.
The Pascal-Fermat contribution to probability theory, which helps us to analyse
risk, was mixed with insights into the role risk plays in our choices arising
from the work of Daniel Bernoulli, a Swiss mathematician, whose father and uncles
were confirmed 18th-century geniuses. The foundation for modern decision theory
was laid. From that foundation, Bernstein sets off on a whirlwind tour of the
development of modern decision theory.
Bernoulli had put forth his revolutionary idea that the utility (satisfaction)
resulting from any small increase in wealth will be inversely proportionate
to the quantity of goods previously possessed. Bernstein believes that
in the final analysis gut rules the measurement.
Through this book, Bernstein has tried to imply the importance of risk and the
urge to implement it as an essential element in the fields of economics, management