Risks

As part of a project at work, we had a discussion about risks quite a while back. Risks are inherently interesting as intuitively everyone is continuously evaluating their probabilities and impacts, whether or not they recognize it. Do I cross the street now? Do I quit my job? Do I enter this relationship?

Risks are also interesting in the way that the ones that you can sort of attempt to foresee and prepare for are seldom the ones that are really the ones to look out for. Nassim Taleb wrote a very fascinating book on the improbable and he brings up a case of casinos. Casinos are in a sense the pinnacle of probability-related studies; everything is calculated and risks analyzed. The house always wins. And recently they've been very heavily investing on technology to catch cheaters. And they're very good at it. But according to Taleb, the top four individual losses that were accumulated by an unnamed casino were not because of cheaters or amazing streaks of luck, but in fact they were caused by the very improbable; risks that nobody had even thought about. These incidents ranged from a disgruntled builder threating to blow up the building to an employee forgetting to file some forms to the tax authorities to the head of the casino dipping into the casino's funds to pay the ransom to release his daughter, and so on.

Similarily Taleb suggests that instead of spending too much effort on catching cheaters in your life, you should focus on minimizing the downside and subjecting yourself to risky situations that have unlimited upsides. Rich people become rich by inheriting their riches or if they don't, then by being lucky. If rich people became rich by being talented and intelligent, then the world is very broken, since I know very many very intelligent people who are not rich.

What about implications to relationships? Well, if one understands risk to be the combination of probabilities of events and the impacts of the same events, then one should, again, focus on managing the downside by minimizing exposure to risks with negative outcomes. Minimize probabilities and impacts. But herein lies another interesting conflict. Relationships are based on trust. I trust that you will not harm me. But if you effectively manage risks and downsides, what might in fact happen is that trust will not grow. If I tell you that I trust you, but am all the time covering my rear and making sure that exits are close by, would you really believe me? And therein lies the pickle.

But in fact, as contradicting as it is, I guess it's just a question of decision making. On one hand by minimizing the downside you also restrict the upside. But by aiming for infinite bliss and happiness and the unrestricted upside, you also, by definition, subject yourself to an ever increasing amount of negative risks as well. The question is where one decides to draw the line. If the meteor hits and the negative risks materialize, will it kill you? Or send you back into the stone age emotionally, physically, mentally, financially, and so on?

So... T-bills, stock, or derivatives?