QUADRANT 2

Risk Models CAN Work – Simple Payoffs with Fat Tails

We remain in a benign, simple world, yet predicting potential risks is difficult as they tend to happen at random and with severe impact. Statisticians refer to such events as fat tails.

The risks are often easy to identify, yet forecasting the timing, magnitude or impact is difficult.

The payoff is Simple, yet the distribution of events is Fat-tailed.

• Coconuts regularly fall from trees, yet drastic consequences only occur if and when someone gets hit on the head. The result could be fatal.
• Tsunamis are well understood, yet they strike when we least expect them (simply because we don’t expect them). They destroy lives, property and industries (Japanese nuclear)

• Rules-based avoidance; don’t sit under coconut trees and don’t live near coastlines.
• Rules-based mitigation; wear a helmet if you must sit under the coconut tree and build your costal residence on a hill.
• Don’t temp fate. Fate always wins.
• Listen to the elders.